Japanese firms to appoint more outside directors to improve governance

Western investors have long criticized Japanese corporations for weaknesses in governance. The lack of outside directors on many boards is one of the issues.

Two major corporate scandals in 2011 brought the issues into sharp focus. In one, the camera maker Olympus Corporation was shown to have fraudulently concealed investment losses of US$1.5 Billion for 20 years. In the other, subsidiaries of Daio Paper Corporation transferred US$139 million to its chairman to fund his gambling habit.

The scandals helped accelerate changes that were already taking place gradually. Today, nearly 61 percent of firms listed on the Tokyo Stock Exchange (TSE) now have outside directors, up about 6 percentage points from September last year, according to a survey by the Nihon Keizai Shimbun newspaper published this July.

Companies that have installed outsiders on their boards this year include Toyota Motor Corp., Fanuc Corp., Hitachi Ltd., and Mitsubishi Chemical Holdings Corp.

While the scandals were a spur to change, there are other forces also at work.

An influential study by Tokyo’s Waseda University found that companies with transparent operations tended to see earnings rise when they installed outside directors.

TSE statistics support these findings. Companies with more outside directors than internal ones have an average return on equity of 12.75 percent, while the ROE for firms where outside directors account for less than one-third of the board is a mere 1.17 percent. There may be other factors at work behind the differences, but the correlation is striking. Even so, only 2.6 percent of firms listed on the first section of the TSE have more outside directors than internal ones.

For corporations operating internationally and on a large scale, the increasing complexity of their worlds is also a driver for change. Toyota is a case in point. In 2010, the company was severely criticized for its handling of a faulty accelerator problem that led to the recall of 4.2 million vehicles worldwide. In the USA, a California judge recently approved a settlement that will pay US$1 billion to Toyota vehicle owners affected by the recall. The criticisms, the reputational damage, and the costs prompted much soul searching.

This June, Toyota appointed three outside directors, the first in the company’s history, including a former group vice president for General Motors Corp.

"We would like advice so that we can avoid making bad judgments," Toyota President Akio Toyoda said at that time.