Misreading the Enron Scandal


By Brian Bremner The Enron saga has fascinated the Japanese business press. That's understandable, given that the supposed guardians of U.S. financial probity -- accountants, credit agencies, laser-focused independent board members, and skeptical journalists -- screwed up on such a massive scale. What was that about the U.S. being the gold standard of global business practices?

After years of listening to triumphal U.S. executives, economists, and Clinton Administration bigwigs lecture about the importance of shareholder values, sound risk management, and yada, yada, yada, the Japanese are breaking into a collective grin. And who can blame them? The pages of the Nihon Keizai Shinbun newspaper as well as top business magazines such as Toyo Keizai and Nikkei Business have been filled with opinion pieces from Japanese execs pointing up the irony of it all.

Still, does the Enron case, as outrageous as it is, mean that the Platonic ideal of corporate governance is a grand deception, a big lie? I don't think so, but some Japanese corporate heavyweights have been invoking Enron to discourage a shift to more independent boards and outside directors.

SUBCOMMITTEES. Last year, as part of an overhaul of Japan's commercial code, the Justice Ministry submitted legislation that would give companies more discretion to switch to a U.S.-style system. A corporation would be allowed to use outside executives and academics to monitor its performance by allowing them to serve on audit, compensation, and other board subcommittees.

Most Japanese companies have sprawling boards that are stacked with insiders. These are guys (yes, we're pretty much talking about men here) with decades of experience who have steadily and discreetly worked their way up the corporate seniority system.

In a recent interview with Nihon Keizai, Canon President Fujio Mitarai used the Enron scandal to trash U.S.-style corporate governance. His remarks certainly carry weight. Canon is considered one of the best-managed companies in Japan. Also, Mitarai is the chairman of the corporate-governance committee at the Keidanren, a business group that's the voice of blue-chip Corporate Japan.

Cushy deals and perks appeal to insiders and outsiders

Thanks to Enron, Mitarai was able to turn on its head a favorite tenet of corporate-governance reform advocates: that insider directors are conformist drones, while outsider directors are invariably skeptical arbiters. Mitarai argues that outsiders are like anyone else, including insiders, when it comes to being able to be bought off with a cushy compensation deal and perks.

More to the point, opines Mitarai: "At U.S. companies, chief executive officers often appoint as outside directors friends who are unfamiliar with the day-to-day operations of the firm, and so they follow the CEO's lead. The dictatorship of top management is much stronger in the U.S. than in Japan and enables scandals such as the one involving Enron Corp."

In the case of Enron, some or all of the above is probably true. The Enron board failed miserably on all counts. But I don't find Mitarai's reasoning very persuasive. Japanese boards may not have produced anything like Enron, but on this side of the Pacific there are certainly some pretty newsworthy goings-on.

SNOW JOB? Two years ago, a Japanese company called Snow Brand Milk Products had an outbreak of food poisoning because of unsanitary conditions at its dairy operations. The company did a mea culpa and vowed to be more vigilant. Yet this year, one of its subsidiaries, Snow Brand Foods, got nabbed for mislabeling its imported meat products as Japanese so it could get government subsidies.

Mitarai might argue that this is merely an anomaly, even an outrage, but that it isn't emblematic of Corporate Japan. But let's put scandals aside for the moment. What about good old-fashioned corporate performance -- things like earnings, market share, and stock price? By most measures of efficiency and profitability, such as return on equity and market capitalization, Japanese companies look like laggards when benchmarked against many of their U.S. competitors.

Heck, companies elsewhere in Asia are starting to look good by comparison. Earlier this year, Samsung Electronics boasted a bigger market cap than Japan's high-tech champion, Sony. Given Japan's sick banking system and dead-in-the-water stock market, its companies often have to tap global markets for capital. The foreigners act like outside directors looking out for their interests, and they don't warm to quaint Japanese business customs.

Foreign investors complain about transparency

The growing number of foreign pension managers and shareholders with stakes in Corporate Japan want to see some changes. A survey done in February by Dentsu among 1,000 foreign investors who trade Japanese equities found that they believe corporate governance is far worse in Japan than in either Europe or the U.S.

The big gripe: the quality of financial disclosure. (To be fair, it must be noted that Japan has shifted to more mark-to-market accounting on assets and now requires all companies to disclose underfunded pensions. Other changes in the offing will close the gap between Japanese accounting practices and international standards.)

My biggest beef with Japanese-style boards is they pretty much leave a Japanese CEO with precious little ability to overhaul an organization that's crying out for radical change. That's the biggest reason for the glacial pace of corporate restructuring and bank reform in Japan -- and by extension, its never-ending stagnation.

LIBERATING. Japanese are highly critical of the stock-option and compensation packages that American CEOs pull down. And CEO compensation in the U.S. is obscene. But this greed has an upside. It can liberate American executives to take dramatic action quickly. It may not always be wise action, but at least things get done.

Also, it's the boards that sign off on top-exec compensation packages -- but they usually come with pretty strict performance goals. You don't meet your numbers in a reasonable time frame? Well, then a good board will bring in the firing squad. CEO turnover in the U.S. is unrivaled anywhere on the planet. And, overall, the U.S. economy has been pretty well served.

Contrast that to Japan. On average, CEOs pull down $200,000 to $300,000 -- a fraction of what their U.S. counterparts make. Then again, Japanese CEOs rarely get fired by boards and can usually count on cushy sinecures as chairman or corporate adviser until they transfer to the corner office in the sky.

ALL TALK. That's why even when it's obvious a company needs shock therapy, there's no big incentive (like a once-in-a-lifetime stock option windfall) for these guys to really try. They'll talk a good game at shareholder meetings, but often that's all they do -- talk. Those that do try have to garner widespread support from their boards, which can mean having to win over 20-plus directors who have known you for decades.

That makes spinning off a money-losing subsidiary, closing down divisions, or firing 15% of the work force very tough. Inevitably, a faction of the board likes things the way they are. The CEO is ultimately just another guy in a blue suit, one voice among many.

The Enron debacle stinks to high heaven, no question. And, yes, it represents a broad-based failure of the checks and balances that are supposed to keep everyone honest. But often the system really does work. Using Enron to derail a move toward tougher, more independent boards in Japan would be a pity. Bremner, Tokyo bureau chief for BusinessWeek, offers his views every week in Eye on Japan, only for BusinessWeek Online


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