Predictions

Trends in Corporate Governance 〈Part II〉

Global Trends and Their Impacts on Japanese Companies

Deloitte Touche Tohmatsu (Japan Group) interviewed Mr. Dan Konigsburg, global leader in corporate governance services offered by Deloitte, during his visit to Japan. He talked about global trends in corporate governance and their impacts on Japanese companies. Here is his interview.

Corporate Governance At Home and Abroad

●You said that Japan is slightly behind in terms of corporate governance compared to other Asian countries. In addition, Japan is still in a recession, they have lost their strong capabilities of surviving in the global market. In many cases, however, Japanese management has ethics and high integrity, so I think that their corporate competitiveness will be enhanced again.

  That is, I think that they can regain their strength to compete with other companies in the global market. So what do you think of that? 

Mr. Konigsburg: First of all, that’s a big question. I also agree with you that there is great integrity among Japanese management. I believe that Japanese management has strong ethics. I think we see evidence of this through the thousands and thousands of strong Japanese companies that continue to be profitable and succeed on behalf of employees, shareholders, and society. The miracle of Japan, of post-war Japan, proves that this works almost all of the time. The reason we need corporate governance, however, is because such strong ethics do not always work. 

 Also in America, management usually has ethics and integrity. The problem is that in Japan there’s no mechanism to insist on accountability. We call this a “failsafe.” It’s a phrase that means, “when something goes wrong, what can you expect to fix it?” When something goes wrong at a Japanese company, you can only count on management to fix it. Unfortunately, there have been cases recently where management was not ethical. And what corporate governance tells you is, we need a mechanism to insist on accountability. And that mechanism in most countries is a board of directors that oversees management, that watches management, that is also a partner with management. 95% of the time they are partners with management as they think about strategy and risk and everything else. But that in a critical way, and at critical moments, the board can change its role and provide oversight. And that’s why we want corporate governance. So that there is some accountability in those perhaps very few cases where things go wrong.

 Now, it could be that Japan has developed an alternative system so that there are mechanisms that will appear when something goes wrong. And maybe, one of the theories is that, in Japan you have companies where people give their entire lives to the company. They are so committed to that company, that if something were to happen or to go wrong, they have a strong incentive to raise their hand, to say something, and to correct it. And perhaps that is what we could count on. But as a foreign investor, they will tell you, they will say, “I am more comfortable with a mechanism for accountability like a board of outside directors.”

  The fact that access to capital has been largely through banks and bank lending is a large reason why Japanese companies look different than those in the rest of the world. But that’s very similar to Germany. It’s very similar to Italy, in the past, 20 years ago. Very similar to France. These were also countries where shareholders were not visible, did not have power, did not have influence. Because companies would borrow money from banks.

  And again that’s a different type of corporate governance. Perhaps we can call this ‘bank-centered governance,’ as opposed to ‘shareholder-centered governance.’ I don’t know that one system is better or worse than another. And I don’t mean to say that Japan is behind in any way. It’s just a different system. But as you move to a system where equity capital is used for M&A, where equity is used as a means to purchase other companies,  Japanese companies will have to listen more carefully to the desires of shareholders, and probably pay more attention to classical, traditional corporate governance.

  The question you ask, in a fundamental way, is “who owns the corporation?” And in the United States, we answer that with “the shareholders own the corporation.” And I think in Japan, historically, in the past, the answer has been very close to “the employees own the company.” They are the ones who give it their energy, their time, their lives. Or perhaps, the answer was some combination of “employees” and “broader society.” And I think, in the sense that the Japanese answer to this question may be changing, that Japan too, is changing, slowly."

Wearing Two Hats

●Do you think that the banks also can regain their strength to compete with others in the global market? 

Mr. Konigsburg: I do think that banks are changing, too. And I think we’re in a position today where we’re balancing this, and the answer to the question “who owns the Japanese corporation?” is probably now more balanced between the employees, society, and also shareholders. And how you manage that, how you accept that and manage that, it will be the big question over the next few years for Japan.

  The experience of other countries could be relevant here. In Germany, for example, they have outside directors, but they also have employees serving on the board. That may be a model for Japan. Where you say, “yes we have ten people on our board: four are from management, three are outside directors that are independent, and three might be from the employees.” That looks very much like Germany. And Germany, I think it is fair to say, has been an economic success over the last generation. 

  So there is more than one model of corporate governance to consider. But I think the model that Japan chooses must come from a real discussion about who owns the company. And not just who owns it, but “in whose interest does the company run?” Do you run it in the interest of the employees? Or do you run it in the interest of shareholders? Or of society? And if it’s all three, how do you balance? What happens when they come into conflict?

  Look at France. Here you have a situation in France where you’ve had several large companies have a conflict between employees and shareholders. Because they were becoming less profitable, they did not need as many factories, so they wanted to close factories. However, the government said, “No. You are a French company, you must remain in France and support the broader society.” And I think France is a country that is debating right now this same question, about how you balance, and in whose interest companies are run. Now I think in a lot of ways, Japan is not dealing with such sharp questions. 

 

●You don't think that Japan is behind in any way. It’s just a different system. And, you also think that we will be so competitive if we are sure of our strong ethics. Am I correct?

  I think at this moment, Japanese government is now focusing on strengthening corporate governance among companies. However, my thought is that more discussion among board members needs to be made in terms of the corporate governance. I think that one of the reasons is, the law and responsibility of board members in that in Japan they have two roles: execution and oversight. That actually compromises the situation, and I think that is one of the reasons less discussion is taking place at the board meeting in terms of the corporate governance.

  What do you think? 

Mr. Konigsburg: I’m not an expert on Japanese law, and I don’t think that’s so unusual. Every private company has board members who have the two roles. I can give you the example of Deloitte. We are a private company, we are a private partnership. Our board is comprised of all internal partners(officers). So we also have two roles. When we go inside the boardroom, sometimes we’re talking about management, what should we do about our operations, and sometimes we talk about oversight. And I think you need to have directors who are smart, and are smart enough to understand about these two hats. In English we talk about wearing two hats. And you have to be able to take one hat off; take your management hat off, and then put your oversight hat on. And I think, at Deloitte, we have directors that are smart enough to do that. 

  Yes, of course, I could be at a Deloitte board meeting and we will take a break and we’ll go to the hallway and I’ll talk to my colleague and say, “what’s happening with this client engagement?” And we work together outside of the board. But in the boardroom, we put on another hat, and we think differently. I don’t make a decision about what will help my business, my personal part of the business. I have to think about what’s best for everybody, and I have to think about oversight. So I think it is possible to do both.

Differences between the Situation of Board Members in the United States and That in Japan

● I heard, in the United States, the board members consist mostly of non-executive directors, but that actually encourages more members to talk about corporate governance, compared to the situation in Japan. The number of non-executive directors is required to exceed half of the total number of directors in the United States. 

Mr. Konigsburg: Yes, that’s correct. Yes. 

 

●In Japan, the new Companies Act will require a company to assign at least one outside director. So that is a difference between the situation in the United States and Japan. 

Mr. Konigsburg: You know, when we look around the world at the experience of other countries, this is always an evolution. It is a journey. We have seen this in other countries where you start with one outside director, and people become comfortable with this. Companies need to understand and be comfortable with the idea that this is not going to be disruptive. Outside directors are intelligent, reasonable people. They are constructive. They are not going to cause problems on the board. And then over time you see that there is support for two, three, four more. They see the value of these directors. It’s not just something to be tolerated. 

  When it works well, these outside directors, in fact, contribute value. They provide this fresh perspective. They ask questions that perhaps someone from inside the company would not ask. They can challenge in a polite way. They bring in experiences from their own past, many times. Think about it, if you have an insider board only, everyone has been working at that same company, in that same industry. It’s like you’re looking at a picture, very close to the same picture. Then, it’s hard to see the bigger picture. What outside directors do, especially if they can come from another industry, is to bring ideas, bring thoughts to the table that add and contribute value. 

  Deloitte, for example, I explained earlier that most Deloitte member firms have only internal partners on their boards. That’s not true everywhere. In London, we very recently added three independent outside directors to the Deloitte board. This did not represent a majority. And I will be very honest and say, our London partners were skeptical. They weren’t sure that this would work. But if you talk to them today, they’ll tell you that this was an enormous positive change. It added a lot of value to board discussions.

Japanese Government and Outside Directors in Big Companies

●As I said, the Japanese government will introduce the requirement that in a big company, they need to elect at least one outside director. Do you recommend the Japanese government should require big companies to keep outside directors exceeding half of the total number of directors? 

Mr. Konigsburg: I would encourage… I think that there’s value in looking at how outside directors can contribute to boards in Japan. 

 

●I think that now the government requires companies at least to elect one. But from the speed of governance, speed-wise, it looks a bit slow for the investors, in terms of the enhancement of the corporate governance.

  How do you see the Japanese government; are they still reluctant to change Japanese companies?

Mr. Konigsburg: I think that any change is difficult in any country. Japan is not different in that sense. Change is very difficult when you have a system that works and that you’re used to for a long time. I respect the Japanese government for promoting some change in a system that is a conservative system. And I think it will take time. It may take more than a few years. And I think that might be okay, frankly. Better to go slowly and have the best result than to go fast and have all kinds of disruption, you know? So I’m not someone who can say what the precise policy prescription should be. But it does seem to me that this is certainly moving in the right direction. "

Best Practices in Outside Directors

●At Japanese companies, we don’t have enough best practices in the outside directors, and we have just a limited number of people suitable for this kind of position.

  If the program is required to rapidly increase the outside directors, we have to kind of educate, grow our society to keep this kind of talent here. 

Mr. Konigsburg: That’s a very good opinion. Does Japan have enough qualified directors? I might argue that in fact you do. If you consider that directors can be existing CEOs, or CFOs, or top management of other companies, you have thousands and thousands of people who are top management, who can go to another industry and provide a fresh perspective. Someone from the automotive industry top management sitting on the board of a food manufacturer. That’s not a conflict of interest. In fact, in many countries, the companies want their management to serve on other boards. Why do they want them to do this?  Because they feel like it gives them a new perspective, and they can bring things back to their company. They see this as a way to develop their people. 

  I also think that, we talked earlier about women. I think Japan has some very smart and talented women. If you think in that direction, you may have more directors than you think. And then also foreign directors. This is a country that, in some ways, has been very welcoming to foreign leadership. You know, the situation in Nissan is of course a great example, but I think that you have more resources than you imagine you have.

  The second point is that you have an organization called the Japan Association of Corporate Directors. It’s an  association of people who serve on boards, and it brings them together, it provides training. You know. It provides a place to come together and discuss. And that could be something that also helps. Maybe Japan needs something in addition to promote more directors. 

 

●So the matter is not because there are few people who can be the outside directors. I think that it is matter of liquidity of human resources. We people in Japan are capitalizing organization. So they join a company, a famous company, after they graduate from university. So they normally work until they retire.

  There are also a lot of types of managers in the Japanese economy. However, it is difficult for the company to find a good candidate for an independent director. Because, as I mentioned right now, for those people there is no chance to play an independent director’s role. 

Mr. Konigsburg: That’s what I’m suggesting. I can work as an executive at a Japanese company, and at the same time give some of my time to be an outside director at another company. This is very common, very typical in other countries. So for example, if I’m an executive at a Japanese company, and a member of top management, but the company has to allow me to spend a day every month on the board of another company. And as I said before, a lot of companies around the world recommend being an outside director at another company. They encourage their people to do this. Because they think it is good experience, it broadens their perspective, it gives them exposure to other industries, other ways of thinking."

 

●However, if they contribute some hours for other companies, they can contribute fewer hours for their own company. 

Mr. Konigsburg: Yes, that’s technically true. But, number one, it’s not very many hours. It’s maybe one day a month. Maybe a little bit more than that. Maybe it’s 10% of your time. But number two, you’re bringing back value to your own company, because you’re being exposed to new ideas, it makes you more effective, you may build relationships with people. I would not see it just as a negative thing where you take away hours. If that’s the case, then I agree, you have very few directors. But this is an opportunity to see things slightly differently. 

  But, in addition to that, you mentioned retired directors, and of course, as Japan is famously an aging society, you have people who are forced to retire because of age, but their mind is perfect and they’re very smart. People could serve as directors into their 70s and into their 80s. This could in fact be one of the solutions to some of the problems. For example, placing some of these retired people in their 70s or 80s as part-time directors. Remember, this is part time, this is not 40, 50, 60 hours a week. In some ways it is a perfect thing for a retired person, because you do it for a couple hours a day, or one day a week, or two days a week, and then you go back to playing golf or whatever you like to do. In America, many, many directors are retired.

Ages of Management

●Yeah, currently the Japanese company does not promote, does not allow the management to become other companies’ outside directors. So if the company management changes their way of thinking and allows their management people to go to other companies to make good practices for this… 

Mr. Konigsburg: Yes. That will require a change in mentality. 

 

●You are suggesting that Japanese management needs to change their minds to allow their board members to be independent directors for other companies. But in Japan, management has two roles: execution and oversight, so there is an issue that they’re too busy. And also they are senior people, so there is another issue, you know, about their physical strength or energy.

  However, the management in a foreign country, in Western countries, they are somewhat younger, I think. Is this a traditional situation or what changed the situation? Could you tell us how can we have young management? 

Mr. Konigsburg: To tell the truth, I don’t think that the management in other countries is younger than the management in Japan. I think we have some young management, of course, Facebook, Twitter. In fact, when I give presentations, I show a very funny slide, a funny picture. And I show “this is the board of directors from the past, from the 1950s” and it’s a group of old men sitting around a table. And then I say, “this is today’s board of directors,” and it’s the board of directors of Twitter. And it doesn’t look like a board of directors, it looks like a rock ‘n’ roll band, because they’re all 20 or 22 or something. 

  Look, I think that is true for Silicon Valley, for technology companies. But you know, I don’t think that our boards are that much younger than yours. If you look at any large industrial company board. Deloitte does research on United States’ average age of directors. It’s very unusual, outside of technology firms, for there to be anyone in their 40s of 50s on boards.. The vast majority of American directors are between the ages of 60 and 72. That tends to be when people serve on boards. 

  I work with a lot of people who want to be board members, and I tell them, you’re too young. You’ll never be on a board if you’re 40 unless you have some very unusual experience. Or unless, again, we’re talking about Silicon Valley.

  Perhaps one difference, the big difference, the obvious difference, is that in the United States we do not always promote CEOs from within. We’ll hire an external CEO, right? And that almost never happens here. And I think that must explain most of the difference. If you are promoting from within, your CEO will probably be older. If you’re hiring external people, possibly, you will have younger CEOs. But I would challenge you, in the sense that I think it’s not always true. I think it will be interesting to compare the average age of CEOs in particular industries. And I think if it were an industry by industry match, you might see more similarities. You know?"

Behavior Expected from Japanese Outside Directors

●In response to the new Companies Act coming into effect next year, we will be seeing a lot of outside directors in Japan. The law just says “elect one outside director.” So there is no role or responsibility listed in the law. How do you expect outside directors in Japan to behave as an expert in corporate governance? 

Mr. Konigsburg: To be honest it’s interesting, because again in other countries, it’s the same. There’s no separate or different responsibility if you’re an outside director. You are outside, but your responsibility is the same as the inside, executive directors. Under law, the duty is the same. 

 

●It is the same in Japan. 

Mr. Konigsburg: So I expect them to behave like other good Japanese directors that happen to be in management. Of course, you expect them to bring their experiences to the table. You expect them to have a fresh view. But they should be participating in the same way. I don’t see too much difference, really, under law. You don’t have any more responsibility or less because you’re an outside director. 

 

●I’m thinking that outside directors should talk much more about the corporate governance just compared to inside directors. 

Mr. Konigsburg: I don’t think so. I mean, they could, if they have that expertise, but I don’t think they have to.

Tasks in OECD

●Please talk about your task as another leader of a task force using OECD. 

Mr. Konigsburg: I serve as chairman of the OECD business advisory task force on corporate governance. That means we provide the opinions of business in OECD deliberation and decision making. This year the OECD is updating its principles of corporate governance. We bring together the views of investors, of corporations, of business groups like the Keidanren in Japan, but other countries too. And we provide opinions about how the principles should change. And it’s very exciting because the OECD has a lot of influence.

  The OECD principles form the foundation of most of the corporate governance codes around the world, including, I suspect, what will be Japan’s corporate governance code.

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