Japanese Corporate Law 3 (Corporate Governance) | Articles

Corporate Governance

Corporate governance aims to manage corporate activities and prevent corporate misconduct, thereby ensuring compliance with laws and regulations. Simultaneously, it seeks to enhance productivity and profitability for sustainable growth.
Establishing internal control systems mainly addresses the former issue (compliance), while designing compensation systems that incentivize management to enhance corporate performance primarily concerns the latter issue (productivity).
In Japan, discussions around corporate scandals have traditionally emphasized compliance, but reflections on the low productivity and profitability of Japanese companies since the 1990s have shifted focus towards enhancing efficiency as well.

Institutional Design in Japanese Stock Companies (Kabushishi Kaisha, KK)

All stock companies must have a shareholders’ meeting and directors.
Public companies (the stock company (KK) that does not have provisions in its articles of incorporation requiring board approval for the transfer of all or part of its shares) must have a board of directors.
Companies with a board of directors must have either corporate auditors (including a board of corporate auditors), an audit and supervisory committee, or a three-committee system (nomination, audit, and compensation committees) along with executive officers. Each company can have only one of these structures.
Large companies (with a capital of 500 million JPY or more, or total debts of 20 billion JPY or more), companies with an audit and supervisory committee, and those with a three-committee system require an accounting auditor.
Japanese corporate law, targeting large companies and drawing inspiration from the U.S. model, established a new type of company known as a “Company with Three Committees” (renamed “Company with Nominating Committee” after the 2014 amendment). The 2014 amendment similarly created another type of company called a “Company with Audit and Supervisory Committee,” which also appoints external directors and does not have corporate auditors.
The adoption of these governance systems is voluntary. As of July 2022, among the 3,770 companies listed on the Tokyo Stock Exchange, 1,392 companies (37%) have chosen to establish an audit and supervisory committee, indicating its popularity. In contrast, only 88 companies (2.3%) have adopted the three-committee system (renamed as “company with nominating committee”), showing its relative unpopularity. This system assigns crucial management decisions, such as personnel and compensation, to the nominating and compensation committees. The reluctance to delegate these sensitive decisions to external members may explain its limited adoption. However, it is noteworthy that all three major banking groups (Mitsubishi UFJ Financial Group, Sumitomo Mitsui Financial Group, and Mizuho Financial Group) have adopted the three-committee system.

External Directors and Independent Officers

In many countries other than Japan, it is common for a majority of the board members to be external directors. In response to growing calls for the appointment of external directors, the 2019 amendment to the Companies Act mandated the appointment of at least one external director for companies required to submit securities reports (most listed companies fall under this category).
The Corporate Governance Code, enacted on June 1, 2015, as a regulation for listed companies on the stock exchange, and revised in 2018 and 2021, mandates that listed companies appoint at least two independent external directors (one-third for companies listed on the Prime Market). This regulation operates on a “comply or explain” basis, where non-compliance without proper justification can lead to violations of listing rules.
The independent officer system, introduced in December 2009 based on the Tokyo Stock Exchange’s listing rules, mandates that listed companies appoint at least one independent officer (referring to an external director or auditor without conflicts of interest with general shareholders) as part of their corporate behavior code. Companies are also required to submit a notification of independent officers to the Tokyo Stock Exchange to confirm compliance with these regulations.

Perspective of Foreign Investors on Japanese Stock Companies

Foreign investors often criticize Japanese listed companies for lacking mechanisms to evaluate corporate performance and management from a shareholder’s perspective. Therefore, it is necessary to establish such mechanisms within the companies, spearheaded by external directors.
The most straightforward approach would be to adopt the “monitoring model”, which separates the functions of operational decision-making and supervising management, and limits the board of directors’ role to deciding on basic business strategies while focusing on supervising management.
However, most Japanese listed companies have traditionally viewed the board of directors primarily as a place for operational decision-making (“management model”), and it is difficult to say that the function of supervising management has been adequately fulfilled.