Managers cautious as Japanese firms revamp governance

While Japanese companies are making huge progress in terms of corporate governance — particularly in relation to board independence and diversity — money management executives say that caution is necessary.

Recent revisions to the country's corporate governance and stewardship codes are pushing Japanese companies and operating standards further in line with best practices around the world. Appointing women to company boards and adding independent directors are among such enhancements.

But executives focusing on Japan warn there is a danger of tokenism and "overboarding" — with directors sitting on too many company boards — as firms rush to comply with the standards put in place by Japan's Financial Services Agency and the Tokyo Stock Exchange under the revised codes.

The problem is exacerbated by more stringent requirements for corporations looking to make it into the Tokyo Stock Exchange's prime listings section, requiring at least one-third independence on the board and in some cases a majority of independent directors.

The proportion of independent directors on Japanese corporate boards is already on the rise — sources said they accounted for 36% of boards in 2020, up from 27% in 2019.

But struggles remain. "For a market that has historically had quite some challenges filling these roles — and I've spoken to a lot of management teams over the years who say they are looking and have not found the right person — we now are going to see more of these issues and we are concerned about that," said Kei Okamura, Tokyo-based director of Japan investment stewardship at Neuberger Berman Group LLC. "We're concerned companies might take a mechanical approach" and appoint directors without the necessary experience. "If those people get picked, what you essentially have is a board of yes men and women," he said. Neuberger Berman has $402 billion in assets under management.

Tokenism is a "risk we have to be aware of — the concept (of adding more women, for example) to boards was so new, nobody really knew what we wanted," said Rob Hardy, corporate governance director at Capital Group Cos. in London, which has $2.38 trillion in AUM.

And as much as Yoko Sakai, director of research and Japan analyst for $80 billion manager Harding Loevner LP, "would like to have women promoted, I'm a little skeptical of meaningful change happening overnight. If a company came up with multiple women on the board ... I'd be suspicious that they had increased gender diversity so quickly."

She said one reason for suspicion is that for the University of Tokyo's 2021 spring admission, only 21% of students are women.

The need to be aware of tokenism on Japanese boards comes at a time when many money managers have been upping their corporate governance guidelines to include, in some cases, at least one woman on boards.

T. Rowe Price Group Inc. formalized its gender diversity policy with a central tenet of voting against any Japanese company with no female board representation. The firm has $1.59 trillion in AUM.

"Progress is slow, but inroads are being made in this area — Japanese companies without a single female director or female officer, for example, shrank from 55% in 2019 to 50% in 2020," Archibald Ciganer, Tokyo-based portfolio manager of the Japan equity strategy at T. Rowe, said in an email. The fund had €1.9 billion ($2.3 billion) in assets as of May 31.

J.P. Morgan Asset Management will require at least one female board member starting the next fiscal year, while Goldman Sachs Asset Management took its policy of having a woman on every corporate board global last year and will vote against any company that doesn't have female representation.

"We were in a situation where, until recently, about half the companies didn't have a woman on the board in Japan," said Chris Vilburn, head of Asia stewardship at GSAM in Tokyo. In the year after the policy came on a global basis, starting in April 2020, the firm voted against 521 companies on the basis of a lack of board diversity — "that's quite a lot of companies in Japan only."

While Mr. Vilburn hasn't yet seen the numbers for 2021, "we have seen more companies adding their first woman," with some adding multiple women. The firm has $2.2 trillion in AUM.

The independence of board members is also an area managers are approaching with caution, with numbers showing improvement: In 2020, 36% of board members were independent, up from 27% in 2019, T. Rowe's Mr. Ciganer said.

"It's hard enough to find male independent directors in Japan because lifetime employment in one company and only knowing that company means it's hard to find qualified people who can act as independent directors on another business," said Harding Loevner's Ms. Sakai, who is based in Bridgewater, N.J.

The reality of smaller talent pools, requirements for increased diversity and independence of board members has led managers to caution against overboarding, too.

"We don't want to see directors sitting on too many" boards, Capital Group's Mr. Hardy said. The firm is aware that suitably qualified female board members may be overstretched due to high demand for their expertise on different boards, "with them being pulled in different directions. We try to be pragmatic about overboarding with more focused discussions about board time commitment and how skills evolve."

Neuberger Berman executives are already seeing overboarding as an "acute issue for some female" directors who are highly sought, Mr. Okamura said. Executives have come across women in Japan with five external director roles, owning their own business and being advisers to public institutions, too.

And Harding Loevner's Ms. Sakai is "struggling with (the fact that) now, a lot of these independent directors are overextended — they're sitting on multiple boards because, once they're on one board, hundreds of companies come to ask them to join theirs. We want them to be effective, but if a company nominates an independent director who is overextended, do I vote against them? It's a very tricky situation."

When a crisis does flare up at a company, the time demands on such individuals are huge — "which is why we take overboarding into account," Mr. Okamura said.

GSAM's Mr. Vilburn does not think there's an issue with diverse or independent talent in Japan, per se. "There's a lot of highly qualified people, women, external directors for those roles. I do hear anecdotally from companies saying it is a very tight market for the directors they want to hire, placement agencies saying that's highly in demand right now, but we're not really seeing places where we think directors have been overboarded or we have concerns about them on the board. Companies may need to look beyond the narrow pool of who they know in their industry — that's the point," he said.

However, the concept of overboarding was also recognized within the revised codes, with a requirement for a skills matrix to map out board directors' expertise.

"It's quite appropriate, and especially in terms of skill set of the candidates, (that) companies are now having to disclose what are the skills that these diverse candidates have," said Shizuko Ohmi, Tokyo-based head of investment stewardship, Japan at J.P. Morgan Asset Management, which has $2.8 trillion in AUM. "In discussions with these companies, they explain it is a good exercise for them to think about what is the strategy for future growth — digital, IT innovations, ESG," she said. Skill matrixes also makes engagement between companies and money managers easier. "We can talk about why they chose this kind of candidate, based on what they think about the skill," Ms. Okhi said.

Harding Loevner's Ms. Sakai and Neuberger's Mr. Okamura agreed the skills matrix will be helpful, helping executives to see the expertise that women in particular add and helping to address other concerns in terms of potential skill gaps.