Business in Japan has always had a certain reputation: hard working, highly conservative, highly regulated, the sort of place you needed to know people to get ahead in the market.

The traditional Japanese model of governance differs from the Anglo-American model, typically seen as a triangle with shareholders, the board and management at each point. In Japan, that triangle was pushed out to a hexagon, representing shareholders, the government, management, independent directors, the bank and something uniquely Japanese called keiretsu. Roughly translated, it’s a network of inter-related companies and industries with agreements to favor and support each other.

That model of doing business and that approach to governance worked well enough for generations, but as the world gets increasingly global and companies find it easier to do business across borders, new ideas and approaches are starting to take effect in Asia – so much so that there are a growing number of corporate governance changes in Japan that are transforming the way the country does business. Better corporate governance is seen as critical for Japan’s future prosperity.

These corporate governance changes in Japan had been quietly introduced as part of Prime Minister Shinzo Abe’s latest “Abenomics” package aimed at modernizing the Japanese economy, but some high-profile corporate governance scandals have brought into sharp focus the need for robust governance approaches both in Japan and elsewhere. That these scandals have highlighted the growing corporate governance changes in Japan was merely a byproduct – the government and regulators were already looking to install more transparency into Japanese business.

Historically, corporate governance in Japan was a closed circuit

Japan’s corporate governance practices hit the headlines in late 2018 with the arrest of Carlos Ghosn, the former Chairman of Japanese automotive maker Nissan, for alleged financial misconduct – just another in a wave of corporate scandals that put a new focus on how Japanese companies are managed and highlighting the need for corporate governance changes in Japan.

Always one of the more developed Asian economies thanks to its late 20th-century boom, Japan introduced a new stewardship code in 2014 as a way to encourage domestic fund managers to more actively question boards and management. However, the country slid from 4th to 7th in the biennial survey by the Asian Corporate Governance Association (ACGA) and Asia-focused brokerage CLSA – tied with India, but behind emerging regional stars Thailand and Malaysia.

One of the issues with corporate governance in Japan, experts believe, is the traditional preference for safe investments and cash. After World War II, with the nation rebuilding its economy from scratch with no wealthy individuals or equity providers to fund corporations, banks had to provide capital under the guidance of the Finance Ministry. Good banking relations became paramount to Japanese CEOs.

But foreign investors want high yields, and the old model of Japanese business was not attractive to them; they either avoided it or discounted expected returns. In 2012-13, a survey of 21 nations by Institutional Shareholder Services found that Japanese corporate boards were the least independent; shareholders tended to vote in favor of the firm’s management.

Even today, with corporate governance changes in Japan increasing to encourage foreign investment, more than half of the board members of Japanese firms are insiders, while more than half of the boards of US and UK firms are independent. Cross-shareholdings in Japan are high, at around 30 percent of the market, although that is half the level it was in 1990, writes Richard Solomon for The Japan Times.

Corporate governance changes in Japan usher in a new era

While progress has been slow, Japan is undergoing a stream of corporate governance reforms. It’s a key pillar of Prime Minister Abe’s economic revival program, with ambitions to improve transparency and revamp the nature of ties between business, investors and society.

The 2014 Stewardship Code (revised in 2017) was quickly followed by a Corporate Governance Code in 2015, and both call for public companies and institutional investors to engage in constructive dialogue to enhance shareholder value. Japanese companies are increasingly putting shareholder needs first, introducing clearer financial targets and higher dividends and buybacks.

Companies listed on the Tokyo Stock Exchange are now under strict scrutiny by investors and are forced to justify their stock holdings – this means boards must annually assess whether or not to hold each individual cross-shareholding, examining whether the holding has an appropriate purpose, and whether the benefits and risks from each holding cover the company’s cost of capital.

Amendments to the Japanese Companies Act, which became effective in 2015, and the new Corporate Governance Code pushed reforms, including:

  • A new internal governance model
  • Amendments to the qualifications for outside officers
  • A principles-based approach to achieve effective corporate governance
  • Protecting the rights and ensuring the equal treatment of all shareholders
  • Appropriate cooperation with stakeholders other than shareholders
  • Ensuring appropriate information disclosure and transparency

The Corporate Governance Code also adopts a “comply or explain” approach for implementation – that is, either adopt it, or have a good reason why you can’t do so.

Make governance simpler to plan and track using entity management software

The “comply or explain” approach is why it’s imperative for companies and entities incorporated in Japan to have a deep understanding of the corporate governance changes in Japan, and to keep strong and robust records of all governance practices. The regulators and shareholders could ask to see the corporate record at any time, and the push for increased transparency in Japanese business means entities must be ready to produce the right information efficiently.

Entity management software can help companies to deal with the growing corporate governance changes in Japan by streamlining entity management and aiding robust governance practices. For example, Diligent Entities enables organizations to centralize and manage their corporate subsidiary data management to simplify entity governance throughout the organization, thus improving compliance and mitigating risk. The system can also create organizational charts to aid those annual reviews of cross-shareholdings, bringing all entity data into clearer focus.

Entity management software can make legal operations more flexible and easier to move in the event of regulatory changes, while also increasing the transparency of the corporate record. Working with a cloud-based entity management system enables compliance managers to store entity information, documents and organizational charts in a highly secure format to create a single source of truth, allowing the right information to be surfaced to the right people at the right time in order to complete routine business processes.

Diligent Entities also seamlessly integrates with a board portal and a secure file-sharing platform to create the Governance Cloud, the only integrated enterprise governance management solution that enables organizations to achieve best-in-class governance. Get in touch and request a demo to see how Diligent’s suite of governance and compliance technologies can help your entities to make the most of corporate governance changes in Japan, and streamline your operations.