In the past two years, Japan has been through two major corporate scandals: one at Tokyo Electric Co (Tepco), and one at camera and medical-instrument maker Olympus. These two events clearly displayed the problems that lay in the country’s corporate governance.
Investigating the Fukushima nuclear plant disaster caused by an earthquake and tsunami last March, Kiyoshi Kurokawa, medical doctor, Tokyo University professor emeritus and the chairman of the independent investigation commission, gave a scathing criticism of a “profoundly man-made disaster” caused by “a multitude of errors and wilful negligence”, as reported by the international press in July this year.
He blamed for the accident the well-known close relationship between political, bureaucratic and financial interests, which Japan has not been able to get rid of since the 1960s – the heyday of the country’s economic miracle.
According to a report by Naoko Shimizu in The Guardian, the Japanese-language version of the report went even further, blaming the close relationship of the regulator and the regulated for enabling the regulated to put “undue pressure on and influence” the regulator.
"We believe that the root causes were the organisational and regulatory systems that supported faulty rationales for decisions and actions, rather than issues relating to the competency of any specific individual. Across the board, the commission found ignorance and arrogance unforgivable for anyone or any organisation that deals with nuclear power. We found a disregard for global trends and a disregard for public safety."
In 2002, Tepco’s then-president Nobuya Minami had to resign over 29 falsified nuclear safety tests, but that did not ring any alarm bells.
At Olympus, it took the firm’s British chief executive – with the company for 30 years – to raise questions about US$1.7 billion worth of accounting irregularities and corporate malfeasance in the highest ranks and take the board to task, as no one raised the matter within the company in Japan. In response, he was fired and had to flee the country. The event moved local and international opinion and calls were made to strengthen corporate governance.
“The reality is that there are numerous factors which contribute to the current perception of governance practices in Japan. There is indeed the tendency for companies in Japan not to focus exclusively on creating wealth for shareholders and, particularly after the Olympus scandal, a lack of oversight is often cited as the catalyst for malpractice. This comes from a lack of legislative instruments in Japan enforcing as such, as well as the cultural practices at the leadership level of companies,” says Scott Lane, Chief Executive Officer of The Red Flag Group.
The close entwinement of different interests makes effectively changing the status quo very difficult.
The intimate relationship between regulator and regulated is due to a number of different practices. Rather than an independent board nominating the chief executive, it is usually the company chief who nominates the non-executive directors to the board – often his own cronies from within the company. Retired company members also end up on the board as non-executive directors, statutory auditors or advisors, allowing them to draw significant salaries from the company even after retirement.
At retirement, the company president will choose his own replacement, ensuring that he will have a loyal employee left in his position, while he will remain with the company as an advisor. This loyalty connecting generations of insiders was the reason why the top brass at Olympus was trying to cover up financial losses suffered as far back as 20 years ago.
Outside or independent non-executive directors are also nominated by the chief executive, and chances are they come from the same old-boy network. Retiring politicians are regularly awarded with non-executive positions and hefty salary packages at banks or large companies.
As tactical cross-shareholding between companies is common in Japan, board members that may seem independent might come from another company that is an important shareholder and in reality closely linked.
Tepco was said to have quite a few former policepersons and politicians on the board and, according to reports, former Tepco president Masataka Shimizu recently joined Fuji Oil Company as an external board member. This was possible because Tepco is the biggest shareholder in Fuji Oil’s parent company, AOC Holdings, with an 8.7 percent stake, according to a BBC report. Shimizu has not yet taken any responsibility for what happened in Fukushima.
Due to personal loyalties and safeguarding their own interests, board members are ineffective in offering checks and balances.
Boards are far too large, and would there be one or two truly outside directors on the board with independent opinions or dissenting voices, they would be quickly and easily suppressed by the large number of old-boy non-executive directors on the board.
Decreasing the number of directors on the board, however, would mean taking away future well-paid positions from people who now are regulating the company. Therefore, solutions that suggest companies should have at least some independent directors on the board as well as having an audit committee would be largely ineffective. Olympus, for example, had both; they even had a risk management unit.
“Corporate governance laws in Japan require considerable work. Laws in this area do exist, but they are incomprehensive, decentralised and often embedded in other legislation which focuses on industry standards and accounting practices. Various legislative instruments have been introduced in the past few years, but their introduction has been piecemeal and authority of their implementation been given to various bodies,” Mr Lane says.
The Financial Services Agency (FSA), which oversees the banking, securities and insurance sectors, introduced the Ordinance on Disclosure of Corporate Affairs, which addresses the disclosure of a company’s corporate governance procedures in its securities reports. This law came into effect in March 2010, and is considered to be quite comprehensive in the transparency it requires of the companies that are within the ambit of the FSA. However, for listed companies which are not monitored by the FSA, there is a clear lack of legal oversight.
In February 2012, in direct response to the Olympus scandal, the Tokyo Stock Exchange published a document entitled Revisions to Listing Rules Regarding Corporate Governance to Restore Confidence in the Securities Market. This aimed at prompting greater disclosure to shareholders regarding independent directors and auditors, creating an environment which encourages and facilitates independent director and auditor functions, and establishing systems to ensure more transparency.
“The results of a public consultation process for this initiative were published on 30 May this year. The original proposal in February had scheduled an implementation date of May 2012 for the new listing rules. It would seem the intention to overhaul corporate governance in Japan is there; however, nothing has been published since the thirtieth of May, and there is no other material which suggests that the proposals have come into force. Until this does occur, corporate governance laws in Japan will continue to be underdeveloped and more stringent government requirements are necessary for procedural improvement.”
Scott Lane is the Chief Executive Officer of The Red Flag Group