Corporate Governance in Japan: Evolution from Stakeholder to Shareholder
Over 400 years ago during the Edo period, traveling merchants known as Omi traversed the various prefectures of Japan in pursuit of establishing commercial trade. By building trust-centered relationships, the Omi were able to successfully conduct business with people of different villages governed by different Shogun. As merchants in feudal Japan were of a low social class, their success relied on delivering on the promise of providing benefits to the community at large, in addition to satisfying the individual buyer. Seen as one of the earliest versions of Corporate Social Responsibility (CSR)—the idea that businesses owe a level of care and responsibility to society—merchants at the time focused on dedicating funds to build bridges or schools, directly involving their businesses into society. The focus on a business’s impact on the community at large set the foundation for Japan’s heavily stakeholder oriented economy, where the primary driver of business decisions are relationship driven, as represented by nationally high levels of vertical integration and cross shareholding. Yet, upon reaching economic maturity in the 1970s, Japan entered a period of stagnant and declining economic growth, becoming more vulnerable to increased competition through globalization. As such, to remain competitive in the fast-paced global market, Japan—primarily through the Tokyo Stock Exchange—has shifted its focus to company profitability. These efforts are reflected in investor and shareholder activism, which fights to improve profit-margins of Japanese companies and make Japan’s potential GDP growth comparable to that of other developed countries.
Understanding the reason for Japan’s major shift in corporate governance requires understanding the fundamental benefits of a shareholder economy. It is widely acknowledged by scholars in economics that American companies are far more profitable than Japanese companies, due to maximization of short-term profits through market-driven decision making. Japan’s focus on the long-term and relational impact to each stakeholder, by contrast, creates rigidity and thereby an inability to respond to shifts in the market as compared to the United States. Through focusing on company profitability through pro-shareholder policies, managerial inefficiencies and firm value improve significantly.
A focus on profitability requires Japan to stray away from longstanding norms of stakeholder oriented corporate and instead cater to the needs and interests of shareholders, many of which are foreign. The Japanese model traditionally prioritizes balancing broad interests between employees, clients, and suppliers in addition to shareholders, referred to as three-way satisfaction, 三方よし (sanpoyoshi). This centuries-long business mindset has been challenged and gradually eroded since the 1990s, a phenomenon best seen through various modern legal reforms, including rewriting laws governing corporations, adding more shareholder remedies, and updating policy recommendations from the Diet and Tokyo Stock Exchange. Ultimately, the legal reforms collectively opened Japan up to foreign management of companies through private equity, implementing firmwide-level change of corporate governance and realigning strategy for profitability. Most of the reforms were achieved through deliberate policymaking, a back and forth political process between resistant business groups and foreign investors through the Tokyo Stock Exchange.
The first notable reform occurred in 1993, when Japan’s Commercial Code was reformed to make shareholder derivative suits more accessible. A derivative suit is a shareholder’s remedy on behalf of a corporation against its board of directors and officers, something attributed to the corporation’s inability to act on behalf of its best interests. The responsibility a company’s officers and boards owe to its shareholders is known as fiduciary duty, which requires holding the company’s best interests in mind in executive decisions. The 1993 reform exacerbated the amount of derivative suits by reducing the filing fee to around 8,200 yen regardless of damages sought, making filing financially feasible. Following the bubble period, when asset prices were heavily inflated, many instances of shareholder-action were recorded in response to the financial troubles that followed, resulting in the spike in derivative suits indicative of shareholder activism. With a greater voice in influencing decisions made in the boardroom, shareholders, many of which are foreign investors, have elevated the standard of responsibility board members hold, in holding Japanese corporations accountable for actions that are not profit-oriented.
The next major reform overhauled Japan’s entire commercial code, creating one one uniform statute governing corporate law. Before the Companies Act of 2005, Japan’s corporate law was governed by the Commercial Code of Japan, written in 1899. The code was heavily influenced by German law at the time, and mainly provided a single, traditional, governance structure: a company with an audit and supervisory board where essential decisions were not delegated to directors. However, the 2005 Companies Act replaced the old system, and introduced two new forms of governance with varying board structures, some of which are similar to that of the United States. These greater flexible governance structures greatly catered to shareholder needs and proactively responded to market conditions. Supplemental codes followed as guidelines for companies navigating new structures, where nonbinding codes became binding de facto due to widespread acceptance as the standard practice. These frameworks include the Stewardship Code on fiduciary responsibility and the Corporate Governance Code from the Tokyo Stock Exchange, which continuously undergo reform and clarifications.
As of today, the legal reform with the most direct impact is the Partial Amendment to the Companies Act in 2019, where rights of shareholders greatly increased in relation to management. The act changed four elements of shareholder influence pertaining to shareholder’s right to proposal, delivery of materials, right to appointment, and increased director liability. All of these elements made it easier for shareholders to exercise their influence, through both active and passive means. Specifically, the act instituted the shareholder’s right to demand matters before the board, allowance of electronic delivery of certain materials for shareholder meetings to all shareholders, imposition of the duty to appoint at least one outside director on large-public companies, and new rules on the indemnification of officers’ liabilities. In essence, the reform demonstrated a clear pro-shareholder vision when it comes to corporate law, as the increased rights of shareholders allows for corporations to realign their priorities with profitability or otherwise face liability and scrutiny.
Despite major shifts in corporate governance, Japan’s longstanding stakeholder orientation still persists, but only in areas of efficiency and profitability. For example, vertical integration and lifetime employment in sectors such as automobile manufacturing that provide a competitive edge on technological expertise and cost cutting are kept. However, the landscape has otherwise changed, with the numerous aforementioned legal reforms being indicative of Japan undoubtedly heading towards a shareholder oriented economy, much like the economy of the U.S. Even though analysis of corporate governance at any single point shows little change, aggregating the reforms implemented by the nation in the past 35 years paints a very clear picture of the shift in the idea and role of Japanese corporations.