Eiji Masuda and Takero Yoshida of Masuda & Partners Law Office in Tokyo look at Japan’s new corporate governance structure
The first major amendment to the Companies Act since its 2006 enactment came into effect in May 2015. Following a string of corporate scandals in 2011, foreign investors levied significant criticism against the corporate governance of Japanese listed companies. One of the 2015 amendment’s primary objectives was to introduce an alternative to, and concomitantly improve, the preceding corporate governance regime. Below we summarise that entirely new alternative.
Corporate governance before May 2015
Under the Companies Act, a company could choose its corporate governance structure from a number of prescribed forms, but only two forms were available to large public companies: (i) company with a board of statutory auditors; and (ii) company with committees.
In companies with a board of statutory auditors, the management function is vested in the board of directors while the board of statutory auditors is to supervise the directors’ conduct. In such companies, the board of directors may not delegate its decision-making functions to individual directors regarding the execution of important operations such as the disposal of and acceptance of transfer of important assets and borrowing in a significant amount etc. As well, such companies must appoint three or more statutory auditors, at least half of whom must be outside statutory auditors. The combination of these rules, together with the additional requirement that such companies also appoint outside directors, is often cited as overly burdensome. Further, foreign investors have claimed that in such companies, outside statutory auditors are unable to effectively supervise the representative directors due to a lack of voting rights at meetings of the board of directors.
The company with committee structure, introduced in 2002 has the following characteristics. Companies must have a nominating committee, an audit committee and a compensation committee. Directors may not execute the business operations of the company; instead, the board of directors appoints one or more executive officers, each of whom may or may not be a director, to be in charge of business operation of the company. Each committee is to comprise three or more members, each of whom is a director, with outside directors constituting the majority on each committee. Unlike companies with a board of statutory auditors, companies with committees are based on a monitoring model in which the board of directors functions as supervisor of the conduct of executive officers, who have the management function of the company.
While the company with committee was a structure introduced to facilitate better corporate governance, it is often claimed that Japanese companies are reluctant to entrust outsiders with the power and responsibility to nominate senior management and determine their remuneration. Probably for this reason, the company with committees has so far not been a popular choice; according to a survey of the Japan Association of Corporation Directors, as of June 7 2016 only 70 listed companies have adopted this structure.
The new alternative structure
Since May 1 2015, the Companies Act permits large public companies to elect a new corporate governance structure, called the “company with audit and supervisory committee”. Where this structure is chosen by a large public company, it must have an audit and supervisory committee consisting of three or more directors, a majority of which must be outside directors (331(1)(6)). Members of the audit and supervisory committee being directors, they can exercise voting rights at meetings of the board of directors.
To strengthen their independence, members of the audit and supervisory committee are appointed at a shareholders' meeting separately from other directors (329(2)), and the term of office of such committee members is two years, while that of the other directors is one year (332(3)). Further, removal of a committee member requires a super majority vote at a shareholders’ meeting (309(2)(7)).
The audit and supervisory committee is responsible for the following three matters: (i) auditing the performance of directors and preparing audit reports (399-2(3)(1)); (ii) determining the agenda for the appointment/ removal/non-reappointment of the accounting auditor, for submission to at a shareholders’ meeting (399-2(3)(2)); and (iii) determining the opinion to be expressed by its members at a shareholders’ meeting in relation to (399-2(3)(3)) (a) any appointment/removal/resignation of directors (other than members of the audit and supervisory committee) (342-2(4)) and (b) the remuneration of directors (other than members of the audit and supervisory committee) (361(6)). On the other hand, the audit and supervisory committee has no power in determining the selection of management personnel or their remuneration.
In addition, members of the audit and supervisory committee may: (i) request directors or employees to report on matters related to the execution of their duties (399-3(1)); (ii) investigate the status of the company’s business or assets (399-3(1)); and (iii) submit a report directly at a shareholders’ meeting if the agenda or other documents to be submitted at the shareholders’ meeting includes, among other things, illegal or materially-inappropriate matters (399-5).
These powers strengthen the audit and supervisory committee’s ability to effectively audit and supervise the company.
Merits of adopting the new structure
Although companies with a board of statutory auditors must appoint at least one outside director and at least two outside statutory auditors, companies adopting the new structure need appoint only two outside directors. The required number of outsiders is thus reduced.
In addition, unlike the companies with committees, the new structure does not require large public companies to have either a nominating committee or a compensation committee, which (each requiring a majority of outsider members) have been major obstacles for Japanese companies.
Further, the monitoring function of the audit and supervisory committee would be enhanced, as the new structure permits many of the matters determined by the board of directors to be delegated to representative directors and executive directors, to the same degree as is possible in companies with committees. Thus, a company with an audit and supervisory committee should be able to achieve tighter and more timely management supervision.
Another advantage relates to the handling of conflict of interest. Ordinarily, Article 423 paragraph 3 of the Companies Act creates a presumption of neglect of duty in the event a director conduct a transaction in which he/she has a conflict of interest. This provision will not apply where a director receives prior approval by the audit and supervisory committee.
For all these reasons, as of late April 2016 more than 560 listed companies have transitioned to the company with audit and supervisory committee structure.
As described above, the new governance structure may overcome problems inherent in both companies with a board of statutory auditors and companies with committees. There remains some skepticism that the new structure does not really strengthen corporate governance in comparison with pre-existing structures, as audit and supervisory committee members are also members of the board of directors of a company. Nonetheless, the 2015 amendment has, at minimum, given large public companies an important alternative corporate governance structure, which is expected to facilitate more effective auditing and supervision.
Masuda & Partners Law Office
Masuda & Partners Law Office
About the authors
Masuda & Partners, founded by the managing partner Eiji Masuda in 2008, is a full service law firm advising on a wide range of business law matters including general corporate, M&A, financial regulations, and commercial litigations. In particular, the firm’s dispute resolution group vigorously works on large-scale and complex commercial disputes, both domestic and cross-border. The firm also advises on compliance, risk/crisis management and employment law matters, backed by the managing partner Eiji Masuda’s experience from serving as general counsel and executive officer of Merrill Lynch Japan Securities Co Ltd.
The firm’s managing partner Eiji Masuda received his LL.M. from Columbia Law School in 2003, and LL.B. from Chuo University in Tokyo, Japan in 1987. He is admitted to practice law in both Japan and the State of New York.