The wealth and welfare of everyone living in Japan is based on the success of Japanese companies, how well companies are managed, and how managers are encouraged, supported and controlled.
Therefore corporate governance reforms are an important part of the “Abenomics” economic reform program. Many think that the corporate governance reforms of recent years have been the most successful part of Abenomics, and the former Chairman of the Tokyo Stock Exchange even said that these reforms happened much faster than he had thought.
Corporate governance mainly refers to the responsibilities of Board Directors who take part in the major decision making of every company, who supervise and support the executive management including the CEO/President of the company, and this make essential contributions to the success of companies.
Another aspect of corporate governance is the “stewardship code”, which refers to the influence of investors on company’s executive management.
Understanding decision making and the control of management, the way Japanese companies reach decisions and how this decision making is supervised, is essential knowledge for everyone who works to persuade Japanese corporations to take desired decisions, e.g. to achieve sales, partnerships, investments, or even Mergers and Acquisitions (M&A), who invests in Japanese corporations. Employees should also understand how the companies they work for are run.
This talk will explain the major components and fundamentals of corporate governance and its reforms in Japan based on several years of practical hands-on experience on the Board of Directors and on the Supervisory & Audit Committee of a stock market listed Japanese corporation.
Speaker: Gerhard Fasol
Gerhard Fasol graduated with a PhD in Physics from Cambridge University and Trinity College. He worked as research scientist at the Max-Planck-Institute Stuttgart on semiconductor and solid state physics research. He was tenured Faculty in Physics at the Cavendish Laboratory of the University of Cambridge, and he was Research Fellow, then Teaching Fellow and Director of Studies in Natural Sciences at Trinity College Cambridge. He was Manager of the Hitachi Research Laboratory in Cambridge, Associate Professor in Electrical Engineering at Tokyo University, and is founder of the advisory firm Eurotechnology Japan. He is Board Director of GMO Cloud KK, and since April 2017 he is Visiting Professor at the University of Kyushu.
Copyright (c) 2017 by Eurotechnology Japan. All Rights Reserved.
Toshiba’s market cap today is YEN 1024 billion = US$ 9.6 billion.
Toshiba is expected today to announce write-off provisions on the order of US$ 6 billion.
Toshiba owes about US$ 5 billion to main banks as follows:
Mizuho YEN 183.4 billion
SMBC YEN 176.8 billion
Sumitomo Mitsui Trust Holdings YEN 131.0 billion
BTMU YEN 111.2 billion
Total YEN 602.4 billion = US$ 5.3 billion
Toshiba is on notice for delisting by the Tokyo and Nagoya Stock Exchanges, and faces the risk of being delisted by March 15, 2017, i.e. in about 4 weeks from now.
Toshiba is trying to raise capital e.g. by seeking investment in the IC/flash memory division, however, Toshiba seeks to keep control, so Toshiba is trying to raise a minority share, or non-voting shares or similar, in order not to lose control.
How did Toshiba get into a situation to potentially need to write off US$ 6 billion?
Toshiba acquired 87% of the US nuclear equipment manufacturer Westinghouse.
In 2015 Toshiba acquired the construction company SHAW’s assets from the Chicago Bridge & Iron Company CB&I for US$ 229 million plus assumed liabilities. CB&I had acquired SHAW for US$ 3.3 billion in July 2012, and SHAW has on the order of US$ 2 billion annual sales.
Why did Toshiba acquire a company for US$229 million, which has US$ 2 billion annual sales, and which was in 2012 acquired for US$ 3.3 billion? Which factors reduced the value of this company from US$ 3.3 billion to US$ 229 million within the 3 years from 2012 to 2015?
Presumably because there are large liabilities arising from nuclear construction, which Toshiba now seems to have to assume.
What is likely to happen now with Toshiba? Is Toshiba too big to fail?
Difficult to say what will happen. Toshiba is a huge corporate group with about 200,000 employees and many factories in many countries, so clearly Toshiba is not going to disappear without trace.
The immediate risk is that Tokyo Stock Exchange carries out its warning, and delists Toshiba, which will further increase Toshiba’s ability to raise capital. In the case of a delisting, private equity, and/or government might invest and restructure, and Toshiba might be split up. For example, Toshiba’s nuclear Westinghouse division is totally separate from its very successful flash memory division, there is not much business logic in having both under one holding company.
Impact on UK
Toshiba acquired 60% of UK based NuGeneration with the view to build nuclear power stations in the UK. This project requires Toshiba to contribute to the funding of the nuclear project, for which Toshiba would probably need a financially healthy partner.
What is the big picture? How did Toshiba get into this crisis?
Toshiba’s crisis has been building up for 20 years, and is in my view a consequence of corporate governance issues over a long time.
Essentially, Toshiba should have been reformed 20 years ago from the top down.
Japan’s 8 electronics giants have had essentially no growth and no profits for 20 years. This tragedy has been obvious for many years now, and was a big contributing factor for Japan’s government to reform Japan’s corporate governance laws and regulations, see:
Toshiba’s Board of Directors was exchanged in September 2015, and now includes several very capable and experienced Japanese independent Board Directors, but unlike Hitachi, even today neither Toshiba’s Board of Directors, nor Toshiba’s Executive Board include one single foreigner.
One might think that a huge global group like Toshiba with complex businesses around the globe might benefit from a variety of view points and experiences from different countries at Supervisory Board and Executive Board level – not all just from one single country. Japanese corporations including Hitachi, SoftBank, Nissan and a small number of others are now recognizing the benefits of diversity of experience and viewpoints at Supervisory Board and Executive Board level.
We can only hope that Toshiba’s executives and Board Directors have the experience and ability to solve the extremely complex issues deep inside the bowels of the US nuclear construction industry – far away on the other side of the world.
Japan electronics industries – mono zukuri. Preview this report:
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Abstract: Changing the way Japanese corporations are managed
The Executive Management Board and the Supervisory Board are normally independent and composed of different people – except in Japan. In Japan traditionally Executive Management Board and the Supervisory Board are one and the same, ie the Executives of traditional Japanese companies supervise themselves – no surprise that the CEO seldom fires himself!
It is obvious that such self-supervision has big disadvantages, and may be one of the major reasons for Japan’s weak economic growth, and several recent corporate scandals. Companies in basically all other countries are managed by an Executive Management Board, which is supervised by a Supervisory Board, which approves or vetoes all major decisions of the company, and evaluates the performance of the Executive Manager, including the Chief Executive/CEO, and if necessary fires executives including the CEO, and selects and approves the new CEO.
To remedy this problem with the governance of Japanese corporations, Japan’s Government, the Tokyo Stock Exchange, and the Financial Services Agency have been changing the rules to improve the supervision of Japanese companies.
Dr. Gerhard Fasol is one of a microscopic number of foreigners who is an independent Director on the Management and Supervisory Board, and also a Member of the Audit Board of a stock market listed Japanese corporation, and he will talk from several years of first-hand experience of how Japanese companies are supervised, which changes are on the way, and which further improvements are necessary to improve the management and supervision of Japanese corporations.
Date: Thursday October 6th, 2016, 18:30
Place: Alfred Nobel Auditorium, Embassy of Sweden, 10-3-400 Roppongi 1-chome, Minato-ku, Tokyo 106-0032
Governments best help economic growth by reducing friction, and by getting out of the way of entrepreneurs building, turning-round, and refocusing companies.
Some required action is counter to intuition: for example, in many cases reducing tax rates increases Government’s tax income, a fact known for many years. Effective education and research are key to create, understand and apply such non-obvious knowledge.
Companies need efficient leadership, leadership needs feedback, wise and diverse oversight by Boards of Directors, who ring alarm bells long before a company hits the rocks, or fades into irrelevance. Corporate governance reform may be the most important component of “Abenomics”. Read a Board Director’s view on Japan’s corporate governance reforms:
Japan’s electrical conglomerates are some of the poster children motivating Japan’s corporate governance reforms. In an interview about Toshiba’s future on BBC-TV a few days ago, I explained that Japan’s electrical conglomerates showed no growth and no profits for about 20 years, and the refocusing Toshiba has announced now should have been done much much earlier, 10-20 years ago (“Speed is like fresh food“). Refocusing Japan’s established corporate giants will release resources for start-ups, spin-outs and growth companies.
Japan can be very good at restructuring and turn-rounds, e.g. see
Corporate governance reforms in Japan are one component of “Abenomics” to bring back economic growth to Japan.
Corporate governance reforms in Japan are driven at least in part by the spectacular stagnation of Japan’s top 8 electronics conglomerates, which 25 years ago dominated world electronics, but largely failed to adapt to the changes driven by much more agile Silicon Valley or South Korea based competitors. The right type of Board Directors, could potentially have rung the alarm bells much earlier, and woken up executive management under their supervision.
A welcome factor is that corporate governance reform costs Japan’s heavily indebted Government almost no money – unlike public works programs, and similar traditional ways of stimulating the economy.
The speed with which Corporate Governance Reforms in Japan are being implemented surprised even one of their main promoters, emeritus Group CEO of the Japan Exchange Group, Atsushi Saito, as expressed in his recent talk.
In March 2014 the shareholders appointed me as independent Board Director of the Japanese cybersecurity company GMO Cloud KK, which is listed on the First Section of the Tokyo Stock Exchange. Our main business are internet security solutions, cybersecurity, digital identity management solutions, and cloud hosting and related services and solutions.
Japan’s Stewardship Code, issued by Japan’s Financial Services Agency (FSA) on February 26, 2014, “Principles for Responsible Institutional Investors ≪Japan's Stewardship Code≫- To promote sustainable growth of companies through investment and dialogue”
Japan’s Corporate Governance Code, which was issued by the Tokyo Stock Exchange on June 1, 2015, defines Corporate Governance as “a structure for transparent, fair, timely and decisive decision-making by companies, with due attention to the needs and perspectives of shareholders and also customers, employees and local communities”.
The subtitle of Japan's Corporate Governance Code is its mission statement: “Seeking sustainable corporate growth and increased corporate value over the mid- to long-term”.
The Kay Review analyzes UK’s capital markets in depth, and argues that its companies’ duty to be successful in the long-term, and its only the success of companies that brings wealth to all stake holders and people who invest in companies, in many cases pensioners. Over the years a fine grained system of specialized service providers has developed between companies on one side, and individual investors on the other side. Professor Kay argues that this system of intermediaries (fund managers, analysts etc) can be seen as “overhead” and needs to be as efficient as possible.
Overall the capital market system needs to be built on long term trust and stewardship, not on anonymous one-time monetary transactions.
Why end the requirement of quarterly financial reports? Because short term focus on quarterly financial performance may cloud the view on long-term success and investment. Intense discussions between fund managers and management are strongly encouraged.
Will the end of quarterly financial reporting reach Japan?
Why Japan’s focus on corporate governance?
GNP as a measure of economic size has many flaws – however many signals, not just GNP, indicate that Japan is the only major economy that does not grow.
While there are many excellent Japanese corporations, overall it is no secret that Japan’s economy has the potential to do much much better.
There is much hope that outside directors supervising executive management will bring outside expertise, and improve the performance of company-insider executive management, and if necessary also insist on replacements.
The cheapest part of “Abenomics” – corporate governance reform comes at essentially zero cost to tax payers
Many measures of Premier Minister Abe’s “Abenomics” stimulation programs pump borrowed Government Bonds (JGB) money into the economy, thus cost money and ultimately increase Japanese very large Government debt.
By comparison, corporate governance reforms cost essentially zero cash and don’t further increase government debt.
Theory and practice
Non-diversity: about 0.6% of Japanese Board Directors of listed companies are non-Japanese
As of 17 December 2015 Japan has 3504 listed companies on the exchanges operated by the Japan Exchange Group:
TOKYO PRO Market: 14 (including 0 foreign company)
Total: 3504 (including 9 foreign companies)
In addition there are three regional exchanges:
Fukuoka Stock Exchange
Nagoya Stock Exchange
Sapporo Stock Exchange
Assuming there are about 10 Board Directors per company, there are about 35,000 Board Directors of listed companies in Japan. Of these approximately 200 are foreigners, ie. about 0.6% of Directors of listed Japanese companies are foreign (I am one of these).
Maybe 10-20 of Japan’s public companies are “Englishized” such as Rakuten or SoftBank, or hire simultaneous interpreters at Board Level (you’ll see Directors with headphones listening to the interpreted/translated version of what is being said – of course slowing and filtering understanding and communication)
All other approx. 3490 Japanese Stock Exchange listed companies are run 100% in Japanese language at all levels including Board level – and almost exclusively by Japanese men.
In a rapidly globalizing world, these companies desperately need global input from many nationalities, different backgrounds, and genders at Board level in Japanese language, but the number of people providing this depth of diversity, having the qualifications and being able to function at Board level in Japanese in addition to several other languages is severely limited – this is one of several factors limiting Japan’s growth after having caught up with developed countries in the 1980ies.
What are the main issues?
Diversity delivers better decisions and better results
Japan has many outstanding leaders, such as SoftBank’s founder Masayoshi Son, or Kyocera’s founder Kazuo Inamori, who also founded part of today’s KDDI, and who turned around Japan Airlines from bankruptcy in his 80s.
Some Japanese Executives are outstanding leaders, however, many are not, but function more like chief administrators – as in any other country.
Outstanding leaders don’t fear working with excellent people and will attract top leaders. However, chief administrator type executives will fear for their power and will assemble teams who fear to speak out, as can be observed in many recent corporate scandals in Japan, and many other major countries. Corporate scandals and corporate governance failures may happen anywhere, not just in Japan.
Diversity at top management levels and Board levels has many benefits, as has been proven in many studies. Diversity delivers better decisions and better results. Boards of Directors are one way to bring diversity to decision making.
Many major Japanese corporations show no growth and no income for the last 20 years.
A showcase example are Japan’s top-8 electronics conglomerates. Combined they are as large as the economy of the Netherlands, but contrary to The Netherlands, they have shown no growth for the last 17-20 years, as well as losing money on average over all these years. Of course, as a consequence the market capitalization = value of these top-8 electronics companies has decreased dramatically. While Japan’s top-8 electronics companies dominated 60% or more percent of the global electronics industry in the 1980, they have fallen steep. Clearly a dramatic example of failed corporate governance, and surely a big push for Prime Minister Abe to put so much priority on improving Japan’s corporate governance, together of course with the need to improve employment, and returns for pension funds to fund Japan’s aging population.
Three forms of corporate organization: splitting supervision and execution
Traditionally, executives supervised themselves at Board level
Traditional Japanese corporation have a Board of Directors composed of corporate executives, i.e. the executives supervise themselves without external supervision or input. Supervision is done by the Kansayaku Board (corporate auditor’s Board) which however has limited powers on corporate decision making.
Japan’s corporate government reforms now give Japanese companies options to split execution (executives, 執行役員) and supervision (Board Directors, 取締役).
Japanese corporations now can chose between three forms of organization
company with Kansayaku Board
company with Supervisory Board
company with three committees:
According to the new Corporate Governance Code, the Board (independent which of the three options is selected) has the following three duties:
setting the directions of corporate strategy
encourage and support appropriate risk taking by senior management
supervise Directors and executive management, including senior executives (執行役員)
Connecting the dots: the link between accounting issues and the space shuttle Challenger disaster
Space shuttle Challenger’s top management was insisting to keep the planned launch date fearing public relations issues, while the workers and engineers on the ground, “genba”, knew that they were not ready. But top management at space shuttle Challenger did not listen to “genba”.
My advice to Japanese corporations: embrace and learn to love diversity!
Embrace and learn to love diversity! Diversity delivers better results overall. We all learn from each other.
My advice to foreign investment funds seeking more influence on Japanese companies
Shouting at the CEO or Boards of Japanese companies will not help – many foreign activist investors have already proven this fact many times. Insisting on your superior knowledge will not make you many friends – as anywhere else.
You need to develop trust and relationships. You need to start by learning Japanese, understanding Japan, and earn trust and contribute with achievements, or partner with people who have: KKR hired Japan Exchange Group emeritus CEO Atsushi Saito.
There are no increasing numbers of examples, where outstanding Japanese corporations careful listen to outside advice from investors, and thus become even more outstanding: SONY and robotics maker FANUC come to mind.
My advice to foreign companies operating in Japan
Your subsidiary in Japan is a Japanese corporations and needs corporate governance. There have been a long list of corporate governance failures leading to huge problems and losses at foreign subsidiaries in Japan, in the financial sector, the elevator sector, the pharmaceutical sector and several others.
Make good use of the Board of Directors of your Japanese subsidiary corporation.
Quarterly financial reports: can they be the trees which obscure long term growth of the forrest?
As a Board Director of a Japanese company traded on the Tokyo Stock Exchange I have to study and approve monthly, quarterly and annual financial reports, and I share responsibility for the future success of the company.
It is obvious that the longterm success and growth of the company is the most important priority for all stake holders. So how useful are quarterly financial reports? Lets look at some recent developments and at an example below from our Report on Japan’s Telecommunications Industries.
Motivated by Professor John Kay’s report, the UK regulator removed the requirement for companies to publish quarterly financial reports.
Mark Zinkula, CEO of Legal & General Investment Management, one of UK’s largest investment management firms, around 8 June 2015 wrote a carefully worded letter to 350 UK company Chairmen, recognizing that each company has different circumstances, and encouraging them to report the most meaningful key metrics and to omit reporting quarterly financial results if these don’t contribute to longterm value creation. You can download Mark Zinkula’s letter as a pdf file here.
The European Union (EU) reduced the reporting requirements including the requirement for quarterly financial reporting.
Will Japan and other important countries such as USA follow this trend as well?
Quarterly financial reports: pro’s and con’s
Essentially all well managed companies have fine grained financial management systems which document the financial position of the company at any moment in time.
As an example, when Kazuo Inamori rebuilt Japan Airlines from bankruptcy, he created a reporting system which calculates the profit/loss of every single flight in real time: i.e. when a Japan Airlines flight from Tokyo arrives in San Francisco, the pilot and everyone else knows before landing in San Francisco whether this particular flight was profitable or not – while before Japan Airlines bankruptcy, profit/loss (mainly losses for the last years leading up to bankruptcy) was determined on a full company basis every 3 months in arrears. Read Kazuo Inamori’s talk here. Clearly Kazuo Inamori thinks that such fine grained profit/loss awareness is a crucial component for Japan Airlines’ revival from bankruptcy.
Its obvious that for today’s IT systems the creation of quarterly financial reports from such fine-grained measurement systems such as Kazuo Inamori had installed at Japan Airlines does not cause much additional effort or costs once the coding is done.
Quarterly financial reports: trees vs. the forrest
The figures below show exactly the same financial data – the net income (= profit) of Japan’s mobile operators NTT-Docomo, SoftBank and KDDI over the last 10-15 years:
Upper Figure:quarterly net income (thick curves) vs annual net income (thin curves)
Lower Figure: quarterly net income (thin curves) vs annual net income (thick curves)
It is hard to draw conclusions from quarterly income curves above. Most eye-catching is that SoftBank’s quarterly income results became much more fluctuating in the last two years. Its hard to judge the relative performance of Docomo, SoftBank and KDDI from the quarterly income curves.
Annual net income curves give a much clearer picture. Annual figures clearly show that SoftBank caught up and overtook Docomo and KDDI in net profits.
As Mark Zinkula points out that every company and every industry is different. In the case of Japan’s mobile operators, annual figures give a clearer picture.
Will quarterly financial reports become voluntary and go away? They might partly in the UK, and maybe also in other countries. As so often in finance, the UK sets the global trends.
Quarterly financial reports & the Toshiba accounting issues
Quarterly financial reports can be the trees and annual reports the forrest… seeing the forrest can be more important than seeing individual trees
Corporate governance Japan: Prime Minister Abe urges reform of corporate governance
Reuters reports that Japan’s Prime Minister Abe urges company boards to reform corporate governance to include independent directors. I added the following comment.
Corporate governance Japan: exercise of shareholder power and emergency situations
The question of independent Board Directors is often framed in terms of exercising shareholder power over the company, as is the main message of the article above. Another focus of discussions on the role of outside independent directors, is during emergencies, and here the Olympus case is often cited.
Corporate governance Japan: steady state contributions of independent directors
As an example, lets compare NTT-Docomo and SoftBank. NTT-Docomo has a homogeneous pure Japanese Board, while SoftBank has independent Directors from many different countries and from many different walks of life. SoftBank recently overtook NTT-Docomo in terms of market cap, revenues, operating income and net income. http://www.eurotechnology.com/2014/05/07/softbank-overtakes-ntt-docomo-kddi/
In the end regulations have limitations, and the realities of the market decide, as is the case of SoftBank.
“Outside Directors” is only one step along the way to end the “inbreeding problem”. Bringing diversity into the management of Japanese companies is critical for growth in Japan: non-Japanese directors, women directors, non-Japanese women directors.
Corporate governance Japan: in the end the markets decide whether diversity is necessary, or whether in-breading wins
Of course the market decides: I believe that companies which do not bring in management diversity will find lower market capitalization than those which do.
I am European and independent Board Member of a Japanese company, traded on the Tokyo Stock Exchange. Since all business and all board meetings are in Japanese, full command of business Japanese is necessary, including the ability to read a big volume of Japanese reports 100s of pages long sometimes from one day to the next.
Corporate governance Japan: very few non-Japanese are capable of functioning on the Board of a Japanese corporation
There are only very very few non-Japanese people with the qualifications to serve as independent Board Directors, who have the necessary full command of Japanese. So there is a substantial bottle neck against bringing diversity into Japanese corporations even if there was a strong pull from Japanese corporations. Currently only a few excellent Japanese corporations exercise this pull, to pull in non-Japanese external Board Members.
One company which is remarkably advanced is Hitachi – Hitachi several outside and non-Japanese Board Members, including also one foreign woman recently.
NSG Pilkington CEO, Stuart Chambers, CEO of NSG Group, press conference on October 16, 2008
NSG Pilkington: Nippon Sheet Glass acquired Pilkington in June 2006
On February 16th, 2006, Nippon Sheet Glass‘ offer for the 80% of Pilkington plc it did not already own, for US$ 3.14 billion in total, was accepted by Pilkington’s share holders and the acquisition was completed in June 2006. At the 142nd Annual Shareholder Meeting on June 27th 2008, Stuart Chambers was appointed Representative Executive Director, President and CEO of NSG Group.
NSG Pilkington CEO Stuart Chambers: Four critical factors for Japanese corporates making major international acquisitions
Here some essential points of Stuart Chambers’ presentation, entitled “Four critical factors for Japanese corporates making major international acquisitions”.
The four critical factors in the title are:
Integration (share holders and customers demanded integration, because the value of the combined NSG + Pilkington after the acquisition must become bigger than the sum of its parts -> must change HR management, and board)
Repaying debt -> senior management must understand the balance sheet
Identifying growth opportunities for the future (glass for solar energy)
From the outset the aim was not to create a Japanese company with overseas subsidiaries, but to create an international company, headquartered in Japan and listed on the Tokyo Stock Exchange. Therefore the greatest changes needed to be made in Japan.
NSG Group corporate governance: new Board structure
NSG Group changed from an exclusively Japanese Board, to a new Board structure:
Board of Directors: 12 (7 Japanese + 5 non-Japanese) and
Executive Officers: 23 (11 Japanese + 12 non-Japanese)
These changes were necessary in order to retain non-Japanese management talent from leaving the acquired company after the merger.
The Board structure was changed from the traditional Kansayaku (Corporate Auditor) structure to a Board with Committees.
HR management changes from internal promotion according to time served in each job level to the international practice of combining internal and external hiring according to capability and demonstrated performance ignoring age as a factor.