Historically, Japanese corporate governance has been marred by scandals (e.g., the Olympus scandal). Does this risk still persist?

Analysis of Corporate Governance Risks in Japanese Companies

Historical Context and the Olympus Scandal

Japanese corporations have indeed experienced multiple governance scandals, with the most notable being the Olympus scandal in 2011. This involved top executives concealing massive investment losses over an extended period, deceiving investors through fraudulent transactions and accounting manipulations, which triggered a sharp stock decline and drew global attention. It highlighted structural issues in Japanese corporate governance at the time, such as lack of board independence, weak internal oversight, and management self-preservation tendencies under the "lifetime employment system."

Similar incidents include the Toshiba accounting scandal in 2015, where inflated profits misled investors and exposed flaws in auditing and disclosure mechanisms. These scandals damaged the overall reputation of Japanese firms and prompted international investors (like Warren Buffett) to adopt greater caution in risk assessment.

Progress in Recent Corporate Governance Reforms

Since the 2010s, the Japanese government and regulators have actively promoted governance reforms to enhance transparency and investor protection:

2015 Introduction of the Corporate Governance Code: Requires listed companies to strengthen board independence, improve information disclosure, and encourage shareholder engagement.
Tokyo Stock Exchange (TSE) Reforms: Pushed for more external directors on boards and reinforced risk management mechanisms.
Impact of Abenomics: Through "Abenomics" policies, corporate governance was emphasized as a pillar of economic growth, leading many firms to enhance internal controls and compliance systems.

These reforms have yielded significant results. According to Japan’s Financial Services Agency, the proportion of external directors in listed companies exceeded 50% in 2023, far higher than pre-reform levels. The Big Five trading houses (Itochu, Mitsubishi Corp., Mitsui & Co., Sumitomo Corp., Marubeni) — in which Warren Buffett invested — exemplify beneficiaries. These firms, with relatively mature governance, prioritize long-term value creation and responsiveness to shareholders, key reasons for Buffett’s investment (he increased his stake in them starting in 2020).

Do Risks Still Exist?

Yes, such risks persist, though significantly reduced. Reasons include:

Structural Challenges: Lingering traces of "insider control" in Japanese corporate culture; some boards lack independence, creating information asymmetry or managerial moral hazard.
Recent Cases: Scandals still occur post-reform. Examples include the 2021 Kobe Steel data falsification scandal involving product quality fraud, and accounting irregularities in some SMEs in 2023. These show reforms require sustained effort, especially in SMEs or traditional sectors.
External Factors: Global uncertainties (e.g., supply chain disruptions, geopolitical risks) may amplify governance gaps. Japanese firms’ multinational operations also complicate compliance.
Relevance to Buffett’s Investment: While the Big Five trading houses boast strong governance (e.g., high dividends, transparent reporting), they are not risk-free. Investors should monitor their risk management practices, such as internal audits and crisis response.

Risk Management Recommendations

For investors (e.g., those emulating Buffett’s long-term value strategy):

Due Diligence: Scrutinize annual reports, ESG disclosures, and external audit opinions.
Diversification: Avoid over-concentration in single firms or sectors.
Monitor Metrics: Track board composition, shareholder returns, and compliance records.
Shareholder Activism: Influence governance through stake ownership, as Buffett does.

In summary, while corporate governance risks in Japan remain, ongoing reforms and international pressure (e.g., foreign capital inflows) have shifted them from "high-risk" to "manageable." Buffett’s investments reflect this confidence, but prudent risk management remains critical.