What is governance?

First of all, let's talk about the definition of what governance is. 

Recently, you often hear the word 'governance! governance!'. It is a word that  always appears as a set when a corporate scandal is reported in newspaper or news. However, I guess there are many people who would say "I know it or I know it vaguely", so let's first check the definition of governance. In a nutshell, governance is 'system management that prevents fraudulent activities in an organization.' Governance is an indispensable element for sound corporate management. Globally, there is a strong demand for sustainability and management transparency, such as ESG and SDGs. This time, we will deepen from the definition to historical background and to why it is important' of this governance with the basics. Governance is a word that indicates 'govern/control/manage ' in the first place. In a world of company, it is called 'corporate governance' and refers to 'a management system by the company itself, aiming for sound corporate management'. 

Why has governance been drawing attention for some time? 

In Japan, scandals by large corporations occurred one after another in the 2000s, and it has attracted attention. Strengthening governance is essential to prevent management risks such as running things one-way, fraud, and personal/confidential information leakage etc.

Understood that it is important. So what should we do? 

'Establish/strengthen of departments to improve internal control such as internal control department or risk management department' and 'Creating a mechanism to clarify the location of R/R (roles and responsibilities) and SoD(Segregation of duties) including job authority and instruction system' should be mentioned. Building and strengthening a governance system is an important initiative for companies to build relationships of trust with their stakeholders.

 There are various words that are similar, and make us messed up.

Common technical terms related to governance include 'compliance,' 'risk management,' 'internal control,' and 'internal audit.' Perhaps few people clearly understand the difference in definition while many are ambiguously aware of it. Let's take this opportunity to clearly understand the meaning of each! 

What is the difference in compliance? 

Compliance means 'legal compliance' in corporate activities. Note that compliance is not limited to 'laws and regulations'. It also includes a wide range of rules such as various internal rules, 'social norms' based on common sense and good sense, and 'corporate ethics' such as corporate philosophy and social responsibility (CSR). Governance is the 'management system' for maintaining/improving this compliance. Strengthening governance also leads to strengthening compliance.  

Just for your reference, I would like to introduce a hot example case in Japan involving governance and compliance at the time of writing this article. A　large electrical manufacturer, Toshiba, chairman of BOD Osamu Nagayama held a press conference on June 14, 2021 after being pointed out by an external investigation that "it cannot be said that it was operated fairly" at the  shareholder's meeting in the summer of 2020. He admitted that the exchange between Toshiba and the Ministry of Economy, Trade and Industry, which was regarded as a problem in the external investigation, "I have to say that there is a lack of compliance and governance' he said. We apologize for the situation." 

How is it different from risk management? 

Risk management is a 'management method for grasping expected management risks in advance'. Now that the risks surrounding a company are diversifying and becoming more complex, it is essential to properly develop the risk management process. Proper maintenance and operation of this process could minimize losses in the event of risk to the organization. We must never forget not only loss and financial loss, but also trust and reputation. Technically, it is called 'reputation risk', but the damage and recovery here has a greater impact on management than money. Risk management is indispensable for sound corporate management and is one of the important functions in governance. 

How is it different from internal control? 

Strictly speaking, internal control is rational that 'the four objectives of operational effectiveness and efficiency, reliability of financial reporting, compliance with laws and regulations related to business activities, and asset conservation have been achieved. It is a process that is incorporated into the business and carried out by everyone in the organization to obtain a guarantee (from 'Financial Statements: Standards for Evaluation and Audit of Internal Controls Related to Financial Reporting'). In other words, 'internal rules and mechanisms that employees of the entire organization, including management, should comply with.' Governance has the purpose of strengthening the control and monitoring functions of corporate management, and is an initiative to ensure the fairness and transparency of business activities and to carry out shareholder-oriented management. Governance is an 'outward' system whose purpose is to protect shareholders, while internal control is an 'inward' system whose purpose is internal control.

 How is it different from internal audit? 

Internal audit is an independent, objective assurance and consulting activity designed to add value to and improve an organization's operations. It may help an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes. It is one of the indispensable roles, together with corporate auditor's audits and external audits. It is called as three-way audits that are extremely important in the world of corporate governance. 

What is the 'Corporate Governance Code' that we often hear recently? 

The Corporate Governance Code is a 'principle / guideline to be observed when building a governance system.' It was formulated by the FSA(Financial Services Agency) and the Tokyo Stock Exchange, and was announced in March 2015. It is designed for the purpose of 'preventing scandals in listed companies' and 'strengthening Japan's international competitiveness.' Listed companies are required to submit a report on the Corporate Governance Code, such as 'Ensuring the rights and equality of shareholders,' 'Ensuring appropriate information disclosure and transparency,' and 'Responsibilities of the Board of Directors.' If one of these principles is not adhered to, the “Corporate Governance Report” should explain why. One of the great features of this code is that it is a soft law called 'comply or explain'. There is no obligation to comply with all principles, just explain why your company does not. It is indispensable for managements to explain their management contents to investors in an easy-to-understand manner, rather than using a scoop ruler. Although it does not apply to SMEs(small and medium enterprise), SMEs are also increasingly using governance codes these days to increase long-term profitability. 

What are the benefits of effective governance? 

“Governance is functioning effectively” means “a state of thorough management and control”. Let7s take a look at the effects and benefits of effective governance below. 

Good thing # 1: Increasing corporate value by strengthening its governance, the external 'trust' and attractiveness of the company will increase, and the recognition as a good company will increase. Improving corporate social value will not only protect the interests of shareholders and stakeholders, but will also support the medium- to long-term development of the company. Corporate value is also the basis for calculating stock prices. By increasing corporate value, trust from financial institutions will increase, it will be easier to receive investment and loans, and financial conditions can be expected to stabilize. It will also lead to securing excellent human resources and contribute to the creation of a strong organization.

Good thing # 2: You can improve the sustainable growth and competitiveness of the company If you can manage the company smoothly by strengthening its governance, you can increase the profitability in the medium to long term. In other words, you can take risks with peace of mind with proper risk management (= fear correctly! This is very important!). Growth and returns are at risk, so if profitability improves without missing profit opportunities, we will aggressively take measures to enhance competitiveness, such as investing in new businesses and acquiring excellent human resources. It will lead to being adopted as a target. This is exactly 'aggressive governance'. In addition, corporate growth is expected to increase engagement not only with management but also with the entire company, leading to the construction of a stronger organizational structure. 

So what's wrong with poor governance?

 “Governance is not functioning” means that the monitoring system within the organization is not properly implemented. Let's look at the disadvantages and risks in this case below.

Bad thing 1: Unable to prevent fraud and scandals and lose social credibility. In a state where governance is not effective, the monitoring system within the company is not widespread, and the risk of fraud and scandals occurring in management and business processes increases. Once a scandal occurs, it is inevitable that social credibility will be greatly lost. As a result of great criticism from consumers and investors, it is possible that business will be sluggish and bankruptcy will occur. 

Bad thing # 2: The globalization that cannot cope with the globalization of the world economy is in progress at the fastest speed. In the VUCA(Volatility, Uncertainty, Complexity, Ambiguity) era, strengthening governance is essential to winning the competition. Without organizational governance, management soundness, transparency, and business execution efficiency cannot be ensured, and it will not be possible to flexibly respond to dynamic changes in the global economy. Especially for companies that are looking to expand overseas or expand / expand their business, there is concern that their business condition may deteriorate due to risks caused by differences in values ​​and culture. 

How to strengthen governance:

What kind of efforts are needed to strengthen corporate governance? Let's take a look at effective measures to strengthen.

 Prescription 1: Building and strengthening internal control in order to strengthen its governance, first and foremost, 'maintenance and operation of internal control' is important. Only when internal control is functioning will it be possible to 'disclosure highly transparent information' inside and outside the company. Let's first establish a system to set rules to be observed in-house (= maintenance) and monitor and instruct whether business is performed according to the rules (= operation)! To that end, it is also important to clarify the roles (ex. Execution, supervision, monitoring) of each department, such as the board of directors and the internal audit department. Prescription # 2: Creating a monitoring system from a third-party perspective (advanced level) To prevent fraud by some management and employees, a monitoring system from a third-party perspective is effective. For that purpose, it would be effective not only to create an internal audit but also to create a monitoring system by specialized personnel that can be evaluated independently and objectively. External audits make it easier to discover opaque rules and business processes that are difficult to notice within the company. It would be effective to set up outside directors, outside corporate auditors, and compensation committees. However, as a caveat, it is NG to have outside officers only for vessels (common cases). Create an environment that functions properly and ensures its effectiveness. Prescription # 3: Instilling Corporate Governance In-house in order to strengthen corporate governance, it is important to instill ideas and directions not only in shareholders and outside the company, but also in employees. Create a code of conduct, a charter of ethics (ex. Mission, Vision, Core Values, slogan, Cred), etc. to clarify the criteria for employees to perform their duties and make decisions. It is also important to visualize the business processes performed by employees and understand the details of business execution. Take measures such as 'collecting the business flow into a manual'

Historical background leading to the establishment of the Corporate Governance Code in Japan

Now, let's touch on the history and background of governance. The meaning of "corporate governance" in Japan has changed slightly with the times. Immediately after the burst of the bubble economy, there was a strong sense of "legal compliance and legality" for proper corporate management from reflection on corporate scandals. So-called "defensive governance". However, as you know, the Japanese economy has been sluggish for 20 years after the burst of the bubble economy. The main reason for this was the slump in the performance and corporate value of Japanese companies. "Corporate governance" was thought to be the cause.

In other words, "insufficient corporate governance" →"cannot improve corporate performance"→ "corporate value does not increase"→"Japanese economy is sluggish"
The idea has become common. The idea is clarified in the "Japan. Revitalization Strategy Revised 2014" announced by the Japanese government on June 24, 2014.

II. Key measures in the revision strategy
1. 1. Regain Japan's "earning power"
(Strengthening corporate governance)
What is needed to increase the "Profitability" of Japanese companies, that is, medium- to long-term profitability and productivity, and to even out the fruits to the general public (household budget)? First of all, it is important to change the mindset of management by strengthening corporate governance, and to strengthen the mechanism to support aggressive management decisions to overcome global competition, with the achievement of global level ROE as a guideline. is there. Excerpt from "Japan Revitalization Strategy" Revised 2014-Challenge to the Future-
As the first of Japan's key strategies, it has stated that it will "regain Japan's profitability", and as a measure for that purpose, "aggressive management decisions" by "strengthening corporate governance" are important. Under these circumstances, the Corporate Governance Code was enacted and started operation in 2015.

Financial Services Agency Corporate Governance Definition

Now, let's confirm the basic concept of the Financial Services Agency's Corporate Governance Code (December 12, 2014).
In this Code, "corporate governance" means a mechanism for a company to make transparent, fair, prompt and decisive decisions based on the positions of shareholders, customers, employees, local communities, etc. To do. This code summarizes the main principles that contribute to the realization of effective corporate governance, and the proper implementation of these principles will lead to sustainable growth and improvement of corporate value in each company over the medium to long term. It is thought that it will contribute to the development of the company, investors, and the economy as a whole through the autonomous response for the purpose.

Therefore, the current meaning of "corporate governance" is

1. "Defensive governance" for so-called compliance purposes
2. "Aggressive governance" aimed at speeding up and proactively making corporate decisions and improving corporate value

There are two points, and we aim for "sustainable growth of the company" by these points. In addition, as mentioned above, in recent years, "aggressive governance" has been particularly emphasized, and the Corporate Governance Code is a mechanism for systematically promoting it.

Summary
As we have seen, strengthening the governance system is an essential initiative for a company to achieve continuous growth. In addition to preventing scandals and fraud, there are merits such as "increasing social recognition as a good company", "sound and smooth corporate management", and "maximizing the interests of stakeholders". Because there is. Why don't you take this opportunity to think about strengthening governance again and take measures including reconfirmation?