Messages from Outside Directors
Amid harsher conditions in international politics, the coronavirus crisis has disrupted global supply chains and restricted movement, seriously affecting the world economy. Some have observed how the crisis seems to be fast-forwarding historical processes. Although this may be a factor that undermines JGC Group performance, it can also be taken as an excellent opportunity to enhance corporate resilience and promote reform.
Last fall, the JGC Group changed course and adopted a holding company structure. The move to a holding company represents the third major transformation following a move from oil refining to engineering business in the early years after the company was founded in the 1930s, and then another when it expanded internationally in the 1960s. Currently, the entire group is working to implement this transformation, and a notable development toward this end is the formulation of the 2040 vision. In the spirit of SDGs and ESG, the Group's determination to take on social challenges and protect the environment is becoming more apparent, and I believe we will see specific shapes this will take in the next medium-term business plan announced in 2021.
Here, I think that it may be necessary to reconsider the nature of corporate value. As a company, one must generate profit as a matter of course. However, this by itself is no longer sufficient. Companies must now create value that is useful not only for investors but also for society as a whole, including employees, their families, communities, and the environment. Recently, the supercomputer Fugaku won four world rankings in computing speed and other areas. When I heard a developer at the announcement mention that rather than aiming to make the world's best system, they sought usability, I was impressed by their stance, which goes beyond functionality and emphasizes something responsive to user needs and valuable to society. Looking back in history, although Panasonic founder Konosuke Matsushita enjoyed early success in business, he later experienced stinging failure. He did some soul-searching after reflecting on his single-minded pursuit of profit and lack of founding ambition, and he decided that their corporate mission would be to bring happiness to people and make the world a better place.
The Group is also improving corporate governance, which is the foundation of this transformation. We also see this in recent developments, such as establishing the Nominating and Remuneration Committees, introducing restricted stock compensation, and ensuring that at least one-third of the directors are outside directors. Steady progress is being made. In the future, I hope we can hold more in-depth discussions on disclosure of non-financial information.
Many employees in the Group have strong feelings about social value. Taking on work with enthusiasm, doing all one can, and devoting oneself to it. I believe this corporate heritage is the Group's greatest core competency. Although many challenges remain, such as digital transformation, I expect the Group to continue working together and rising to the occasion with determination.
These are trying times for the JGC Group. Investment by oil majors and oil- and gas-producing countries rapidly came to a standstill this year from factors such as the Covid-19 pandemic. Meanwhile, as the global macrotrend toward decarbonization continues over the long term, it seems inevitable that companies seeking orders in oil and gas will face a headwind.
But the slump in oil and gas capital investment will not last forever; there is no need to be overly pessimistic, and it would also be a mistake to believe that continued overreliance on oil and gas poses no risk for the Group.
With this awareness, the Group is in the process of transforming its existing management strategy and sales structure in pursuit of lasting, sustainable growth. One facet of this was adopting a holding company structure as of October 2019. In 2020 the Group has also been mapping out, with input from various divisions and experts, new business that appears to be promising over the next 20 years. As these proposals are scrutinized relative to an array of criteria and prioritized, they will begin to take shape as soon as possible. To survive in the challenging world of the 21st century, the JGC Group is also planning a shift toward higher productivity, with both flexibility and tenacity, as a corporate group that has implemented digital transformation (DX).
I am of the opinion that companies may well respect their history and traditions, but unless they adapt to changes in their environment, they will fall into decline. I encourage the Group to move to their new corporate structure with a sense of speed, undaunted by risks associated with the unknown, which come with any transformation. On this occasion, I have also advocated further promotion of efforts toward a personnel system where international and diverse human resources can play active roles. And especially at a stage such as this, I hope each member explores and vigorously discusses what the Group should be like in 20 years and the action they themselves should take.
Close monitoring will be needed, however, to prevent this far-reaching and rapid-fire transformation from causing undue friction or reform fatigue in the workplace. There is no concern that organizational reform will disrupt governance, however. Fairness and transparency have been enhanced by structural improvements to corporate governance over the past few years, such as refining the composition of the board and streamlining its management, as well as having a majority of outside directors in the Nominating and Remuneration Committees.
It is said that crises are also opportunities. Everyone is motivated when they share a sense of crisis. Getting through trying times is never easy, but I am convinced that when all members stand together and encourage each other, surely they can seize the future.
It has been a year since I became an outside director of JGC Holdings in June 2019. This has given me a chance to ask many questions and make a variety of suggestions at board meetings, drawing on my expertise in finance. What interests me in particular, of course, is whether the company earns returns commensurate with risks, as expected by shareholders.
Risk and return varies greatly from one project to another. We have discussed the nature of risks, the returns expected, and the methods of risk management for each project of the JGC Group, and I have made various suggestions.
The Group has targeted 10% ROE as described in the current medium-term business plan, which took effect in 2016. At present, the rate of return on safe assets is near 0% internationally, with the equity risk premium generally placed around 3-6%. Considering that the rate of return on safe assets was previously higher than it is now, I believe this is an appropriate level.
However, if financial leverage is high-that is, the equity ratio is low-higher return is expected by shareholders, and if the business risk is high, naturally, the expected return also increases. As a textbook example of this, the expected return for each project is calculated according to the extent and nature of financial and business risk. If expected return exceeds this level, it will be adopted, but in actual business, it is not this easy.
For example, it is unrealistic to assume a statistical distribution of returns for projects in Africa and calculate risk and then cost of capital based on it. But many things are revealed if we attempt this anyway, and seeking to reduce unexpected events and keep risks within a calculable range is a key component of risk management.
As we actively engage in these kinds of discussions, I hope it helps improve decision-making.
In reality, Group earnings yielded an ROE of 1% in the fiscal year ended March 31, 2020, and the average over the past three years has been less than 4%, which is far from the target. We should not be too concerned about a low rate of return over a few short years, but this is a problem if it persists long-term.
As for the economic environment which will affect current and future return, the energy industry faces significant impact not only from short-term factors such as economic repercussions of the pandemic but also from medium and long-term influences, as well as a shift toward environmental conservation. Indeed, it is in this context that the Group itself is moving ahead in formulating a 2040 vision. Long-term corporate survival relies on an approach of determining a vision of the company far in the future and then calculating backward to plan for the near future.
For situations far in the future, it becomes more difficult to make reasonable economic calculations. However, calmly reviewing the distinctive knowledge and technologies that a company has built up over years in the context of the external environment will surely reveal the right path to take. Being competitive enough to be a player in the global arena, which relatively few Japanese enterprises can claim, will also be fundamental in the long-term vision. Looking ahead, I hope to continue contributing through these kinds of discussions.