3 Ways Boards Of Directors Can Improve

Investing in Japan is hot. Warren Buffet has taken stakes in five major Japanese trading companies. The Tokyo Stock Price Index has been rising even faster than the S&P 500, up 29% over the past 12 months versus 21% as of early February. And on a visit last fall, BlackRock’s Larry Fink compared the current moment to the country’s 1980s economic miracle.

At the same time, a weak yen and aging population remain headwinds. To maintain momentum and rediscover long-term growth, investors say corporate governance will need to continue to improve.

And on this too, Japan Inc. is making progress. The Wall Street Journal’s Heard on the Street column noted that an ongoing government push to improve corporate governance is already making the market less insular, fueling restructurings that simplify corporate structures, and encouraging better capital returns.

But for all the progress, the data suggests there remains a way to go. In the late 1980s, 32 out of the world’s top 50 companies measured by market capitalization, were headquartered in Japan. Today, even after the recent bull market, there is just one. Japanese companies trade at enterprise value to earnings multiples roughly 40% lower than US and EU counterparts, and at low price to book ratios. Their high cash balances – roughly two times those of companies in the US and China – signal a reluctance to reinvest and an uncompetitively low tolerance for risk.

Boardroom leadership has an important role to play in Japan’s evolution. As we move into proxy season, first in the US and then in Japan, continued governance reform should be a focus.

The unique roles directors can play in setting a foundation for lasting improvement became clear in recent research conducted by Bain & Company Japan and Board Advisors Japan. We conducted interviews with more than 40 CEOs, non-executive directors, and institutional investors, and studied the recent evolution in Japan’s corporate governance code, comparing that to what other countries and global companies are doing. This research pointed to universally useful ways in which any board can improve their own operations and three jobs they most need to focus on.

Internal board changes

Interviewees described Japan’s prevalent board culture as overly hierarchical and formal, and said that more open, constructive, and insight-driven discussions are needed to accelerate value creation. Though they have diversified over the past few years, Japanese boards remain more homogenous than global peers. Regionally, Japan has the highest percentage of CEOs also serving as board chair and the lowest percentage of independent directors. Its directors are, on average, the oldest among its peers, very likely to be male, and unlikely to be international.

Three key jobs for directors

Building more diverse, open, and outspoken boards, focused on long-term strategy will help Japanese directors do three things their companies need:

• Articulate a “full potential” corporate ambition. Historically, corporate governance in Japan was arguably more focused on managing risk than sustainably growing enterprise value. “Boards do not spend nearly enough time discussing the long-term vision and mission,” one CEO told us. “They spend too much time debating the short-term “what” and “how,” which should be a management discussion.” Directors should refocus on what their company’s stretch ambition could be. As another CEO put it, “If you don’t change, change will happen to you.”
• Build a clear plan for creating value. The next step is translating that full-potential strategy into a concrete plan for creating value, and then monitoring plan execution. That focus will keep board discussions on track and dedicated to value. “Each board needs a comprehensive discussion on the core competencies of the company,” one independent director told us. “If that is not aligned, it is very hard for a non-executive director to give good advice.”
• Communicate a compelling equity story. It is up to the board to translate strategy into the returns shareholders can expect, particularly return on assets and equity. As one non-executive director explained, “A critical function of the board is the ability to translate things that are often left unsaid about a company’s mission, vision, and strategy into words that investors and stakeholders will understand and accept.”

For all its challenges, Japan does have some strengths to build on. Japan’s “Sampo Yoshi” management philosophy has long recognized the importance of customers, employees, and society, a valuing of a broad set of stakeholders beyond investors that many US companies are now embracing. And the country has a history of long-term thinking. In the past, some Japanese companies published 150-year strategies as part of their mission to grow with society.

In an increasingly turbulent world, with corporations facing more disruptions, at a faster pace, it’s the responsibility of board leaders to help management navigate this turbulence and come out stronger, no matter where they are based. It is time to act.