How the worm has turned!
After the collapse of the Japanese financial bubble in the early 1990s, the Japanese financial system lost its shine with the implosion of stock and land prices and the collapse of many banks whose clients were unable to pay back their loans. Japan’s long-standing bank-centred corporate governance system was blamed for the country’s economic bust not lauded for its past strengths.
The financial markets and corporate organisation in the United States, Australia, Canada, New Zealand, and the United Kingdom gained lustre and the Japanese government gradually decided to promote an Anglo-American style corporate governance system. A range of corporate governance reforms were put in place. They aimed to facilitate market based transactions, competition, individual shareholder rights, as well as transparency and information disclosure. Japan’s economic regulatory institutions were also reformed. New laws were introduced and existing laws revised, including company law, the commercial code, the anti-monopoly law, and the financial instruments and exchange act.
In this week’s lead essay, Bruce Greenwald from Columbia University’s business school in New York explains that, as part of the Abe administration’s structural reform agenda, Japan’s new corporate governance code focuses on making Japanese corporations more transparent, more responsive to shareholders — including minority shareholders — and subject to more effective oversight by boards of directors, including especially outside directors. It seeks to make boards of directors not only more active and independent, but more diverse. In most respects the code moves Japan toward Western, especially US, corporate governance practices.
That might be all very well, suggests Greenwald, but what do we know about how US corporate governance practices perform?
There’s one single factor that stands out clearly, says Greenwald: it is corporate culture that completely dominates corporate behaviour in the United States. Formal governance rules have an effect which is an order of magnitude significantly smaller.
Says Greenwald: ‘They fail to manage costs efficiently, seek to grow in areas where they enjoy no competitive advantages (or worse suffer from significant disadvantages) with disastrous consequences for returns on investment, have self-indulgent capital structures (low debt and lots of cash accumulated at the expense of shareholder distributions), pay limited attention to effective succession planning, hire and fire workers in response to short term fluctuations in market conditions (a costly practice for workers and shareholders) and pay themselves generously without regard to their performance. They achieve this by observing the letter, but not the spirit of corporate governance rules. For example, they appoint “diverse” outside directors, who are overcommitted, generally uninformed about the economics of their businesses and conflict averse. Moreover, a significant fraction of shareholders (institutional and individual) either give management the benefit of the doubt or fail to vote at all’.
Other United States corporations in the same ‘governance’ environment, Greenwald points out, perform outstandingly well. His conclusion: the difference is culture, not governance.
So what does this mean for the reform of corporate governance in Japan?
The new Japanese corporate governance system allows firms to operate in a way that is similar to those in the United States. A corporation can use a US-style board system with committees consisting of majority outside directors. These outside directors oversee firm performance in management and governance. The market for corporate control now also operates largely as it does in the West. A hostile takeover of a firm is generally possible. Firms must also disclose consolidated financial statements.
But has the corporate governance structure changed?
Japan probably has even more deeply entrenched corporate cultures than the United States or Europe. So, Greenwald observes, the effect of corporate governance reform is likely to be small. On the upside, strong Japanese emphasis on long-term value building, ‘social cohesion and discomfort with extreme individual distinctions means that the effect on differences in compensation and employment security within firms will also be minimal’. On the downside, the chances of lifting management performance through changing the rules are low. ‘Japanese corporations are just as capable as their United States counterparts of observing the letter of the new governance code while defeating its spirit’, says Greenwald.
Not to worry, Greenwald argues, Japanese manufacturing productivity and corporate performance is the best in the world, higher than that in the United States. The real problem for Japan, he concludes, is to create a management culture in services that will boost performance in that sector where the future growth will come from.
Peter Drysdale is the editor of the East Asia Forum.