The Future of Japanese Corporate Governance: Participation, Sustainability, and Technology

Japan is the third largest economy in the world and has one of the most advanced technology industries. Its economy is critical to global economic growth, providing major foreign direct investment as well as financial stability for hedging. Its legal system has been influential in Asia-Pacific, and Japanese corporate law has been a particularly important value benchmark for other economies. However, despite enjoying a very high living standard, Japan’s corporate performance has not been regarded as competitive in recent years compared to that of other advanced economies such as the US and the UK. At the same time, Japanese companies have lost global market share to companies from neighbouring economies such as South Korea. The geopolitical situation in the region, particularly with China’s economic rise, has prompted Japan to re-think its corporate model. Domestically, an aging population means that there is an increased burden on pension providers due to lower productivity compared to that enjoyed during the post-war period until the early ’90s. Because of this, Japan has launched several corporate governance reforms aimed at increasing corporate productivity at home and competitiveness abroad, which we discuss in a recent paper.

Corporate Governance for Shareholder Participation and Sustainability

We saw the development of corporate governance in Japan over the last fifteen years. Corporate Japan is moving away from the post-war bank-dominated, heavy-industry led, and interlocked model toward a new corporate model for Japan. Since the Japanese government embarked on corporate governance reforms in 2014, various changes have been implemented such as the establishment of a Corporate Governance Code in 2015 (with revisions in in 2018 and 2021), and the Tokyo Stock Exchange’s market restructuring. The main aim of these changes has been to improve companies’ earning power, including improving their profitability and restoring economic growth. The background is that Japanese companies’ ratios of Return on Equity (ROE) and Return on Assets (ROA) have remained lower than those of US and European companies and have stagnated for two decades. To remedy this situation, Japan has developed an economic system in which sustainable growth of companies and improvement to their corporate value can distribute benefits to their stakeholders more widely, leading to economic growth through investment and expansion of consumption. In such a system, a lack of monitoring capability among board directors, ineffective engagement with shareholders, and inadequate group governance (for instance, within the Keiretsus) are seen as barriers to improving profitability and economic growth; so the Japanese government has therefore enhanced leverage for profitability and economic development through corporate governance. To improve profitability and restore Japan’s economic growth potential, the government introduced three significant reforms to strengthen management systems and group governance, to create an ideal environment for constructive engagement with shareholders, and to promote medium to long-term investment.

 Decentralised Governance for ESG

The reform was accomplished in Japan mainly through the encouragement of shareholder engagement and reconsidering corporate governance structure (decentralised governance) of listed companies by Japan’s Corporate Governance Code and related guidelines. As a result, the number of companies which received shareholder proposals has significantly increased, whereas the number of new cases of shareholders’ derivative actions that Tokyo and Osaka district courts accepted has decreased. This demonstrates evidently that shareholder engagement has effectively worked in Japan.

Chart 1: The number of companies which received shareholder proposals

 This graph is based on data from ‘The general meeting white paper’ from 2011 to 2021 (Commercial Law Review (商事法務)).

Chart 2: The number of New Cases of Shareholders’ Derivative Actions

This chart has been compiled from data from Tokyo and Osaka district courts provided by H Takahashi, T Takemura, and K Nishimura in Commercial Law Review (商事法務) No 2144, 2273 and 2274.

Japan’s new corporate model can catalyse sustainability through encouraging companies to be more purpose-based and through digital governance. Although concern for the environment only has a short history in Japan, initiatives are now getting underway, mainly because of the disclosure requirements of the revised Corporate Governance Code. For social issues, human resource management in the context of corporate governance is receiving attention in Japan, specifically as a result of the declining birth rate, an aging society, and the diversification of the workforce and its perceptions of value. Adding to these factors, lifetime employment is no longer assumed. The COVID-19 epidemic has brought to head issues in human resources strategy such as business continuity and resilience, including the response to a diversified work style and environment.

Digital Transformation in Corporate Governance

In Japan, digital transformation is regarded as an issue of sustainability that includes the use of data for operational efficiency and also radical reform of business models to improve productivity leading to corporate reform and new profit opportunities. The Guidelines for Investors and Company Engagement suggest digital transformation as a topic for dialogue with investors. Japanese Ministry of Economy, Trade and Industry (METI) has promoted Digital Governance as a framework for enhancing corporate value which balances the challenges associated with innovation, such as cybersecurity and resistance to the loss of tradition, against the social responsibility of companies and organizations. In 2020, METI issued a Digital Governance Code that has four sections: Vision and Business model; Strategy (including human resources and cultures as well as environmental maintenance of the IT system and digital technologies); Performance and important benchmarks; and Governance Systems, whose structure is aligned with Japan’s Act on Facilitation of Information Processing. Each section includes the basic concepts on which it relies, certification criteria, the ideal direction of initiatives promoted, and examples of implementation.

Regarding digital issues, corporate initiatives using artificial intelligence are known to be potentially hazardous and in need of proper governance. This has now been addressed in Japan by the publication in March 2019 of ‘Social Principles of Human-centric AI’. Japan has also contributed to the formulation of the OECD’s recommendations on artificial intelligence, which included social principles for AI to be implemented in society at large. To support the implementation of these AI principles, in July 2021 METI issued Governance Guidelines for implementing AI Principles. The Guidelines contain action targets to be implemented by AI businesses, hypothetical examples of implementation for the action targets, and practical examples for a gap analysis between AI governance goals and the current state. The Guidelines are not legally binding but are ‘expected to support a company’s voluntary efforts as widely shared material that is referred to by AI companies who are involved in AI business, typically the development/operation of AI systems, in their business transactions, and through the development of a common understanding among stakeholders on the implementation of AI principles’. These Guidelines are designed to integrate with other relevant guidelines in such a way that a comprehensive set of guidelines is built up.

Conclusion

The reforms to Japan’s corporate governance can be summarized as follows: 1) decentralization of the decision-making process to increase shareholder participation; 2) embedding ESG factors to make corporate governance conform to international practice; and 3) deploying technology, along with the means to control it, to achieve corporate governance.

To embed ESG in corporate governance, a combination of government guidelines, the Stewardship Code, and the Corporate Governance Code have provided a framework for the engagement of boards, investors, and market operators.

E-voting, e-disclosure, and e-meetings have increased shareholder participation not just through technology but also with strong support from the necessary law and regulation to facilitate their implementation. At the same time, Japan has recognized that the coming of the digital era can transform corporate operations and that digital governance is an important element of corporate governance (the ‘G’ in ESG).

Joseph Lee is a Reader in Corporate and Financial Law at the University of Manchester.

Mizuki Suma is an Attorney at Law, Sumitomo Mitsui Trust Bank, Japan.