012: Towards the Establishment of a New Shareholder-Corporate Relationship in Japan

Below chart is the comparison of shareholder distribution in Japan.

Corporate governance in Japan used to be characterized by cross-shareholding among banks and client companies or companies that formed conglomerates. Corporate governance was practiced within the framework, and companies or banks of higher rank in the same business network used to exert influence on the management of a certain company in a variety of ways. Nonetheless, they wielded influence as a client or creditor rather than a shareholder. Also, in Japanese companies, interests of other stakeholders such as employees and clients tended to come before the power held by shareholders. Composition of the board is also an important factor in corporate governance. In Japanese companies, the board was mostly comprised of former employees due to the traditional lifetime employment. Thus given the context of cross-shareholding, decisions made by the executive board were considered to reflect the will of employees, clients, or regulatory agencies rather than that of shareholders.

Against this background, the composition of shareholders in Japan began due to change due to various factors such as bursting of the bubble economy, consequent downslide of the status of banks, growing tendency to seek for more efficient fund management, increasing foreign investment in Japan because of the internationalization of capital market and expanding the influence of institutional investors caused. Accompanying these changes, a shift in traditional Japanese system started to occur. Also, Commercial Code was repeatedly revised in a way to facilitate corporate restructuring to help deal with complex forms of corporate finance as well as enhance international competitive power. This resulted in widely shared awareness about corporate governance. The non-statutory executive officer system has been introduced to make the monitoring and operational functions of the board more clear. Compared to the situation a few years ago, the size of the board in Japanese companies has been cut back, and now the appointment of outside board member is quite common. Below, the situation of the board in Japanese corporations can be summarized as of June 2003 (when general meetings have been completed). It shows that many companies are actively pursuing corporate governance.

Along with the above development, research is advancing on the fiduciary duties accompanied with fund management by institutional investors who are responsible to the ultimate asset owners. The Pension Fund Association is a federation of corporate pension funds and revised its basic principles for fund management in 1999. It stipulates that "the trustee would exercise the voting right of shareholder only for the profit increase of the Association as an investor", and it has sought to get a better grip on the way the voting rights of shareholders have been exercised by the fund management agencies who are entrusted with domestic stocks according to the above principles. Furthermore, the Association announced that it voted 4043 in favor and 2992 against the 7035 bills proposed at the general meetings of 1264 companies in June 2003. The voting was conducted based on the Pension Fund Association Code for exercising the voting rights of shareholders that was set in February 2003 following the beginning of in-house domestic stock investment.

How institutional investors regard fiduciary responsibility has become apparent in the expression of their opinion on corporate governance in the invested companies.

Exercise of the voting rights of shareholder by the Pension Fund Association reinforces the shift in corporate governance in Japan. It should be rated highly that concerned parties' quick actions overcame various obstacles in the exercising of voting rights in Japan. Although current system concerning the exercise of voting rights functions well in terms of the old shareholder makeup of cross-shareholding, it is not necessarily convenient for institutional investors.

In order to build a fruitful interactive relationship between companies and institutional investors in Japan, effective exercising of the voting right is required. However, current system has, at least, problems to be solved as shown below.

1. Scheduling for account settlement and general meeting
2. Connecting resolutions at general meeting with corporate governance
3. Issues concerning company information disclosure

The chart below reveals the schedule for account settlement and general meetings in companies listed in the first section of TSE.

Note #1: Includes meetings held in June 2003 only
Note #2: Although some very short ones were about 7 days, the majority was around 50 days.
Note #3: Out of the companies listed in the first section of TSE, researched on 1516 companies
Research by Japan Investor Relations and Investor Support, Inc.

Compared to many other countries, general meetings of shareholders in Japan have several notable characteristics. For institutional investors who invest in many companies, the biggest problem is the concentration of companies on the same date for account settlement (in March) and general meeting (late June). This custom not only limits the number of general meetings that shareholders can attend, but forces shareholders with fiduciary responsibility to examine a large amount of general meeting agendas with almost no time before their chance to vote expires.

Also, in Japan, it is problematic that the period between the mailing date giving notice for general meeting and the date for actual general meeting is quite short. As discussed above, currently, notice is mailed out approximately two weeks before general meeting and such practice assumes that the owners of record are domestic. It is extremely difficult for foreign institutional investors who appoint global custodians or domestic institutional investors attempt to rationalization the role of securities custodian. Being aware of this problem, more than 100 companies (among the listed companies in the first section of TSE) have put ahead of the date to mail out notice for general meeting. However, such practice has not prevailed yet. Although comparison among different systems is beyond the scope of this column - especially issues concerning disclosure of financial statements and rules in Commercial Code related to general meetings in Japan --, the stated problem with scheduling dates would stay as a major obstacle even if IT would be introduced to the conduct of general meetings.

With a new focus on corporate governance, institutional investors have become more assertive about what they think is favorable about the management system or the way business is operated. Their preference is first expressed in the exercise of their rights at general meetings, that is, the exercise of shareholder voting rights. Resolutions submitted to general meetings concern matters such as plans for appropriation of profits, appointment of directors and auditors, issuing advanced purchase rights for new stocks (mainly concerning stock options), changes in company statutes, payment of special service bonus for retiring employees, and issues concerning company restructuring. Institutional investors increasingly seek executives who regard shareholders' stakes more highly and are willing to monitor company operation strictly. Institutional investors think board of directors should represent shareholders and the board should be managed by this principle. Since such idea touches upon the accountability of the board, it is expected that their watchful eye on the appointment of board members or changes in corporate statutes will become stricter. If clearer board accountability would emerge, desirable corporate governance would be expressed in their confidence in members of the board. From now on, beyond the evaluation of business performance, the following matters should also be taken into account in the process of appointing the board:

• Selection of management style (company with committees, creation of important asset committee, adoption of executive officers)
• Actual size and composition of the board, and realities of the independence of outside board member
• Tendency in matters described the above compared to previous year
• Size and composition of the board of auditors
• Tenure of directors
• Realities of the conduct of the board
• Procedures for general meeting (timing of accounting settlement, mailing date of notice, the date for holding general meeting etc.)
• Capital efficiency(ROE dividend tendency, capital adequacy ratio etc.)
• Whether the company meets social responsibility

It is apparent that the way the board of directors operates in Japanese companies has changed dramatically in the past a few years. In order to meet its accountability toward shareholders surely, disclosure of company information is required. Information disclosure is not necessary only about obvious facts such as lessening the number of member in the board and increasing outside board member, but also

• Clear statements regarding the independence of outside directors
• Description about the establishment and management of internal control systems
• Clarification of the accountability of directors
• The method and actual amounts of payment to directors

Although these practices have already been implemented in companies abroad, they have not been common in Japanese companies yet. If such information disclosure prevails, institutional investors would value it highly and would react favorably. Also, since institutional investors diversify their investments to reduce the risk, their influence on each invest is limited. Therefore, it is important to cooperate with other shareholders, and consequently, it is desirable that general meeting is conducted in a way that various opinions by shareholders are heard and reflected in votes. The board in Japanese companies tends to maintain stratified system like a pyramid occupied by former employees and moreover, many major clients are also shareholders due to cross-shareholding. In cases like this, shareholders could be put in an awkward position when their voting records would be publicly disclosed. Also, even for institutional investors, there may be cases that they would be forced to be considerate of the intentions of their parent firm. Thus voting by secret ballot would be important for democratization in the process of exercising voting rights. Such voting is typical in the US

This paper has pointed out some problems concerning general meeting in Japanese companies. Each one needs to be remedied in order to make the company-investor relationship smooth. Although it is possible to strengthen a company-investor relationship through IR activities, it may be even more important to reform institutions as explained in this paper.

October 29, 2003