The Attributes of Japanese Corporate Governance Influencing the Quality of Internal Controls

Abstract

This study examines the corporate governance characteristics that influence the improvement in the quality of internal controls. Previous studies suggest that corporate governance independence and expertise affect the quality of internal controls (Krishnan et al. 2005; Hoitash et al. 2009). In Japan, however, any company that discloses significant deficiencies (SD) in internal controls has the motive to increase the independence of corporate governance to mitigate any subsequent negative consequences. As a result, independent directors are made the scapegoats, rather than allowing them to fulfill the expectation of improvement in the quality of internal controls. On the other hand, directors with financial expertise that have a high status in a company do influence the improvement in SD in internal controls. This suggests that in Japan it is important to provide financial experts with the power and authority to improve the quality of internal controls in the short term, due to the difference in the provisions between the Financial Instruments and Exchange Act (J-SOX) and the Sarbanes–Oxley Act (SOX). The requirements in Japanese Corporate Law (JCL) for independent directors are not as strict as those within SOX. Therefore, companies in which the boards are able to promote expert directors to important positions improve the quality of internal controls more often than those that are not. It is thus revealed that auditors should be able to discuss with the financial experts as to what is required to improve any significant deficiencies that are detected in the process of internal control audits.