NEW YORK: On June 1, Japan’s new Corporate Governance Code went into effect. This was a big and important step in the revitalisation of Japan’s stagnant economy.

Increased productivity at Japanese companies will boost investment, and will also free up more resources to be used by ambitious entrepreneurs. The code will nudge Japan in the direction of shareholder capitalism, away from the stifling corporatism that has perpetuated inefficient business practices.

The code — which is not a law, but merely a guideline — is only a first step. In an explanatory packet I received during a visit to Japan’s Financial Services Agency this October, the agency called the code “a starting point, not a goal.” The code tells companies what to do, but more steps are needed to make sure they actually do it.

To this end, the Financial Services Agency has established a council of experts to follow up on the implementation of the code, and to recommend further steps. The members of the council are quite a star-studded cast — economics professors, think-tank researchers, business executives, investors and money managers. If the council has one weakness, it is that it has only one foreigner — Scott Callon of Ichigo Asset Management.

The council is gathering evidence on the degree to which Japanese companies have complied with the code so far. Companies that reported early show almost total compliance. But this is a biased sample, since more compliant companies are almost certainly more likely to report early; the true compliance rate will not be known until the end of December.

Even at this stage, however, there are encouraging signs. The fraction of big companies on the Tokyo Stock Exchange with independent directors on their boards went from 31.5 per cent in 2010 to 61.4pc in 2014 and then to 87pc in 2015. The fraction with two or more independent directors has gone from 21.5pc in 2014 to 48.4pc in 2015.

That is a pretty dramatic increase. It shows the power of administrative persuasion in Japan — simply by publicly and privately encouraging companies to make needed reforms, the government can get a lot of traction.

So what happens if compliance rates turn out to be lower than the government hopes? The Financial Services Agency has two recourses. First, it can use more persuasion — essentially, summoning corporate execs into its offices and grilling them. That probably doesn’t sound very threatening to most Americans, but in Japan it may be more effective.

Second, the FSA can lean on companies indirectly, through investors. In 2014, even before the governance code came into being, Japan enacted a Stewardship Code for institutional investors. This code encourages investors to monitor companies, exercise voting rights and engage more energetically in corporate affairs.

Traditionally, institutional investors in Japan are relatively passive, making bets on companies without interfering in management. The stewardship code is designed to change that culture. Basically, the FSA will call investors in and harangue them until they do some haranguing themselves, pressing corporate boards to raise profitability. That, anyway, is the hope.

This may be enough to create sustained and meaningful change in Japan’s hidebound corporate culture. Or it may not be. If harangues and persuasion fail, what next?

In an interview, the FSA also expressed the hope that foreign investors and the media will act as watchdogs on companies, sounding alarms when governance doesn’t improve. But foreign investors are notoriously fickle, putting in and pulling out capital based on global financial trends. And the Japanese media is hardly known for its toughness.

By arrangement with The Washington Post

Published in Dawn, December 20th, 2015