TOKYO -- Japanese corporations got an advance look Tuesday at an updated set of government guidelines designed to discourage the insular business practices long excoriated by international investors.
Under the draft of the revamped Corporate Governance Code released by the Financial Services Agency, boards of directors will be required to operate with more transparency. For example, the code will instruct boards to be involved in forming CEO succession plans, and to supervise the grooming of candidates.
The new code would also, in effect, obligate boards to create a process for hiring and firing executives that is grounded in both objectivity and transparency.
The draft also calls for an expanded role for outside directors. The governance code currently prescribes at least two outside directors, but the amended version would expect an appropriate number to be chosen if a company needs to fill at least a third of its board with outside directors.
Furthermore, the guidelines will add a clause emphasizing gender and nationality considerations in forming more diverse boards. The aim is to promote the hiring of female and non-Japanese executives.
The Corporate Governance Code is not legally binding, but companies are required to provide an explanation if they violate the guidelines. The FSA will officially approve the revised code by early April, and it will take effect in May. Listed corporations will be advised to submit to the changes starting with June's stockholders' meeting season.
Japanese corporations have not adopted corporate governance principles to the extent that their U.S. peers have. Among companies listed on the Tokyo Stock Exchange's first section, 88% formed boards with two or more outside directors, according to the TSE, which introduced the Corporate Governance Code in 2015 along with the FSA.
However, the same data shows that external directors occupied fewer than 30% of the board seats, which pales in comparison to the 80%-plus figure seen in America. Furthermore, only around half of Japan's outside directors have any managing experience, compared with 70% in the U.S.
Experts on a panel put together by the FSA have said that both the format and the quality of the corporate governance reforms adopted by Japanese companies will be called into question.
Many international investors, such as the California Public Employees' Retirement System, a big U.S. pension fund, and British asset manager Legal & General Investment Management, have been pressuring Japanese companies to appoint outside directors to at least a third of their board seats.
The fresh eyes provided by a truly diverse board would be reflected in a company's business management, and would help keep the organization from falling victim to one-sided thinking. Corporations will be faced with the new task of securing candidates from nontraditional backgrounds to fill their executive ranks.
Kazuhiko Toyama, CEO of corporate consulting firm Industrial Growth Platform, and a member of the FSA's expert panel, predicts a dire situation for Japanese businesses if corporate governance is not taken more seriously. "At this rate, the business community will not stop weakening," he said.
Futoshi Saito, head of Sumitomo Mitsui Asset Management's stewardship enhancement section, is struck by how the draft corporate governance code seeks to reduce so-called strategically held shares, a synonym for equity owned reciprocally by two companies for the purpose of maintaining a good business relationship.
"That they indicated the general principle that [such shares] should not be owned leaves an impression of considerable boldness," said Saito. "By unwinding cross-held shares, we can expect Japanese corporations to improve capital efficiency, which has been comparatively lower than that of overseas companies."
Saito also welcomes the diversification of boardrooms, though he cautions that companies should select officers that can contribute to lifting corporate value. "Succumbing to formalism would be meaningless," he said.