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I am not here to preach. There's an ancient Japanese proverb that I abide by: "Better an inch of practice than a foot of preaching."
I am not here to advance the American "way" and I don't carry with me vested political or corporate interests of any flavor. I am not here to advocate specific revisions to Japan's corporate governance or corporate control; nor do I wish to see a foreign framework imposed. Ideas regarding the need for particular structural changes and the implementation of such changes must come from Japan's corporate executives, appropriate ministries, and those investors with a stake in corporate performance.
Some foreign investors view Japanese corporate governance with disdain. They cite large inside boards of directors, the entrenchment of affiliated stakeholders, and thirty minute shareholders' meetings as evidence that corporate governance in Japan epitomizes Japan's exclusionary business practices and unfair trade. In the view of most Americans, the well publicized absence of a market for corporate control in Japan is an intentional barrier to foreign investment and proof positive that the playing field is not level. "Look at T. Boone Pickens," they say.
I do not agree with this view. Clearly, corporate governance has worked in Japan well enough to assure the extraordinary success of Japanese industry. During the postwar era, Japan's economic performance has far exceeded that of the United States or Britain. The long-term corporate relationships that are expressed through stable or interlocked cross-shareholdings and are based on trust -- rather than detailed written contract -- have functioned well and assured many efficiencies. If Japanese corporate governance didn't work and impaired economic growth then it would have been altered a long time ago. In any case, large industrial groups defined by enduring cross-shareholding and entrenched management are not confined to Japan. In East Asia, we need only look as far as Korea; and in Europe -- Germany bears many resemblances to Japan; corporate groupings similar to keiretsu are to be found also in Sweden and Italy.
I do believe, however, that kaisha keiei , Japan's system of corporate governance, needs "an inch of practice" -- a realignment between practice and law, between the image of Japanese corporate governance that is projected abroad to foreign investors and governance as it actually exists in practice here in Japan.
There is a need for debate and measured consideration of Japan's system of corporate governance and corporate control. Most of all, there is an urgent need to communicate the rationale and the effectiveness of Japanese corporate governance to the world outside Japan.
I have been involved in the evolution of the concept of corporate governance in the United States for a long time. During the course of the past two decades, I have developed clear ideas about the kind of change that will be suitable in America and have been working with the federal government to create a code of "responsibilities of ownership" for institutional investors. While I firmly believe that American concepts are not applicable directly to Japan, some of the underlying philosophy and goals may be of relevance and value. I think that there are a number of reasons why the time has come for a critical review of Japanese corporate governance.
First , the formal structure of Japan's corporate governance has hardly changed since the nation began its postwar recovery nearly a half century ago. Even if the current system is satisfactory, corporate governance, like all systems for control and oversight, should be evaluated on a regular, if not continuous, basis.
Second , there is some recent evidence suggesting that proper alterations in corporate governance can improve corporate results and thus competitiveness. Studies have been conducted in the United States that seem to establish positive correlations between corporate structures and governance. There is a pressing need for such studies to be undertaken in Japan. The Nomura Research Institute has taken the first step. Watanabe
and Yamamoto link steadily declining returns on capital for Japanese industry since 1981 with inadequate corporate governance. They term the on-going Japanese recession a "corporate governance recession."
Third , surely more stringent oversight would have prevented many of those scandals in recent years that have involved illegal payments by senior management to political and corporate interests or to select investors. These scandals, by undermining trust, are responsible for damage to the prestige and profitability of the firms concerned as well as to Japan's political system. Yet, although politicians in Japan have come under increasing critical examination, there has been no change in the scrutiny of corporate executives.
Fourth , American investors and trade representatives are openly perplexed by the Japanese system. They are often unable to identify the source of corporate control and find that cross-shareholding combined with the consolidated power of senior management render the corporation impenetrable. These foreign interests believe that just as politicians must be held accountable to all of their constituents, top corporate executives must also be held accountable to all of their shareholders. The question of by what mechanism such accountability can be measured and enforced raises difficult problems and is a matter that will need to be debated for many years to come.
I believe that corporate power in Japan urgently needs a new foundation for legitimacy that can be understandable to the world outside Japan. It is likely that many of Japan's trade problems, conflicts with trading partners, and negative image in the United States and the European Community could be softened if there existed a mechanism assuring executive accountability to all shareholders of the corporation.
Corporate governance is a concept that has arrived but lately in Japan. In its simplest sense, corporate governance is the process of exercising power over the modern corporation and the regulation of that power. Of course, by definition,
Japan has neither more nor less corporate governance than any other nation. Every kabushiki kaisha [joint stock corporation] has a board of directors that meets on a regular basis and oversees the firm. According to Japan's Commercial Code, the board of directors is answerable to shareholders and shareholders may vote for directors in person or by proxy at AGMs. The 1982 revisions to the Commercial Code as well as additional amendments in 1993 were specifically designed to insure increased accountability on the part of management and to encourage greater shareholder participation in corporate oversight.
I once read a Japanese folktale that claimed we can identify a ghost by looking at its feet: there aren't any. So it is with the legal frame of Japanese corporate governance. While it is true that the joint stock corporation has a board of directors and shareholder's meetings, these governance configurations are strictly pro forma and are not grounded. Thus, the formal institutions of shareholder representation in Japan are ghostly images that exist only to satisfy the legal requirements specified by the Commercial Code and to fulfil the normative expectations of the world community.
In Japan, relationships of trust take the place of many of the safeguards, conflict resolution processes, and incentives that together constitute the structure of American corporate governance. In the United States, the "letter of the law" is the solid mortar that holds together the bricks of corporate governance. Conversely, in Japan, the spirit of enduring personal relationships between managers provides a liquid base on which corporate governance floats. Although the personal trust relationship is industrial Japan's greatest strength domestically, it is its greatest weakness internationally.
American investors are puzzled by the fact that the function of the board of directors and their accountability, the locus of corporate power and its limitations, and the role of shareholders in the governance of corporations are issues that have not been debated in Japan. It is taken for granted that the kaisha 's [corporation's] board is an arm of executive management and that it is the jomu-kai [board of top executives] that effectively controls the company. The torishimariyaku-kai [board of directors], exists in little more than name only. As a result, management is
indistinguishable from control and limitations on power are not explicitly articulated. This is an open secret and Japanese business leaders are hardly disturbed by it. But American investors are very disturbed.
Although external constituencies, such as the shacho-kai [the presidents' clubs -- e.g., Mitsubishi's Kinyo-kai] and main bank relationships, do exercise some oversight, under ordinary circumstances the role of these constituencies is as invisible and elusive as the ghosts of folklore. The shacho-kai , of course, are only peripherally concerned with supervisory strategy and are not accountable to shareholders. And the main banks only intervene to address non-performance in the event of an imminent or actual financial crisis.
It is taken for granted that, excluding impending financial disaster, no sane shareholder (affiliated or unaffiliated) would ever actively seek the removal of a board member let alone the resignation of a president. Affiliated shareholders and outside investors have no de facto role in Japanese corporate governance. That is the status quo and few business leaders in Japan publicly maintain that there is any compelling reason for change.
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Many observers have remarked that recent political change in Japan is symptomatic of a greater systemic and structural change. My friend and colleague, Makihara Minoru, President of Mitsubishi Shoji, commented in a recent speech in Boston that the level of change in Japan today is comparable only to the two other critical moments in modern Japanese history: the Meiji Restoration and the postwar recovery. Yet, during the Meiji Restoration and the immediate postwar era, there existed powerful centralized governmental forces that were able to impose drastic change on often unwilling participants. In the early years of Meiji, for example, few samurai were willing to give up their swords and get haircuts. Today, the political situation is very different from these two other periods; it may well be unique in modern Japanese history.
The Japanese political system is in turmoil and is hard pressed to implement political solutions of any kind. In Japan today, as is the case throughout the industrialized world, major corporations embody at least as much power as the ministries or governmental branches that supervise them.
This being the case, it is not surprising that the political quagmire has its counterpart in the corporate system. Indirectly, there is some recognition of this. A recent revision of Japan's Commercial Code, intended to permit easier derivative lawsuits by shareholders, is serving to bring to the forefront of public attention the idea that directors must account for their actions to unaffiliated shareholders. The more than eighty suits under the new law that are now pending are at least a slight indication, if not an expression, of the growing involvement by unaffiliated Japanese investors with corporate governance.
Historically, Japan's corporate governance activism, if it can be so termed, has been largely associated with environmental issues. Beginning with the Minamata tragedy in the 1950s to the most recent nuclear activism aimed at power companies, shareholder proposals at annual general meetings and votes against management have been primarily motivated by green agendas. Whatever their merits, environmental activists have contributed to a largely negative view of outside investor involvement by corporations. These environmental activists, in combination with the unfortunate existence of sokaiya , have served to obscure the importance of the role of unaffiliated shareholders in determining the source of corporate power and corporate accountability.
I am not now concerned, nor are most informed foreign investors, about the culpability of directors regarding specific actions that have occurred in the past. I see no evidence to suggest that the present pursuit of shareholder litigation will lead to improvements in Japanese corporate governance. Instead, I believe that Japanese corporations must begin immediate preparations for transforming the organizational structure of corporate supervision for the 21st century. Those concerned about the supervision of Japan's corporations must look forward to a world in which companies will harbor more power and influence than the national governments that regulate them. This is already beginning to happen.
Recently, in part as a direct result of corporate related scandals that undermined public support of the long dominant Liberal Democratic Party, the Japanese political system has been in upheaval. Frequent recent changes of government combined with perceptions that the power of the office of the prime minister is severely constrained, have led to confused perceptions throughout the world regarding the source of political power in Japan.
Just as foreigners are confused about who represents Japan politically, they are confused about who represents the corporation. Who owns the Japanese corporation? What is the role of shareholders in oversight? Are shareholders viewed as having rights distinct from stakeholders? The Commercial Code indicates that this is the case. Yet, both in private and in public, representatives of the corporation often state otherwise, asserting that shareholders as a distinct category are less important than stakeholders (who may also be shareholders) such as employees, suppliers, distributors, creditors, and the community at large.
These questions are by no means unique to Japan. There is now an ongoing global debate about who owns the corporation in each nation and precisely to whom corporate executives are ultimately accountable for their actions. Throughout the industrial world there is confusion and disagreement regarding the source of corporate accountability.
In Japan, as in the United States, there is a pressing need to move the level of debate concerning corporate governance issues from the realm of local concern and local law to the arena of the international economy and international politics. Japan is part of an emerging world system and within this system national structures are gradually converging. As even isolated North Korea has come to appreciate, there can be no escape from the pressures and demands of the world system. Furthermore, the greater the integration with global markets, the greater the ongoing economic success of the nation.
As a result of the growing global character of corporations, the separation between corporate governance and political governance is becoming progressively more indistinct. Consequently, corporate governance has entered the domain of
the political debate. The ramifications of this union of corporate and political governance are wide ranging and significant. While on the one hand, national culture invariably influences the interaction of economic and political life; on the
other hand, each nation's form of capitalism must adapt to the global economic environment. Thus, the merging of political and corporate governance occurs simultaneously on a domestic and on a global scale. Like merging rivers, the result can be unpredictable currents and whirlpools.
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In light of the observations that I've sketched thus far, there is a need for the Japanese corporate world to find a mechanism that will enable communication with investors and political interests in North America, the European Community, and elsewhere. The belated and minor emergence of investor relations (IR) in Japan suggests to me that this leads nowhere in terms of corporate supervision and ultimate determinations of accountability to shareholders. What is needed is a totally new structure that can provide a supervisory function and a communications function, linking oversight of Japanese corporations to domestic investors as well as to the international community.
Investors need to be able to turn to a source of accountability -- a distinctive supervisory entity that takes responsibility for oversight. As Japanese household investors and foreign institutional investors have become more aware of corporate behavior, they are becoming increasingly concerned about such thorny problems as excessive investment in declining core industries, speculative uses of cash reserves, and excessive proliferation of products. These concerns, however, can not be voiced because the current system of corporate governance renders the outside shareholder mute.
Today, if senior executives of a public corporation make questionable payments to politicians, consort with yakuza , or manipulate financial statements, shareholders have no recourse other than a criminal investigation or civil litigation -
- "solutions" that are marginal at best. At their worst, criminal investigations and derivative law suits shower unfavorable publicity on the corporation, undermine investor confidence, and waste corporate resources.
The implementation of a solution to the problem of accountability and supervision in Japan can not be achieved on a case-by-by-case, company-by-company, basis. It is not sufficient for each company's executives to create an ad hoc manifesto, announcing the intention to supervise themselves responsibly. Even among the most honorable executives, there is discord and divergent perceptions regarding what is right for the firm.
Nor is it possible or desirable to impose on corporations a new legal framework requiring two-tier boards with separate non-executive units as in the German, French, or Dutch systems. Similarly, it is inappropriate to mirror recent developments in the United States and introduce a requirement or preference for a predominance of outside directors on the board. In Japan, the idea of an outsider sitting on the inside is a virtual contradiction in terms.
I believe (and would anyone here disagree?) that nothing is to be gained by revolutionizing board structure. Yet, something needs to be done. Something needs to be done because there is a problem of accountability . Something needs to be done because there is a problem of impenetrability by outside investors, especially Japanese household investors and foreign institutions.
The question remains, "What is to be done?" And by way of answer I propose the formation of a new association for Japanese business that would be dedicated exclusively to corporate governance issues and supervision. However, I firmly believe that business itself must be involved in all levels of corporate oversight. Only a stand-alone entity that understands business from the inside can understand the problems of corporate governance. In this sense, the Tokyo Stock Exchange (TSE) offers one model for the creation of an entity that would be a quasi-autonomous non-governmental organization devoted to the self-regulation of corporate governance.
The TSE is a private group with its own membership. It is an agency that understands its business from the inside and has a vested interest in the health and welfare of its industry. The TSE represents a prime case of the Japanese private sector becoming ever more engaged in the regulatory mechanism and thus becoming a key participant in it. Because the institutions that are regulated are invested in the regulatory agency, a clear understanding of the most pressing industry problems is assured. The TSE is an example of collective cooperative action for self-regulation for the common good. It is an example that, I believe, could be successfully emulated in other areas.
In Japan, as in the West, the private sector has a vital role in the regulatory mechanism. For example, the Keidanren's recently drafted [1991] code of conduct, the "Charter for Good Corporate Behavior," is an instance of the self-regulatory mechanism at work in Japan. Designed to prevent the recurrence of corporate scandals and corporate involvement with the yakuza , the charter represents a new and growing commitment on the part of the Japanese business world to a greater engagement in self-regulation. Perhaps business leaders here in Japan, like their counterparts in the United States, are beginning to find that self-discipline is more welcome than discipline imposed from above.
The "Japan Corporate Governance Association" that I am suggesting would serve to regain public trust in business, specifically in the capacity of corporations to confront directly those problems of oversight and accountability that are most disturbing to Japanese household investors and the international community. The formation of a business association concerned with corporate governance supervision could do much to enhance the image of Japan's major corporations by demonstrating the willingness of business leaders to take concrete action in recognition of the current crisis.
So, in simple terms, I propose the formation of a "Japan Corporate Governance Association" that would provide a supervisory and preliminary investigatory function and would serve to oversee the corporate boards of all listed
companies. The "Japan Corporate Governance Association" would be the appropriate place for investors to lodge complaints about perceived problems that would be inappropriate for existing legal entities to investigate.
The "Japan Corporate Governance Association" would be well placed to disseminate information about corporate structure, corporate governance in general, and the make-up of specific corporate boards to investors in Japan and throughout the world. More importantly, the "Japan Corporate Governance Association" could set the corporate governance standards for all of Japan's joint stock companies. Because the Association's membership would include all leading Japanese corporations, it would understand problems of implementation and enforcement.
Simply stated, the "Japan Corporate Governance Association" would have four basic objectives:
One , it would work to prevent conduct that would go against the interests of shareholders.
Two , it would investigate, provide guidance, and make recommendations to ensure fair corporate governance practices.
Three , it would conduct research, surveys, and publicity activities regarding corporate governance standards in Japan.
Four , it would make suggestions to, submit its views to, and maintain liaison with related government offices and other agencies.
Like other associations in Japan, the formal organization of the "Japan Corporate Governance Association" would consist of a general meeting and a board of directors. As advisory bodies to the Board of Directors, there would be a committee on general affairs as well as other standing committees. Academics and other specialists could be appointed as consultants to advise and make suggestions to the Association.
Like the Tokyo Stock Exchange, the "Japan Corporate Governance Association" would be a quasi-autonomous non-governmental organization vested with certain self-regulatory responsibilities. Its membership would consist of corporate executives, with a full-time president who would be devoted exclusively to overseeing and studying corporate governance practices and providing oversight of such practices.
The "Japan Corporate Governance Association" would consider issues of improper actions on the part of the torishimariyaku and would be empowered to recommend administrative proceedings against particular directors or firms. In the event that the Association were to discover evidence of wrongdoing, it would have a series of predetermined courses of action to follow that would include passing the investigation on to the police or the judiciary, delivering a reprimand, or requesting the removal of board members.
The creation of the proposed Association would address four serious problems:
First , it resolves the dilemma that the highest level of the firm, the board of directors, virtually coincides with the jomu-kai , so that executives are answerable only to themselves. Just as students can not be expected to grade their own exams, a board of insiders can not be expected to evaluate itself and impose negative sanctions on the basis of its own prior poor judgments. The "Japan Corporate Governance Association" would provide a system of checks and balances by adding a new layer of judgment and oversight against the abuse of power.
Second , the proposed association provides a mechanism for communication with foreign (and local) interests who otherwise have nowhere to turn for an explanation of how Japanese corporate governance really works, where accountability is to be found, and how it is to be enforced. In so doing, the association would serve to add international credibility to the way that Japan conducts business, thus improving the global image of Japan's corporations in the eyes of its trading partners.
Third , as the world economy becomes progressively more integrated, Japanese industries are coming in increasing contact with differing and conflicting national corporate governance structures. This is especially so in cases of joint ventures and cross-border acquisitions. Mutual understanding is indispensable to the success of such ventures. Indeed, it could be argued that many Japanese joint ventures and acquisitions in the United States have failed (and failed miserably) because of the mutual failure to understand underlying corporate governance structures and philosophies. In such cases, the proposed "Japan Corporate Governance Association" could function as a kind of relay switch, conveying information about governance to both sides of the transaction. In this way, the association would complement (without competing with) JETRO [the Japan External Trade Organization].
Fourth , the creation of the association would necessitate a clear formulation of the role of the torishimariyaku-kai and expectations of proper board oversight. Although such a formulation may have little perceived need in Japan today, foreign institutional investors and their governments would be very receptive. Thus, ultimately, the new association could do much to facilitate corporate access to foreign capital.
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There is growing recognition in Japan today that bureaucratic control of the economy and business structures will no longer promote economic growth. Japan's highly centralized regulatory system, which guided the postwar miracle so brilliantly, today threatens to reduce efficiency. Japan must move toward an economy of free competition based on the responsibility of each participant.
Therefore, the standards of corporate governance must be largely self-executed, rather than imposed. Especially in matters of policing the structure and conduct of the board of directors, an Association comprised of senior executives of leading corporations could act more promptly and more surely than any ministry.
By creating an autonomous, high profile, "Japan Corporate Governance Association" with membership of Japan's top corporations, much can be accomplished at the level of supervision and public relations. The Association that I am proposing could, by its mere existence, achieve far more than any ad hoc committee. The autonomy and necessarily high status of such an association would demonstrate a commitment to corporate self-regulation that would go far to regain lost public confidence in corporate investment. The "Corporate Governance Association" would help blaze a trail to a future Japanese economy that will be deregulated and decentralized.