Corporate objectives and CEO accountability
- The stock company (kabushiki kaisha) is a profit-making corporation. Its
objective is to make profits through its business activities and to distribute
these profits to shareholders. Shareholders are the owners of the firm,
and as residual claimants, bear risk from business activities. Therefore,
the governance of the firm should be in the hands of the shareholders.
- The Japanese stock company system is based on the separation of ownership
and management. Shareholders, through the general shareholders' meeting,
have the right to nominate and dismiss directors, and the board of directors
nominates and dismisses the representative director who is the CEO of the
firm and other executive directors. In this way, ownership and control
are aligned.
- Under the system of separation of ownership and
management, the representative director or an executive undertakes the
management of the corporation. We refer to this top management position
as the CEO. The responsibility of the CEO is to realize the goal of the
corporation, which is to make profits. In the Japanese capital markets,
institutional investors and other investors who seek to use the stock
market to increase the value of their shares are predominant.
Consequently, the CEO of the modern corporation must strive to maximize
long-term shareholder value, through achieving profits. We refer to this
as creating shareholder value.
Structure and monitoring function of the board of directors
- If the CEO is aware of his or her role, and strives to create shareholder
value, there will be no problem for shareholders. However, because this
cannot always be expected, a system that assures that the CEO will make
his or her maximum effort for the shareholders is required. We refer to
this as a governance system.
- In the face of increasing global competition, continued development of
information technology, and rapid technological progress, speedy and flexible
decision-making is necessary. For a corporation to respond appropriately
to this environment, a CEO must have maximum authority to make decisions.
However, if a CEO who holds this maximum authority exercises poor or inappropriate
management, not only the shareholders, but all other stakeholders will
suffer. Therefore, a system must be established to assure that the CEO
uses his or her authority wisely.
- Business experts around the world increasingly acknowledge that in the
current environment the most effective system is one in which management
is left to the CEO, while the board of directors is responsible for governance
from the perspective of the shareholders. We refer to this system as separation
of management and governance.
- In order to monitor the CEO, the board must be independent from the CEO.
Also, in order to focus on profits for the shareholders, it is desirable
for the board to take a neutral stance vis-a-vis other stakeholders. We
refer to a director who fulfills these conditions as an "independent
directors." Corporations should consider independence as a fundamental
standard for the nomination of directors, and should clearly disclose the
degree of independence of their directors.
- Shareholders want the CEO to raise shareholder value over the long term.
For this reason, the CEO should establish clear and concrete performance
goals, and shareholders should constantly monitor the management system
and evaluate performance. The CEO should be provided with incentives to
reach the performance goals with a compensation system that is based on
the achievement of these performance goals. We refer to these two functions
of a governance system as monitoring and motivation.
- The board, centered around independent directors, uses monitoring and motivation
to assure that the CEO is making maximum efforts to create value for shareholders.
Monitoring is achieved through an internal auditing system (or internal
control) system while motivation is achieved through the compensation system.
From the perspective of governance, the role of the board of directors
is to assure the effective function of the internal audit and compensation
systems.
- To further assure that the CEO strives to
achieve the performance goals, the board of directors should be able to
appoint and dismiss the CEO.
Management system
- The CEO should take the firm's performance goals and break them down by
business unit and subsidiary. The CEO should assign these specific performance
goals to each sub-unit manager, and supervise and monitor these managers
in achieving their goals. The internal control and compensation systems
should induce responsible managerial behavior among these sub-unit heads.
The CEO should oversee the construction and operation of systems for planning,
budget, performance evaluation and compensation that assure that sub-unit
managers achieve their goals. The objective of these systems is to create
shareholder value through steady profits, and we refer to these systems
as executive systems (shikko system).. The system that makes sure that
these systems are functioning properly is the internal control system (naibu
tosei system). We refer the internal control system and the executive systems
as the management systems. The fundamental task of the CEO is to manage
and monitor sub-unit managers through these management systems.
- A corporation has dealings with a wide range of
stakeholders. Under the fundamental principles of capitalism, the state,
corporation, and individual engage in fair dealings according to market
principles, based on the spirit of respect for the law and liberalism.
Companies that violate the law or market principles will be severely
sanctioned by society, and cause losses not only among shareholders but
among all stakeholders. An internal control system is critical to
preventing and rectifying violation of the rules. The CEO's most
important responsibility is to assure that the internal control system
functions effectively, while the board of directors must also constantly
monitor the system to assure that it is operating effectively.
Accountability and transparency
- The CEO uses the assets of shareholders to conduct business activities
to earn a profit for the shareholders. In this sense, the CEO bears a fiduciary
duty and has an obligation to report appropriate information to the shareholders
to demonstrate that he or she is fulfilling this fiduciary duty. We refer
to this as accountability. At the same time, the CEO must demonstrate to
shareholders that he or she can be relied upon to create shareholder value
in the future. In order to do this, the CEO must maintain good communication
through the shareholders general meeting and through investor relations
activities.
- The role of the CEO, vis-a-vis the shareholders,
is to make profits. But the CEO must also conduct business with a firm's
various stakeholders in accordance with the law and with market
principles. In order to assure that transactions with each stakeholder
are carried out in a fair and equitable way, it is imperative to provide
each stakeholder with appropriate and timely information. It is also
important to demonstrate to all other stakeholders that transactions
with any single stakeholder are being carried out in are fair and
equitable way. In today's business environment, a firm that does not
carry out its transactions in a fair and equitable way will be
sanctioned by law and by society, and not only the shareholders, but
also all stakeholders will suffer. Therefore, the CEO must always
provide the maximum amount of information to external constituencies. We
refer to this as disclosure. Because shareholders in today's corporation
are very dispersed, the provision of information to shareholders is in
effect disclosure. By disclosure, we mean disclosure to all
stakeholders, with the objective of maintaining corporate ethics through
transparency.
JCGR'S BASIC STANCE
- The most important aspect of corporate governance is that the CEO is aware
of his or her responsibility to shareholders, and strives to increase performance
for the sake of the shareholders. To some extent, aspects of a governance
system, such as monitoring by independent boards of directors, internal
control systems, and incentive systems are all formal practices, which
in the worst case, can exist in appearance only. The most critical element
of a governance system is the awareness of the CEO, and the way in which
the CEO exercises his or her managerial duties. Good governance is not
only the appearance of good governance through formal systems, but is determined
by the actual content of governance practices. Therefore, good governance
may be achieved in different ways.
- While we believe that it is the essence of
governance, not simply the formal practices, that is important, and that
good governance may be achieved in different ways, we also believe that
there is a governance system that is most appropriate in the environment
faced by Japanese corporations today. We believe that for a corporation
to contribute to society by maintaining steady performance over a long
period of time as a going concern, it is crucial to adopt a governance
model that fits its current environment. Based on this belief, we have
developed a model that indexes the governance of Japanese corporations,
based on principles which include the setting clear performance goals
and a board of directors centered around independent directors that
monitors the CEO. While other forms of governance may have been
effective in the past, we believe that this model is most appropriate
for the Japanese corporation in current business environment.
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