The past few years have forced Japanese companies to rethink many aspects of their historical HR and governance practices, prompted by a trifecta of change:
- Japan’s demographics: a maturing population is intensifying the need to find and keep talent.
- Globalization: new and quickly growing economies such as China are causing the Japan government to realize that without a shift in corporate management practices, there is a real risk that Japan faces a “long-term, slow-growth economy.”
- Regulatory change: a new Governance Code (GC), passed two years ago, is putting new emphasis on director independence and shareholder rights.
As these trends are regional in nature and many firms around the region are or soon will be facing similar challenges, Japanese companies’ experiences can be instructive for other Asian firms that are looking to expand globally.
Some Japanese companies have tried to limit their responses to these changes, while others have embraced the changing environment as an opportunity to improve how their companies are managed. In particular, the changing role of long-term incentives in Japanese companies captures reaction to these changes.
Compared with non-Japanese, and particularly European and U.S. enterprises, Japanese companies have tended to operate their local and foreign HR systems and practices separately with either a "Japan and overseas" or "region and subsidiary" approach. Either approach can limit the career prospects of non-Japanese executives and create barriers to integration and coordination across countries and business units. It creates significant issues when trying to drive growth and recruit and retain top executive talent. A number of Japanese companies recognize these issues and are working to align their management and HR systems under global policies – including performance evaluation and incentive systems. These companies are likely to be much more successful competing against their global counterparts.
Long-term incentives (LTIs) are often a demarcation between Japanese and foreign companies, impeding global commonality. Japanese companies have used stock compensation as a substitute for eliminated retirement benefits for domestic executives and, as such, have not used LTIs as a performance incentive. The new GC code encouraged the previously uncommon practice of treating stock compensation as a key performance motivator for Japanese employees. But to remain competitive in other labor markets, Japanese companies have often used LTIs in their overseas subsidiaries, often cash-based LTIs tied to local performance, to replace stock-based incentives in acquired companies. The resulting differences in pay practices and reward outcomes across geographies often resulted in significant pay and motivational differences across executive ranks. In contrast, many foreign competitors have created globally consistent stock-based LTI plans, encouraging and rewarding corporate growth and building a wider executive perspective.
As Japanese companies modify their home country LTI plans to be more performance- and shareholder-focused and continue to expand globally in search of growth opportunities, they are increasingly creating company-wide LTI plans. And by shifting from local, cash-based LTIs to globally consistent stock-based plans, companies are trying to avoid performance goals that local subsidiaries may feel provide them with little line of sight. This shift is accelerating following the lifting of a ban on restricted stock in 2016 and new approaches to meeting regulatory impediments to granting shares to foreign workers.
The use of global LTI plans – a commonplace practice among Western companies for years now – is a first step. Large Japanese companies still organize domestic personnel management with assumption of long-term service, making it more difficult to align other compensation and HR systems globally as Western companies do. But leading Japanese companies have recognized that to succeed globally, they need to align LTIs with shareholder outcomes and also:
- Identify, develop, reward and promote the best talent, no matter where it is found
- Create a more diverse management team and ensure that more voices are heard on the board and within management
- Improve governance practices that include empowering outside directors with greater oversight powers and visibility
- Continue to focus on shareholder returns and profitability as well as workforce stability
The recent demographic, competitive and regulatory challenges are undeniable, and Japanese companies have responded in a variety of ways. Many continue to monitor the changes and make changes only when required. What is increasingly clear is that this minimal response will not be sufficient for companies that want to take calculated risks to grow and satisfy shareholders’ expectations. As now seen in Japan, the most proactive Asian companies will be the winners in an increasingly global, customer-centric marketplace that requires top executive talent in order to succeed.
How LTI helped a tech company pursue global goals: a case study
The importance of taking a global approach to personnel management to meet competitive challenges was recently highlighted by one Japanese company. Here’s their story.
- A subsidiary of a large Japanese high-tech company with operations in the U.S., Europe and Africa was looking to retain key overseas executives, share and strengthen commitment to mid-term goals as a group and reward them accordingly.
- The parent company is listed in the Tokyo Stock Exchange 1st section (large companies).
- The company expected to expand its overseas senior management and was considering an alignment of global pay practices and the establishment of a global long-term incentive plan to link rewards with the achievement of mid-term goals.
- Willis Towers Watson supported the LTI plan’s design, which consists of performance share units (PSU) and restricted share units (RSU), both vesting in three years.
The award was granted to the senior management level globally.
- Vesting of the PSUs was linked to achievement of the company’s mid-term goals, including growth and efficiency indicators.
- Both vehicles were settled in parent company shares to enhance the sense of ownership and reinforce the alignment with shareholder return.
- A trust was set up in the U.K. with a trust administration company. Once the PSUs/RSUs are vested, shares will be delivered to the participants’ accounts, administered by the trust administration company, and participants can hold or sell shares at any time and receive cash in return.
- The company carefully crafted an implementation and communication process to ensure participants understood and valued the awards; the design and implementation process included not just Willis Towers Watson, but also advisors from the legal, tax and accounting fields. Detailed plan brochures and other materials were developed to introduce the key features of the LTI plan to participants.
Sumio Morita is a director in Willis Towers Watson’s Tokyo office who leads the firm’s executive compensation consulting practice in Japan. Email email@example.com