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April 17, 2006

Separation of Governance and Management is a Global Trend

Takaaki WAKASUGI (Professor, Tokyo Keizai University)

Corporate governance is when the directors as representatives of shareholders supervise managers to fulfill corporate objective of seeking profits while avoiding illegal or illicit behaviors. In order for corporate governance to function effectively, separation of the functions of governance and management is becoming a global trend.

Corporate managers, in their effort to seek profits, form business plans, make budgets, and set performance goals. This is the job of management. In order for management to function properly, managers need to be motivated in the right direction to achieve target profits. And it is governance that establishes corporate target profits.

In Japan, governance and management have customarily been integrated. It has been observed commonly that the board of directors would elect among themselves a representative director, who would then be assigned the tasks of the chief executive officer. Because a board member who should be supervising managers is assigned to head management, it has been practically impossible for directors to supervise the chief executive.

A way to separate governance and management is to assign the board of directors to supervise the conduct of managers. In Japan, such a format of running a company ("committee system company") became possible in 2003 through a revision of the commercial code.

The objective of a company being seeking profits does not mean the company is allowed to do anything to achieve profits. Behaviors that attract negative response from the public such as unlawful conduct must be prevented, while legitimate relationships should be established and maintained with shareholders and other stakeholders including clients, suppliers and employees. Supervising the establishment of such an internal control system and the effective functioning of it are also the tasks of board of directors.

Absence of management and governance in Japan

The role of shareholders is important as well. It is the responsibility of shareholders to elect directors and delegate the command of a company to them for it to operate properly in seeking profits. In Japan, however, shareholders aware of such responsibility are very rare, with the Pension Fund Association being possibly the sole exception. In the U.S. there are semi-public pension funds such as CalPERS (California Public Employees' Retirement System), which actively use their voting powers to carry out governance functions in electing external board members. One reason for the apathy toward management and governance issues in Japan is the ineptness of shareholders.

It is common in any country that when corporate performance begins to tumble, discussions on governance becomes active to look for the causes. In Japan, too, the topic has been fiercely debated after the bubble collapse. But as can be seen in the case of CSR (Corporate Social Responsibility) being treated within the realm of governance, discussions on management and governance often are confused and miss the point.

Furthermore, the current discussion on corporate governance in Japan is limited within the scope of compliance, i.e. how to abide by the law, and lacks the view of achieving target profits. Sound governance and proper management is required for Japanese companies to fare well in global competition. Corporate performance seems now to be finally recovering. But unless a healthy corporate governance scheme is established, problems will resurface and become fatal for companies when the economy cycles into recession.

The mission of management is to lead employees and seek target profits. In Japan, however, the motive to seek target profits has been generally weak, making the duty of management obscure. Many companies are currently in a state of sans management. Where there is no management, there can be no governance. Such is Japan's unfortunate reality.

(The original Japanese article appeared in the April 11, 2006 issue of "Economist," published by Mainichi Newspaper Co.)

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