In February 2019 the Legislative Council of Japan (‘Hosei-shingi-kai’) submitted to the Minister of Justice its final report on the proposal for a reform of the Japanese Companies Act, in response to the Minister’s consultation in February 2017. The proposal of the Legislative Council, available here in Japanese, is a result of two years of discussions at the Council’s Working Group on the Companies Act (chaired by Professor Hideki Kanda). The reform bill of the Companies Act, which will be drafted in accordance with the Council’s proposal, is expected to be submitted to the National Diet in due course, at the earliest in fall this year.
While the proposal covers many subjects (such as the power of bondholders’ meeting), it mainly focuses on improving corporate governance of Japanese companies by: 1) requiring listed companies to appoint at least one outside director; 2) prompting communications with shareholders through adoption of the so-called ‘notice and access’ system for shareholders’ meeting; and 3) improving disclosure regarding director’s compensation. This article provides a brief overview of these three issues.
The requirement for an outside director
The appointment of outside directors was also on top of the agenda of the previous reform in 2014, which introduced a ‘comply or explain’ rule for listed companies regarding appointment of one ‘outside director’ (for details, see here). In order to nudge listed companies into appointing outside directors, the 2014 reform included a supplementary provision that required the Japanese government to revisit the issue after two years and to strengthen the regulation, for example by making appointment of outside directors mandatory, if necessary. The consultation by the then-Minister of Justice to the Legislative Council in February 2017 was the government’s response to this mandate.
To cut a long story short, the Legislative Council concluded that the Companies Act should be revised to require listed companies to have at least one outside director. Interestingly, this decision, which was a response to investors’ demand, was made overriding the oppositions not only from the industries but also from some academic members of the Working Group: they had argued that the soft-law approach taken by the 2014 reform had worked well, nudging more than 90% of listed companies into appointing one or more outside directors (for recent statistics, see here), and that there was not enough compelling data showing that the merits of introducing uniform requirement on the board structure exceed its demerits especially for small-sized listed companies that have not appointed one outside director yet. As such, the proposed requirement might be better understood as a declaration of Japan’s commitment to promote board independence to bolster investor confidence in capital markets in Japan rather than as a precise measure to promote corporate value.
Promoting communications with shareholders
The Legislative Council also proposed to introduce a Japanese version of the ‘notice and access’ system on provision of information regarding shareholders’ meetings, which would allow shareholders to obtain information in a more prompt and convenient way.
To call a shareholders’ meeting, the current Companies Act requires companies to send paper documents including annual business reports and financial statements, which tend to be very thick. Under the new rule, listed companies instead may send a simple notice providing the URL of the website where the relevant materials are uploaded. This would save companies the time and cost of printing large amounts of documents.
In addition, the new rule requires companies to upload and disclose the relevant materials on their websites at least three weeks before shareholders’ meetings, whereas the current rule requires companies to send the documents only two weeks in advance. The new rule would thus give shareholders more time to consider the agenda of meetings.
Although these reforms might seem rather technical, they are in line with the Japanese Corporate Governance Code, which aims to ‘develop an environment in which shareholders can exercise their rights appropriately’ (General Principle 1.), and specifically mentions that ‘companies should strive to send convening notices for general shareholder meetings early enough to give shareholders sufficient time to consider the agenda.’ (Supplementary Principles 1.2.2.).
The Japanese Companies Act requires directors’ compensation to be determined either by a decision of the shareholders’ meeting or by the articles of incorporation. Although this may sound like a strong form of ‘say on pay’, the Japanese Supreme Court has held that this requirement is only applicable to the total amount of compensation for all directors, that once the maximum amount of total compensation is fixed, the board of directors may decide how to divide that amount among directors, and that boards are allowed to delegate the decision of compensation of each director to a representative director, who is often the CEO. The rationale is that putting a cap on the total amount would sufficiently prevent excessive compensation to directors as a group. It is also worth noting that companies are not required to disclose compensation for each director unless it exceeds 100 million JPY (for details, see Robert J. Jackson Jr. & Curtis J. Milhaupt, Corporate Governance and Executive Compensation: Evidence from Japan, 2014 Colum. Bus. L. Rev. 111 (2014)).
While Japanese corporate law traditionally has not paid attention to the appropriateness of compensation for each director, recent discussions on corporate governance are placing more emphasis on directors’ compensation as a means to incentivize top management (see for example, Principle 4.2 of the Japanese Corporate Governance Code). From this standpoint, the Working Group discussed various proposals to reform rules on directors’ compensation.
While proposals to restrict delegation of the power to decide individual directors’ compensation to a representative director, and to require disclosure of individual directors’ compensation were not adopted due to opposition from the industry, the Legislative Council agreed to require companies to set their policy on deciding each director’s compensation and to disclose such policy as well as other matters including whether the power to decide individual directors’ compensation is delegated to a representative director. The details of items to be covered by such policy, such as the proportion of cash and equity, are expected to be laid out in the Ministerial Ordinance for the Enforcement of the Companies Act when the reform act enters into force.
The proposed reforms on executive pay are again a small step, but an important one for Japanese corporate law as for the first time it recognizes providing appropriate incentives to directors as a goal of the regulation of directors’ compensation.
It must be added here that although the alleged scandal of the former CEO of Renault/Nissan initially focused on the misrepresentation of the amount of his compensation, it did not have much effect on the above result as it broke out in November 2018 when the discussions at the Working Group were about to be concluded. Whether it will have some impact on the coming discussions in the National Diet remains to be seen.
Nobuko Matsumoto is Professor of Law at Gakushuin University, Faculty of Law.
Gen Goto is Professor of Law at the University of Tokyo, Graduate Schools for Law and Politics.
Although Matsumoto has served at the Ministry of Justice of Japan as a part-time officer since 2016 and participated in the reform project of the Companies Act, this post does not represent the views of the Ministry.