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Improving Japanese corporate governance

In the second of two articles, we suggest some specific ways to improve Japanese corporate governance practices.

In part one we identified some of the key challenges for Japanese companies, such as cross-shareholdings, limited disclosure around remuneration, and board composition.

Governance systems differ from one country to another and it is difficult to say which is the best. Some believe that Japanese companies have achieved their success through operating in a uniquely Japanese way, and have a resistance to accepting Western views. However, as the Japanese domestic market is shrinking due to the ageing and declining population, Japanese companies are expanding overseas, while the financial markets continue to seek inward investment. This means that Japanese companies will need to adjust.

1) Board composition

Boards need to recognise that their role is one of monitoring management, and should aim to increase their independence. At the same time, diversity in many forms is essential for more effective decision-making. Board effectiveness would improve with the appointment of more women and the addition of experience from other industries and overseas. Many companies say they find it difficult to appoint female directors due to a limited talent pool, but this may be impacted by the implicit age restrictions that some companies apply to candidates. Discarding this age-based limitation and considering younger, talented people would expand the pool of female candidates and add age diversity to the board.

2) Cross-shareholdings

We urge companies to fundamentally rethink the purpose of their strategic and cross-shareholdings and accelerate their efforts towards eliminating them, with specific timebound targets for reduction. Companies that are obliged to hold these shares should be reminded that the Corporate Governance Code clearly states that companies should not hinder the sale of cross-held shares by, for instance, implying a possible reduction of business transactions. If a company decides to continue with these strategic holdings, it should enhance the transparency around them, by providing specific reasons for holding them1 and disclosing how it exercises its voting rights. This could help ease investor concerns.

3) Remuneration

Executive remuneration should promote the company’s long-term sustainability. Companies should explain to what metrics the variable pay is linked, and the amount to be paid out, depending on the level of achievement against targets. The inclusion of long-term factors such as environmental, social and governance issues in addition to financial performance would be desirable. Paying part of the fixed as well as the variable pay in restricted shares, and therefore increasing the shareholdings held by management, would help align the interests of management with those of shareholders.

4) Engagement with investors

Lastly, it is important that independent directors, as well as top management, discuss these matters with shareholders. EOS welcomes the increasing number of opportunities to have a direct dialogue with the executive directors of Japanese companies but opportunities to meet independent directors are still limited. In the UK, for example, investors can discuss board composition with the chair of the nomination committee and executive remuneration with the chair of the remuneration committee. Such opportunities would enable more technical and effective discussions, which would benefit Japanese companies as well as investors.

  1. 1 Companies are required to give a reason for holding these. In reality, however, a vast majority of companies merely state that the holdings are beneficial for their business transactions, or something similar. We expect much more specific and meaningful explanation, including quantitative evidence to support the argument.

This EOS Insights web post is based on our Japanese language article for Brain Center, a Japanese consultancy.

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EOS Client Service and Business Development

Amy D’Eugenio,
Head of Client Service and Business Development, Hermes EOS