Corporate Governance

Corporate Governance, Executive Compensation and the Japanese Approach (Part 3)

By J Robert Brown Jr.

So what impact will these disclosure requirements have on executive compensation?  The best case scenario is none.  The worst case scenario is a full blow escalation of executive compensation.  At least in the short term, however, cultural norms and, importantly, arm twisting by the Financial Services Agency will likely keep the worst case scenario from taking place. 

CEOs in Japan are already poorly paid by international standards.  As the WSJ noted:

• U.S. chief executives of companies with revenue of over one trillion yen, or $10.9 billion, received a total compensation package nine times greater than their Japanese counterparts, according to data compiled from 2004 to 2006 by New York-based human-resources-services firm Towers Watson. European compensation was 4.4 times greater.

Why?  Culture and history.

• Masato Shirai, a director in the human-resources-consultancy group at PwC, said the lower levels of executive compensation are a historical and cultural legacy of Japanese corporations where salary increases are largely set by fixed formulas, and not by performance or negotiation by individual executives. The lower pay, Mr. Shirai said, is also a trade-off for job security.

Yet there is already pressure on this system.  Foremost, disclosure will reveal disparity among companies in Japan.  For example, the aggregate pay to the top 20 officers showed that companies like Nissan and Sony paid much higher averages.  Second, the disclosure will reveal higher compensation paid to non-Japanese officers, a consequence of having to compete with compensation standards in other countries.  In short, disclosure will help build pressure for increases in executive compensation.

Culture will keep the numbers down to some degree but so will the strong arm of the government.  This can be seen with the recent treatment of compensation at Shinsei Bank. 

Shinsei is the successor to the the Long Term Credit Bank, a financial institution created in the aftermath of WWII to provide long term capital to Japanese corporations (long term credit banks had debenture issuing authority, ordinary commercial banks did not; see Brown, Japanese Banking Reform and the Occupation Legacy:  Decompartmentalization, Deregulation, and Decentralization, 21 Denver J. Int'l Law 361 (1993)). 

This is a particularly sensitive institution in Japan.  With the economic collapse in 1989 and the demise of the compartmentalized banking system in Japan, the LTCB couldn't make the transition.  It went bankrupt and was ultimately acuired by a consortium of foreign investors, making it the first Japanese bank to be acquired by foreign interests.  Moreover, the government still holds a large percentage of the shares. 

As the executive compensation disclosure deadline loomed, Shinsei looked likely to announce a structure that paid foreign executives substantially more than Japanese executives.  In response, the WSJ reported that the FSA pressured the Bank to force the high paid executives out.  According to the Journal: 

• When the slate of board members was presented to the FSA, the regulator said the four executives with compensation of more than 100 million yen should leave so embarrassment could be minimized, according to the person. An FSA spokesman declined to comment on the discussion.

In other words, the FSA did not leave matters to culture or social pressure.  Those sources of restraint would likely have less impact on a financial institution with foreign ownership.  As a result, the government acted as the enforcement mechanism.

The approach -- to the extent true -- shows that the current system of "cultural" limits cannot be counted on to restrain executive compensation.  While banks can be pressured by the FSA, not all companies are subject to the same level of regulatory oversight.  Moreover, while the FSA may be in a good position to address outliers in the compensation area, it will not be in a good position to stop compensation from creeping upward.

So, with the new disclosure requirements, we can expect an increase in executive compensation in Japan, albeit slowly.  Onward and upward.  

Full post as published by The Race to the Bottom on July 02, 2010 (boomark / email).