Trends in Corporate Governance 〈Part I〉
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.
- Introduction of Global Leader
- Trends in Corporate Governance
- Interest of World CEOs in Corporate Governance
- Corporate Governance Seen from Investors of the World
- Investors and Stock Markets
Introduction of Global Leader
Mr. Konigsburg: My name is Dan Konigsburg. I am managing director of corporate governance and public policy for Deloitte Touche Tohmatsu Limited (DTTL). And I’m based in New York.
I have two roles mainly. First, I lead and oversee our corporate governance work globally in 34 countries. We provide advice and consulting to clients about corporate governance. In particular, we talk with directors and build good relationships with board rooms around the world. We also provide research to the market.
My second role is that I serve as managing director for public policy. And “public policy” means how Deloitte engages with government, talks with people who make policy around the world, and promotes a Deloitte point of view: broader societal questions, like unemployment and investment, jobs, the role of women in the economy. I also have responsibility for DTTL’s relationship with the G20, with the Organization for Economic Co-operation and Development (OECD), with the Asia-Pacific Economic Cooperation (APEC), organizations like that. As part of that, I also serve as chairman of the corporate governance advisory committee at the OECD in Paris.
So those are my roles. I have a very fortunate job to travel around the world and meet people and talk to people about the board room and about corporate governance. It’s a privilege to meet people from so many parts of the world."
Trends in Corporate Governance
●And related to corporate governance, in Japan, deliberations are on going in the Diet toward amendment to the Companies Act, and Japan is going to implement a new legislation, a commercial law, starting from April 1st, 2015. In accordance with the new Companies Act, it will force many big companies to elect at least one outside director. If they cannot elect an outside director, they need to give an explanation for why they cannot elect the directors in a new disclosure report. And also, the Tokyo Stock Exchange introduced a new index, which is called the JPX index 400. The index includes other corporate governance factors.
People are saying that it eventually will change the mood of management, and also, that some of the Japanese management hasn’t yet focused on corporate governance. So the government is focusing on corporate governance in Japan, and also the management of Japanese companies are now thinking about the importance of corporate governance.
Could you tell me about the trend of corporate governance as a whole, in the world and the United Kingdom?
Mr. Konigsburg: Well that’s a big question. Maybe I could start with your two examples about the new requirement to disclose, to either appoint a director or explain why, and also about the index.
Those are both, I think, very positive innovations for Japan. But Japan is not the first country to try them. And it’s very interesting to compare the experience with these programs in other countries. So, for example, the United Kingdom was the very first country to introduce a similar system of disclosure. In 1992, the United Kingdom introduced what was called a code of corporate governance. At the time, it was called the Cadbury Code, because the chairman of the body that created the code was a person named Adrian Cadbury, who led the chocolate company. You know, Cadbury Chocolate. Anyway, that code was innovative at the time, because it set out three or four or five very specific suggestions for better corporate governance. One was about independent directors, of course. Another was about separating the role of chairman and CEO.
There were other things, but like Japan, the focus was very much on having an outside director. And like Japan, its approach was what they called “comply or explain.” You must disclose, you must either appoint that one director, meaning to comply, and if you do not, you then have to explain why you did not. And that has been very successful for the UK. It has been very successful in many other countries, like France, like Australia, like Ireland, like Canada.
Now, it has not been successful everywhere. One of the reasons it works so well in the UK is because companies very much want to comply. They want to look like they are the same as all the other companies. In the United States, where I’m from, companies are often very happy not to comply. And I think that “comply or explain” will work best in a culture where there’s a lot of pressure on companies to conform, to look like everyone else. That may mean that this is very useful for Japan, I don’t know. But the rest of the world has this experience.
The second example you gave was about the index. This has also been tried before, most notably in Brazil. This goes back nearly ten years. Brazil’s stock exchange in São Paulo is called the BOVESPA（Bolsa de Mercadorias e Futuros：BM&F BOVESPA);. They created a special listing segment of the exchange, sort of like an index, that was only available to companies that had good corporate governance. And they defined...they had a definition of what that meant. It meant that you needed some outside directors; your board must look a certain way; there was a minimum free float, a minimum number of shares listed on the stock exchange. And they had some other rules about takeover defenses, which probably aren’t very relevant to Japan. But there were a lot of rules, and if you wanted to be on that index, you had to comply. And its recognition started slowly, but then became very successful, and today this is perhaps one of the most successful stories about corporate governance in Brazil. It has worked to encourage better practices in Brazil.
Considering the background, other countries have tried to follow Brazil, most notably, I think, India, Russia. Romania, even. However, contrary to Brazil’s success, they have not always worked. Due to a variety of factors involved, no one really knows why. In Brazil at the time there was a great need to raise equity capital. Brazil did not have, I think, a lot of opportunity for debt capital. So there was a lot of pressure to go to the exchange. It may not work in countries where banks are very strong and you have other options to seek capital..
●But it is interesting. As you said, Brazil is an advanced country in terms of corporate governance, minus only Brazil is certainly developing…
Mr. Konigsburg: It is certainly developing.
●But from corporate governance perspective, it is a developed country.
Mr. Konigsburg: I think that’s true. One of the interesting things about corporate governance is that the division between the developed world and the developing world is less clear.
From an economic perspective, you have some very advanced countries that have, frankly, very poor corporate governance. We sometimes see serious problems with corporate governance in the Netherlands, or in Italy. You know, these are advanced economies. But they have struggled at times with respect to corporate governance. For example, my country, the United States, is an advanced economy, but we have scandal after scandal in our boardrooms. I don’t think there is a connection or a correlation between high standards of corporate governance and the level of advancement of an economy.
Interest of World CEOs in Corporate Governance
● I would like to ask you in terms of corporate management, what types of corporate governance issues are CEOs around the world interested in?
Mr. Konigsburg: Yes. I think there are some traditional issues, and then there are some new issues. The traditional ones are, of course, about board composition: How do you organize your board? Who should sit on your board? What is the role of the chairman at a company? That remains a question for many companies and many boards. The question of remuneration, of pay, is always a big question. How should you pay your CEO? Should it be stock options? Should it be with shares, directly? Should it be cash? And what are the incentives that each of these provide? There’s a lot of discussion about that. That’s always been a topic for debate.
Newer questions related to diversity and placing more women on boards,; the question of how you control your subsidiaries, what you might call your internal governance or subsidiary governance. If you open a subsidiary in Vietnam or in China, should you create a board of directors for that subsidiary? And should you place Japanese people on that board, or not? These are big questions people are thinking about. So that’s a new question.
I think the question of how to work with investors and shareholders is new, also. How to deal with activist shareholders（so-called ""Outspoken Shareholders"") around the world. What’s happened recently is that debt has become much cheaper. It’s very easy to raise money in the debt markets. So you have today hedge funds who will raise money through debt, and they will buy shares, and they will try and become more active, and begin to influence a company. How should you respond to that as a company? That’s a difficult question. So these are some new areas.
Corporate Governance Seen from Investors of the World
●I want to hear from you about the investor’s view. So you think you used to work for Standard and Poor’s (S&P: US-based investment information firm, which is also known as a credit-rating agency) before, and that means you also have the viewpoint of an investor. So how do you think investors in the world see corporate governance? Do you think they see it as, for example, a driver of more revenue for a company? How do you see...how do they see corporate governance?
Mr. Konigsburg: I think it depends who you are, and what kind of investor you are. First of all, at S&P (Standard and Poor’s), they were advising holders of debt, not equity, and I think that means there’s a difference in what corporate governance means to you. If you own debt, it means you have, we say, no upside. You cannot profit more than your investment; you can only get your investment back. However, there’s an unlimited downside: You can lose 100%. So the kinds of things you want as a debt holder are very different than an equity holder. So you probably think about corporate governance because you want lower risk, less risk taking. You might care more about stability of the company and its strategy. You might care much more about succession planning and making sure that there’s a stable transition from one CEO to the next CEO. And you might want multiple businesses, perhaps, to offset the effects of cyclical downturns. It might affect strategy, for example: you might prefer conglomerates (a group of companies involved in diverse business categories and operations) that have multiple businesses because they might offset each other and lead to more stable cash flow. As a creditor, as a holder of debt, you want more stable cash flow in order to repay outstanding debt.
On the other hand, completely differently, if you are an equity holder, you have an unlimited upside. However, your downside is limited, because you can only lose your original investment. So thinking about it this way, again, what investors want is very different than bondholders. If you are an equity holder, you will likely accept higher levels of risk-taking from management, because you want very high returns. You might want remuneration that is focused on stock options, because that encourages more risk taking. You might want a more focused business that has a greater chance of payoff. So there are these big differences.
Within the category of equity holders, of course, there are many types of shareholders, and corporate governance will expect many different things from them. So a hedge fund might decide that corporate governance is a tool or a mechanism for them to influence management and increase returns. However, for a pension fund like a large Japanese government pension fund, governance may mean something else. It may mean that you want very stable management over the very long term, because you’re holding your investment for retirement for people 30 years into the future. So I think even within the equity asset class there can be very different thinking and approaches to what governance means.
And then of course, well, you asked about investors, so I will tell you about the government as well. But I think when most people think about governance and what does it mean, you said earlier that there is no single good definition. I think this is a problem for corporate governance. I think corporate governance is the relationship between the board, management, shareholders and employees, all of those groups, the relationship among them, so that the company produces strong financial returns over the long run. How do you get these people to work together? How do you encourage shareholders, management, the board, employees – all of these groups – to work together so that the company is successful and produces financial returns? And by financial returns, I mean both equity returns and return to debt, debt holders, those are the two. And that those are returns not just for next month or next quarter, but for the long term, several years into the future. So you could look at each one of those and argue something different. You could say, “well, maybe the return mainly used now is not for employees, or maybe it’s more short-term, but that’s my view.”
Investors and Stock Markets
●Actually, the Japanese government tried to change the corporate governance in Japan. The background with this is, I think, the fact that the Prime Minister Abe tried to relate the Japanese stock price to one of the initiatives of Abenomics, so he tried to promote foreign investors to buy the Japanese stocks.
So because of the differences between Japanese corporate governance and corporate governance in other countries, foreign investors are anxious about the Japanese stocks, so that’s a kind of a barrier to the Japanese market.
Mr. Konigsburg: If you look at ownership of the Japanese stock market, foreign investors are already the largest players; they hold nearly 30%, I think, more or less 30% of all shares. So it’s not as if foreign shareholders are avoiding Japan. At the same time if you compare Japan with France or the United Kingdom, foreign investors in those countries are more than 50% of the market. So you might argue that, yes, the Prime Minister Abe is correct, that there could be more foreign investment. On the other hand, again, it’s very difficult for a country when foreign investors own the majority of your market. It’s more comfortable when domestic owners have control. For example, I know that in the United States, some people might be uncomfortable if foreign investors were to own the majority of our market. I suspect many people feel more comfortable when most shares are held domestically.
But I think that certainly a focus on corporate governance should increase comfort and the attractiveness of Japanese shares, and the kind of things that the Prime Minister Abe is talking about seem to be, in my view, responsible, useful changes, and also incremental changes. He’s not seeking to change everything right away. You know. The biggest change, of course, would be adding these outside directors. Japan remains an outlier in corporate governance, very different from other countries in the world. Even in Asia, Japan is remarkably different from others. Japan typically does not have, as we know, outside directors, unless you have selected the “company with committee” model. I think only 1% or 2% of companies have chosen that model, right? Other countries in Asia, such as China, Hong Kong, Malaysia, and Vietnam, they require all boards to be composed of up to 30% outside directors. If you look at Indonesia, if you look at Korea, boards are composed of between 20% and 30% independent directors. The lowest outside of Japan in Asia is the Philippines, which is at 20%. But, still, 20% is high compared to Japan.
And the reason outside directors are useful is they can provide an outside perspective. Yes, they may have less knowledge of the company, but they can provide a very fresh outside perspective, and they can, in a very constructive way, they can challenge management. They can say, “Are you sure of the decision making?” “Have you thought about this?” or “Have you thought about that?” One of the things we find around the world is that boards that do not have outside directors tend to be, not always, but they tend to be very focused on operational questions. They don’t spend a lot of time thinking about the bigger questions of strategy or taking time to talk about outside influences on the company. They tend to be very internally focused, and they tend to be focused on compliance and operations. Again, that may not be true of all companies in Japan, of course, but this is a trend that we see around the world where boards are inside only.
Relationship between Corporate Performance and Corporate Governance
●So, some people say that there is no direct correlation between corporate performance and corporate governance. What do you think of that?
Mr. Konigsburg: People have been trying to demonstrate a connection between corporate performance and corporate governance for many years. And it’s very difficult. There are some studies that show “yes, there’s a strong correlation;” there are others that do not. You can look at the Brazilian index and it can show that depending on the year, sometimes it performs much better than other indexes, with less of a focus on corporate governance.
The problem is that investors can be greedy and short-term. Investors will always invest in companies, even if they’re badly governed, because they know the returns can be very high. There are examples in some countries where everyone knows that certain companies are corrupt. But at the same time these can be profitable companies, and investors may feel “I must invest in this company.” As long as that is the case, I think we will always have difficult data when you look at this. So that’s part of the problem.
If you look at what Standard and Poor’s has said about corporate governance and its impact on credit ratings, it’s very similar. Standard and Poor’s says that good corporate governance can never be the reason to increase a rating. However, it can support a rating from going down. So it can protect value. It might not be able to add value, but it can protect value. And in my heart, I feel that that is the connection between performance and governance. Governance alone cannot give you a better strategy. It cannot create a better economy. It cannot do anything about interest rates. It cannot do anything about the price of oil. But it can protect you from making errors. It can’t give you a good strategy, but it can protect you from bad strategies. Because you’ve asked questions, you’ve challenged people on the board. So in my heart, I think that that’s the connection. You know, I also hope one day we will show a positive correlation, as well. But I think it is a complicated question, really.