The Tokyo Stock Exchange, Inc. (TSE) revised Japan's Corporate Governance Code (Code) effective from 11 June 2021. The first version of the Code was compiled by TSE in March 2015. Originally the Code was inspired by the ‘Japan Revitalization Strategy’, and it had been formulated as part of Japan’s economic growth strategy. In the 2015 as in the 2021 version of the Code, ‘corporate governance’ indicates a structure under which companies should follow transparent, fair, timely and solid decision-making, while paying due attention to the needs and perspectives of shareholders, customers, employees, and local communities.
Since the first version, the Code has adopted a ‘comply or explain’ approach and has established five general principles: (1) Securing the rights and equal treatment of shareholders, (2) appropriate cooperation with stakeholders other than shareholders, (3) ensuring appropriate information disclosure and transparency, (4) responsibilities of the board, and (5) dialogue with shareholders.
In June 2018, the Code already underwent its first revision (2018 Revision) with the following changes innovations included: (1) reduction of policy-held shares (cross-shareholdings); (2) establishment of procedures for appointing and dismissing CEOs; (3) establishment of objective and transparent procedures in the compensation system; (4) strengthening the roles of corporate pension funds as asset owners; and (5) understanding capital costs, reviewing business portfolios, and allocating resources. In line with this 2018 revision of the Code, the Guidelines for Investor and Company Engagement (Guidelines), which is positioned as a supplement document of the Code, were also compiled
The second revision of the Code in 2021 (New Code) was timed to coincide with the launch of the new market division system (prime, standard, and growth market) of the TSE, scheduled to start in April 2022. In the prime market, where many of the current companies listed on the First Section of TSE are expected to be included, higher standards will be required than those established by the previous Code, for example, regarding the ratio of independent outside directors on the board of directors
The revisions in the New Code are the following ones
(1) Regarding ‘Enhancing Board Independence’, the New Code prescribes an increase in the number of independent directors from at least two to at least one-third of the board for prime market listed companies (where necessary, a majority of the board members should be elected as independent directors) and the establishment of a nomination committee and remuneration committee (appointment of independent directors in sufficient number so that they form the majority of the committee members in prime market listed companies). In addition, the New Code prescribes to use a skill matrix of board members conforming to the company's business strategy and appointment of independent directors with managerial experience at other companies.
(2) Regarding ‘Promoting Diversity’, the New Code prescribes disclosure of a policy and voluntary measurable targets with respect to promoting diversity in senior management by appointing females, non-Japanese, and mid-career professionals, and disclose human resource development policies ensuring diversity, including the status of implementation. (With respect to board diversity, the previous 2018 version of the Code already required companies to ensure diversity in terms of gender and nationality.)
(3) Regarding ‘Attention to Sustainability and ESG’, the New Code prescribes the development of a basic policy and disclosure of initiatives on the company's sustainability and enhancement of the quality and quantity of climate-related disclosure based on TCFD recommendations or equivalent international frameworks at prime market listed companies. Additionally, as the other major points, the New Code prescribes the appointment of a sufficient number of independent directors to have them form a majority of the board or establishment of an independent special committee at prime market listed subsidiaries to cope with conflicts of interest between their parent company and minority shareholders, as well as to promote the use of electronic voting platforms and disclosure in English at prime market listed companies. In line with this 2021 Revision of the Code, the Guidelines were also revised.
We can discern that since the 2015 first version, the Code’s theme is to improve corporate value over medium- to long-term corporate value. However, from the perspective of achieving that goal, for example, I have pointed out the following issues and problems in my paper: (1) Although the rights of shareholders at shareholders’ meetings are much stronger than those in Delaware (under the Companies Act), it seems that the focus of the Code is still on strengthening the rights of shareholders. (2) As for the dialogue with shareholders (engagement), the perspective of dialogue in line with long-term improvement of a company’s value is not sufficient. (3) Due to the influence of the Code and other such structures, takeover defensive measures and cross-shareholding at Japanese listed companies have been waning dramatically in recent years. It should be noted that the number of companies that plan to delist is rapidly increasing because the pressure from shareholders has grown significantly in recent times. (4) With regard to the low-level ROE of Japanese companies (and other such measures), even if the figures are improved in the short term by share buybacks and other moves, the essential problems will not be solved. Measures should be taken to create more innovation and regain ‘earning power’ (see also my recent paper).
In the New Code, various directions were presented to promote sustainability and diversity, and to improve the function of the board of directors. However, from the point of view of improving the ‘earning power’ that is the driving force for Japanese companies and improving their corporate value over the medium to long term, I believe that the Code has not provided enough principles or rules yet and needs support through practice and further review in the future.
Hiroyuki Watanabe is a Professor at the Faculty of Law at Waseda University, Japan.