Japan Association of Corporate Directors
Yoshihiko Miyauchi, Chairman
There are still no signs of the end of the global COVID-19 pandemic that started early in 2020. Even during this difficult time, the growth of the global economy is continuing.
Dramatic changes are taking place in the activities of companies. One example is the rising interest of companies and institutional investors worldwide in the Sustainable Development Goals and in environmental, social and corporate governance (ESG) measures. In Japan, activities to end the COVID-19 pandemic are currently the highest priority. Companies in Japan are also very aware of the urgency of environmental issues such as the need to reduce CO2 emissions.
The promotion of corporate governance as a measure for corporate growth, which has been an issue in the past, is about to be further promoted. Now we are seeing a further increase in these activities. Two significant events are proposed revisions to Japan's Corporate Governance Code and the decision of the Tokyo Stock Exchange to create a new market section called the Prime Market. There are many important points concerning revisions to the governance code. The most noteworthy is increasing the number of independent directors to one-third or even a majority of all directors at Prime Market listed companies.
Increasing the number of independent directors is definitely an important step concerning corporate governance. In order to achieve the objectives of corporate governance, it is important to prepare the frameworks. However, without sufficient consensus building on the essence of corporate governance, there is a concern that the frameworks alone will be sufficient, and the results will not be effective. The essence of governance is the sustained creation of value over many years and a commitment to corporate social responsibility. In order to achieve this, governance also requires the oversight of how a company's executives conduct business activities for sustained growth by external individuals who can view markets from a perspective that differs from that of these executives.
As the COVID-19 pandemic brings about momentous changes to behavior and awareness on a global scale, there is no doubt that corporate governance has advanced to a stage that requires enormous reforms involving company executives and the board of directors.
This year, the Japan Association of Corporate Directors (JACD) will reach its 20th anniversary. Our operations started as amendments to the Companies Act in 2002 established the new corporate governance structure called the company with committees. Other major events since the JACD's inception are the establishment of the Stewardship Code and the Corporate Governance Code. Overall, corporate governance in Japan is very different now than it was 20 years ago.
I am very grateful for the constant activities and cooperation of our members that have enabled the JACD to play a meaningful role in strengthening governance. One element of this role is our responsibility to raise questions about recent activities involving governance and submit new proposals.
For example, the current proposed Corporate Governance Code revisions includes points that need to be closely examined. One point concerns the roles and duties of independent directors, who are the key component of governance. Normally, these roles and duties are believed to be providing advice to management, disclosing a director skill matrix concerning this advisory function and other activities related to how business operations are conducted. However, the code revisions appear to place more emphasis on these roles and duties than on the traditional management oversight role of directors. It is unfortunate that this is being used as a reason for the shortage of suitable people to be independent directors and the lack of confidence in independent directors caused by scandals at large Japanese companies and other considerations. As a result, there has been very little progress with discussions about the roles of independent directors.
No clear understanding exists about the original purposes of governance and the reasons for electing independent directors. Simply adding independent directors to the board is not enough. Companies must establish frameworks that allow these directors to perform their roles. Frameworks encompass the separation of management oversight and business operations, an understanding by senior executives of the monitoring function of directors, an understanding of independent directors of what they should and should not do, and other items. I believe that the inadequacy of these frameworks is the reason for the lack of a clear understanding of the objective of governance.
The role of independent directors is the assessment of the results of operations generated by executives for business operations in relation to the targets, while also taking into account short, medium and long-term market trends. Pointing out minor problems is not part of this process. Independent directors instead focus on encouraging the CEO to aim for more growth and providing support for accomplishing that goal. Assessments are vital for the proper functioning of the Remuneration Committee, which determines individual remuneration, and the Nominations Committee, which identifies people with the potential to become executives, replaces executives if prospects for growth are poor and takes other actions.
Many companies in Japan have started placing emphasis on altering the mindsets of employees, in part because of the effects of the COVID-19 crisis. However, companies should realize that it is the CEO's thinking rather than that of employees that needs to change.
As these changes take place, the JACD is focusing on three key issues.
First is a fundamental question about governance systems in Japan. Currently, the Companies Act provides for three governance structures. However, these structures may have a negative effect on the ability to establish sound governance systems. We need to think about ways to resolve this problem.
Second is concerns about the current status of governance in which directors and corporate auditors are mostly allowed to be regarded in the same way. In fact, the auditing function of directors and the role of corporate auditors are completely different. Corporate auditors are involved with how business operations are conducted and clearly have no function concerning governance. Therefore, we want to clearly define the roles of directors who are Audit Committee members.
Third is the need to clearly define the roles of the Audit Committee, Nominations Committee and Remuneration Committee.
The JACD will continue to study these issues as we move from general discussions to examinations of specific points. Our committees will hold discussions, prepare position papers and conduct training programs with the goal of increasing the comprehension of these issues by executives who conduct business operations and directors.
As I mentioned earlier, many listed companies in Japan still do not have a thorough understanding of the elements of governance. Some companies are making progress toward establishing a proper governance structure and using this governance for the growth of sales and earnings. We recognize these accomplishments with our Corporate Governance of the Year award.
The JACD is dedicated to enabling many companies acquire an accurate and complete comprehension of governance. We will continue our activities for giving executives who conduct business operations, independent directors and institutional investors an understanding of the type of governance that Japan requires now. Our objective is to help companies contribute to the advancement of the Japanese economy.
Altering the structure and activities of the board of directors in line with the traditional purposes of corporate governance will not be easy to accept at times for executives who conduct business operations. The longer executives have worked and remained loyal to their companies to earn their promotions, the more these individuals will resist evaluations by people from outside the company. However, executives must deal with immense challenges. For instance, companies need to overcome competition on a global scale, respond to increasing uncertainty, as demonstrated by the COVID-19 pandemic, and incorporate rapid information technology progress in their business operations. No company can meet these challenges and expect further growth in the same way as before.
To succeed, company executives need to switch to a mindset that differs from the conventional thinking about management. Specifically, companies should be guided by a consensus of the executives for business operations and the board of directors concerning the commitment to sustained grow and decisions about what needs to change. Furthermore, the company's performance, which is the result of this consensus, must be evaluated by independent directors, who are not involved with business operations. The support of institutional investors is necessary too.
The JACD will be working on numerous problems to accomplish these goals. For example, we urgently need more CEOs committed to addressing these issues. In addition, it is also essential to have more independent directors capable of accurately evaluating the performance of their companies and assessing their impact on society and environment. Another challenge is to create a credible financial market and to take action by institutional investors to support their growth with companies.
The JACD is the only organization in Japan that facilitates the sharing of information and opinions concerning corporate governance and management. I believe our association is in an excellent position for more progress during our next 20 years as we work with even more partners and build on the strong support of our members.