In a promising development for corporate governance in Japan, Prime Minister Shinzo Abe has charged officials with making new rules for the uniquely-Japanese phenomenon of "listed subsidiaries"--- publicly-traded companies controlled by a dominant shareholder.
The new regulations, due to be unveiled later this summer, will be a revealing test of the Abe Administration's commitment to real corporate governance reform -- not least because the government itself is the controlling shareholder of some of Japan's most prominent listed subsidiaries.
If the government is serious about requiring, for example, listed subsidiaries to fill a majority of their board seats with truly independent directors, how can it credibly exempt itself from the new rules as they apply to companies that the government itself controls?
While most listed subsidiaries are controlled by other listed companies, the government directly controls five, Japan Post Holdings, Japan Tobacco, Nippon Telegraph and Telephone (NTT), Inpex and Japan Petroleum Exploration (Japex), with a combined market capitalization of 21 trillion yen and indirectly controls three more, Japan Post Bank, Japan Post Insurance and NTT Docomo.
A key feature of the new rules will be raising the number of independent directors who sit on the boards of listed subsidiaries. Currently, the Corporate Governance Code recommends that all listed companies, whether or not they are "listed subsidiaries," have at least two outside directors-- a much weaker standard than the New York Stock Exchange's requirement that a majority of directors be independent.
Listed subsidiaries present special issues that demand a higher standard. Most significantly, parent entities can abuse their position to turn their listed subsidiaries into subordinate entities forced to supply goods and services to the parent on unfavorable terms-- at the expense of the listed subsidiary's general shareholders. Independent directors help ensure that pricing and other terms of transactions between the controlling parent and listed subsidiary are not skewed in favor of the parent.
It is not clear to what extent the government has anticipated how the new rules will affect the board structure and composition of the publicly-traded companies it controls. The government's own listed subsidiaries are largely former state-owned industries that have been partially privatized-- Japan Post Holdings (and its listed subsidiaries Japan Post Bank and Japan Post Insurance); Japan Tobacco; NTT (and its listed subsidiary NTT Docomo); and the lesser-known petroleum exploration and refining companies Inpex and Japex.
Perhaps because they were partially privatized quite recently, in 2015, at a time when the Abe Administration was first promoting corporate governance reform as a centerpiece of its structural reform initiatives, the three Japan Post companies all have internal regulations that "in principle" require a majority of outside directors. (It is worth noting that an independent majority has not prevented the Japan Post entities from trading at a miserable 40% of book value.)
It will be interesting to see whether the new rules will impose tighter standards of independence than the forgiving Tokyo Stock Exchange standards that currently prevail. Nonetheless, the three Japan Post entities have set an important precedent for independent directors in a government-controlled listed company.
Unlike the Japan Post entities, the outside directors on the boards of the other government-controlled listed subsidiaries are heavily outnumbered by insiders:
What justification do the other government-controlled listed subsidiaries have for not requiring, like the three Japan Post entities, a majority of outside directors?
The conflicts of interest between the government, as controlling shareholder, and the general shareholders of the government-controlled listed company are more subtle but in many ways more serious than in the case of a normal listed subsidiary. For general shareholders, the biggest concern is that the government will use its control to subordinate the listed company's profitability and corporate value to the government's public policy objectives.
Is the government-controlled company's mission to serve the nation as a whole or to maximize profits for its shareholders? Or perhaps a little of both? Government-controlled private companies-- which many would argue are a bad idea to begin with-- are inherently schizophrenic, never quite sure whether they should be for-profit or nonprofit operations. Independent directors may not totally cure the schizophrenia, but they are in a better position than government bureaucrats (or employee-directors reporting to government bureaucrats) to make choices on a principled, consistent and transparent basis.
Higher standards of director independence for listed subsidiaries, including government-controlled listed subsidiaries, will have another consequence perhaps not fully anticipated by Ministry of Finance and the Ministry of Economy, Trade and Industry, which are responsible for the new rules. It will expose another conflict of interest-- namely the use of the government-controlled companies as post-retirement landing spots and generous amakudari sinecures for career MOF and METI officials.
Take Inpex and Japex, petroleum exploration and refining companies, which are owned 19% and 34% respectively by METI, as well as being joined at the hip by mutual cross-shareholdings. The Chairman and President of each company is currently, and has been historically, a retired METI official. The supposedly independent directors of the two companies also, not surprisingly, include former bureaucrats.
Truly independent boards at companies like Inpex and Japex would be under an obligation to scrutinize the practice of reserving the two most senior and highly-paid positions in the organization for retired employees of the companies' dominant shareholder. Almost inevitably, one of the ironic consequences of the government's efforts to improve governance of listed subsidiaries will be to deprive senior bureaucrats of customary post-retirement sinecures.
When the new framework of rules for listed subsidiaries are made public later in the summer it will interesting to how far they go to raise the current weak standards for independent directors at listed subsidiaries. Will a majority of independent directors be required, or will the number be incrementally increased without requiring a majority? Will standards of independence be tightened to exclude employees of affiliated companies and transaction counterparties who are now treated as "independent?" Will there be real sanctions for companies that fail to comply, or will the new rules remain, like the Corporate Governance Code, soft law without real enforcement teeth?
The clearest evidence of the Abe Administration's commitment to corporate governance reform, however, will be seen in the impact on the government's own listed subsidiaries. If the promised rules lead to a majority of independent directors at NTT and the rest, and an elimination of sinecures for former bureaucrats, the government will have set an admirable example and Japan will have taken a difficult step in the right direction.
Stephen Givens is a corporate lawyer based in Tokyo.