The rise of corporate governance in Japan and the challenge of integrity

For an ever-growing number of jurisdictions around the world, the demonstration of good corporate governance is becoming increasingly important. However no two words illicit such a committed discussion as in Japan, where rising scrutiny from the media and the public has propelled this prevalent topic into the spotlight. 

Historically, companies in Japan have emphasized incumbency and promotion from within, however, since 2013, a rapid succession of measures have been introduced to impose a higher level of corporate standards, as the country seeks to change its status quo.

While many regard Japan’s Prime Minister Shinzo Abe’s economic policy (termed “Abenomics”) to have had limited success in boosting the county’s economic growth, there has been praise for Mr Abe’s “third arrow” reforms – in particular in the area of corporate governance. Designed to spur private investment in Japan, the most relevant changes are two code enactments, the Japanese Stewardship Code (2014) and the Japanese Corporate Governance Code (2015), which aim to promote transparency and collaboration between shareholders and directors. 

While many companies are still only paying lip-service to the rules, there are heartening signs: more businesses are engaging with investors, the appointment of external and independent directors has risen, and more companies are aware of capital efficiency. Moreover, for a large number of companies the governance code has brought out the Japanese quality of majime – an earnest diligence in following the rules. But is ‘following the rules’ really enough?

More than just following a framework

Corporate governance is traditionally understood as the set of systems and controls by which a business is controlled and managed. So, on that basis, it stands to reason that if the corporate governance codes are implemented, and the systems and controls are in place, we have good corporate governance. However, recent discussions are suggesting that face value compliance with the various codes is not enough. They are just the beginning. Ensuring good corporate governance goes much further, and much deeper within an organisation than the adoption of a set of standard codes.

Adopting the industry standard package of controls may in fact encourage the development of a laissez-faire attitude, under the false belief that simply complying with the various corporate governance codes will ensure safe passage. This is simply not the case. While they have certainly been a force for improving governance structures, procedures and reporting, governance codes on their own have not necessarily changed corporate behaviour.

In 2015, Japanese-based multinational Toshiba had falsified accounts, inflating profits by over $1.2 billion, at a time when corporate governance dominated the Japanese news and a reformed corporate governance framework was in place. One does not have to search far to find examples of poor corporate governance elsewhere. Take Microsoft’s failed bid for Yahoo in the US, or Volkswagen’s emissions debacle in Europe – all are examples of where a robust corporate governance framework was in place, but integrity and sound decision making were not. The absence of ethics or integrity is therefore critical; without them, good corporate governance cannot exist. Indeed, analysis of regulatory sanction statements in all respected jurisdictions regarding wrongdoing almost always include some reference to poor decision making, integrity and/or ethics.

The power of decision making

The ability to make considered, ethical and fair decisions at a senior level is typically taken as absolute, but this is not always the case. Decision making is tough. Directors must act in the interests of their stakeholders, but there is a fine balance to be struck between the drive for short-term financial gain and the long-term future of a business.

A board’s strength depends upon the degree to which its members possess and exercise critical thinking skills when making decisions and the extent to which they possess true integrity. But ensuring that appointees possess the skills and confidence to demonstrate integrity in all they do presents fundamental challenges.  

In Japan, loyalty is paramount to the company and, as such, employees can become blind and unquestioning – where the rights and wrongs of any particular issue can become easily lost. Michael Woodford, former chief of Olympus

How many people at board level are genuinely skilled at stepping back, questioning and challenging a decision made or information received? How many directors stand back and ask objectively how a decision may appear to external stakeholders, including the general public? 

When looking at business performance we focus on the tangible: on achievements, on numbers and on corporate fit. It is almost impossible to evidence occasions when an individual’s decisions, integrity or challenge resulted in the avoidance of corporate disaster or reputational damage. But while positive benefits of good decision making cannot easily be demonstrated, proving the negative is somewhat easier. If those at the helm are not in possession of integrity, common sense and an ability to question not only their colleagues but also themselves, then any business will be scuppered from the start. The majority of corporate governance failings in recent years may well have been prevented if those making the decisions had set the ethical bar a little higher, and demonstrated a little more integrity.

The success of a business depends on good corporate governance – the way power is exercised over corporate entities, from strategy creation to day-to-day supervision. But above all else, governance is about the people within the business. It is about doing things properly, with ‘intellectual honesty’, integrity, trust and accountability, and not just sticking to rules and regulations.

In Japan, there is still a long way to go inside the corporate boardroom. Ongoing improvements and operational changes are crucial in driving forward the reforms, and without a rigorous commitment to ‘true’ corporate governance practice, they may lose their momentum. The expression ‘to instil the spirit of Buddha’ stresses the importance of sincere dedication to substance rather than just following the motions. Time will be the testament to whether this expression rings true.

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