The Three Committees — Why Separate Nomination, Compensation, and Audit

Personnel, pay, and audit. If executives decide each of these themselves, every one becomes a conflict of interest. So these three are taken out of the executive's own hands and entrusted to others. That is the idea behind a committee. This piece returns to the Companies Act and the Corporate Governance Code to confirm why the three areas are separated, and reads how the same logic that runs through the "separation of drafting and approval" in materials review is at work here.

01The Impossibility of Grading Your Own Paper

Nomination, compensation, and audit share one trait: each is an area in which executives end up taking themselves as the object. Who to choose as successor (nomination), how much to pay oneself (compensation), whether one's own execution was proper (audit). If executives hold these, the one evaluating and the one being evaluated become the same person. Call them, if you like, three areas prone to self-assessment.

When the evaluator and the evaluated are one and the same, no check can hold. So governance design severs these three from the executive's hands and passes them to independent ones. If the independence of outside directors we examined earlier was about bringing in "an outside eye," the committee is the mechanism that makes concrete where, and how, that outside eye is placed.

02The Three Areas — Nomination, Compensation, Audit

Set out the three to be carved off by what each one handles.

What the three share is a structure in which judgment is distorted when the party judges itself. This is not a matter of competence or good faith. If the same person holds appointment, pay, and audit, a path always opens for self-interest to bend the judgment. So authority is dispersed, and an independent eye is placed over each.

03The Statutory Three Committees, and Designs That Fill the Gap Voluntarily

What turns this idea into a system is the choice of corporate organizational structure. In a company with a nominating committee, etc. (shimei iinkai-tō setchi-gaisha), the three committees — nomination, compensation, and audit — are required by statute, and each must be composed of a majority of outside directors (Companies Act, Articles 400 and 2(xii)). The nominations and compensation a committee decides carry strong authority that even the board cannot overturn. To cut off the distortion of self-assessment, the design moves the decision-making power itself into independent hands.

In a company with a board of corporate auditors (kansayaku-kai setchi-gaisha) or a company with an audit and supervisory committee, by contrast, the three committees are not mandatory. Many companies therefore fill the gap by setting up voluntary nomination and compensation committees that are not required by law. Supplementary Principle 4-10① of the Corporate Governance Code calls for voluntary committees whose principal members are independent outside directors. Here is the separation of supervision and execution brought down to the level of organizational design.

04Compensation Is a Device for Steering

Among the three, compensation stands out in character, because pay is at once a reward for past work and a device that steers the executive's future conduct. Designed wrongly, it breaks in two directions. Let the person set it, and it drifts toward self-dealing — excessive pay set by oneself. Make it all fixed, and the incentive to take risk and create value thins out.

So the compensation committee prevents self-dealing while building in a performance-linked portion to encourage growth. Into that yardstick enters the idea, set out in the Ito Review, of an ROE that exceeds the cost of capital. Performance linkage that is conscious of the cost of capital turns the executive's attention from this term's figures toward medium- and long-term value creation. The design philosophy of compensation, like comply or explain, is tested not by getting the form in order but by the explanation of what one is trying to encourage.

05Down to the Materials-Review Floor — Drafting and Approval Are Not Held by the Same Hand

How does all this connect to materials review? The idea at the core of the three committees is, in a phrase, "do not let people approve their own work." This overlaps with the very structure of materials review. The drafter who creates a material and the approver who clears it are separated. If the person who carries the sales numbers clears their own material, the same distortion arises as when executives hold nomination, compensation, and audit.

The independence of review is determined not by how the organization chart looks but by whether this "the party does not judge itself" structure is held. Are the drafter and the approver not effectively the same person? Are the approver's evaluation and treatment not subordinated to sales by the number of materials cleared? The same question that keeps a committee independent of executives stands on the review floor as well. The reviewer is in the position of implementing, at the unit of a single material, the logic of separation that governance adopts across the whole company.