The Japanese corporate governance framework is based on codes, regulations and laws. In October 2001 the Revised Corporate Governance Principles were published by the Japan Corporate Governance Forum, a private-sector association. In March 2004, the Listed Company Corporate Governance Committee, appointed by the Tokyo Stock Exchange (TSE), published its Principles of Corporate Governance for Listed Companies. A new Company Law came into force in May 2007, replacing provisions of the Commercial Code that relate to companies. As part of its 2007 Plan for Strengthening the Competitiveness of Japan's Financial and Capital Markets, Japan's Financial Services Agency has introduced an internal control report system, also known as the Japanese Sarbanes-Oxley Act (J-SOX), which took effect in April 2008. The TSE's policy for FY2008 comprises further improvements in the TSE listing system to strengthen governance of listed companies. Despite this progress in codifying good corporate governance practices, the Asian Corporate Governance Association's (ACGA) 2008 White Paper asserts that the lack of shareholder activism and extensive cross-shareholding impede structural change. The Economist Intelligence Unit's 2008 survey of Japan concurs that pressure from institutional investors has historically had a limited effect on corporate management. However, the ACGA's 2008 White Paper reports a positive development in the Japanese corporate governance framework through the increasing use of "hybrid" board structures, which follow the traditional statutory auditor (kansayaku) system, while appointing one or more external directors.

General Overview

According to the International Monetary Fund's (IMF) 2003 Financial System Stability Assessment (FSSA), the corporate governance system in Japan is characterized by a lack of shareholder activism, transparency, and relatively few outside directors on corporate boards. The relatively small corporate bond market and extensive cross-shareholding further impede structural change. To address these issues, important reforms have been undertaken in the Japanese system, including improvements in accounting standards in line with international best practices, a strengthening of the accounting and auditing framework, and the revision of the Commercial Code. The IMF report recommends promoting investor activism through the development of the capital markets and strengthening the position of creditors in the corporate restructuring process. It is further advised to introduce stronger market incentives for management to ensure the effective implementation of legal and regulatory measures.

In its 2008 survey of the M&A and investment environment in Japan, the Economist Intelligence Unit (EIU) assesses the development of Japan's corporate governance and investment environment. The EIU report finds that pressure from institutional investors has historically had a limited effect on corporate management. As managers in Japan often prioritize social responsibility towards stakeholders, they fail to take into account shareholder value. Another major concern is that of third party share placements executed by the management of listed companies under a closed arrangement, which dilute the holdings of existing shareholders. Despite the rising numbers of "poison pill" takeover defenses, and growing levels of cross-shareholdings, the EIU report states that "there is increasing scope for shareholders and managers to work more closely in Japan to raise corporate value" (p. 6). In this regard, the Tokyo Stock Exchange (TSE) should issue stricter regulations to reinforce shareholder protection.

In October 2001, the Japan Corporate Governance Forum (JCGF), a private-sector association, published its Revised Corporate Governance Principles. The Listed Company Corporate Governance Committee--established in December 2002 by the TSE--also issued its Principles of Corporate Governance for Listed Companies in March 2004. In December 2004, the Financial Services Agency (FSA) adopted a Program for Further Financial Reform, which was aimed at enhancing governance of financial institutions by clarifying criteria to evaluate the qualifications for directors of financial institutions. A White Paper on Corporate Governance in Japan was published on May 15, 2008 by the Asian Corporate Governance Association (ACGA) in a collaborative effort with global institutional investors. As stated on the ACGA website, the paper argues that "while a number of leading Japanese companies have improved their corporate governance practices in recent years, the system of governance in most Japanese listed companies fail to meet the needs of stakeholders or the nation." In particular, the corporate governance system fails to provide for adequate supervision of corporate strategy, protection of management, and critical returns on the pension system. The White Paper makes recommendations on six key issues, namely the 1) Recognition of shareholders as owners of listed companies; 2) Efficient use of capital; 3) Independent supervision of management; 4) Pre-emption rights and third-party share placements; 5) Poison pill takeover defenses; and 6) Fairness and transparency in shareholder voting.

The ACGA's 2008 White Paper reports that Japan's corporate governance structure is often portrayed as a system of "stakeholder capitalism" (p. 5). This system is, however, outdated, according to the ACGA, and there is a need for shareholders' rights to be better recognized and protected. Annual shareholder meetings are also clustered in a short period of time, and cross-shareholding structures distort voting results at shareholder meetings. Furthermore, the use of "poison pills" (p. 28) by companies hinders corporate value and fails to recognize the rights of shareholders. In 2002, Japan amended provisions of the Commercial Code to allow companies to choose between either keeping the traditional statutory auditor (kansayaku) system or adopting a U.S.-style corporate governance system. The revised system required the appointment of executive officers and the establishment of a board committee, in which at least the audit, nomination, and compensation committees were composed of a majority of outside directors. In July 2005, Japan published the new Company Law No. 86, which replaces and significantly modifies the current provisions of the Commercial Code that relate to companies. The Company Law came fully into force in May 2007. In its 2008 White Paper, the ACGA reports a positive trend in Japan's use of "hybrid" board structures, which follow the kansayaku system while appointing one or more external directors.

The Financial Instruments and Exchange Act No. 25, which replaces the Securities and Exchange Law, was adopted in June 2006, and came into force in April 2008. The U.S. Department of Commerce (DoC) 2008 Country Commercial Guide states that the Act may help promote investment in the financial, insurance, and real estate sectors by establishing "a more flexible regulatory system for financial markets" and applying "a uniform set of rules for similar financial instruments." According to a May 2008 International Financial Law Review (IFLR) article by the law firm Nagashima, Ohno & Tsunematsu, a bill to amend the Financial Instruments and Exchange Act was submitted to the Diet on March 4, 2008, which will create a new market for professional investors; revise firewall regulations affecting banks, securities, and insurance firms; and expand the administrative monetary penalty system. As part of its 2007 Plan for Strengthening the Competitiveness of Japan's Financial and Capital Markets, Japan's FSA has introduced an internal control report system, also known as the Japanese Sarbanes-Oxley Act (J-SOX), which took effect in April 2008.

The TSE is the second largest stock market in the world by domestic market capitalization. As of 2007, there were 2389 domestic and 25 foreign companies listed on the TSE, as stated on its website. According to a June 2008 IFLR article by the law firm Nagashima, Ohno & Tsunematsu, the TSE will revise its listing rules and publish guidelines regarding shares without voting rights. The change should enable companies to list more non-voting stocks, and to protect shareholders of these stocks.

In its 2008 Doing Business report, the World Bank rates investor protection in Japan in 2008 as being higher than the regional and OECD averages. The Investor Protection Index is a subcomponent of the World Bank's 2008 Doing Business Indicators, and consists of three dimensions of investor protection: transparency of transactions (Extent of Disclosure Index), liability for self-dealing (Extent of Director Liability Index) and shareholders' ability to sue officers and directors for misconduct (Ease of Shareholder Suits Index). The indices range between 0 and 10, with higher values indicating greater disclosure, greater liability of directors, greater powers of shareholders to challenge the transaction, and better investor protection. Japan scores 7.0 in the disclosure index, against a regional average of 5.0 and an OECD average of 6.4. It scores 6.0 in the Director Liability Index, against a regional average of 4.4 and an OECD average of 5.1 and 8.0 in the Shareholder Suits Index, against a regional average of 6.3 and an OECD average of 6.5.

The Principles

Principle I: Ensuring the Basis for an Effective Corporate Governance Framework

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The IMF's 2003 FSSA states that important reforms have been undertaken in the Japanese system, including improvements in accounting standards in line with international best practices, a strengthening of the accounting and auditing framework, and the revision to the Commercial Code. In October 2001, the JCGF, a private-sector association, published its Revised Corporate Governance Principles. The Listed Company Corporate Governance Committee--established in December 2002 by the TSE--also issued its Principles of Corporate Governance for Listed Companies in March 2004. In December 2004, the FSA adopted a Program for Further Financial Reform, which was aimed at enhancing governance of financial institutions by clarifying criteria to evaluate the qualifications for directors of financial institutions. Japan amended the Commercial Code in 2002 to allow companies to choose between either keeping the kansayaku system or adopting a U.S.-style corporate governance system. The revised system required the appointment of executive officers and the establishment of a board committee, in which at least the audit, nomination, and compensation committees were composed of a majority of outside directors. In July 2005, Japan published the new Company Law No. 86, which replaces and significantly modifies the current provisions of the Commercial Code that relate to companies. The Company Law came fully into force in May 2007.

A White Paper on Corporate Governance in Japan was published on May 15, 2008 by the ACGA in a collaborative effort with global institutional investors. The White Paper makes recommendations on six key issues, namely the 1) Recognition of shareholders as owners of listed companies; 2) Efficient use of capital; 3) Independent supervision of management; 4) Pre-emption rights and third-party share placements; 5) Poison pill takeover defenses; and 6) Fairness and transparency in shareholder voting. Nonetheless, the available sources do not directly address Japan's compliance with this principle.

Principle II: The Rights of Shareholders and Key Ownership Function

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The IMF's 2003 FSSA states that the legal powers of shareholders do not ensure effective control over boards of directors due to their limited participation. Furthermore, although boards undertake both executive and shareholder functions, they are often ineffective due to dominance by insiders. The IMF report states that greater importance is being given to shareholders' rights, and that institutional shareholder activism has been increasing. It is recommended to develop the takeover markets, and promote stronger shareholder activism. As annual shareholder meetings are clustered in a short period of time, and cross-shareholding structures distort voting results at shareholder meetings, the ACGA's 2008 White Paper states that there is a need for shareholders' rights to be better recognized and protected. In this regard, it is recommended that the timing and process of shareholder meetings and voting be "accessible, fair and transparent" (p. 6). The ACGA report further recommends introducing pre-emption rights to protect the rights of shareholders.

Pressure from institutional investors has historically had a limited effect on corporate management, according to the EIU's 2008 survey. As managers in Japan often prioritize social responsibility towards stakeholders, they fail to take into account shareholder value. Another major concern is that of third party share placements executed by the management of listed companies under a closed arrangement, which dilute the holdings of existing shareholders. Despite the rising numbers of "poison pill" takeover defenses, and increasing levels of cross-shareholdings, the EIU report states that "there is increasing scope for shareholders and managers to work more closely in Japan to raise corporate value" (p. 6). In this regard, the TSE should issue stricter regulations to reinforce shareholder protection. Nonetheless, the available sources do not directly address Japan's compliance with this principle.

Principle III: The Equitable Treatment of Shareholders

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The ACGA's 2008 White Paper states that "the rights of shareholders as owners of listed companies need to be better recognized and protected" (p. 5). In this regard, the ACGA advises that the fair treatment of shareholders be aligned with that of other stakeholders. However, the available sources do not directly address Japan's compliance with this principle.

Principle IV: The Role of Stakeholders in Corporate Governance

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Pressure from institutional investors has historically had a limited effect on corporate management, according to the EIU's 2008 survey. As managers in Japan often prioritize social responsibility towards stakeholders, they fail to take into account shareholder value. The ACGA's 2008 White Paper reports that Japan's corporate governance structure was formerly portrayed as a system of "stakeholder capitalism" (p. 5). This system is, however, outdated, according to the ACGA, and there is a need for shareholders' rights to be better recognized and protected. In this regard, the ACGA advises that the fair treatment of shareholders be aligned with that of other stakeholders. Nonetheless, the available sources do not directly address Japan's compliance with this principle.

Principle V: Disclosure and Transparency

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The IMF's 2003 FSSA notes that accounting standards have been brought toward international best practices. Moreover, the accounting and auditing framework has been strengthened to implement the new standards. According to a regulatory and standard-setting framework assessment published by the Japanese Institute of Certified Public Accountants in December 2004, listed companies are required under the Securities and Exchange Law, which was replaced by the Financial Instruments and Exchange Act, to comply with regulations on additional disclosure requirements, including the preparation of consolidated financial statements. In January 2005, per the 2005 update available from the Deloitte & Touche IAS Plus website, the International Accounting Standards Board (IASB) and the Accounting Standards Board of Japan (ASBJ) launched a joint project to reduce differences between IFRSs and Japanese accounting standards. The ASBJ was established in July 2001 as a private sector organization, under the authority of the FSA. According to the April 2008 update, the IASB met with representatives of the ASBJ in Tokyo from 8-9 April 2008. This was their second meeting in Tokyo since the announcement of the initiative to accelerate convergence between Japanese GAAP and IFRSs in August 2007. Nonetheless, the available sources do not directly address Japan's compliance with this principle.

Principle VI: The Responsibilities of the Board

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The IMF's 2003 FSSA reports that corporate boards are comprised of relatively few outside directors. In this regard, legal reforms giving companies "the option of a specific governance structure with a majority of outside directors" (p. 29) were a step in the right direction. The IMF report recommended introducing stronger market incentives for management to ensure the effective implementation of legal and regulatory measures. The ACGA's 2008 White Paper notes that Japan is the only major Asian market that does not establish minimum requirements for an audit committee, or independent directors. In this regard, it is advised that all companies appoint a minimum of three independent external directors, as well as an audit committee. Furthermore, the ACGA encourages companies to avoid the use of "poison pills" (p. 28), which hinder corporate value and fail to recognize the rights of shareholders. These poison pills, which were mainly adopted by companies to protect management and prevent takeover bids, have experienced an exponential rise from 21 poison pills in 2005 to 266 poison pills by late 2007. The ACGA report highlights that they are further expected to rise to around 400 in 2008. However, the available sources do not directly address Japan's compliance with this principle.