May issue: Our Governance Issues and Challenges

I believe the biggest governance issue and challenge at the Nippon Paint Group is whether the management team can continue to boldly take risks in a timely and appropriate manner for achieving Maximization of Shareholder Value (MSV).

The Asset Assembler model currently executed by the Co-Presidents pursues MSV based on autonomous and decentralized management built on mutual trust, which is a refinement of our previous business model called the Spider Web Management. Based on this model, we are aiming for more growth of existing businesses and making acquisitions to create additional opportunities for growth in the future by adding to our Group more high-quality businesses led by talented management teams.

Under the leadership of the Co-Presidents, the management of our partner companies, which are our existing assets, manage their operations with agility in the current very challenging business climate. Directors must fully understand the intent of proposals submitted by management and properly perform their supervision and support roles in order to avoid hindering the speed of decision making. In addition, Directors must constantly share their views and goals regarding the acquisition strategy with the management team so as not to miss an opportunity to add a new asset. The right path to pursue MSV is to aim for increasing the value of existing assets and adding new assets with strict adherence to financial discipline while making efforts to further deepen understanding of our Group by the capital markets.

Mutual trust between the parties performing the supervisory function in the Board of Directors and the management team, which conducts business operations, is essential for accomplishing this process. As a Company with Three Committees (Nominating, Compensation and Audit), Nippon Paint Holdings (NPHD) delegates significant authority to the management team. Naturally, the delegation of authority is premised on the Board's confidence in the management team. Without this confidence, Directors would be required to closely analyze and manage risks associated with every proposal, resulting in excessive involvement in business decisions. This would slow down decision making, which could cause us to miss opportunities for growth. On the other hand, if Directors blindly trust the management team and automatically approves their proposals, we may incorrectly assess a proposal or miss an opportunity to avoid risks. This would increase the possibility of missing the next opportunity for growth. In addition, the management team cannot be expected to trust the supervisory function of the Board if we cannot give them proper advice. The management team will then lose motivation to discuss their growth strategies at the Board of Directors meetings in order to refine these strategies. The management may feel that they might as well opt to take actions that are neither good nor bad within the scope of their responsibility.

Achieving the proper balance is very difficult. The Nominating Committee of NPHD prioritizes experience involving corporate management, global business operations, and M&A for every Director (see another article of this series, titled "The Board's Size and Skills Matrix" released on February 28, 2023.) Each Director has experience of making decisions on his/her own responsibility as a corporate executive to take risks with a commitment to the outcome, or to be required to give up on a project, by conducting a detailed analysis and gaining insight into risks associated with each proposal and measuring risk tolerance. Directors with this kind of background are expected to accurately identify the critical points of every agenda item and give appropriate advice without becoming excessively involved with the execution of business operations. Every Director needs to keep updated with the latest information both inside and outside the Group to examine proposals. As you would expect, our responsibility requires significant commitment and determination. We also hold the Independent Directors meetings at the same frequency as the Board of Directors meetings. At these meetings we exchange views and opinions and maintain our independence while enhancing mutual trust.

Let me go through the secondary offering of common stock by NPHD in January 2022^* to explain the type of governance the Board of Directors is seeking. I hope this will further explain my true intent as the Board Chair when I say that the biggest governance issue and challenge at our Group is whether the management can continue to boldly take risks in a timely and appropriate manner for achieving MSV.

The low market liquidity of our stock relative to our market capitalization was obviously one of the major challenges we needed to deal with. The management team also has been seeking solutions for many years. We had confirmed the intention of six financial institutions to liquidate their holdings of our stock. However, we had only limited windows to conduct a secondary offering because we are constantly examining potential acquisitions and other projects. Stock prices were generally weak or decreasing, including our stock, due to the worldwide supply chain disruptions caused by the pandemic. There were concerns that a secondary offering at that time could significantly erode the price of our stock due to a temporary deterioration in the supply and demand balance. As a result, it was extremely difficult for us to determine the best time for the secondary offering. The Board of Directors carefully examined whether the management team was exploring every possible opportunity and method for a secondary offering and was able to monitor market conditions accurately. We also considered the possibility that not conducting a secondary offering at that time would impose restrictions on growth opportunities in the future. We maintained our support framework in order to reach quick decisions about proposals to be submitted by management.

The management team's proposal for the secondary offering came when market visibility was not clear. However, management clearly explained that an international secondary stock offering would allow the Group to build a base of global investors who support our growth strategy with a long-term viewpoint. Furthermore, the offering was aimed at alleviating concerns about the potential sale of our stock held as crossholdings. Management also explained that the offering would improve the liquidity of our stock and contribute to meeting the listing maintenance criteria for the Prime Market of the Tokyo Stock Exchange. All things considered, the Board of Directors concluded that the offering was consistent with our commitment to pursue MSV based on the Asset Assembler model and approved the proposal.

If the Board's highest priority was to avoid risks, we might have been inclined to postpone the offering because of insufficient objective information about market conditions. However, the Board of Directors must support the appropriate assumptions concerning risk by the management team in order to achieve our sole mission of MSV. It is our responsibility as Directors to make the best decisions based on all the information available at that time and by using our own wisdom. Our stock price was temporarily weak following the secondary offering. However, we were able to accomplish the initial objective and the price recovered in the second half of the year to a level comparable with the P/E ratios of prominent global competitors. Looking back, we couldn't have achieved this outcome if we had delayed the decision. Naturally, the Compensation Committee of NPHD did not lower the evaluation of the management team on account of the temporary stock price decrease. We believe that a clear demonstration of the Board's resolute stance on evaluations and recognition of the management team's performance will further support their proper risk taking.

I stated that our group's biggest governance issue and challenge is whether the management team can continue to boldly take risks in a timely and appropriate manner for achieving MSV. In other words, can the Board of Directors keep moving forward with the management team with a firm commitment to our responsibilities? This is the management based on mutual trust that the Board of Directors is seeking. We are confident that our Group can achieve sustainable growth based on the Asset Assembler model, which will definitely enable us to achieve MSV.

*This transaction was awarded Deal of the Year 2022 in the Equity Finance category selected by Nikkei Veritas.