Changes in Japanese Corporate Governance

One of the greatest pressures facing the Japanese economy and business organisations from being absorbed into an increasingly global world are issues related to corporate governance. Professor Ruth Taplin, Director of the Centre for Japanese and East Asian Studies, discusses the situation.

As the tendency of Western companies for mergers and acquisitions (M&A) accelerates alongside the need for foreign investment into Japan, tensions are being created that challenge current Japanese corporate governance and company law.

Japanese companies, since the family-run Zaibatsu such as the Mitsui group (which began in the 16th century), have been interconnected, not through cross shareholdings but through the family. After the Second World War and the American dissolution of the family-operated monopolies which broke anti-trust law, a new large conglomerate emerged. This is the sogo shosha / keiretsu which is a complex institution that is not family-owned and has its own banks and internal financial systems. Commercial law in Japan, which has governed corporations since the Meiji Era, had remained unchanged until the Koizumi government initiated and carried out widespread reforms. Central to the traditional practice of corporate governance which kept out foreigners, except at the extreme margins of the business world, has been a system of cross shareholdings, but with the impetus to become more globally competitive, new laws have been introduced to promote transparency and accountability in the Japanese corporate sector. Cross shareholding has seen a decline as a defence mechanism, being replaced by other measures including the “Poison Pill” which has been used to defend Japanese companies from hostile takeovers by either other Japanese or foreign companies or from the recent triangular mergers ⁽¹⁾.

Horizontal and Vertical Groupings

Japanese corporate groups can be divided into two different forms, one is horizontal and one vertical. The former is based on the old zaibatsu family-owned grouping. Today these companies, such as Mitsui and Mitsubishi, hold at least 25 per cent of member groups own company shares. Such crossholding of shares has developed to prevent member companies being subject to a hostile takeover. Main members of the company groups gather at monthly meetings of the groups’ Presidents called shachokai. Such meetings allow for important information concerning the entire group to be shared and decisions to be discussed informally. This is quite a feat of organisation when considering these corporate groups can have more than 30 main companies and 200 subsidiaries.

Cross shareholding is diminishing in the horizontal groups largely because recent banking regulation does not allow latent gain from shares to raise the equity ratio.

Cross share holding has been the main reason why a cap was put on the amount of foreign share ownership which usually amounted to less than 5 per cent at maximum. With the decline of crossholdings the “poison pill“ has emerged as a protection against hostile takeovers in M&As ⁽²⁾.

Another pressure on the traditional crossholdings arrangement is current value accounting which is being encouraged increasingly by the International Accounting Standards Board which may be causing a fall in profit when the re-evaluation of the cross-ownership shares occurs. Despite the Japanese GAAP (Generally Accepted Accounting Principal) there is increasing pressure from the IASB and Japan’s own need to become a fully-fledged member of the global economy that is making both the corporate governance system and the banking system more transparent and open to foreign investment. It is notable that Japan was initially reluctant to commit to the IASB through convergence. The Japan GAAP was a measure that looked to both the US GAAP and the IASB while adhering to the ASBJ (Accounting Standards Board of Japan). This has changed with the signing of the Tokyo Agreement and a new Project Plan based on it that was published on 6 December 2007, outlining the steps towards achieving convergence with the IASB. The Keidanren, the Japanese employers organisation, and the top representatives of the four major auditing firms in Japan have all been positive towards the Tokyo Agreement.

Sir David Tweedie, Chairman of the IASB, pointed out on 25 December 2007 that, as shown by the timeline of the Tokyo Agreement, the direction of Japanese Accounting Standards is moving in the same direction as the global standards and, importantly, that there is now an expectation that Japan will participate fully in the development of global accounting standards. He noted further that Japan’s participation has encouraged the US to set a date to switch to IFRS (International Financial Reporting Standards). With Japan now supporting the IASB and China, India and Korea moving in the direction of meeting international standards, Japan is keen to be involved in setting the standards. This was confirmed in the most recent joint ASBJ and IASB meeting held in Tokyo on 8 and 9 April 2008 and progress towards convergence according to the project plan was progressing to plan ⁽³⁾.

Essential Changes to the Commercial and Company Codes

Company law in Japan has been a target of great reform under the stewardship of the Koizumi government. Since 2002, the Working Group on Company Law of the Legislative Council which is the consultative body of the Ministry of Justice has led a drastic reform of the company law which also includes Part 2 of the Commercial Code, the Limited Liability Company Law and the Law of Exceptional Provisions to the Commercial Code Concerning the Audit of Stock Companies. The Working Group published the results of their deliberations in February 2005 and it was submitted to the Diet for approval. With a few amendments which will be looked at where appropriate below it was approved by the Diet (the Japanese Parliament) on 29 June 2005.

The basic reforms that have taken place under the Koizumi government includes:

1. securing the realisation of corporate governance;
2. bringing the law into line with the internationalisation of corporate activity;
3. modernising terms and consolidating the company law;
4. bringing the law into line with the highly developed information society; and
5. improving fundraising measures.

One of the most fundamental tasks of the 2005 reform was similar to what occurred in the Intellectual Property field, the modernisation of the old language. So much of company, IP and economic and trade law have been archaic, preventing foreigners in particular from understanding its essence. Much of the frustration of foreign investors is not simply cultural and language difference, but the extent that the old language has been unintelligible and an impediment to doing business. In the case of the Commercial Code, until this reform, it was written in the original language of the Meiji Era.

The current reformed company law, in accordance with the current social and economic situation, requires all companies to have at least a shareholders’ meeting and a board of directors. Meanwhile, the structure of corporate governance, except for the shareholders’ meeting and the board of directors, differs between a Company with Committees and a Company with a Corporate Auditor. The Exceptional Provisions provide different auditing system rules depending on the size of the company. The larger companies were not seen as a concern in relation to how close the shareholders are to the management, especially when protecting an inefficient membership is assessed among other reforms. However, smaller closely-held companies were a source of concern as the relationship between the management and shareholders is very close which can bias decisions and may even open it to criminal elements. Therefore, the main focus of the corporate governance reforms was concerned with the role of shareholders and directors ⁽⁴⁾.

To find out more contact Professor Taplin at:
E: Ruth.Taplin@btinternet.com