Corporate Governance Principles

Transcription

1 Excellence. Responsibility. Innovation. Principles, August 2016 Hermes EOS Corporate Governance Principles Japan For professional investors only

2 Principles, August 2016 Introduction We welcome the progress Japan has made in corporate governance in recent years. Particularly since the introduction of the Corporate Governance Code in the country in 2015, which followed that of the Stewardship Code (Principles for Responsible Institutional Investors) in 2014, we have observed an increased level of interest among companies in discussing corporate governance with institutional investors or their representatives, including Hermes EOS. Although it is still at an early stage, we hope that constructive and meaningful dialogue between companies and their shareholders will continue to develop and help achieve positive changes that lead to long-term value creation for all stakeholders. Hermes EOS works on behalf of some of the largest pension funds in the world to ensure that companies are run sustainably and focus on the creation of long-term value. These funds represent millions of individuals who depend on them for at least part of their long-term financial well-being. Therefore pension funds are the classic long-term investors with a close interest in the wealth-creating capacity of the companies and economies in which they invest. As a representative of these long-term investors, Hermes EOS makes recommendations to most of its clients on how to cast their votes at shareholder meetings of investee companies globally and engages with the boards of companies on matters it believes will preserve and add value. Our activities are based on the fundamental belief that companies with responsible, interested and involved shareholders are more likely to achieve superior long-term returns than those without. In line with Japan s Stewardship Code, we expect pension funds and other long-term investors to play an important role in promoting best corporate governance effectively. Accountability: Open and ongoing dialogue with shareholders Active and ongoing dialogue between a company s board, its management and its shareholders is key to accountability. Hermes EOS believes that a relationship based on mutual understanding and trust between the company and its shareholders is central to good corporate governance and to the creation of value over the long term. A high standard of transparency and accountability gives shareholders more comfort in holding shares for the long term and ultimately helps to reduce the company s cost of capital in an increasingly competitive global market. We encourage companies to consider corporate governance in a strategic manner and demonstrate a clear commitment from the top to essential improvements in corporate governance and culture to support sustained growth and profitability. We also urge more Japanese companies to provide better access to their senior management and board members, including direct dialogue and meetings with independent directors, who can provide shareholders with a different perspective from that of management. Importantly, these meetings also provide independent directors with the opportunity to hear directly the concerns of shareholders. Effectiveness and appropriate composition of boards To optimise the long-term value of companies, an effective system of checks-and-balances is required at the board level. We believe that the board should comprise members with an appropriate and diverse range of competencies, knowledge and experience. These include leadership skills to move the company forward, expertise to make decisions and ability to challenge executive management. Independence For boards to effectively discharge their responsibilities, they should include sufficient independent elements. Independent directors, who are able to exercise objective fiduciary judgment, are best positioned to hold management to account on a wide range of matters. They are expected to direct a company in a way that ensures the creation of long-term value and to advise and support the decision-making of the executives, assisting them to improve the performance of the company to ensure sustained profitability and returns above the cost of capital. While the Corporate Governance Code requires boards to include at least two independent non-executive directors, we expect more from large boards particularly if they consist of more than 15 directors. We also encourage large companies to ensure that one third of the board is independent. We expect independent directors to have unbiased views and therefore urge boards to apply strict definitions of independence when considering candidates for such positions. For example, we do not consider independent those who work or recently worked for group companies, significant shareholders or business partners or who have any material transactions with the company. We also perceive that long tenure undermines independence. While we acknowledge the valuable contributions that statutory auditors make to companies, we do not believe that independent statutory auditors can implement their duties and responsibilities in practice so as to effectively fulfil the expected role of independent directors. Diversity Boards are most effective when they have access to a diverse range of knowledge, experience and skill sets relevant to the company. In addition, a wide variety of viewpoints and perspectives will make for better debate and challenge and ultimately, we believe, better decisions. Japanese boards are typically made up of a large majority of executive directors who have been with the same company for many years, lacking diversity in terms of gender, nationality and experience. We believe that boards with too much commonality of backgrounds run the risk of groupthink and even hubris. Despite the historical challenge¹ to secure a sufficient pool of women candidates, as well as the potential language barrier in having non-japanese members on the board, we continue to encourage boards to enhance their diversity which we believe would be beneficial for companies in the long term. Nomination process We welcome the voluntary establishment of a nomination and compensation (advisory) committee at many companies in recent years. We believe this can help enhance focus and transparency on these matters as the prevailing Japanese board structure lacks formal committees. The committee should play a key role in nominating independent directors, ensuring the right mix of skill sets and independence among board members, as discussed above. It should also lead on succession planning for key executives, including the chair and president, by identifying individuals who have the skills and expertise needed for the business, instead of endorsing senioritybased promotions. ¹ Few opportunities for career development were available for women in Japan until the Equal Employment Opportunity Law was introduced in 1986 and followed by the 1997 ban on gender discrimination in recruitment and promotion. 2

3 Hermes EOS It is important that the committee has a majority if not comprising solely of independent directors in order for it to be effective and maintain objectivity. While the committee is usually described as an advisory body because companies are not legally required to have one, we expect companies and boards to ensure that the committee s decisions are not undermined or dismissed as advisory. Last but not least, companies should make transparent the nomination process and the role of the relevant committee for appointing senior executives, directors and statutory auditors. Cross-shareholdings We believe that the widespread practice of cross-shareholdings (also known as strategic shareholdings)² among Japanese companies is not only an inefficient use of shareholder funds but may also lead to problems. While major banks and some companies have indicated plans to unwind many of the legacy holdings, more needs to be done. Many companies believe it to be acceptable to hold shares of other companies to maintain long-term business relationships, including the securing of contracts for distribution and the stable supply of goods and services. This can however conflict with market principles of fair competition because companies are expected to do business with those with whom they have shareholding relationships, instead of those who can offer the best quality of products or services or the lowest price. Cross-shareholdings may also contribute to poor corporate governance. The holders of such shares tend to support management of the investee companies instead of exercising their shareholder rights appropriately to hold management and the board to account. Cross-shareholdings can also function as anti-takeover measures. It is important to note that the practice promotes the unequal treatment of shareholders because those who hold shares for strategic purposes may receive benefits for their business, while other shareholders, including institutional and retail investors, do not. Ultimately, Hermes EOS would like to see these holdings phased out. We understand that this may not be possible in the short term, as it will involve the action of various parties and companies may fear that the unilateral sale of strategic shares could have a detrimental effect on their business. As a first step, we seek more transparency in relation to company policies on cross- or strategic shareholdings, as well as on how shareholder rights, including voting rights, are exercised at investee companies. We also encourage companies to disclose details of existing cross-shareholdings, including owners of their shares and the specific purpose of these holdings. From this position, boards and shareholders can develop plans for unwinding cross-shareholdings more easily. Efficient capital management Companies should seek an appropriate balance in capital management decisions. They should strive to maximise long-term corporate value by implementing rigorous financial and business discipline. The appropriate capital structure is a question for the board and depends on the particular circumstances of the company concerned. However, we note that some Japanese companies still have substantial cash balances or cross-holdings of investments in securities for considerable periods of time, without providing a solid strategic plan or sufficient explanations for this use of shareholder capital. An increasing number of companies is setting targets for higher returns on equity (ROE) and seeks to discuss their plans with shareholders. We welcome this development and expect management to clearly explain the company s capital policy, demonstrating a strategy and roadmap towards utilising capital more efficiently to enhance long-term corporate value and achieve sustained growth. In doing so, management should consider a wide range of metrics in addition to ROE. Protection of shareholder interests Pre-emption rights As a representative of long-term investors, Hermes EOS strongly supports the principle of pre-emption. We believe that it is a fundamental right through which current shareholders of a company can retain their ownership without finding their interest diluted by the introduction of other investors. We have seen a number of new share issues in the past which resulted in significant dilution of existing shareholders. It is widely accepted by global investors that rights issues offer an important, efficient and fair way for companies to raise further equity which are preferable to private placements. We accept that flexibility and diversity of new sources of capital can be required to reflect the individual circumstances of companies. However, we expect companies to provide sufficient strategic explanations for any capital raising beyond a minimal level so that we can be assured that any funds raised will be used in the best interests of all shareholders. Takeover defence schemes We have concerns about the purpose, legitimacy and effectiveness of poison pill schemes and discourage companies from adopting them. We will only support such a scheme if the company is able to provide a convincing rationale for it and assure us that it will not be used merely to entrench management. The company should also provide details of a sound implementation mechanism specifically designed to protect and enhance value for shareholders. We will carefully consider management s track record and the company s overall governance profile and progress, such as board composition and actions to optimise shareholder value, before making a decision on whether to support poison pills. Remuneration Hermes EOS generally does not seek disclosure beyond the current regulatory requirements on details of individual compensation in Japan, given the relatively low level of executive compensation in most cases and cultural sensitivities. However, we expect companies to articulate their remuneration structure and provide clear performance criteria for executives to ensure that remuneration schemes align management incentives with strategic objectives, key drivers of business performance and long-term value creation. This should encourage appropriate risk-taking by senior management. We welcome the moves by many Japanese companies to abandon the historic practice of paying lumpsum retirement bonuses to directors and statutory auditors. This is a step forward in the shift away from remuneration schemes based on seniority to those more closely linked to performance. For more context and Hermes EOS views on executive pay please consult our Remuneration Principles for Building and Reinforcing Long-term Business Success which can be found at Remuneration-Principles-PLSA-NAPF-March-2016-update.pdf ² Despite the commonly used term cross-shareholding, holdings of this type are not always mutual. On the other hand, strategic shareholding may not always apply as some holdings lack a clear strategic purpose. 3

4 Principles, August 2016 Environmental and social risk management Companies should manage effectively environmental and social factors that are relevant to their business, with a view to enhancing their sustainability. This is critical for their sustainable growth, as well as for meeting their responsibilities for various stakeholders. Failure to manage these material risks can affect the ability of companies to do business or impact shareholder value through reputational damage and/or interruptions to operations. We expect companies to regularly disclose to shareholders how they identify and manage these risks and provide evidence that the processes to do so are effective. They should also clearly define board and senior management responsibilities for environmental and social issues. Uncontrollable climate change is a systemic risk to the value of our clients portfolios because of its economic and geopolitical consequences. We therefore support the ambition of the 2015 Paris agreement of 195 countries to limit climate change to below 2 C. This historic commitment was helped by the intervention of companies globally which publicly encouraged political action in the run-up to and during the UN climate change conference. Because of the systemic risk to the global economy, we encourage all companies to publicly support the ambition of the Paris agreement and to have this commitment embedded as a central tenet of their public policy and sustainability activity. To support this, boards should ensure that they have climate change on their board meeting schedules at least annually and that they expose themselves and senior management to experts who can challenge them on the strategic risks and opportunities that climate change represents. We expect companies to demonstrate how they are preparing for a low-carbon world and the risks and opportunities such a transition provides. Corporate Governance Code We firmly welcome the comply-or-explain approach taken by Japan s Corporate Governance Code. We believe that a thoughtful and effective use of the comply-or-explain mechanism will help facilitate constructive dialogue between companies and their shareholders, as well as foster trust and good long-term relationships. Indeed, we have noted an increased level of interest from companies in discussing governance practices with investors since the introduction of the Code. While the effective implementation of the Code is likely to take time, we strongly discourage a box-ticking approach or boilerplate explanations. Explanations should be tailored to the company s position and be sufficiently informative to enable shareholders to use them as the basis for dialogue. To ensure the comply-or-explain approach works as effectively as intended, there needs to be a shared belief about what constitutes good corporate governance and its value. Companies should not confuse superficial compliance with good corporate governance, and we have concerns that a large number of companies stated in their first reporting that they comply with all or most of the principles of the Code. Japanese regulators and investors need to make continuous efforts to encourage and assist listed companies in gaining a greater understanding of the purpose and standards of good disclosure which should contain a meaningful level of detail and provide a coherent rationale for the chosen governance arrangements. We expect companies to embrace the spirit of good governance and seek to use their disclosure and other means, in particular dialogue with investors, to demonstrate that good governance is important to them and that they are striving constantly to improve it. 4

5 Excellence. Responsibility. Innovation. Hermes Investment Management Hermes Investment Management is focused on delivering superior, sustainable, risk-adjusted returns responsibly. Hermes aims to deliver long-term outperformance through active management. Our investment professionals manage equity, fixed income, real estate and alternative portfolios on behalf of a global clientele of institutions and wholesale investors. We are also one of the market leaders in responsible investment advisory services. Why Hermes EOS? Hermes EOS enables institutional shareholders around the world to meet their fiduciary responsibilities and become active owners of public companies. Hermes EOS is based on the premise that companies with informed and involved shareholders are more likely to achieve superior long-term performance than those without. Our investment solutions include: Private markets International real estate, UK commercial real estate, UK private rental sector real estate, infrastructure and private equity High active share equities Asia, global emerging markets, Europe, US, global, and small and mid cap Credit Absolute return, global high yield, multi strategy, real estate debt and direct lending Multi asset Multi asset inflation Responsible Investment Services Corporate engagement, intelligent voting and public policy engagement Offices London New York Singapore Contact information Hermes EOS Sachi Suzuki +44 (0) sachi.suzuki@hermes-investment.com Business Development United Kingdom +44 (0) Africa +44 (0) Asia Pacific Australia +44 (0) Canada +44 (0) Europe +44 (0) Middle East +44 (0) United States +44 (0) Enquiries marketing@hermes-investment.com Disclaimer This communication is directed at professional recipients only. The activities referred to in this document are not regulated activities under the Financial Services and Markets Act. This document is for information purposes only. It pays no regard to any specific investment objectives, financial situation or particular needs of any specific recipient. No action should be taken or omitted to be taken in reliance upon information in this document. Any opinions expressed may change. This document may include a list of Hermes EOS Limited ( HEOS ) clients. Please note that inclusion on this list should not be construed as an endorsement of HEOS services. HEOS has its registered office at Lloyds Chambers, 1 Portsoken Street, London, E1 8HZ. CM155113/T4604 Global 08/16