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The lack of board independence has been a persistent drag on corporate governance in Japan, where top executives have too often wielded excessive power in public companies. 

The problem has often been blamed on Japanese traditions such as lifetime employment and seniority-based promotion, both of which tend to slow board turnover. But we believe a key obstacle to board independence lies in the C-suite’s sway over the remuneration of directors. At about one third of listed Japanese firms, the CEO has the final say on pay packets for board directors, based on our estimates.

Taking action

In 2021, we saw an opportunity to take action to address the issue. Ongoing revisions to Japan’s Corporate Governance Code and recent amendments to the Companies Act have both strengthened the case for better governance. In April, Fidelity International launched a campaign in Japan to engage our investee companies on curtailing CEO influence and instead empowering the board with remuneration decisions. So far, our Sustainable Investing team in Tokyo has sent letters to around 400 companies and held online meetings with representatives of several dozen firms. Besides engagement, we have revised our voting policy to put pressure on managements that fail to address the problem. 

Getting results

The early indications are that our stewardship efforts, which echo Japan’s ongoing governance reforms, are starting to pay off as an increasing number of investees commit themselves to the protection of board independence. More than half of the 44 companies that we met with in recent months to discuss the issue have already taken action to free their board members’ remuneration from C-suite influence, according to their latest business reports. 

One of our investees that have acted swiftly to solve the problem is a leading automotive chipmaker. When we met with its representatives in April, the company had already been operating under a board structure that was relatively independent by Japanese standards. Three out of four members of its remuneration committee were independent, as were all members of its nomination committee - well above the average in corporate Japan. Nevertheless, the power to decide board members’ pay levels ultimately rested with the CEO.

The firm recently reviewed its internal policies to enhance board independence. When we met again in September, company representatives confirmed that they had removed the CEO’s power over remuneration. 

Another investee, a machinery maker with a market cap of around $50 billion, has also made fast progress on board independence. Fidelity has been engaging this company in governance improvement since 2017 and started to raise more board-related issues in early 2021. The company followed our advice to free board members’ remuneration from CEO control in the second quarter, when it raised the ratio of independent non-executive directors to 40 per cent from 20 per cent. In addition, the company in June appointed the first female board director in its 63-year history.

Another recent example is a dialogue with a consumer goods manufacturer. Despite several conversations with their staff, they were initially reluctant to review their CEO’s influence over the remuneration of directors. We then managed to have a one-to-one conversation with the company’s high-profile founder and CEO and, after asking him directly,  we succeeded in getting him to commit to reviewing the process.

Bigger-picture reforms

Our recent engagement campaign has benefited from Japan’s years-long drive to enhance corporate governance, which is a key part of the country’s stock market reform. Japanese regulators enacted the Corporate Governance Code in 2015 and have been revising it every three years, starting with updates in 2018 and again in 2021. Encouragingly, over the last six years, the average ratio of independent non-executive directors in Japan has been steadily climbing - to 36 per cent from below 20 per cent - although it still lags UK and US levels. 

In June, the latest version of the code was published, with higher requirements on board diversity and independence. Governance requirements will form part of the threshold for the new Prime Market segment of the Tokyo Stock Exchange, which will be reorganised into three tiers in April 2022. Companies in the top-tier Prime Market would generally be better positioned to raise capital and promote their brands, but they are required to have independent nomination and remuneration committees. Many of our investees have been well-prepared for the new requirements, as we started engaging them in dialogues on board diversity and independence as early as last year.

Besides the governance code, amendments to the Companies Act in March have also contributed to the protection of board independence. As a result of the amendments, companies are now required to disclose in their business reports whether executives hold the power to decide the remuneration of board directors.

Following the amendments, Fidelity has revised its voting policy in Japan such that we will oppose any proposals that seek to appoint top executives with discretion over board remuneration.

Given the long history of overlap between the management and the board in corporate Japan, it will take time and patience to boost board independence in the country towards Western levels. But we are seeing real progress. And we believe concerted stewardship efforts by investors and the ongoing regulatory push from policymakers will combine to bring substantial progress to governance in Japan Inc in the next few years.

Tomohiro Ikawa

Tomohiro Ikawa

Yi Hu

Yi Hu

Investment Writer