Join us in reading this book, The Only Way to Survive for Japan, subtitled "Corporate governance is sure to save our country." In this chapter, the author takes on the need for a clear head and separation for those playing more than one role in related businesses and foundations. Then, the chapter turns to how management can leverage whistleblowers for the company's greater good. But perhaps the bottom line of the corporate governance case studies is the need to stay fully informed and keep an open mind.
Find all published chapters at 'The Only Way to Survive for Japan'
Read Chapter 2.4, the 11th segment of the book:
Problems Involving Incorporated Foundations
The immediate appeal of the founding family was rejected, and Idemitsu Kosan Co, Ltd implemented a public stock offering. As a result, the shareholding ratio of the founding family, who is opposed to the merger with Showa Shell Sekiyu KK, dropped to about 26% from 33.92%. The management team was determined to continue to persuade the founding family, a major shareholder, to agree to the merger.
First of all, about 12.75% of the shares of Idemitsu owned by two public interest incorporated foundations, of which the founding family serves as the head, do not belong to the founding family. This point seems to have been disregarded.
If an individual donates such assets as shares to a public interest incorporated foundation, he/she will be exempted from income tax under certain conditions. No corporate tax is imposed on the public interest incorporated foundation, either. This can be used as a tax-reduction strategy. If so, the shares owned by the public interest incorporated foundation should not be under the control of the individual.
Disentangling Founding Families and Incorporated Foundations
There are some other concerns about incorporated foundations.
For example, DMG Mori Co, Ltd has actually allocated about 3% of the total number of shares issued by the company in the form of a trust to a general incorporated foundation, of which the president of the company serves as a representative director. Because ISS, a leading American proxy advisory firm, recommended voting against it, this item of business was passed by a slender majority with only 67.02% of the votes from the shareholders present at the general shareholders meeting.
It is agreed that the company and the general incorporated foundation shall not instruct the trust company to exercise its voting rights for their benefit. But I wonder how far they can go in exercising their voting rights against the wishes of the founding family.
If a director of an incorporated foundation exercises his/her voting rights attached to the shares owned by the incorporated foundation, it should be done solely for the interests of the incorporated foundation itself. I think that directors' voting rights should be exercised under the supervision of a meeting of directors with a third party present in order to make sure that their voting rights are duly exercised only for the benefit of the incorporated foundation not for the benefit of any other particular entity. Therefore, not only joint-stock corporations but also incorporated foundations should be subject to more discussion on effective governance.
(The Asahi Shimbun dated August 2017)
Governance of Overseas Subsidiaries
The Tokyo Regional Taxation Bureau pointed out that SoftBank Group Corporation had failed to declare about ¥93.9 billion JPY ($ 637 million USD) in corporate income during the four-year period through the fiscal year ending March 2016. The Tokyo Regional Taxation Bureau determined that the income of a subsidiary in a tax haven owned by a foreign company that the group had acquired in the past should be included in the total income of SoftBank Group Corporation.
The tax amount which it had failed to report was huge. However, the group was exempted from heavy penalty taxes on the grounds that the tax dodge was not determined to be a willful act. The losses incurred by the company in the past had been taken into account, and as a result, additional tax was calculated to be about ¥3.7 billion ($25 million). Then, the amended return was submitted and the tax was already duly paid.
This may happen to any Japanese corporation which makes it a goal to be globalized.
There can be seen an increasing number of cross-border M&A, by which companies acquire overseas companies in an attempt to gain access to overseas markets. But I wonder whether the parent company is able to have a sound grasp of the actual circumstances of the overseas subsidiary which is brought under the umbrella of the parent company?
There is no end to the number of scandals arising in connection with overseas subsidiaries, including those of Toshiba and Fujifilm Holdings Corporation. SoftBank Group Corporation was reportedly unable to have a clear understanding of the income regarding the affiliate of the company subject to acquisition, thereby failing to look into the possibility of any lurking problems on a timely basis.
Know What You're Buying Into
The root cause of the problem may be attributable to the lack of knowledge on the part of the parent company. There would be quite a few companies which consider it as easy to buy an overseas company as to buy another domestic company to add to the number of subsidiaries in Japan. "Now that you have become a member of our family, we don't need the means of language to understand each other."
Such emotional thinking is lost on the acquired overseas company. Especially, if the company has minority shareholders, they can accuse the parent company of its malfunctioning governance. Whatever it may be, it is quite doubtful if the parent company is staffed with competent personnel who can properly oversee and manage such subsidiaries.
It is absolutely indispensable for the company to have a solid grasp of the circumstances of the overseas subsidiary at the time of acquisition as well as after the acquisition in order to maintain and enhance corporate value. Also, it is necessary to build up governance leveled at the whole group along with the expansion in size.
(The Asahi Shimbun dated May 2018)
A Certification Regime for Corporate Whistleblowing Systems
There is an increasing tendency toward making corporate whistleblowing systems more practical. This is in order to detect problems lying in organizations at the earliest stage possible.
In the fall of 2018, the Consumer Affairs Agency will introduce a certification regime for corporate whistleblowing systems. In accordance with the guidelines regarding whistleblowing as provided by the Consumer Affairs Agency, each company itself evaluates its whistleblowing system in an effort to apply for registration as a company with a whistleblowing compliance management system. Such registration will be granted by the non-profit designated registration organization of the Consumer Affairs Agency.
From the fiscal year 2019, a third-party agency will be held responsible for evaluation and certification of each company's whistleblowing system, and the designated registration organization will register it if it is determined that the company's whistleblowing system meets the certification requirements. The purpose is to enable a registered company to publicize the reliability and safety of its products and services, thereby promoting the development and management of corporate whistleblowing systems.
The application of administrative measures and penal regulations on corporations which have resorted to vengeful dismissal or transfer of whistleblowers is being discussed, and a revised draft of the Whistleblower Protection Act was to be submitted to the ordinary diet session in 2019.
But these kinds of actions demonstrate that Japan's whistleblowing regime overall still leaves a lot to be desired.
Compliance Violations Have Consequences
The number of companies which were driven to bankruptcy because of compliance violations is still over 200, although it has been on a downward trend from fiscal 2015, when the year saw a record-high number. In order to get a grasp of any possible problems lurking in-house at the earliest stage possible and take proper measures in respect of them, it is important more than anything for an organization to secure the efficiency of its whistleblowing system as the last resort of the internal control regime.
For this purpose, the thinking and attitude of the top corporate executive counts the most.
Here is a top executive who exhibited exemplary behavior: In 2004, the representative director of Teijin Limited telephoned the whistleblower who had exposed some wrongdoing inside the company and thanked the person by saying, "Thanks to you, we were able to voluntarily disclose our scandal before it was too late." Thus, unless the corporate top executive is really serious about positively appreciating and leveraging whistleblowing, the employees of the company would hardly be able to trust its whistleblowing system.
It follows that if top executives lack awareness of the importance of whistleblowing, external force is required to act on them.
(The Asahi Shimbun dated August 2018)
Outside Directors and the MBO Guidelines
The Ministry of Economy, Trade and Industry opened a call for public comments necessary for formulating the "Guidelines for fair M&A." A study group set up by the Ministry of Economy, Trade and Industry in 2018 had been engaged in discussions to revise the current MBO Guidelines (established in 2007) and to produce new Guidelines.
Through an MBO (Management Buyout), the management of a listed company buys the shares from its shareholders and takes the company private, again. In MBOs, conflicts of interest and informational asymmetries exist between the management of the company, the buyer, and the shareholders, the sellers. The management who wants to buy the shares at cheaper prices may willfully refrain from providing sufficient and adequate information to the shareholders. Furthermore, the minority shareholders, fearing that they will be driven to let go of their shares at prices cheaper than the price of a takeover bid if the buyer resorts to a tool such as a squeeze-out, may accept the takeover bid even though they are not satisfied with the offered price.
It is exactly where outside directors are required to play their roles. More than ten years have passed since the establishment of the Guidelines, and it is true that the number of outside directors has drastically increased. But I just wonder if those outside directors are not necessarily cutting the mustard.
Good Outside Directors are Proactive
The new Guidelines state that an outside director is the most suitable as a member of the Special Committee which is to deliberate on the advantages and disadvantages of an MBO and the reasonableness of the transaction terms and the fairness of the transaction procedures. The Special Committee should not serve as a neutral third party, but is expected to make judgments in the capacity of promoting the interests of the company and its shareholders. There is an ever-increasing expectation for outside directors to supervise the conflicts of interest and to ensure the protection of the interests of minority shareholders.
The employment of an outside director just for the sake of formality is far from satisfactory. Unlike the United States, Japan lacks judicial discipline. Japanese corporations may blindly believe that their outside directors should act based on the theory of good human nature and just let them keep their positions as if displaying them on a Shinto altar. For realization of practically fair procedures and protection of the interests of minority shareholders, how to discipline outside directors should be seriously debated.
(The Asahi Shimbun dated June 2019)
Illegal Sales of Postal Insurance by Japan Post Insurance Co, Ltd, and Its Governance
In December 2019, Japan's Financial Services Agency issued a partial business suspension order as an administrative penalty to Japan Post Insurance Co, Ltd, and Japan Post Co, Ltd, for their illegal insurance sales.
Their parent company, Japan Post Holdings Co, Ltd, had failed to attain a clear understanding of the real situation and to take proper measures even though it was aware of how its subsidiaries resorted to such misconduct. Therefore, the Financial Services Agency issued a business improvement order to the parent company to encourage it to drastically enhance its governance for the purpose of building, establishing and implementing the governance system of the whole group.
But Japan Post Insurance Co, Ltd itself is a listed company including minority shareholders. How should a parent company govern its listed subsidiaries?
It is needless to say that any damage to the corporate value of the group as a whole should be prevented. At the same time the parent company is required to ensure independent decision-making by its listed subsidiary in order to protect the regular shareholders of the listed subsidiary when the parent company sets up the governance system of the listed subsidiary.
What the METI Guidelines Say
According to the guidelines of the Ministry of Economy, Trade and Industry, it is necessary for a parent company to increase the ratio of outside directors in its listed subsidiary when setting up any kind of group governance system.
But now we need to focus attention on the fact that the outside directors comprise a majority of the board of Japan Post Insurance Co, Ltd. According to the report of the special investigation committee, even after the issues had been unveiled under the guidance of the Financial Services Agency in the fall of 2018, proper information had not been disclosed to the outside directors of Japan Post Insurance Co, Ltd in a timely and appropriate manner.
If outside directors are not made to function effectively, no governance system would serve its purpose. If so, I think it would be better for Japan Post Holdings Co, Ltd and Japan Post Insurance Co, Ltd to convert to a company with a board of company auditors which can freely express their opinions being independent of the board of directors and investigate the business operators in their own right, thereby performing risk management in cooperation with each other.
What matters to governance is not "formality" but "practicality."
(The Asahi Shimbun dated February 2020)
Follow the book from Chapter 1, as it is published.
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Author: Shin Ushijima
