Flirting with governance reform

Do you know what a “hostess” is in Japan? If you guessed that it’s a woman who greets you at the entrance of a restaurant, guess again. “Hostess” in Japan refers to a woman who works in a bar or a lounge and is paid to flirt with men. A French journalist once referred to them as “prostitutes who do not think they are prostitutes.”

Japanese corporate employees are the main customers at hostess bars. It’s a tradition in Japan to send (all-male) work teams to hostess clubs after hours, on the company dime. These sessions are often mandatory. Clients are also traditionally taken to hostess clubs by salesmen. Companies pay for these excursions, which go under the heading of “entertainment expenses.”

These entertainment expenses are quite high. Decades of slow economic growth have squeezed corporate expense accounts, so in 2013, Shinzo Abe’s government introduced a plan to make “entertainment expenses” partially tax-deductible for large businesses (as they already are for small companies).

Needless to say, this is probably not a step in the right direction for Abe’s “Womenomics” initiative. But even more importantly, it illustrates one of Japan’s biggest structural problems: poor corporate governance. Fortunately, thanks to a new set of guidelines being introduced by Abe’s administration, governance may be about to experience a revolution.

Japan’s approach to corporate governance has, for the past 40 years, been very different from that of the United States. Independent directors are very rare and boards are filled with corporate managers. As you might expect, this makes companies focus more on empire-building than on creating shareholder value and boosting low profitability. Wasting money on useless perks like hostess-club visits is merely a symptom of a much deeper disease.

There is evidence that poor corporate governance is also partly responsible for the drought in business investment that is holding back Abenomics. International Monetary Fund economists Chie Aoyagi and Giovanni Ganelli, in a recent paper, show that companies that score more poorly on a Bloomberg measure of corporate governance tend to hoard more cash.

Smart people in Japan’s finance industry and bureaucracy have been beating the drum for change for a long time now, and it looks as if the ruling Liberal Democratic Party might finally be ready to dance. Since mid-2014, Abe’s government has been talking about a new corporate governance code, which would enhance the number of outside directors and encourage greater concern for shareholders.

Now, a draft of the new guidelines has been released to the public. Instead of hard-and-fast rules, it focuses on general principles, and adopts a “comply-or-explain” approach. Companies are basically being told what kind of things to do, and being warned that if they don’t do them, bureaucrats will notice and will give them a hard time.

It remains to be seen if these loose principles and vague threats will be as effective as hard-and-fast rules would be. On one hand, the absence of specific targets may signal to Japanese companies that the government isn’t serious about forcing anyone to change. On the other hand, the lack of hard guidelines may spur companies to exert greater effort just to be on the safe side, and the vague threats of negative attention by a powerful bureaucracy may provide an incentive for companies to try to outdo their peers in order to escape notice by the watchdogs.

As for the content of the code, it’s all very encouraging stuff. Companies are admonished to maintain better communication with shareholders, to value shareholders based on the size of their ownership stake and to focus more on increasing shareholder value. Antitakeover measures are also discouraged, a step I think might be the most important, if it is enforced. There is a provision encouraging diversity and the promotion of women. Another provision mandates the use of neutral external auditors. There is, as expected, a mandate to include outside directors on every board. And there are many admonishments to enhance profitability.

Veteran observers of Japan have become used to false starts and rapid reversals of reform over the past two decades. But in a recent interview, Nicholas Benes, head of the Board Director Training Institute of Japan, said that he thinks Japan is serious this time around:

The government understands that they need to improve productivity here or we have a real debt default crisis looming. When I started 15 years of corporate advocacy, I used to be told you couldn’t use the word productivity, because to Japanese it sounds like “restructuring,” which sounds like you’re firing people. And now we’ve got the Japanese government itself saying that we need productivity and governance is good and connected to productivity. There’s no way you can view this as other than a sea change...

Japanese people are very quick about executing stuff; now that it’s national policy, the crane has squawked - the one cry of the crane that makes all the others fly. So the fact that the government has clearly set forth all these concepts in its policy document, is a crucial tipping point.

There is at least one sign that Benes is actually being conservative in his predictions. In the interview, he predicted that a diversity clause wouldn’t be included in the corporate governance code. But it was. So the world will watch as Japan decides whether to embrace neoliberalism after all. If this corporate-governance code passes, and if companies heed it, Abe’s legacy will be assured.

The author is an assistant professor of finance at Stony Brook University and a freelance writer for a number of finance and business publications.

by Noah Smith