In many ways, the problems surrounding Nissan Motor Co. have spawned renewed interest in the state of Japan’s corporate governance.

Initially, Nissan’s corporate governance practices came under fire following the arrest of its former chairman, Carlos Ghosn, as allegations emerged that the former chairman misused corporate funds while operating under little, if any, oversight.

Now the issue has become whether the embattled automaker can bring its corporate governance practices up to speed.

Earlier this year, Nissan pledged to present a new corporate governance system at its shareholders meeting this month that would include plans to install a more independent board.

But last week, reports emerged that Nissan, under public pressure from French partner Renault SA, had watered down its governance reform plans to meet its demands, raising fresh concerns that Nissan’s final proposals would not go far enough. In the end, however, those concerns were swept away at the 11th hour, just before Nissan’s general shareholders meeting, which is taking place Tuesday.

Over the past decade, following the Olympus Corp., Toshiba Corp. and other financial scandals, Japan has strengthened its corporate governance regimen. Penalties were significantly increased for violations of the Financial Instrumentation and Exchange Act and a new whistleblower law was enacted.

The ongoing Nissan scandal is proving to be even more notorious than earlier cases, and efforts to strengthen Japan’s Corporate Governance Code are taking on new urgency.

Governance explained

Almost every discussion on corporate governance starts with a definition suggesting that the concepts are not well understood. But there is nothing mysterious about it.

It is a system of processes, checks, and balances that covers every function in a publicly listed company from finance and engineering to human resources. It covers the board of directors, auditors, officers and all employees.

At its heart, it is a system to assure that everyone in a company is always “doing the right thing.” And it can quickly identify any risks of bad behavior or illegality and mitigate them before they cause material damage to the company, its employees and shareholders.

As evident from Japan’s recent corporate scandals, a major failure in corporate governance can cause massive damage to a company and, in some cases, lead to its demise.

The ‘gold standard’

The best corporate governance systems will have, among many others, the following elements:

A board with a majority of qualified, independent directors with expertise directly relevant to the company’s business. This excludes former officers of the company, its subsidiaries or shareholders.

Three permanent board committees composed entirely of independent directors who have full oversight over executive compensation, nomination of directors and executives, and audit functions.

A CEO who does not hold an executive officer role in another publicly listed company.

A board chairman who is an independent director.

How Japan is trying to catch up

Japan’s first Corporate Governance Code came into effect in 2015.

It does not have a legal mandate. Instead, like most corporate governance codes, it requires companies to either comply with a long list of principles or explain in annual reports to the Tokyo Stock Exchange why they did not.

In June 2018, the code added additional focus on reducing cross-shareholdings, clarifying CEO appointment and dismissal procedures, and requiring a board committee for nomination or compensation decisions that is staffed 50 percent or more with independent directors.

Nissan as laggard

So how did Nissan’s governance stack up against the governance code?

By many accounts, Nissan has been a laggard for a long time.

Of the 500 largest companies in Japan in 2011, only 11, including Nissan, did not have two independent directors, according to an analysis by Zuhair Khan, head of research at the Jeffries Group. Nissan’s sole “outside” director was a retired Renault officer.

Even after the code took effect in 2015, it took Nissan until 2018 to add two independent directors to the board of directors — a former trade bureaucrat and a retired female race car driver. Neither had any business background, raising questions about their qualifications.

Other red flags continued to exist, as Nissan had no board committees — panels that provide a critical oversight function for auditing and for finalizing executive compensation and management appointments.

In most businesses in Western countries, a nomination committee has the mandate to propose directors who meet competence and independence standards.

Nissan’s global communications office confirmed that its former chairman personally selected its independent directors and statutory auditors, subject to perfunctory approval from the board.

Nissan’s board also did not issue the customary compensation reports, which explain the rationale and measurements for compensation, Robert Sloan, a senior lecturer at MIT Sloan School of Management, noted in the Harvard Business Review.

And most appallingly, one of the most fundamental oversight mechanisms was glaringly missing.

From 2005 onward, Ghosn, as chairman and CEO of Nissan, effectively reported to himself in his role as chairman and CEO of Renault. So much for oversight.

As required, Nissan has issued a compliance status report annually to the TSE.

Neither the TSE nor Nissan would comment on Nissan’s specific performance in comparison with other companies. But the bourse did indicate that failing to establish board committees for nominating directors and for executive compensation was frequently an area where compliance was low.

Since Ghosn’s arrest and subsequent removal as chairman, certain changes have already been implemented.

It did away with the board delegation that was used for Ghosn to set compensation for himself and his lieutenants, installed a more independent system for statutory auditors, and began training directors and auditors in Nissan’s code of conduct and compliance.

Training is key, as Nicholas Benes, head of The Board Director Training Institute of Japan, says.

“After 10 years, I need more than one hand to count the number of companies like Nissan where the legal department tried to convince executives to receive such training from us, failed, and then several years later, there was a damaging governance failure,” Benes said.

The drama with Renault

Nissan announced in late March that it had established an interim board committee to be staffed by three independent directors and three external advisers to nominate a new board of directors, and to prepare proposals for its upcoming shareholders meeting.

As for Renault, it returned to its pre-2005 governance practice of splitting the roles of CEO and chairman.

Last month, Nissan announced it would ask shareholders in June to elect 11 directors — seven of whom they describe as “independent” — and approve the establishment of three board committees, each chaired by an independent director for nominations, compensation and audit.

It also announced that one of the independent directors would be named chairperson of the board.

Nissan’s special governance committee recommended that the committees “each have a majority of independent directors.”

The other four directors would be new Renault Chairman Jean-Dominque Senard, CEO Thierry Bollore, current Nissan CEO Hiroto Saikawa and Chief Operating Officer Yasuhiro Yamauchi. The two Renault-nominated directors on the Nissan board, together with all the other directors, approved the proposed structure subject to approval by the shareholders.

But then a new drama erupted earlier this month. Surprisingly, Renault moved to obstruct Nissan’s push to improve its corporate governance. Renault publicly announced its intention to abstain in the shareholder meeting, effectively attempting to block the reforms that would bring Nissan into full compliance with the code for the first time.

In the face of Renault’s threat, news reports emerged that Nissan agreed to give more representation to Renault on its proposed board committees. But what did this mean for the future of Nissan’s corporate governance?

In a very unusual midnight press release late last week, Nissan swept away multiple incorrect media reports and provided full transparency on what the new proposed governance structure would be, subject to shareholder approval on Tuesday.

Nissan announced that proposed independent director Yasushi Kimura become chairman of the proposed new board.

In addition, they announced the individual members of the three proposed statutory board committees. The nomination and audit committees would consist of five directors, four of whom would be independent, with Senard joining the nomination committee and Bollore joining the audit committee. The compensation committee would have four independent directors. Each of the committees would also be chaired by an independent director.

If the shareholders approve this plan on Tuesday, this new board structure will certainly receive high marks from the TSE in terms of board independence, with seven of the 11 directors and the chairperson independent, matching gender and international diversity recommendations, and full compliance with the requirements of the code’s statutory board committee.

The Renault-Nissan relationship always seems to entail some public drama. But with these changes to its board and governance system, Nissan will have moved from perennial laggard to head of the class in terms of corporate governance in Japan.

Edo Naito is a retired international business attorney advocating for corporate governance in Japan. He has held executive positions at several U.S. and Japanese multinational companies.