Corporate Governance, Executive Compensation and the Japanese Approach (Part 1)

Some aspects of corporate governance are converging in the global markets.  Countries have increasingly turned to the use of independent directors to protect the interests of shareholders (usually, outside the United States, minority shareholders).  Similarly, there is movement towards the use of specialized committees of the board, particularly compensation and audit, with membership consisting at least in part (if not entirely) of independent (or, in some cases, non-executive) directors.

Another place where converging seems to be occuring is in the area of compensation disclosure.  Since 1992, the US has had robust disclosure requirements for executive compensation.  After the 2006 reforms, the requirements apply to the CEO, CFO, and top three highest paid officers.  Moreover, the US has moved towards a system where all benefits (including perqs) must be included in "total compensation."  Total compensation does not necessarily reflect the amount actually paid to the officers but provides a basis for comparability. 

Disclosure seems like an inherently good thing but there is clearly a cultural component to the requirement.  In the United States, the expectation is that compensation will largely be determined and regulated by the market.  To the extent excessive, unhappy shareholders can sell, depressing share prices.  In order for this dynamic to work, shareholders must know the amount of compensation. 

Of course, the whole approach is flawed.  Shareholders do not react solely because of a single variable that makes them unhappy.  Moreover, even if they sell their shares and prices fall, the board is still in a position to award excessive amounts to top officers.  Indeed, most years when share prices have fallen, average executive compensation has risen.  

As a result, disclosure of executive compensation has not had downward pressure on the amounts paid.  Quite the reverse.  Executive compensation has likely gone up as a result of disclosure.  CEOs and CFOs in comparable companies can use the higher pay awarded by their competitors as a basis for arguing for a raise.  

Nevertheless, pressure has increased in other countries to follow the lead of the US and require robust disclosure of executive compensation.  One of the most recent converts has been Japan.  Yet as public reports indicate, the impact of disclosure is likely to be very different than what occurred in the US.