Implementation of Corporate Governance Incentives and Reforms toward an Increase in Corporate Value

Transcription

1 Implementation of Corporate Governance Incentives and Reforms toward an Increase in Corporate Value July 24, 2015 Corporate Governance System Study Group Ministry of Economy, Trade and Industry

2 Table of Contents Section 1. Changes in the environment and the necessity of responding 1. Changes in the environment surrounding Japanese companies 2. Direction of future responses Section 2. Basic concepts 1. Creation of incentives for a mid- to long-term increase in corporate value 2. Utilization of the oversight function of boards of directors 3. Securement of the mobility of human resources who perform oversight functions and utilization of the roles and functions of outside directors 4. Necessity of deliberations based on both specific efforts (practices) and systems Section 3. Specific Measures 1. Presentation of practices of companies (1) New board practices (2) Practical, well-designed efforts for the design of remunerations and utilization of D&O insurance 2. Clarification of relevant legal interpretations, etc. (1) Matters to be discussed at boards of directors meetings (2) Outside directors roles and functions, etc. (3) Conditions for appointment of officers (4) Introduction of new stock-based remuneration systems

3 Section 1. Changes in the environment and the necessity of responding 1. Changes in the environment surrounding Japanese companies With the arrival of the artificial intelligence (AI) and big data era, in the midst of a fully globally competitive era, global competition has become unprecedentedly intense; for example, sweeping changes from conventional industrial structures and discontinuous innovations are required, and a drive toward greater cost efficiency has become paramount. Under these circumstances, it is important to improve the mid-to-long term profitability and productivity of Japanese companies in order to enhance Japanese companies earning power. The formulation and introduction of Japan s Stewardship Code (February 2014), the enforcement of the amendments to the Companies Act (May 2015) toward the securement of outside directors, and the formulation of the Japan s Corporate Governance Code (applicable from June 2015) have been carried out against this backdrop. Previous statistical data, in particular, shows that Japanese companies have tended to be stability-oriented, or to prefer a low-risk, low-return approach. In comparison with major member countries of the Organisation for Economic Co-operation and Development (OECD), the return on equity (ROE) and return on total assets (ROA) of Japanese companies have been at markedly low level in terms of both median and variance. Meanwhile, Japanese companies face a host of other challenges and needs, including how to improve the business environment so as to allow individual human talent to exercise and reach their fullest potential, and to secure diversity in human resources, including women, while simultaneously struggling with structural constraints at the macro level, such as a decrease in labor input due to a declining population as well as a falling birthrate and an aging population. In a situation where the establishment of new mechanisms and business models beyond the conventional is required, how to respond to more intense competition, which will be even more intense in the future, entails in part how to recruit superior human resources internally and externally, and becomes an ever increasingly important

4 strategic issue. In conclusion, under heightened uncertainty that has never before been experienced, in a situation which necessitates significant improvement in productivity, how to incentivize and motivate human resources, including management and employees of companies, so as to respond to expectations from the capital markets, has become a pressing and important issue. 2. Direction of future responses In a situation where unprecedented improvement in productivity is required, the setting of a vision, strategy, and performance targets, which should be pursued by individual managers and employees, must be rational and clearly defined in order to contribute to a mid-to-long term increase in corporate value. Additionally, it is necessary to provide satisfactory conditions whereby companies and individuals are able to best pursue and achieve their goals. If such target setting or provision of motivation is not appropriate, intangible assets accumulated by companies can become inefficient or unable to meet expectations from the capital market. Meanwhile, in a situation where it is necessary to deal with matters under unprecedented uncertainty, unpredictable events are likely to occur during the execution of business, even after setting targets. If individuals persist too much in pursuing their own initial targets and are unable to respond promptly and flexibly to changing events, they could completely miss opportunities for growth. Therefore, it is recommended that ex-post evaluations on the achievement of targets should be flexible in light of changing circumstances. This flexibility of ex-post evaluations, however, can be an obstacle to commit to individual targets depending on the situation, which may not motivate individuals to make appropriate efforts. It is necessary to take this potentially negative result of ex-post evaluations into consideration. In other words, for the pursuit of improvement in productivity under this uncertainty, it is necessary to design an incentive system which will dynamically meet the requirements for clarity and flexibility, which are apparently contradictory, for individuals in a creative ways.

5 These propositions have been raised between shareholders and directors, between boards of directors and executives, such as representative (or executive) directors or executive officers, and between executives and employees, separately. Current discussions of corporate governance reform seek to answer the question of how to design these bundles of incentives to be rational. Note that this report will limit focus to deliberations on matters between shareholders and directors, and between boards of directors and executives. Section 2. Basic concepts 1. Creation of incentives for a mid- to long-term increase in corporate value Conditions for the appointment of officers, including their remuneration, insurance, and indemnification conditions, have primarily been considered to be costs for companies. Therefore, the contents of and the procedures for decisions on regulations for remuneration have also been considered, in order to prevent self-serving determination of remuneration. However, the conditions for the appointment of officers contribute to the securement of excellent human resources, sourced both internally and externally, and the creation of appropriate motivation for executives, including managers, for the sake of raising corporate value over the mid-to-long term, can be considered as investments in the company s future. The appropriate utilization of conditions for the appointment of officers, including their remuneration, insurance, and indemnification conditions, makes it possible to secure excellent human resources internally and externally and to create incentives for executives, including managers, toward a mid- to-long term increase in corporate value. 2. Utilization of the oversight function of boards of directors As mentioned above, in order to provide appropriate incentives for managers, the effective functioning of the board of directors is a precondition. The function of a board of directors is to undertake the following matters in addition to the fundamental management strategies and management plans: overseeing by evaluating business execution through the appointment of management and determination of remuneration (oversight function), and specific decision making for business execution (decision-making function).

6 That is, boards of directors fulfill both overseeing and decision-making functions. Traditionally, the board of directors in Japanese firms have mainly focused on and fulfilled the decision-making function. Internationally, however, boards of directors are expected to fulfill mainly the oversight function, on the assumption that this in turn determines the fundamental management strategies and management plans. According to the Japan s Corporate Governance Code, boards of directors in Japan will benefit by strengthening their functions in a similar way regardless of their organizational design. When boards of directors exercise their oversight function, based on fundamental management strategies and management plans, and managers fail to make appropriate efforts, it will be necessary to respond strictly, such as by replacing the managers. and managers make appropriate efforts, it will necessary to positively evaluate their work, and in some cases, it may be necessary to protect the managers from temporary, emotional criticism based on external causes that cannot be controlled by the managers. In conclusion, the utilization of the oversight function mentioned above will make it possible to drive the resolute decision-making of managers toward a mid- to-long term increase in corporate value. 3. Securement of the mobility of human resources who perform oversight functions and utilization of the roles and functions of outside directors In accordance with the Japan s Corporate Governance Code, under the comply or explain rule, it is necessary to appoint at least two independent outside directors. The outside directors, who perform oversight functions, also need to make judgements, from the point of view of the managers, to evaluate business management through the appointment of officers and determination of remuneration. Thus, personnel who have experience in company management are strong and also primary candidates for outside directors. It is desirable, therefore, that personnel who have experience in company

7 management actively serve as outside directors beyond their own industry or sector. In this regard, for example, it is necessary that chief executive officers (CEOs) who have retired from a company assume positions as outside directors at other companies rather than as consultants for their own companies, and that executive director-level personnel who have experience in the management of their group company assume their positions as outside directors at other companies. Regarding such executive director-level personnel in particular, it is expected that their knowledge gained from such experience as outside directors at other companies will further contribute to the management of their own company. In addition, it is also desirable that such personnel who perform oversight functions be given incentives, including through mechanisms that are appropriately evaluated in the human resource market according to whether or not they perform the functions described in Paragraph 2, so that the personnel will appropriately fulfill their functions. By utilizing the roles and functions of outside directors who are appointed through such mechanisms, such as by involving designs for remuneration, an appropriate design for incentives can be realized (as described in Paragraph 1) and also the oversight function of boards of directors can be enhanced (as described in Paragraph 2). Consequently, this will make it possible to drive the resolute decision-making of managers toward a mid- to-long term increase in corporate value. 4. Necessity of deliberations based on both specific efforts (practices) and systems It is the essential purpose of the enhancement of corporate governance to increase corporate value over the mid-to-long term. A mere superficial deployment of governance systems may result in only generating corresponding costs for companies. In light of recent systemic improvements, it is truly important for every company to enhance its efforts (practices) relating to corporate governance and to utilize them for a mid-to-long term increase in corporate value. In order to increase corporate value over the mid-to-long term in light of recent systemic improvements, at this very moment, re-arrangement focused on both their specific practices and systems relating to corporate governance is necessary. This report, based on deliberations in previous Study Group meetings, describes the

8 basic concepts of corporate governance, which are necessary for a mid-to-long term increase in corporate value, in Paragraphs 1 through 3 above, and compiles specific policies and measures in Section 3 in order for them to be put into practice. However, note that practices related to corporate governance should be well designed by each company depending on its own situation, and the practices described in this report should not be regarded as recommendations for all cases. Section 3. Specific Measures 1. Presentation of practices of companies (1) New board practices While the Japan s Corporate Governance Code requires the strengthening of the oversight functions of boards of directors in light of fundamental management strategies and management plans regardless of their organizational design, most boards of directors of Japanese companies have mainly served as decision-making bodies. Also, although the introduction of outside directors by Japanese companies has steadily progressed in light of the system enhancement, the number of outside directors who are playing active roles in companies has not necessarily been large or diverse. Therefore, not many practices concerning issues surrounding how boards of directors exercise their oversight functions, what roles outside directors specifically play, and what functions they specifically fulfill have been undertaken. Furthermore, while it will be necessary for each company to respond to the Japan s Corporate Governance Code, including through the strengthening of the oversight functions of boards of directors and the introduction of outside directors, not all the practicalities concerning boards of directors that this code envisions are familiar to Japanese companies. Therefore, the Study Group has compiled actual cases of practices of boards of directors of Japanese companies (board practices) in expectation that Japanese companies will be able to refer to these board practices when conducting independent deliberations and

9 efforts including the strengthening of the oversight functions of boards of directors and the introduction of outside directors in light of the Japan s Corporate Governance Code. (2) Practical, well-designed efforts for the design of remunerations and utilization of D&O insurance The situation surrounding incentive remuneration including mid-to-long term performance-based remuneration in Japan is that it is not adequately utilized. It is pointed out that Directors & Officers Liability insurance (D&O insurance), which is broadly used in Japan, can be further utilized. Therefore, in order to effectively make use of the functions of remuneration as an incentive, perspectives for fundamental deliberations on the design of remuneration are presented, and based on this presentation, specific cases of each company s design for remuneration are compiled. In order to further utilize D&O insurance, perspectives on practical deliberations for companies and officers are presented. 2. Clarification of relevant legal interpretations, etc. (1) Matters to be discussed at meetings of boards of directors In Company with Audit & Supervisory Board (Kansayaku-kai), it is mandated that decisions on the execution of important operations including the matters listed in any of the items in Article 362, Paragraph (4) of the Companies Act should be discussed at meetings of boards of directors. While the overwhelming majority of Japanese companies are Company with Audit & Supervisory Board (Kansayaku-kai), the oversight functions of boards of directors need to be strengthened in light of fundamental management strategies and management plans regardless of their organizational design as described in Item 2 of Section 2. Legal interpretations relating to the scope of the execution of important operations in light of the roles and functions of boards of directors are presented. (2) Outside directors roles and functions, etc. Outside directors roles and functions are presented from a legal perspective, and

10 based on this interpretation, the scope of the execution of operations that would cause outside directors to forfeit their outsideness in the event that they perform such acts and the scope of outside directors obligations to oversee other directors are specified. By doing so, legal interpretations relating to outside directors roles and functions are presented. (3) Conditions for appointment of officers Conditions for appointment of officers including officers remuneration, indemnification by the company, and D&O insurance are one of the important mechanisms in corporate governance for providing officers, including executives, with appropriate incentives and preventing them from excessively avoiding risks. The matters described below are presented focusing on their functions as incentives and the securement of appropriate decision-making procedures as aspects common to these conditions as well as considering the utilization of outside directors roles and functions. Officers remuneration: in Company with Audit & Supervisory Board (Kansayaku-kai), procedures required when determining remuneration in light of its function as an incentive from the viewpoint of preventing self-serving determination of remuneration. Indemnification by companies: although indemnification by companies (a procedure under which, in the event that officers liability for damages is pursued, their companies indemnify them for the amount of money that these officers are liable to pay for the said damages and costs in disputes) is not expressly prescribed in the Companies Act of Japan, procedures for lawfully conducting this indemnification, etc. Insurance premium burden for D&O insurance: although currently, in practice, insurance premiums for D&O insurance for coverage options for shareholders representative actions are personally borne by officers, procedures necessary for the insurance premiums to be borne by companies. Decisions on whether to file actions to enforce liability against directors: In Company with Audit & Supervisory Board (Kansayaku-kai), it is the Audit & Supervisory Board Members (Kansayaku) who decide whether to file actions to enforce liability against directors. When decisions on whether to file such actions are made, it is necessary to comprehensively take into consideration matters including disadvantages caused by cases where such actions are filed and the

11 possibility that directors may avoid proactive decision making in the future, utilizing outside directors roles and functions at the time of such decisions. When each company selects officers remuneration systems to be employed, the effects of tax systems can be one of the factors to be considered. Matters concerning tax systems relating to officers remuneration including whether or not the inclusion of officers remuneration as deductible expenses is permitted, for example, in the event of provision of performance-based remuneration, were pointed out at the meetings of the Study Group. Deliberations on the enhancement of systems necessary to further utilize conditions such as officers remuneration, including deliberations on such allowances in the tax system, is considered. As for decisions on whether to file actions to enforce liability against directors, in cases where the oversight functions of outside directors are appropriately utilized, and Audit & Supervisory Board Members (Kansayaku) decide not to file such actions based on this utilization, and these decisions are reasonable, it is appropriate that shareholders should not file such actions either, giving proper regard to those Audit & Supervisory Board Members (Kansayaku) decisions. It will be worth considering in the future taking measures such as the establishment of a mechanism by which the courts can dismiss such actions in cases where shareholders file representative actions despite Audit & Supervisory Board Members (Kansayaku) reasonable decisions not to file such actions. (4) Introduction of new stock-based remuneration systems Stock options that aim to realize a status similar to shareholding, called stock options as stock-based remuneration (stock options whose exercise price is extremely low, such as one yen), already exist in Japan. In order for Japan to introduce systems similar to the performance shares and restricted stocks that are broadly employed in Europe and the U.S. as mid-to-long term incentives, new stock-based remuneration systems using trusts are beginning to be introduced. Furthermore, legal matters in cases where stock-based systems are introduced by contributing in kind to claims for monetary remuneration are presented. End of document

12 Roster of the Corporate Governance System Study Group (Titles omitted) Chairman Hideki Kanda Professor of Graduate Schools for Law and Politics / Faculty of Law, The University of Tokyo Yasuhisa Abe Managing Director, Keidanren Nobuyuki Isagawa Professor of Graduate School of Business Administration Division of Business Administration Kobe University Takeyuki Ishida Executive Director at Institutional Shareholder Services Akitsugu Era Vice President, Head of Corporate Governance, BlackRock Japan Co. Ltd. Kenichi Osugi Professor of Law School, Chuo University Akiyoshi Oba President & CEO, Tokio Marine Asset Management, Chairman, The Securities Analysts Association of Japan Yasuhiro Osaki Professor of Law, Waseda University Hiroyuki Kansaku Professor of Graduate Schools for Law and Politics / Faculty of Law, The University of Tokyo Atsushi Kunii Staff Executive Director, Legal & Compliance, Astellas Pharma Inc.

13 Keizo Kuromi General Manager, Corporate Legal & General Affairs Dept., Sumitomo Corporation Minoru Sawaguchi Partner, Mori Hamada & Matsumoto Masaki Shizuka Director & Senior Executive Officer, Tokyo Stock Exchange, Inc. Takaya Seki Managing Director, Corporate Practice Partners, Inc. Kazuhiro Takei Partner, Attorney at Law, Nishimura & Asahi Yuichi Tashiro Senior General Manager, Global Legal Administration Center, CANON INC. Shirou Terashita President and CEO, IR Japan, Inc. Daisuke Hamaguchi Chief Investment Officer, Pension Fund Association Masayuki Hirose Chairperson, Japan Audit & Supervisory Board Members Association Tomotaka Fujita Professor of Graduate Schools for Law and Politics / Faculty of Law, The University of Tokyo Shozo Furumoto General Manager, Head of Division, Legal Division, Nippon Steel & Sumitomo Metal Corporation

14 Noriyuki Yanagawa Professor of Graduate School of Economics, The University of Tokyo Observers Toshikazu Takebayashi Counsellor, Civil Affairs Bureau, Ministry of Justice Motoyuki Yufu Deputy Director-General, Planning and Coordination Bureau, Financial Services Agency (previously Director, Corporate Accounting and Disclosure Division)