Archive for the ‘Japan’ Tag

Pay Ratios

 

Interest by the media, the public, and shareholders in the pay of CEOs has never been higher, and governments have increasingly taken notice of this in recent years. It is perceived as inequitable and often unjustifiable as to why there should be such large discrepancies between the pay of CEOs and of the employees in their companies. Recent legislation in some countries, and proposed legislation in others, has sought to address this concern by ensuring that companies disclose the ratio of CEO pay and the median employee’s pay in their company.

US Companies

In 2015 the SEC adopted amendments to Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, and Item 402(u) of Regulation S-K, on pay ratio disclosure such that companies have to provide details of the relationship of the annual total compensation of their employees and the annual total compensation of their Chief Executive Officer (CEO), i.e. the ratio of the CEO pay to the median of the annual total compensation of all employees. This applies to companies’ for their first fiscal year beginning on or after 1st January 2017.

Honeywell International, a large multinational corporation, was the first major U.S. public company to disclose its ratio of CEO pay to that of the median employee with a pay ratio of 333:1.

The American Federation of Labor and Congress of Industrial Organizations (AFL-CIO) highlights that in the S&P 500, Mattel had the highest ratio of CEO pay to median worker pay with a ratio of 4987:1. They reported a higher ratio still in the Russell 3000 where Weight Watchers International had a pay ratio of 5908:1. More detail is available at:

https://aflcio.org/paywatch/company-pay-ratios

UK Companies

In the UK, listed companies with more than 250 UK employees will legally be required to annually publish and justify the pay difference between chief executives and their staff for the first time. The regulations governing pay ratios will, subject to Parliamentary approval, come into effect from 1 January 2019 with companies reporting their pay ratios in 2020.

The disclosure of pay ratios is part of a move to hold larger companies more accountable for CEO pay and will provide helpful insights into the difference between CEO pay and average employee pay in different sectors and in individual larger companies in the UK.

https://www.gov.uk/government/news/uks-biggest-firms-will-have-to-justify-pay-gap-between-bosses-and-their-workers

 

Japan

Japan is a country whose CEOs have traditionally earned less than their global peers and where the ratio of CEO pay to that of the average employee has been lower than in countries such as the US. Part of this is attributable to the culture of Japan where very high pay ratios between CEO pay and average employee pay would not be viewed favourably.

It will be interesting to see what the impact of the disclosure of pay ratios in the US and other countries will be in the coming years.  Already shareholder revolts over executive pay during 2018 are growing and high pay ratios of CEO pay to the average employee’s pay could increase shareholders’ dissent on this issue.

 

Chris Mallin

June 2018

 

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Succession Planning

Why is succession planning important?

Succession planning is seen as crucial to ensuring that a successor is in place to carry on the work of key individuals in a business should they leave the company in either a planned manner (e.g. retirement, job move, generational succession, or ownership changes) or an unplanned manner (e.g. fatal accident, unplanned removal from post). Sometimes the immediate successor is seen as a safe pair of hands, ready and waiting to carry on the work pending the appointment of another individual, whilst at other times there has been more time to search for a successor.

Investors are keen to know that a succession plan is in place for key directors to help ensure the ongoing smooth running of the business, its strategy going forward, and to maintain a steady steer at the helm, thus retaining investor and market confidence. The successor may also be appointed for their new ideas on strategy, whether that is to take the business forward into new spheres or to concentrate more on a few core sectors which may be more appropriate for the company at that time.

 

Corporate Governance Codes

Corporate governance codes mention succession planning in different degrees of detail.  Looking at a few of these, the UK, Japan, and Italy, illustrates this.

The UK

The current UK Corporate Governance Code (2016) mentions succession planning in the context of the role of non-executive directors, they ‘have a prime role in appointing and, where necessary, removing executive directors, and in succession planning,’ (A.4, Non-executive Directors, Supporting principle, UK Corporate Governance Code 2016, Financial Reporting Council); and in the context of Appointments to the Board ‘The board should satisfy itself that plans are in place for orderly succession for appointments to  the  board  and to  senior  management,  so  as  to  maintain  an  appropriate  balance  of skills and experience within the company and on the board and to ensure progressive refreshing of the board (B2 Appointments to the Board, Supporting principle, UK Corporate Governance Code 2016, Financial Reporting Council) https://www.frc.org.uk/getattachment/ca7e94c4-b9a9-49e2-a824-ad76a322873c/UK-Corporate-Governance-Code-April-2016.pdf

However the proposed revisions to the UK Corporate Governance Code (2017) cover succession planning in more detail.  Section 3 is headed ‘Composition, succession and evaluation’, and its Principle J states ‘Appointments to the board should be subject to a  formal, rigorous and transparent  procedure, and an  effective succession  plan  should  be in  place for board and senior management. Both appointments and succession plans should be based on merit and objective criteria, and promote diversity of gender, social and ethnic backgrounds, cognitive and personal strengths.’ Provision 17 states that ‘The board should  establish a nomination committee that should lead the process for appointments, ensure plans are in place for orderly succession to both the board and senior management positions, and oversee the development of a diverse pipeline for succession.  A majority of   members of the committee should be independent non-executive directors, with a minimum membership of three. The chair of the board should not chair the committee when it is dealing with the appointment of their successor,’ (December 2017, Proposed Revisions to the UK Corporate Governance Code Appendix A – Revised UK Corporate Governance Code) https://www.frc.org.uk/getattachment/bff48ee6-4fce-4593-9768-77914dbf0b86/Proposed-Revisions-to-the-UK-Corporate-Governance-Code-Appendix-A-Dec-2017.pdf

Japan

Japan’s Corporate Governance Code (2015) states that ‘Based on the company objectives (business  principles, etc.) and specific business  strategies, the board should engage in the  appropriate oversight of succession planning for the CEO and other top executives,’ (4.1.3, Japan Corporate Governance Code, Seeking Sustainable Corporate Growth and Increased Corporate Value  over the Mid- to Long-Term (2015), Tokyo Stock Exchange) http://www.ecgi.global/sites/default/files/codes/documents/japan_cg_code_1jun15_en.pdf

Italy

Italy’s Corporate Governance Code (2015) refers to the fact that ‘The Board of Directors shall evaluate whether to adopt a plan for the succession of executive directors. In the event of adoption of such a plan, the issuer shall disclose it in the Corporate Governance Report. The review on the preparation  of  the  above  mentioned  plan  shall  be  carried  out  by  the nomination committee or by another committee established within the Board of Directors in charge of this task.  Should the issuer adopt a succession plan, the Corporate Governance Report shall disclose whether specific  mechanisms are set forth in the succession plan  in  case  of  early  replacement, the corporate bodies and the persons in charge of the preparation of the plan as well as the manners and timing of its review.  As far  as the succession  procedures  are  concerned, the Committee believes that these procedures shall clearly define their scope, instruments and timing, providing both for the involvement of the Board of Directors and for a clear allocation of tasks, also with regard to the preliminary stage of the procedure,’ Appointment of directors, 5.C.2. Corporate Governance Code (2015) http://www.ecgi.global/sites/default/files/codes/documents/cg_code_italy_15july2015_en.pdf

Also in Italy in 2017, the Corporate Governance Principles for Unlisted Family-Controlled Companies were issued. Article 9 relates to Planning and Succession Plans going into some detail. On this issue, there are two Principles: 9.P.1. ‘Being  aware  of  the  differences  that  the  company  size  and  ownership  structure  involve,  it  seems appropriate for the members and the Board of Directors to ensure the continuity of corporate governance and  management  of  the  company  by  defining  precise  regulations  for  effectively  addressing  generational transitions or ownership changes.’ Also 9.P.2. ‘For  the  purposes  of  administration  of  the  company,  succession  plans  must  be  appropriately established  in  advance,  taking into  account  the  specific  conditions  of  the  company,  the  Group  and possibly the currently controlling family.’

Five application criteria are then listed which provide guidance on the process to be followed including the timeliness of establishing the process and having it ready in good time. Corporate Governance Principles for Unlisted Family-Controlled Companies 2017 http://www.ecgi.global/sites/default/files/codes/documents/principi_per_il_governo_delle_societa_non_quotate_a_controllo_familiare._codice_di_autodisciplina%202017%20English_0.pdf

 

Examples of succession issues in practice

For many family firms – large and small – succession planning is a real issue when either the next generation doesn’t want to take on the mantle of the founder, or there is no obvious successor.  Leo Lewis in his article ‘New prescription’ about Takeuchi Optical, a Japanese glasses manufacturer, highlights that ‘thousands of family-owned businesses in Japan face uncertain futures due to a lack of heirs,’  (Financial Times, 5th April 2018, page 9). Whilst Japan has a rapidly ageing society, similarly, other countries also face succession planning issues.

In South Korea, for example, Lee Jae-yong, vice-Chairman of Samsung Electronics and grandson of the group’s founder, was arrested in February 2017 on charges relating to bribery and corruption connected to a nationwide political scandal. Lee Jae-yong was convicted and sentenced to five years in prison on corruption charges. However in February 2018, he was freed on appeal with his original sentence being halved and suspended for four years. In April 2018, Samsung Electronics announced that it would split the roles of CEO and Chair but there will continue to be three co-CEOs with ultimate power still residing with Lee Jae-yong as vice-chairman. However Elliott Management, the activist institutional hedge fund, is seeking a change in the company’s corporate governance to limit the power of the family successor in waiting, Lee Jae-yong.

Chris Mallin

April 2018

Culture and corporate governance [1]

 

Commentators frequently mention the importance of culture in corporate governance.  They recognize that the ‘comply or explain’ regime of adherence to corporate governance codes does not capture the reality of corporate behaviour,   But there seems to be some confusion about what is meant by culture  and why it is really relevant to corporate governance.

What is culture?

Culture can be thought of as the beliefs, expectations and values that people share.  Like the skins of an onion, culture has many layers – national cultures, regional cultures, the culture of a company, and the culture in a board room.

The culture of a country is influenced by its social, economic and political heritage, its geography, and its religion.  Culture is moulded by situations that affect relations between individuals, institutions, and states.   Culture is influenced by law, is reflected in the language, and is passed on by experience in families, schools, and organizations.  It is culture that determines what is thought of as acceptable, important, and right or wrong.  Culture affects how people think and act.  It is fundamental to understanding corporate governance.

In the late twentieth century, when ideas about corporate governance began to be discussed, much of the thinking and practice was influenced by countries that shared Anglo-American cultures – a belief in the rule of law; the importance of the rights of individuals to personal freedom and the ownership of property, in the context of accountable, democratic institutions, including an independent judiciary.

In the United States, corporate governance practices stemmed from the rule of company law laid down by state jurisdictions and at the Federal level by regulation from the US Securities and Exchange Commission.

In the UK, and subsequently in most Commonwealth countries associated with the UK, the governance of companies was determined by Companies Acts and, for listed companies, by corporate governance codes, reinforced by Stock Exchange rules, which required companies to report compliance with the code or explain why they had not.

The influence of religion on corporate governance 

Religious beliefs are part of the culture of every country and affect personal values, relationships, and attitudes to authority.  They influence morality, ethical standards, and what business behaviour is considered acceptable.  Under-pinning beliefs are reflected in the way business decisions are made, corporate entities operate, and corporate governance practices develop in different countries.

The United States was founded by Puritans seeking religious freedom.  The founding fathers, the majority of whom were lawyers, placed great emphasis on their constitution, the rule of law, and democratic rights.   Those same traits are reflected in the governance of American companies to this day.  Legal contracts, litigation, and shareholder rights are still at the forefront of business issues.

In the United Kingdom, on the other hand, the approach to corporate governance was more flexible, less rule-based and litigious, reflecting the broader traditions of Britain’s religious inheritance.  The Church of England, rejecting control from Rome, established a freedom of expression and tolerated other non-conformist religious traditions, which became embedded in British culture. The voluntary approach to corporate governance – ‘conform or explain why not’ – reflects this more flexible, voluntary approach.

Other countries influenced by Britain during the days of the British Empire (including Australia, Canada, South Africa, other countries in Africa and the West Indies, as well as Hong Kong and Singapore, shared these corporate governance influences.

In Germany, the teachings of Martin Luther, 500 years ago, shaped the country’s language and changed its way of life.  Luther influenced belief in the moral imperative to seek principle and order, to be prudent with money, and to avoid debt.  Southern European nations, on the other hand, influenced by Roman Catholicism, took a less austere approach: a distinction that is still being played out among the nations that adopted the Euro as their national currency.

Northern European nations were also affected by the teaching of John Calvin, which emphasized the importance of working for the community, not just for their families and themselves.  Germany’s co-determination laws view companies as partnerships between labour and capital. In the two-tier board governance structure, the supervisory board contains representatives of workers as well as investors.

The influence of religion on corporate governance practices can be seen strikingly in Japan.  Buddhism and Shinto, the national religion, have been dominant religious influences.  Even though relatively few Japanese now identify with either religion, belief in spirits is widespread.  Shrines to spirit deities are commonplace.  Social cohesion is a dominant feature of Japanese business life, with high levels of unity throughout the organization, non-adversarial relationships, lifetime employment, enterprise unions, personnel policies emphasizing commitment, initiation into the corporate family, decision-making by consensus, cross- functional training, and with promotion based on loyalty and social compatibility as well as performance.

The Japanese Keiretsu networks connect groups of Japanese companies through cross-holdings and interlocking directorships, Chairmen and senior directors of companies in the keiretsu have close, informal relationships.   Although the paternalistic relationship between company and lifetime ‘salary-man’ is under economic pressure, boards still tend to be decision-ratifying bodies rather than Western style decision-making forums.

Although there have been recent efforts to require independent non-executive directors, as in the Western corporate governance model, Japanese top management remains rather sceptical.  Many Japanese do not see the need for such intervention ‘from the outside’.  Indeed, they have difficulty in understanding how outside directors function. ‘How can outsiders possibly know enough about the company to make a contribution,’ they wonder, when they themselves have spent their lives working for it?  How can an outsider be sensitive to the ingrained corporate culture?

Of course, the cultural significance of religion does not mean that religion or religious organizations played a part in the development of corporate governance norms.  Indeed in some countries, the UK, China, and Japan for example, many people no longer claim any religious affiliation.  But the religious culture provided the ethical context, the moral influence in creating law, running business, and influencing approaches to corporate governance.

Culture and the future of corporate governance

When corporate governance norms were first discussed in the 1980s, many thought that corporate governance in countries around the world would gradually converge with Western practices.  They believed that because these countries needed to raise capital, trade in securities, and do business globally they would adopt Western practices.   Institutions such as the World Bank and the OECD[2] put considerable effort into advising developing countries about modern corporate governance practice.

Globalization became a dominant feature in world trade because some countries offered significantly lower costs to developed markets.  Some thought that globalization of the movement of goods, services, money, people, ideas  and information, would inevitably lead to a convergence of intellectual insights, politics, and ideology.  Such arguments are seldom heard these days. Capital can be raised in the East as well as the West.   Securities can be traded on many stock exchanges.[3]   The notion, which might be termed ‘globalism,’ seems unlikely to survive.  Attempts by countries to protect their own industry and labour markets, control the flow of people, money, and information across their borders challenge the onrush of globalization.

Now, as the 21st century moves forward, discussion about corporate governance increasingly recognizes the significance of culture – national, regional, corporate, and board-level – to successful corporate governance.. The governance of companies within a country needs to be consistent with that country’s culture.

Bob Tricker

March 2017

[1]  The material in this blog has been adapted from:  Corporate Governance in Modern China – principles, practices, and challenges; Bob Tricker and Gregg Li, to be published next year

[2] the Organisation for Economic Co-operation and Development

[3]  The stock exchanges of Singapore and Hong Kong now rank third and fourth in significance after London and New York