The people of Japan placed themselves under new national governance in August with the historic election of the Democratic Party of Japan. Now the DPJ and Japanese regulators seem likely to move forward with changes to corporate governance as well.
Exactly what the DPJ might propose remains unclear. At the moment, the party is devoting much of its energy to larger priorities, such as overhauling the country’s postal system and improving Japan’s sagging birth rate. Shizuka Kamei, the new chief of Japan’s Financial Services Agency, said recently that corporate governance measures agreed on during the Liberal Democratic Party’s rule were yet to be discussed. But the country’s stock exchanges have a raft of reforms they can push through themselves, and the FSA seems likely to carry out regulatory changes proposed during the previous administration’s tenure.
Kamei
“I haven’t heard anything about [corporate governance] policies” specifically, since he is new to his post, Kamei said at a press conference last month. But, he added, “I plan to make a clean break” from previous policies, “which were based on radical free market principle and capitalism.”
Kenji Tamura, the FSA’s parliamentary secretary, chimed in. “We may decide to change the government’s policy [on corporate governance],” he said. “This applies to everything that was determined by the previous administration.”
The FSA’s budget for the new calendar year starting April 2010 is expected to increase slightly, to 23.9 billion yen ($263.5 million). Since 2006, the FSA budget has hovered around 20 billion yen. Budget requests have mainly been around increased personnel in areas such as corporate accounting and disclosure or surveillance.
Tamura’s comments reflect an important attitude among DPJ players that corporations should heed: The new administration wants Japan to become more of a politician-led government, instead of one molded around decisions made by bureaucrats.
Saito
Bureaucrats elsewhere in Japanese business circles, however, still have some momentum. Atsushi Saito, president of the Tokyo Stock Exchange, says the TSE will “promptly” carry out several changes to improve corporate governance at its listed firms. Chief among them will be a requirement that Japanese public companies have outside officers on their boards. It will be implemented as a “soft rule,” meaning the rule firmly encourages companies to appoint outsiders, rather than as a “hard rule” codified into Japanese corporation law.
Outside directors may be old hat in the United States, but 55 percent of companies listed on the Tokyo Stock Exchange have no outside directors at all, according to a recent government report. The TSE’s new rule would require outsiders either in the form of kansayaku (Japanese “corporate auditors”; there is no precise counterpart in U.S. corporations) or an independent board member.
Kansayaku are also expected to play an increased role altogether, whether they sit on the board or not. Companies will be expected to provide more support staff to aid the kansayaku, and to report about ongoing improvements made to that department. More importantly, listed firms will be asked to present and explain their overall corporate governance strategy and model to investors.
There’s more. Companies will need to start disclosing detailed results of shareholder proposals made at annual meetings, including the number of ballots tallied for or against a proposal—not simply whether the measure passed or not.
Rule changes at the TSE should kick in by early 2010, according to Shosaku Shimomura, head of the planning section in the listing department at the TSE.
Why Reforms Now?
The Tokyo bourse hopes such governance improvements will entice foreign shareholders who may have left Japan for China or India to return. Based on annual data compiled by the TSE, foreign investors were net sellers of stocks at major Japanese exchanges during fiscal year 2008. Foreigners sold 3.7 trillion yen ($40.7 billion) more of stocks than were bought, reportedly the most since 2000.
STRUCTURAL ASPECTS
Below is an excerpt from the Financial System Council Study Group report on the internationalization of Japanese capital markets.
1. The structure of board of directors
Adopting the “Company With Committees” system. At present, very few companies have adopted the Company with Committees system (2.3% of Tokyo Stock Exchange listed companies). For the majority of listed companies, adopting this system looks unrealistic in the near future.
Board of directors comprised mainly of independent outside directors. For example, at least one-third or half of the company’s board of directors is to be comprised of independent outside directors. This requirement may overlap with that of the board of statutory auditors, where, by law the majority must be outside auditors.
Joint monitoring by independent outside directors, the board of statutory auditors and the officers in charge of internal audit and internal control. Elect one or more highly independent outside directors. Coordinate with the board of statutory auditors, officers in charge of internal audit and internal control to strengthen the supervision of management. To gain and maintain the confidence of shareholders and investors, present this as a preferred model for the majority of listed companies. Based on this, listed companies are to disclose the details of their governance structure and the reasons for adopting that structure in relation to the preferred model
2. Other reforms.
Strengthening the function of statutory auditors. Identify the following as desirable attributes for listed companies, and listed companies to disclose their current status: (1) to maintain adequate human
resources and infrastructure to support the audit by statutory auditors, (2) to appoint highly independent outside auditors, and (3) to appoint auditors with an
in-depth knowledge of finance/accounting
Independence of outside directors and auditors. Enhance disclosure concerning the relationship between the company and the outside director/auditor, as well as the company’s view on their independence
Authority to determine the agenda for electing accounting auditors and their compensation. Encourage further discussion on the issue of giving statutory auditors the authority to determine the agenda for electing accounting auditors and their
compensation.
Enhancing the disclosure of executive compensation. Disclosure of the executive compensation policy and the categorized breakdown of compensation.
Source: FSA Study Group Report on Corporate Governance (June 2009).
According to a 2007 report on global investment by the Organization for Economic Cooperation and Development, from 1997 to 2006 Japan ranked last as a destination for foreign investment among highly developed countries.
“What we are able to do is have less negative factors as an exchange for investors and that is where improving corporate governance comes in,” Shimomura says. “We always say we need to create an environment that is comfortable for institutional investors.”
The TSE rule changes come as a result of recommendations made through a series of discussions that took place earlier this year at two separate study groups. One group was hosted by the Financial Services Agency, the other by the Ministry of Economy, Trade and Industry. Both panels included industry leaders, scholars and representatives from business organizations such as the Keidanren. Each issued a separate summary report in June, outlining changes that should happen.
Some reforms, such as the rules to get listed firms to disclose their status on cross shareholdings and to disclose voting results for shareholder proposals, were then handed off to the TSE for implementation first. (The FSA will ultimately adopt the changes itself as well.) Other reforms, such as disclosure of executive compensation policies, are still pending.
Japan’s trade ministry says it will most likely be able to uphold recommended changes listed in its June study group report on fiduciary duties to investors. Futoshi Nasuno, director for the corporate system division at METI, says his ministry will monitor how listed companies will react to the new rules of placing independent or outside officers on its board. METI will take additional measures on an “as needed” basis, he says.
“It wasn’t realistic for the government to change the Corporation Law at this time,” Nasuno says. “It was decided things would go more smoothly if companies voluntarily adopted changes.”
Meanwhile, some other changes have been underway at the exchanges in the interest of shareholders. Foremost, the exchanges have been promoting transparency by doing more than simply delisting companies for violations. The Tokyo Stock Exchange has set up a special category called tokusetsu chui shijyo meigara (“securities on alert”) for companies that have committed minor rule violations. Implemented two years ago, the new policy effectively suspends a company caught for an offense not deemed serious enough for prompt delisting, such as was the case with Nikko Cordial Securities, which was charged in an accounting scandal in 2006.
The “on alert” company needs to improve its performance within three years or faces delisting. The first company placed in the category was heavy machinery maker IHI Corp., which was charged for filing inflated earnings. IHI has since been removed from the probationary status. Japan Digital Contents Trust and Futaba Industrial are currently categorized as “on alert” companies. Both were found filing false accounting statements.
The TSE has also introduced measures to better protect shareholder interests in private allocations. Third party allocations by listed companies with dilution ratios of 300 percent or more are discouraged and can face delisting upon review. Furthermore, listed companies doing private allocations that would change the controlling shareholder or cause a dilution of 25 percent or more need to face review by an independent group that will maintain some distance from the board, or gain shareholder feedback via measures such as seeking a resolution at a general shareholder meeting.
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