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Learning From Toyota's Troubles: Where's the Board?

JURIST Guest Columnist Bruce Aronson of Creighton University School of Law says that Japanese automobile manufacturer Toyota's current safety crisis - now the subject of Congressional hearings - should prompt the company to address its seriously flawed system of governance more than just its public image....

The next phase in Toyota's crisis will be the appearance of the President of Toyota Motor Corporation, Akio Toyoda, before the House Committee on Oversight and Government Reform on February 24th.

His message will likely reflect an opinion he published in the Washington Post on February 9th entitled "Toyota's Plan to Repair its Public Image."

In it he outlines a number of steps he is taking to address Toyota's current crisis, including internal and external reviews of operations and quality controls, more vigorous investigation of consumer complaints, more effective internal sharing of information, and better communications with regulators.

Conspicuously absent from this list of worthy measures is any mention of the role of the board of directors in corporate governance. The structure and function of a typical Japanese corporate board reinforces the penchant for corporate secrecy in Japan, which is often cited as a cause of Toyota's problems.

In both the United States and Japan, the board of directors has a legally mandated function to ensure a corporation's compliance with law. In both countries, case law provides that directors have a duty of oversight—as part of their fiduciary duties owed to the corporation and its shareholders—to establish and monitor an information and reporting system designed to ensure such compliance. In the United States the duty of oversight in Delaware stems from the well-known Caremark decision, while in Japan it results from a shareholder derivative suit related to the $1.1 billion trading loss scandal in Daiwa Bank's New York branch in 1995 (see my law review article analyzing this case and its impact in Japan). Statutes in both countries also provide for broader systems of internal controls. In this case Toyota's systems failed badly.

In Japan the legal duty of oversight often clashes with the traditional structure of Japanese boards—large, hierarchical boards in which directors are all insiders and retain "line" management responsibilities. As a result, any problem can appear to be limited to the director(s) "in charge" of a particular area despite the common fiduciary duty owed by each director.

The Toyota case is particularly interesting because Toyota has been held out in Japan as the prime example of the strength of this "traditional" system of Japanese corporate governance. This system relies on competition in product markets, team production alliances with suppliers, and "main banks" to monitor the performance of corporate management, as opposed to "Western" approaches such as independent directors and a market for corporate control.

A "Western" approach appeared in Japan in 2002 as part of an ongoing debate on reform of corporate governance following Japan's "lost decade" of the 1990s. An amendment to Japan's corporate law at that time provided Japanese companies with an option to replace their German-inspired, traditional positions of representative director (a director chosen by the board to represent the corporation, much like a president) and internal corporate auditor (elected by shareholders to monitor directors' performance) with an "American-style" system of executive officers and board committees with independent directors. Not many Japanese companies have adopted this new system, although the number is slowly increasing.

Until recently the Japanese often contrasted the success of Toyota, the champion of traditional Japanese governance, with the poor performance of Sony, which adopted the "American-style" board committee system and now has a foreigner as its CEO. This popular comparison was always somewhat exaggerated. For example, in 2003 Toyota modified its system through the introduction of "non-board managing officers" and a reduction in the number of directors on its board (from over 40 to 29). However, even today every area of the company is represented by a senior manager on the board of directors and there are no outside directors. Given Toyota's current problems and its prominence, it will be interesting to see if other Japanese companies will now reconsider this traditional system and incorporate a greater element of independent monitoring of management.

This is not to suggest that the apparent downfall of Toyota condemns the entire system of Japanese corporate governance. Every system has its corporate scandals. The result of scandals such as Enron in the United States has been an even greater emphasis on independent directors in the Sarbanes-Oxley Act and elsewhere. Such measures were not effective in preventing new scandals, such as those accompanying the financial crisis of 2008. For example, one oft-cited weakness at Citigroup was the board's lack of industry expertise and experience, and its resulting inability to monitor traders' risk management practices concerning complex financial products.

Nevertheless, Toyota's response to its current troubles is striking because it has maintained its rather narrow emphasis on manufacturing quality and production issues in the face of a full-fledged crisis. A problem of this magnitude is not simply a matter of a technical fix or of repairing Toyota's public image. There were also significant flaws in Toyota's governance system. Perhaps Mr. Toyoda and his colleagues should also consider a plan for a greater role of the board of directors, compliance with law, and corporate governance issues within "the Toyota Way."

The House Oversight Committee might even be interested in hearing about it.

Bruce Aronson is Associate Professor at Creighton University School of Law and was formerly a practicing attorney who represented Japanese clients.

Suggested Citation Bruce Aronson, Learning From Toyota's Troubles: Where's the Board?, JURIST - Forum, Feb. 23, 2010, http://jurist.org/forum/2010/02/learning-from-toyotas-troubles-wheres.php .

Opinions expressed in JURIST Commentary are the sole responsibility of the author and do not necessarily reflect the views of JURIST's editors, staff, donors or the University of Pittsburgh.

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