RSR Partners: Let The Outsiders In: Reforming Japanese Corporate Boards

Japanese companies are rushing to fill board seats with outside directors, following the enactment of new corporate governance reforms by Prime Minister Shinzo Abe’s administration in June. As part of the LDP’s ambitious economic stimulus plan, popularly known as “Abenomics,” a Corporate Governance Code has been promulgated for the first time in history. The Code urges all publicly traded companies to appoint at least two independent outside directors to their boards. Though not a legal requirement—as is the case with most governance codes—companies that fail to adhere to this principle of the Code must explain their reasons to their shareholders. Abe’s boardroom shakeup is designed to make Japanese companies more transparent and responsive to shareholders, to boost investor confidence, and to attract foreign capital.

But appointing more outsiders to boards is not a panacea that will immediately change the business culture of Japanese companies,with their famously compliant boards. Instead, companies must hire experienced, globally-minded senior executives to their boards of directors, who will open management to independent scrutiny, work for shareholders, and make themselves more competitive and profitable.

Historically, Japanese companies have been governed by insider boards composed primarily of senior members of the management team. There is little to no independent oversight. But nearly 20 years of economic stagnation—China surpassed Japan as the world’s second largest economy in 2010—and the recent series of high-profile scandals at companies such as Toshiba and Olympus have drawn attention to the country’s lax corporate governance laws. According to Sustainalytics, Japanese companies have the lowest average governance ranking of developed markets, in line with their lack of corporate oversight and gender diversity. In 2004, for example, more than 70 percent of companies listed in the first section of the Tokyo Stock Exchange (TSE) had no outside directors. Though that figure has dropped precipitously in the past decade—only a quarter of these TSE companies still had no outside directors by 2014—the culture and function of Japanese boards has yet to catch up.

External directors are essential to holding management in check and ensuring that shareholder interests are prioritized. Accordingly, most developed—and even emerging—economies have regulations ensuring a certain percentage of board members are outsiders.

Prime Minister Abe’s 2-by-2020 campaign, then, is a step in the right direction. And Japan is quickly advancing in the numbers game. Currently, 94 percent of publicly traded companies on the first section of the TSE have at least one outside director. The percentage of companies with two or more independent outside directors—the proportion suggested by Japan’s new corporate governance code— has jumped to 48.4 percent from only 21.5 in 2014.

But simply bringing in outside directors is not enough; the choice of board members is crucial. Many Japanese companies appoint so-called outsiders that are neither independent nor truly outside the fold. According to a 2013 survey by ProNed, 62 percent of external director positions in Japan were filled by the chairman and/or CEO through personal connections. That often means relatives, friends, company attorneys, celebrities, or executives from connected companies or banks. These members add little in terms of management oversight and are often more loyal to their executive connections than to shareholders—a problem the corporate governance code was designed to remedy, not exacerbate.

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