Japans Corporate Governance Code from the Perspective

Japan’s Corporate Governance Code from the Perspective Date: October 05, 2023 Performed by: Prof. Hiroyuki Watanabe Background And Objectives Of Japan's Corporate Governance Code  The Codes has been created and published by the Tokyo Stock Exchange.  The foundation of Japan's Corporate Governance Code lies in the "Japan Revitalization Strategy," and it has been formulated as part of Japan's economic growth strategy.  A "Principles-Based Approach" and a "Comply-or-Explain Approach Transitions Of The Code At The Tokyo Stock Exchange - Principles of Corporate Governance of Listed Companies (Predecessor of the Corporate Governance Code, 2004) - Japan's Corporate Governance Code (first 2015 version. - Current 2018 version U (Forthcoming 2021 version) General Principles Of The Corporate Governance Code (Since The First 2015 Version) 1. Securing the Rights and Equal Treatment of Shareholders 2. Appropriate Cooperation with Stakeholders Other Than Shareholders 3. Ensuring Appropriate Information Disclosure and Transparency 4. Responsibilities of the Board 5. Dialogue with Shareholders A "note" is added to each "General Principle", and there are many "Principles" and "Supplementary Principles" in addition to the "General Principles".  2018 Revision of the Corporate Governance Code (Major Revision Items)  Reduction of Cross-Shareholdings (Supplementary Principle 1.4.1 and 1.4.2)  Establishment of procedures for appointing and dismissing CEOs (Supplementary Principle 4.3.2 and 4.3.3)  Understanding capital costs, reviewing business portfolios, and allocating resources (Principle 5.2) Final Proposal for Re-Revision of the Corporate Governance Code (April 2021) Functioning of the Board of Directors - (For Prime Market) the market that upgraded the first section of the Tokyo Stock Exchange, which will be introduced soon.  More than 1/3 of independent outside directors. Majority if there is a controlling shareholder. - (For other Markets)  Two or more independent outside directors. More than 3/1 if there is a controlling shareholder. - Creation and Disclosure of "Skill Metrics" for the Directors Addressing Issues of Sustainability - Disclosure of Sustainability Initiatives and Investments in Human Capital - (For Prime Market) Disclosure of Policies and Impacts on Climate Change within the framework of the TCFD (Task Force on Climate- related Financial Disclosures which was created by The Financial Stability Board) - TCFD Task Force on Climate-related Financial Disclosures which was created by The Financial Stability Board Ensuring Diversity among Core Corporate Human Resources The principle of diversification of managerial positions will be introduced. Specifically, women, foreigners, and mid-career hires are listed and voluntary target setting and disclosure are required. In addition, there is a need to disclose specific interna environments and human resource development policies and implementation status to ensure diversity. Scrutiny Of The Code From the Perspective of "Sustainable Growth of the Company and Improvement of Mediumto Long-Term Corporate Value. In the forthcoming 2021 Code Revision, various directions will be introduced to promote sustainability and diversity, and to improve the function of the board of directors. However, it seems that no specific direction has been presented for improving the "earning power" that is the driving force for Japanese companies to improve their corporate value over the medium to long term. Does the current Code provide enough principles and rules to improve corporate value over the medium to long term? General Principle 1: Securing the Rights and Equal Treatment of Shareholders Companies should take appropriate measures to fully secure shareholder rights and develop an environment in which shareholders can exercise their rights appropriately and effectively. (Supplementary Principle1.1.2) When proposing to shareholders that certain powers of the general shareholder meeting be delegated to the board, companies should consider whether the board is adequately constituted to fulfill its corporate governance roles and responsibilities. Comment on General Principle 1 (Securing the Rights and Equal Treatment of Shareholders) and Supplementary Principle 1.1.2 The statutory rights of shareholders at shareholders' meetings under the curren Companies Act is much stronger in Japan than in the U.S. In Japan, shareholders' rights have been exercised on a wide range of matters at shareholders meetings, including exercising a strong direct control over accountability of management oversights. In contrast, in the U.S., the function and authority to detect management oversights is being increasingly delegated to the board of directors, and shareholder rights regardi shareholders' meetings are limited. For example, the decision on dividends is not a matter of resolution at the shareholders meeting, and even if it is decided there, it has no legal effect. In addition, regarding the amendment to the articles of incorporation, if the board of directors submits a proposal for the shareholders' meeting, the shareholders only have veto rights and cannot present a shareholder proposal. General Principle 2: Appropriate Cooperation with Stakeholders Other Than Shareholders (General Principle 2) Companies should fully recognize that their sustainable growth and the creation of mid- to long-term corporate value are brought about as a result of the provision of resources and contributions made by a range of stakeholders.  There are some views that Japanese companies should not blindly take the stakeholder management which could weaken their management discipline.  They insist that if they take the stakeholder, Japanese businesses would lose the power to earn money and gain international competitiveness, since their capital efficiency (such as, their return on equity, or ROE) and labor productivity are generally lower than in other major economies.  The low level of financial indicators such as ROE in recent years in Japan is mainly due to the low rate of return on sales, which means that Japanese companies have recently not been able to create many innovations that generate high profits. Therefore, even if ROE has been improved in the short term by buying back shares, the essential problem remains. The key question is how to create innovations that generate high profits and help regain the original "earning power."  Labor productivity is also closely related to industrial structural issues. For example, Japan is currently the base for supply of raw materials and parts to US and European companies. Raising the prices of these products will increase labor productivity, but transformation of Japan's industrial structure is needed. The problem, however, is not that simple, and enhancing management discipline by shareholders alone will not increase labor productivity. General Principle 3: Ensuring Appropriate Information Disclosure and Transparency Companies should appropriately make information disclosure in compliance with the relevant laws and regulations, but should also strive to actively provide information beyond that required by law. This includes both financial information, such as financial standing and operating results, and non-financial information, such as business strategies and business issues, risk, and governance. Comment on General Principle 3(Ensuring Appropriate Information Disclosure and Transparency) Disclosure of non-financial information and ESG investment  To promote disclosure of non-financial information, there is a need to develop investment methods that focus on the relationship between ESG scoring etc., and a company's performance or stock price. Recently, how to quantify these ESG indicators and link them to sophisticated ESG Investment has been of great interest in financial markets. Some European institutional investors have been doing this for quite some time.  However, it has also been pointed out that it is difficult to measure results when indicators such as ESG scores are linked to the remuneration of directors and managers, there are also those who question the significance of the remuneration system that links the two. Regarding the improvement of ESG indicators through corporate activities, it seems that we should expect progress in ESG investment to be made by investors rather than linking the remuneration system to its successfu implementation. General Principle 4: Responsibility of the Board Given its fiduciary responsibility and accountability to shareholders, in order to promote sustainable corporate growth and the increase of corporate value over the mid-to long-term and enhance earnings power and capital efficiency, the board should appropriately fulfill its roles and responsibilities. Comment on General Principle 4 (Responsibility of the Board) Significance of "Grow the Pie" Perspective  The idea that both business and society can benefit might seem too good to be true. However, rigorous evidence suggests that companies that treat their stakeholders well deliver superior long-term returns to investors. Creating value for stakeholders is not just a worthy ideal but also good business sense.  If companies make social value the goal and remember the indispensable principles (materiality, multiplication, and comparative advantage), more often than not profit will follow.  We should return to the way of thinking that the company grows the pie (social welfare) by working to achieve its "purpose" under the oversight of shareholders and, as a result, enhances the interests of its stakeholders.  According to Professor Edward Rock (who is a reporter of the US "Restatement of Corporate Governance" project, "shareholder supremacy" does not mean the idea of "maximizing shareholder value" but means that "priority is given to the interests of shareholders when the interests of other stakeholders of the shareholders are fundamentally conflicting." Based on this way of thinking, a "grow the pie" perspective in company management does not contradict with the idea of "shareholder supremacy" even under the US Delaware Case law. General Principle 5: Dialogue with Shareholders In order to contribute to sustainable growth and the increase of corporate value over the mid- to long-term, companies should engage in constructive dialogue with shareholders even outside the general shareholder meeting. When establishing and disclosing business strategies and business plans, companies should articulate their earnings plans and capital policies, and present targets for profitability and capital efficiency after accurately identifying the company's cost of capital. Comment on General Principle 5 (Dialogue with Shareholders) "Dialogue with shareholders" is essential for "sustainable growth of the company and improvement of corporate value in the medium- to long term." and not as a dialogue with shareholders which is held exclusively to improve short-term shareholder returns and shareholder return rates. However, it has been said that actually "dialogue with shareholders has been mainly used by some shareholders who intend to increase the amount of distribution and share buybacks rather from the short-term perspective. The perspective of dialogue in line with long-term improvement of a company's value has not been sufficient. Comment on Principle 5.2 (Establishing and Disclosing Business Strategies and Business Plans) Capital efficiency, R&D investment etc. When evaluating companies, it is necessary to increase the weight of evaluations over the medium- to long-term span and to develop new practical indicators that match long-term growth and profitability. At the very least, we should consider company profits (among other aspects) in comparison to "total procurement costs (debt + capital)" and so forth (such as return on invested capital, or ROICO, and not solely with capital costs. For example, the buying back of shares improves ROE figures, but ROIC figures are not improved by the action. Even if ROE is used as one of the main indicators for the time being, it should be emphasized that the period of ROE measurement is not only in quarters or years but also in decades. Summaries 1. Although the statutory rights of shareholders at shareholders meetings are muc stronger than those of the US. (under the Japanese Companies Act), it seems that the focus of the Code is still on strengthening the rights of shareholders. 2. As for the dialogue with shareholders (engagement), the perspective of dialogue with long-term improvement t of a company's value is not sufficient in line 3. Due to the influence of the Code etc., takeover defense measures and cross shareholding at Japanese listed companies have been waning dramatically in recent years. It should be recognized that the number of companies that plan to delist is rapidly increasing because the pressure from shareholders has grown significantly in recent times. 4. As for the low level of ROE (and other such measures), even if the figures are improved in the short term by share buybacks and other moves, the essential problems will not be solved. Measures should be taken to create more innovations and regain “cramming power”