Japan’s New Corporate Governance Code a Novel ‘Principle-Based Approach’

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By Toshio Aritake

Jan. 8 — By the summer, Japan will have a corporate governance code that would be shaped as a hybrid regime of the voluntary U.S. and legally driven European modes. It will mark the first time that Japan introduces formal rules on corporate ethics.

The impact of this non-binding code on corporate activities such as executive compensation, directorship, accountability and shareholder rights is expected to be limited initially, though it is likely to have long-term bearings—including the possibility of making corporate management cringe at the thought of missteps.

On Jan. 5, a Financial Services Agency official, who had written the draft code, told Bloomberg BNA that the code amounted to “a soft law, and is not a law or any form of government ordinances, regulations or circulars.” The official, who spoke on the condition of anonymity, added: “It is a principle-based approach and it will be introduced as Tokyo Stock Exchange regulations … . (Thus) there will be no amendments of laws or ministry ordinances.”

The TSE, the official said, would announce details before June 1 for immediate enforcement.

The proposed code would initially apply to publicly listed companies of the TSE and other exchanges, as well as over-the-counter exchanges, according to the draft code.

Formalizing Ethos

In a country where business ethics, including corporate governance, have been entrusted to the ethos that all Japanese are honest, companies have been allowed to sail freely inasmuch as they do not deviate course radically from societal norms, such as awarding extraordinarily generous executive compensation or shoddy management leading to corporate failures and deep losses.

Corporate governance has become an important business issue over the past decades, but rarely has occupied national attention until 2011-12, when Olympus Optical Corp. executives were arrested for covering up huge latent losses by deploying exotic offshore financial products. The Olympus scandal revealed that the company's directors were all yeomen subservient to the arrested former chief executive officer, meaning that the board failed to function as a governance body.

About the same period as the scandal, the Japanese government began amending the Corporate Law, which sets policies on business corporations, shareholders, management, boards and other matters. The amendments were enforced in June 2014. The law was devoid of great detail, as customarily is the case with Japanese law. Thus, corporate governance codes largely are still entrusted to the TSE.

‘Energizing, Not Cooling.'

Asked where the proposed Japanese code stands among global corporate governance regimes, the FSA official said the draft Japanese code was modeled on the Organisation for Economic Cooperation and Development's corporate governance principles and that in drafting it, the U.S., U.K., French and Singapore codes were studied

The official emphasized that the proposed code is aimed at “energizing, not cooling” Japanese corporate activities as it was defined as part of the government's long-term growth strategy. For example, one of the items in the code, the official said, is “uniquely Japanese” in that it urges listed companies to increase dialogue with shareholders to deepen mutual understandings on business and investment. “It can be seen as an assault governance,” the official said.

Key Provisions

Among other key points, the draft code calls for having no less than two outside directors on the board, up from one under current TSE rules. As of 2013, of about 1,400 publicly listed Japanese companies, roughly 600 did not have any outside, independent director on their boards, while more than half of NYSE-listed companies had outside directors, according to a Japan Securities Dealers Association official. And only a handful of those 600 Japanese companies had more than three outside directors.

Another key code provision urges listed companies to disclose procedures if they plan to have outside directors comprise more than a third of their boards.

Although the outside director rule can be considered a “rule-based approach,” the draft code emphasizes that as a whole, it is a “principle-based approach” with governance details to be entrusted to corporate discretion.

The draft code also states that it intends for companies to have greater interactions and interfacing with shareholders and other stakeholders.

Among other points, the code states that:

• on shareholder rights and equality, listed companies should adopt measures for small shareholders and overseas shareholders;

• boards should proactively map out corporate strategies, support management in preparing for risk taking, and perform highly effective supervisory duties on management, such as establishing supervisory and auditing boards;

• listed companies should strive to arrange for electronic voting by institutional and overseas investors, and hold consultations with trust banks that represent institutional investors at shareholder meetings;

• listed companies should disclose detailed information about shareholder meeting agendas well in advance of the meetings on their websites and other media;

• measures to prevent acquisitions should not be to defend listed company management and boards, and in deploying such measures, companies must offer adequate explanations to shareholders;

• similarly, adequate procedures and explanations must be taken in executing MBOs and other policies that alter shareholding distributions radically; and

• listed companies publicly should disclose information about policies on management and executive compensations, and policies and procedures about the retirement of management and executives, as well as the appointment of directors and auditors.

‘Far-Reaching Effect.'

Hideaki Miyajima, a Waseda University professor, wrote in a report for the Research Institute for the Economy, Trade and Industry, a Ministry of Economy, Trade and Industry research arm, that the code's dialogue rule would have a far-reaching effect on listed companies, ranging from not only day-to-day operations, but also income distribution, and mergers and acquisitions.

“Winning shareholder support will become far more important than ever before,” he wrote. “At the same time, excessively tilting to shareholders would run the risk of paying excessive dividend, disposal of valuable assets, failures to taking necessary measures to avoid takeovers, and others.”

Masayuki Naoshima, a senior Democratic Party of Japan lawmaker, told Bloomberg BNA Jan. 6 that perhaps a more long-term problem is that the code could force corporate management and executives to excessively deliberate before making business decisions, producing excessive lead time before action, such as on acquisitions.

“Obviously, companies can not hold board meetings everyday,” Naoshima said, adding that the FSA seems to prefer more regulations.

To contact the reporter on this story: Toshio Aritake in Tokyo at correspondents@bna.com

To contact the editor responsible for this story: Ryan Tuck at rtuck@bna.com

More information about the draft guideline is available at http://www.fsa.go.jp/en/refer/councils/corporategovernance/20141226-1/01.pdf.