SOCIAL TOPICS (Archive): EMERGING ISSUES

Published, November 1999

       Besieged with serious economic woes in his country’s financial industry and markets, three years ago Japan’s then Prime Minister Hashimoto ignited the “Big Bang” — a plan to ensure that Japan’s markets would be “free, fair, and global” by the dawning of the next millennium. While headlines of mob influence, corporate racketeering, fraudulent accounting, insider trading and other scandals have not disappeared, we are witnessing the first wave of significant corporate governance reform at Japanese banks and multinationals. Some have voluntarily begun to implement reforms such as shrinking the size of boards of directors and cutting directors fees and executive compensation. Though not revolutionary by U.S. standards, these measures signal an acknowledgment by management that ineffective boards might have contributed to Japan’s financial predicament.

       Pressure to reform corporate governance continues to intensify. Large institutional investors like CalPERS, which has adopted specific governance guidelines for Japan, and others including the Corporate Governance Forum of Japan, are flexing their muscles in the movement toward reform. The Tokyo Stock Exchange recently started asking listed companies to report on corporate governance and may soon require that they comply with a set of governance standards.

       While Walden has been investing in Japanese companies and voting their proxies for three years, we have just established a set of global proxy voting guidelines that addresses issues specific to Japan. Our policies support increased board independence, transparency, and accountability to shareholders. To gain insight and baseline information on existing governance practices, Walden surveyed its top 20 Japanese holdings on director and statutory auditor independence, board size, and remuneration and nomination committees. We are encouraged that 80 percent of the companies responded.

       1999 Proxy Season Most Japanese boards are very large and composed exclusively of inside company executives, and have thus earned a reputation for being ineffective. Many Japanese companies continue to ensure a majority of pro-management shareholders through cross-ownership with related companies and connected board seats. This is changing as more banks (often major shareholders in their clients’ companies) divest of these cross-holdings.

       Board Size: In recent years many companies have reduced board size — some significantly. According to Global Proxy Watch, in 1999, 37 companies asked shareholders to approve a reduction of board size from an average of 20 to 40 directors to an average of 10 directors. Another 100 companies attempted smaller reductions. According to policy, Walden supported proposals asking for a reduction in board size. In our survey, over 50 percent of respondents claimed they had or were considering reducing board size.

       Board Independence: Almost all of the companies Walden surveyed said that they had no independent directors and were not contemplating adding any soon. Many cited the lack of qualified independent directors. One respondent stated, “If the concept of true corporate governance took hold in Japan and we were able to locate potentially beneficial candidates, [we] would be more than willing to consider adding an independent director or directors to our board.” By contrast, our expectation of US companies is that at least half of the directors should be independent. We withheld support of over 90 percent of Japanese director slates due to a lack of independent directors in conjunction with little advance notice of proxy agendas.

       Independent Statutory Auditors (second tier of the board): Japanese Commercial Code requires at least one statutory auditor to be an outsider. Statutory auditors have an informal mandate to oversee internal financial and management conduct for shareholders. This year, shareholders saw more “outsiders” as many companies reported having more than one. However, the legal definition — anyone that has not been an employee of the firm or any of its subsidiaries within the past five years” — does not guarantee independence. As is our policy, Walden supported “outsider” statutory auditors and voted against additional “insider” statutory auditors.

       1999 Annual General Meetings: Four out of five Japanese companies hold their annual general meeting on the same day, without giving sufficient advance notice of proxy agendas. This year, over one hundred of our portfolio companies held their annual meeting on the same day. With such a great number of proxies to review in a compressed timeframe, it is exceedingly difficult for shareholders to cast their votes thoughtfully. However, a few leading companies broke with this tradition. Canon went so far as to give advance notice of its proxy agenda on the Internet.

       What catalyst will push Japanese companies to institute real corporate governance reform? Another financial crisis? Regulatory reform? What role will the Tokyo Stock Exchange take to further encourage better corporate governance of its listed companies? As we wait and see, Walden will continue to push its Japan-based portfolio companies by communicating with management through proxy voting, surveys, and letter writing. In addition, Walden will continue to be active in forums such as the International Corporate Governance Network to promote global corporate governance standards and share-voting reforms.