If one were to take a time machine back 35 years, it would be shocking to see how much corporate Japan has changed. In the heyday of the late 1980s, 32 out of the world’s top 50 companies, measured by market capitalization, were headquartered in Japan. Today, there is one. Once universally revered for the power of kaizen, Japan Inc. has fallen behind its global competitors and needs to catch up.
In 2015, the Japan Exchange Group (JPX) introduced the Corporate Governance Code (CGC), articulating principles for elevating board effectiveness as part of a broader effort to enhance global competitiveness. Eight years in, and after multiple revisions, much progress has been made, but much more is required.
Policymakers play a critical role in setting guidelines and boundary conditions. But business leaders—chief executive officers (CEOs), nonexecutive directors (NEDs), and investors—must do their part. This challenge led us to explore the following question: What can business leaders do in Japan to dramatically improve the effectiveness of corporate boards in driving enterprise value?
Bain & Company Japan, in partnership with Board Advisors Japan, launched a study in early 2023 to answer this question. We interviewed more than 40 CEOs, NEDs, and institutional investors to better understand the current state of board effectiveness in Japan and opportunities for improvement. We looked at how the CGC has evolved in recent years—where we have seen compliance and where there are still gaps. Further, we studied what can be learned from what other countries and global companies are doing. Following is a summary of our findings and practical suggestions on what business leaders can do to shape “A New Board Agenda for Japan.”
Point of departure: Procedure over value creation
Looking at the data, it can easily feel like Japan has been left behind regarding economic value creation. Japan Inc. has consistently been trading at a valuation discount vs. other markets. Today, relative to the US and EU, enterprise value (EV)/EBITDA multiples are 40% lower compared to 2022, and the gap has been widening over the past decade (see Figure 1). Total shareholder returns (TSR) for the largest 10 companies in Japan over the past decade have been 5%, vs. 13% in the US and China and 8% in the UK. The price-to-book ratio (PBR)—a measure of a company’s market value divided by its tangible net worth—has garnered attention recently in the Japanese press for being so low. Japan significantly lags the US and EU, and the gap has only increased in recent years (see Figure 2). More than 40% of the top 500 publicly traded Japanese companies have a PBR less than 1 (vs. 3% for companies in the US).
Japan’s EV/EBITDA multiples have lagged those of global counterparts
Japanese companies have lower PBRs than their US and European counterparts, and the gap is widening
This “Japan discount” has the increasing attention of investors, further fueled by the recent devaluation of the yen. Warren Buffet grabbed headlines earlier this year by investing in the five large Japanese trading houses, or sogo shosha, increasing his ownership to more than 8.5%. The potential upside has also attracted activists, who are becoming increasingly relevant players in influencing the market.
If we dissect the various causes of TSR, we see that growth has been the primary challenge for Japanese corporations relative to their counterparts in the US and China over the last decade (see Figure 3). At the same time, the top 30 Japanese companies have significantly more cash on hand than their global peers—roughly two times compared to the US and China, signaling a reluctance to reinvest and a different threshold for risk. Indeed, a common criticism of corporate governance in Japan is that it has historically been more focused on risk management than sustainable EV growth (see Figure 4).
There are multiple reasons for Japan’s low total shareholder returns, but low growth appears to be the main cause
Japanese companies hold more cash than US and Chinese companies, implying they are not reinvesting in growth
The economic forces behind these trends are complex and certainly not all driven by corporate governance. However, the executives we spoke to agreed that improved board effectiveness must be part of the solution.
The CGC has certainly stimulated several positive developments, challenging boards to increasingly focus on return on equity (ROE), board independence, and diversity. The latest reform has raised the bar for environmental, social, and governance (ESG) disclosures. According to one CEO, “The CGC has been beneficial in part because it is increasing the level of dialogue on the issue, which is positive.” Compliance rates have been high, starting with risk management and then expanding to additional guidelines to diversify board composition (see Figure 5).
CGC compliance levels are relatively high
But while procedural compliance has been high, it has not been enough to drive sufficient value-additive board behavior. One NED serving on multiple boards in and outside Japan complained, “The lack of fiduciary duty of some Japanese boards is staggering. You may never hear the words ‘equity value’ or ‘multiple.’ The reality is that Japanese companies are part of the global corporate community and cannot avoid these topics any longer.”
Others we spoke to characterized the norm in Japan as, on average, overly profit and loss (P&L) and short-term focused rather than ROE and future-back focused. Said one CEO, “Boards do not spend nearly enough time discussing the long-term vision and mission. They spend too much time debating the short-term ‘what’ and ‘how,’ which should be a management discussion.”
Interestingly, this is reflected in the incentive structure for executives. Japan has by far the lowest share of long-term incentives for large-company CEOs compared to the US and the UK. Furthermore, the specific key performance indicators (KPIs) that drive executive compensation in Japan are much less weighted toward ROE and TSR than in the US and UK (see Figure 6).
KPIs of executive compensation are based more on total shareholder return in US and UK than in Japan
Interviewees also described a prevalent culture that remains overly hierarchical and formal vs. the more open, constructive, and insight-driven discussions needed to accelerate value creation. As one NED put it, “Everyone needs to speak up. If you don’t speak up, you are not fulfilling your duty as a board member.”
One of the reasons for this is that the composition of boards, while diversifying over the past few years, is still more homogenous relative to boards of global peers. One female NED described most Japanese boards as “old boys’ networks. … They all know each other from their past lives, often attended university together, and there is not enough accountability or pressure coming from outside these networks. This is often because the CEO wants to surround himself with those who do not challenge management. This is the opposite of good corporate governance.”
Indeed, relative to other countries, Japan has by far the highest percentage of CEOs who also serve as chair, at 71%. At the same time, the percentage of independent directors is the lowest, at 35%. The ratios of women and foreign nationals, albeit climbing, are also lower than those of other countries, at 14% and 6%, respectively. Even within the Asia-Pacific region, Japan is nearly the lowest in every dimension of age, gender balance, and percentage of international directors (see Figure 7).
Regionally, Japan’s boards have the highest average age and the fewest international members, while ranking next to last in the number of women
While there are many opportunities for improvement and lessons to be learned from other markets, Japan does have a few strengths that play in its favor. Foremost among them is the global shift from shareholder primacy to multi-stakeholder management. Arguably, Japan’s “Sampo Yoshi” management philosophy has long embedded into corporate DNA the importance of customers, employees, and society. In the past, several companies and sogo shosha who have built the Japanese economy published 150-year strategies, a testament to their mission to grow with society. After all, the kanji for “firm” (会社) is an inversion of “society” (社会). That said, among the various stakeholders, shareholders seem to have been the most neglected, hence the “Japan discount” in valuations.
Never before has the case for accelerated change been stronger. In an increasingly turbulent world, corporations face more disruptions, at a faster pace, than at any other time in living memory. Navigating this turbulence—and coming out the other side even stronger—is a priority for corporate boards. Japan must find a way to use its strengths and rapidly address its gaps. Not all of the weight should be on the government’s shoulders—business leaders can be a powerful accelerant. It is not enough to be passive consumers of good corporate governance; we must act.
The path forward: A new board agenda
The board must have fiduciary accountability to drive stakeholder value creation.
American author and MIT lecturer Peter Senge has described systems thinking as “a discipline for seeing wholes … a framework for seeing interrelationships rather than … static ‘snapshots.’” Our research has identified seven key factors that can help boards in Japan create more value (see Figure 8). They are interrelated and must be addressed as a system. They can be categorized into two broad themes: a future-proof board agenda and a new board operating model.
We identified seven success factors for Japanese boards to create more value
Future-proof board agenda
1. Full-potential strategy at the center
It is essential to start with a stretch ambition of what the company could be, including how long-term industry trends might affect the business. Independent directors should provide their inputs and hypotheses on what might be possible, including bringing in experts and advisors. One board chair of a major consumer packaged goods company described what a good strategy process looks like: “Our board spends a significant amount of time discussing the disruptive forces we expect in the market. For example, millennials will become the majority of consumption power in 2025—what are our plans to address their expectations? The trend will become even stronger for Gen Z. Governance should be about debating and making long-term decisions on our position as a company on these key trends that impact our sustainability as a business.”
The stretch ambition must then be converted into a sharp point of view on the full potential of the business. We define “full potential” as the quest to make a company the best it can be. It is an outside- in perspective on what could be, not an incremental inside-out perspective on what comes next. Too often, boards and management teams can slip into a cycle of mediocracy or “satisfactory underperformance” (recall that more than 40% of large-cap companies in Japan have PBRs less than 1).
Stable but below benchmark and below full-potential performance are not enough to compete effectively on the global stage and create maximum value for all stakeholders. It is the board’s role to demand and own a robust and compelling picture of full potential. One CEO we spoke to put it this way: “If you don’t change, change will happen to you. The board’s single mission is to make sure the company is versatile during disruption.” A full-potential view of the business defines not just the incremental next step but what is possible and what would be required to get there.
2. Clear value-creation plan
The full-potential strategy must be translated into a concrete value-creation plan, whose execution needs to be monitored by the board. Ideally, this is led by the strategy sub-committee with deep involvement from independent directors. Sufficient time is required outside of official board meetings to learn the plan’s intricacies, including organizational capacity and capability. One independent director observed, “Each board needs a comprehensive discussion on the core competencies of the company. If that is not aligned, it is very hard for a NED to give good advice.”
A clear value-creation plan can help keep discussions on track and focused on value. It gives confidence to the market that the company can deliver on its strategy at pace. Passive board oversight has not proved effective enough to overcome the Japan discount, especially for more complicated conglomerates. The CFO plays a significant role in grounding the value-creation plan in the right financial KPIs so that tough decisions can be made. According to another NED, “A good board has a pulse on whether discussions are advancing a decision. If there is a backlog of agenda items that are in the ‘parking lot,’ there needs to be honest feedback given to the management to facilitate the right agenda, at the right pace.” This “right agenda” starts with bold ambition, is anchored in a full-potential strategy for the business, and is translated into a specific value-creation plan.
A turnaround moment for a major Japanese pharmaceutical player was the development and public release of the company’s portfolio strategy, eliminating half of its business domains and bolstering the remaining with acquisitions. What was particularly well received by investors was the simultaneous release of a detailed list of capability gaps in pursuing the full-potential agenda and a concrete plan to either grow or acquire these capabilities.
3. Compelling equity story
One NED summarized this point very nicely: “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. Just the forcing mechanism of clear messaging uplifts the equity story.” It is part of the board’s role to tightly connect the strategic full potential into return expectations for shareholders, particularly regarding return on assets and ROE metrics, not just P&L reporting.
It is crucial to solicit feedback more regularly from the investment community. One CFO of a Japanese technology conglomerate lamented, “Japanese companies usually only mentally engage on the capital market and investors a few times a year when preparing for reporting. A good CFO is thinking about this every day.” Upon stepping into the role, this CFO completely pivoted his company’s investor relations (IR) reporting structure to short- and long-term equity metrics (in particular, ESG commitment actions) and future-back value drivers. The company quickly experienced a sharp uplift in investor engagement and is still recognized as one of the best disclosers in Japan.
The same is true for the investment community, which is important in reinforcing fiduciary responsibilities. One NED said, “Many institutional investors do not have a clear direction on their own stewardship codes, resulting in an ineffective oversight on what is and what’s not working in a company, what messages they need to instill to the board.”
Board operating model
4. Diverse and relevant panel of independent directors
Board appointments should be made based on what capabilities and expertise are needed to support the ambition and full potential of the business. The majority should be independent directors. As one global NED said, “If Japan Inc. wants to change, there needs to be a more aggressive shift in board composition. In many countries, the rule is all independent directors except CEO and CFO.” While recognizing that this may take time in Japan, a continuous investment in increasing the pool of qualified and relevant NEDs is the future.
Diversity still has a long way to go in Japan. For example, many boards are still not representative of the company’s geographic footprint and where money is made. As one CEO said, “If you are building a global company where value is driven by your overseas businesses, you need a global board.” This CEO made waves by replacing his all-Japanese board with half non-Japanese members (both NED and management) to drive value outside of Japan. Today, most of the company’s profit is driven by Europe and Asia.
We heard in our interviews a sense of shared frustration regarding the relative lack of diverse, board-experienced talent in Japan. While it is true that labor mobility in Japan has historically been relatively low, that dynamic is changing. It is incumbent on nominating committees and CEOs to keep pushing. One NED observed: “While there may be some merit to the statement that ‘there are no credible/experienced executives that fit the bill to serve as a NED’ due to the historic preference for lifetime employment and thereby relatively little rigor on performance management, things are changing rapidly. There is more talent movement than ever before, and there [is] more and more talent coming into the pipeline to become effective NEDs. It’s on the management side to go looking for them.”
5. Open and honest discourse
As one NED said, “There needs to be a culture of constructive and consistent pressure. That’s the board’s job.” This is true both in official and unofficial meetings. The chair’s role is to advocate for contrarian views during debates to encourage different views to come forward. And it’s everyone’s role to speak up. Another NED said, “If you don’t speak up, you are not fulfilling your duty as a board member. Don’t outsource this to the foreigners. The chairman needs to lead the charge on changing the perception—that there are no negative ramifications for asking healthy questions.”
Some boards we talked to have employed a simple rotating or random seating system, which has helped break the “management vs. NED” dynamic and build one team culture. Others are opting for a third-party facilitator to ensure the best thinking of all board members gets captured.
Often boards do not spend enough time in the right environments that encourage deep engagement and “healthy friction.” Carefully designed workshops and off-sites can help. One NED advised, “Boards need to spend significant time with each other. The board needs to be ‘one team.’ More executive off-sites, more dinners, more nonbusiness discussions to tease out how we can complement each other and harness our diversity to create value.”
Fundamentally, boards need to have more honest conversations about risk, including where to lean in when the potential returns are attractive. It cannot all be about risk avoidance but rather where, when, and how to place smart bets on future growth.
6. Reinforced fiduciary duty
Several tactics can be used to reinforce the sense of fiduciary responsibility within boards. Aligning long-term equity targets to board compensation can be one, and conducting regular board performance evaluations can be another. Some companies have implemented peer-to-peer evaluation systems. One Japanese medtech company has taken it further by introducing an artificial intelligence (AI)-powered system to determine the quality of board members’ comments as timely and transparent feedback.
It is essential to set clear expectations, particularly between the role of the CEO and NEDs. One NED admitted, “Frequently in Japanese companies the ‘board office’ takes directives from the CEO to manipulate the agenda, and all too often independent directors don’t blink an eye.” On performance management, one board chair advised: “Chairmen, take a mental note of which board member gives how many value-additive statements. Don’t shy away from rotating, even after a year, if you feel a particular NED is value dilutive.” Remember that in some other countries, boards can be sued and CEOs routinely fired.
7. Clear investor strategy and market engagement
Global best practice is to develop an explicit investor strategy to balance long-term value-creation objectives with near-term performance. The ultimate goal for the board is to align the equity story with investors who have similar, aligned interests in the long-term value-creation potential for the company. As one institutional investor said, “Companies need to choose investors too. The more aligned they are on the long-term potential of the business, the higher the quality of the feedback.”
Those we interviewed consistently voiced the importance of engaging investors and stakeholders more outside of IR days. It is essential to ask for candid feedback on the stated strategy and reactions from the market. Boards can thoughtfully share information on their priorities and use independent directors to help create understanding and support for the equity story. It is a two-way street.
One institutional investor gave the following advice to investors: “Understand the fundamentals and the value drivers of the business, not just the financial dashboard. Get to know the board members, their personalities, and shepherd them on how they can create more value, and at the same time give direct feedback if there is a risk of value dilution. Analysts, align with your fund managers on voting strategy.”
Call to action: What business leaders can do
In our interviews, we surfaced several common symptoms that signal the board is not fully doing its job to create value for stakeholders. The first step of action is to confront reality. What is your honest assessment of where you are? How many of these symptoms apply to you?
- Mid-term strategy that is akin to internal sales targets and budgets rather than a comprehensive plan on EV creation
- Low enthusiasm and engagement from the market on published mid-term strategy
- Organizational permissiveness to underachieve publicly stated targets
- Board discussions that are largely question-and-answer sessions between NEDs and management, with little progress on key decisions
- Nominating committee indifference on relatively opaque CEO/CXO skill requirements, not holding the bar sufficiently high for what the company’s full potential requires
- Insufficient and overly abstract discussions regarding the implications of significant market trends and disruptions (AI, ESG, cybersecurity, etc.)
- Strategy anchored to the status quo and incremental improvement, not sufficiently engaging on portfolio optimization decisions via clear cross-unit KPIs
- Unclear multiyear talent requirements and human capital strategy to drive business’s full potential
- Decline in organizational capacity or capabilities to attract, mobilize, and inspire the right talent (e.g., decline in employer rankings, departure of star talent, inability to hire key positions)
It is easy to convene at the local izakaya to lament Japan’s corporate governance challenges. They are real. It is easy to complain about what this or that politician, investor, or executive is or is not doing. It is a system, and it is complex. But ultimately, change is driven by the concerted individual efforts of those in positions of influence. Leaders need to lead.
At Bain & Company, we believe in the power of action. In Japan, our mission is to help “ignite Japan’s full potential” one client, one company, one executive at a time. Board Advisors Japan is similarly mission-driven. We invite you to take your next step from wherever you are today to stimulate and ignite positive change.
In this quest, we offer five recommendations for each of three important constituencies—CXOs, independent directors, and institutional investors—to effectively harness the power of corporate governance and create greater stakeholder value in Japan:
- Develop and own a robust “full-potential” view of the business vs. only incremental midterm planning exercises.
- Actively build a pipeline of relevant, diverse, and experienced independent directors vs. optimizing for convenience, networks, and comfort.
- Invest in quality time, including training, between NEDs and management vs. check-the-box formal interactions.
- Engage with investors as a source of external feedback and healthy pressure vs. arms-length formal interactions with little transparency.
- Quantify the equity journey with discipline vs. a high-level, conceptual description of the vision.
- Prioritize fiduciary duty over all else vs. ease of compromise to avoid conflict.
- Commit to actively learning the business vs. leaving it to passive internal briefings.
- Model constructive, open, and honest discourse vs. staying quiet to not “rock the boat.”
- Help shape the management of the future according to what the business really needs vs. resigning to past and current succession practices as the default.
- Bring a helpful external view—give feedback and connect the board with other experts vs. risk of insular “echo-chamber”-like discussions.
- Prioritize return on capital employed and ROE to drive debate on capital allocation vs. surface-level drill-down of P&L and balance sheet.
- Request board oversight and discussion about a short list of most critical issues vs. little to no direct engagement with the board on key agenda and decision items.
- Signal clear performance expectations for the business and inform management of potential future voting behavior vs. “watch and wait” posture.
- Enable independent directors with relevant data and alternative views vs. using them as a one-way official communication channel.
- Prepare for shareholder meetings and vote vs. passive and unaligned approach.
Put it all together, and what does success look like? It looks like shifting:
- from risk mitigation to value creation;
- from P&L to ROE, anchored in a robust full-potential perspective;
- from majority management to majority independent boards, with greater diversity;
- from formal checklist-based interactions that adhere to policy and procedure to a one-team culture, with open and constructive dialogue around the equity story; and
- from satisfactory underperformance to full potential—Japan’s full potential.
It is time for a new “board agenda” in Japan that accelerates progress and value creation for all stakeholders. We know what a time machine journey into the past would reveal. What about a journey into the future? The answer is up to us.