Commentary: Japan: Learning the Hard Way

By Brian Bremner

In the land of the sinking Nikkei, corporate governance is finally getting a little respect.

On Apr. 24, Sony Corp. Chairman Nobuyuki Idei told investors his company has added eight -- count 'em, eight -- outside directors to its reformulated, 17-person board, including Nissan Motor Co. President Carlos Ghosn. And Toyota Motor Co. announced in April a major restructuring that will slim down its board and make it more responsive to shareholder concerns. The auto maker has also just started reporting quarterly earnings for the first time. And it has beefed up its investor-relations department, once a backwater.

Other big names such as Toshiba, Hitachi, and giant retailer Aeon are also launching board shakeups. Says McKinsey & Co. Director Masao Hirano: "There is now an overall concern that companies need more transparency."

This is indeed progress in a land where good corporate governance used to mean paying off sokaiya -- gangland thugs -- so they wouldn't ask embarrassing questions during annual meetings. And it follows the much-ballyhooed Apr. 1 revision of the Japanese commercial code that gives companies the option of replacing their enshrined, insider-stacked boards and audit systems for more open and independent U.S.-style overseers.

It's easy to see why the best Japanese companies are paying more attention to outside shareholders. For one thing, more whistleblowers have stepped forward to reveal the appalling lack of disclosure in some major companies. At Tokyo Electric Power, for example, a contract worker kicked off a storm when he fingered the company for falsifying safety reports on its 17 nuclear power reactors. In the subsequent political blowup, its president, Nobuya Minami, was forced to resign.

Scandals help; so do hard economic times. Friendly banks used to own gobs of stock in their Japanese corporate clients, who were never prodded to clean up their governance. But the banks, hard-pressed to raise cash, are unwinding their portfolios, knocking down their share of Japan's stock from 41% in 1996 to 35%.

As the banks pull back, the foreigners step in, and they want companies that produce clear financials and strong results. Wilbur L. Ross, whose U.S. private equity fund, W.L. Ross & Co., manages assets around the world, sees "a huge need for good corporate governance in Japan," but judges that "the environment is changing." With that in mind, he is raising a $1 billion Japan investment vehicle called the Taiyo Fund that will sink money into small companies. CalPERS, the feisty California pension administrator, is a $200 million investor. Ross sees "a whole world of good little companies out there" that with better management and more transparency would be attractive to investors.

It's encouraging -- but there's more to do. The bluest of Japan's blue chips are starting to sing the governance gospel. But as many as 80% of all the listed companies in Japan still don't give a hoot. Why should they, when the government props up Japan's sick banks, which in turn roll over loans to scarcely viable construction companies, retailers, and golf course developers? Listed companies have cut their debt levels by $30.6 billion since 1998 -- but banks forgave $28 billion in the same time period, according to HSBC Securities. That means "a lot of zombie companies are still dancing," quips Akio Mikuni, president of credit-rating agency Mikuni & Co. Meanwhile, with no real restructuring in sight, outside investors suffer.

Even some smaller Japanese companies with surplus cash and low debt loads aren't necessarily interested in shareholder value. A case in point was the surreal proxy battle last year between $480 million apparel maker Tokyo Style and a Japanese fund group, M&A Consulting, which owned an 11% stake. Tokyo Style was sitting on $1 billion in cash and securities, about 70% of its total assets, but paid a skimpy dividend and had no clear expansion strategy. M&A wanted to liberate some of that cash for shareholders. It should have been a lay-up. But M&A lost at the showdown shareholder meeting after Tokyo Style management rallied friendly big shareholders. M&A plans to try again this year.

What's needed to complete the revolution? The banks have to shed the remaining stocks in their portfolios and leave their clients completely exposed to market forces. Big leaps forward in the quality of corporate management "will only happen if big institutional investors see all this as critical," says Hiroshi Nonomiya, managing director of New York-based Ripplewood Holdings LLC, a private equity fund that holds stakes in Shinsei Bank and other companies. The Japanese government should encourage more foreign direct investment; Prime Minister Junichiro Koizumi has said he wants to double foreign investment over the next five years.

The final thing needed is the toughest of all: More pain. Only the savaging of the Nikkei has forced Japan Inc. to make any progress in governance at all. Another downward lurch in stock prices would certainly hurt. But if it forced more companies to boost their governance, Japan would be the winner.

Bremner reports on Japanese business from Tokyo.

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