Japan, the US and corporate governance

["Ian Murray" <seamus2001@xxxxxxxxx>]

< http://www.japantimes.co.jp >
Monday, April 8, 2002
JAPANESE VS. U.S. APPROACH
The 'corporate governance' debate

By GLEN S. FUKUSHIMA

Over the past decade, "corporate governance" has come to replace
"industrial policy" and "Japanese-style management" as the key factor to
explain Japanese business performance.

>From the 1960s through the early 1990s, many observers focused on the
close and cooperative relationship between Japan's economic ministries --
especially the Ministry of Finance and the Ministry of International
Trade and Industry -- and the companies under their "jurisdiction" to
explain Japan's economic success. As a student at the Harvard Business
School in the 1970s, I remember taking the required first-year MBA course
on BGIE (Business, Government, and the International Economy), where
nearly half of the country cases focused on the success produced by
Japan's industrial policy.

Those who felt uncomfortable giving government so much credit for Japan's
economic success emphasized what they viewed to be the strengths of
Japanese-style management, which included long-term employment, promotion
and wages based on seniority, enterprise unions, low labor mobility,
patient capital and "keiretsu" ties centered on main banks.

The bursting of the bubble economy in Japan in the early 1990s and the
ensuing "lost decade" of economic stagnation led all but the staunchest
advocates of the Japanese system to concede that changes are necessary to
revive the economy. In recognition of the rise of market forces and the
power of globalization, most now look to the government primarily to
provide the macroeconomic environment for growth and see the enhancement
of Japanese corporate competitiveness to be up to the private sector.
This has led to the debate over "corporate governance" as a key to
Japanese economic revival.

On one side of the debate are those who contend that Japanese corporate
performance will improve only if Japanese companies adopt Western
(primarily U.S.) forms of corporate governance. This includes greater
emphasis than at present on shareholder rights, information disclosure,
transparency, profitability and management accountability.

Advocates argue that without reform, Japanese firms will continue to lose
in global competition. According to the Tokyo Stock Exchange, major
Japanese companies' return on equity declined from 8.46 percent in 1983
to 1.2 percent in 1999. Corresponding figures for U.S. companies rose
from 12.36 percent to 17.88 percent during the same period. A survey of
450 companies listed on the first section of the Tokyo Stock Exchange
conducted last year by Keio University and the Japan Corporate Governance
Forum revealed that companies in which outside directors participate in
corporate decision-making reported higher growth in sales and pretax
profit over the past four years than those that did not.

Sony Corp. has been a front-runner among Japanese companies in adopting
certain aspects of U.S. corporate governance. In 1997, the company
reduced the number of board members from 38 to 10 and reinforced the role
of outside board members. Sony's board now consists of three outside
members and nine inside members. In 1998, Sony also established a
nominating committee (consisting of one outside and five inside board
members) responsible for selecting executives and a compensation
committee (consisting of two outside board members and a Sony counselor)
to determine executive compensation.

Although Sony is often cited as an example of change in Japanese
corporate governance practices, it is atypical. Since 1996, Davis Global
Advisors has conducted an annual survey of leading corporate governance
indicators. Among the seven countries surveyed (Britain, United States,
France, Germany, Belgium, Netherlands and Japan), Japan consistently
ranks at the bottom. On "board independence," Britain and the U.S.
usually lead with a score in the 5-6 range (10 representing the highest
independence), France and Germany come next in the 3-4 range, and Japan
usually receives a score of 0.

This is because, unlike the U.S., where the average board size of Fortune
500 companies is 12, of whom 9 are outside board members, the typical
large Japanese company maintains a board three to five times that size,
with few or no outside board members. Even those companies that have
opened their boards to outsiders usually invite individuals who are from
companies that are corporate partners, creditors, customers, suppliers,
etc. -- not "independent."

The arguments offered by those on the other side of the debate provide
interesting insights into the Japanese zeitgeist. First, they argue that
the purpose of a corporation in Japan differs from that in the West.
Whereas the latter is aimed primarily to provide profits for
shareholders, Japanese corporations exist fundamentally to produce
economic value to Japan as a nation, which means that providing
employment to the Japanese people is the highest priority.

Second, the argument goes, given this difference in corporate purpose,
Western notions of corporate governance have limited applicability in
Japan. Whereas the West emphasizes the relationship between shareholders,
management and the board of directors, Japanese corporations are
responsible to their stakeholders, which includes, most importantly, the
employees, customers, suppliers, creditors and community.

Third, the opponents of change question whether conformity to Western
corporate governance practices will lead to better economic performance.
Here they cite Toyota Motor Corp., one of Japan's strongest and most
successful companies and the first Japanese company to record annual
group pretax profits exceeding 1 trillion yen. Toyota's board of
directors consists of nearly 60 members, every single one a Toyota
executive, who have consistently refuted the need to adopt Western modes
of corporate governance.

Fourth, even if adopting Western practices were to improve profitability
in the short term, the skeptics believe that such practices could have
the corrosive effect of encouraging short-term profit-seeking at the
expense of long-term investment, creating massive inequalities of income
and wealth among employees and weakening commitment to the company as an
institution because the market might dictate that greater short-term
value can accrue to shareholders if a company is sold off to the highest
bidder. And such mergers and acquisitions may result in corporate
restructuring that would almost certainly lead to unemployment.

Finally, the critics like to cite Enron Corp. as a showcase of Western
corporate governance at work. The erstwhile darling of Wall Street ended
up as one of the biggest bankruptcies in history despite the U.S. rules
and regulations aimed at information disclosure, transparency, board
independence, rigorous financial accounting and audits, legal and
regulatory oversight, management accountability and investor protection.
If what is touted as the best corporate governance system in the world
could not prevent the Enron debacle, the argument goes, why should Japan
be so foolish as to adopt the U.S. system?

As a board member of several American and Japanese organizations
(corporate boards of directors, corporate advisory boards and foundation
boards), I am fascinated by the differences in the role, composition and
function of these boards compared with their U.S. counterparts. From this
vantage point, I would offer three observations.

First, any U.S.-Japan comparisons should take into account the time
dimension. It was only in the 1960s and 1970s that the voice of
shareholders started to gain prominence in corporate governance in the
U.S. For instance, most U.S. boards of 30 or 40 years ago looked rather
similar to what Japanese boards look like now in terms of independent
outside directors.

Second, it is important to keep in mind the diversity of corporate
governance practices among U.S. companies. Some adhere to practices that
are radical by Japanese standards (e.g., IBM Corp. and Dell Computer
Corp., whose boards comprise all outside members except for one), whereas
some do not look too dissimilar to the typical Japanese pattern. By the
same token, there is increasing diversity of corporate governance
practices among Japanese companies so that the most progressive Japanese
companies may be more open than the most conservative U.S. companies.

Third, as globalization proceeds there will be a certain amount of
"convergence" of Japanese corporate governance practices with the U.S.
model. However, given the deeply rooted differences in the role, behavior
and function of corporations in the two countries, it is likely to be
many years, if ever, before corporate governance in Japan truly resembles
that in the U.S.

This is not something to be lamented, but rather accepted as an
indication that there are indeed different forms of capitalism and that
in many ways the U.S. and Japanese forms lie at the polar extremes among
the advanced industrialized countries.

Glen S. Fukushima is president and CEO of Cadence Design Systems, Japan,
and was president of the American Chamber of Commerce in Japan from 1998
to 1999. From 1985 to 1990, he directed Japanese affairs at the Office of
the United States Trade Representative.