Redesigning Corporations: Incentives Matter

By Nicholas Benes
(also published in the Harvard Law School Forum on Corporate Governance) 

The Birth of the Corporation: Public Interest Organizations

The evolution of the modern corporation is the fascinating story of a series of self-serving legal and societal mutations over hundreds of years, which have morphed the original concept and endowed corporations with freedom of activity, rights, and limitations on liability that would shock their original “inventors”.

As we all know, for many years most corporations were established by way of an exceptional “charter” by a sovereign, granted only in specific cases where: (a) large amounts of capital were needed (b) to conduct investments and activities that served public or national interests and had good profit potential, but (c) where the risks were so large that few parties would invest if their risk were not shared with many others and/or limited to the amount of money they invested.

In the 1600s and 1700s, the activities that sovereign nations felt met those requirements were the exploration of foreign lands on the other side of the globe, the creation and administration of colonies there, and conducting lucrative trade on long (and dangerous) sea routes to and from those colonies. Thus, the most well-known early corporations include organizations such as the British East India Company (the original “too-big-to-fail company), The Dutch East India Company, the Hudson’s Bay Company, and companies to construct the Erie Canal.

As the industrial revolution gathered steam, the need to raise large amounts of capital increased many times over. Driven by this need, the immense benefits of corporate status for raising financing became increasingly obvious and desirable to investors and managers: easy stock transferability vs. rewriting partnership agreements, separation of ownership from control, legal personhood that simplified large transactions such as loans and large investments (a single counterparty to deal with and sue), and the possibility of receiving a charter that conferred “limited liability” on shareholders. All of these made it much easier to raise funds in large amounts than any other form of business organization.

Amendments to Japan’s Foreign Direct Investment Law—Heightened Review of Inbound Investments

(Summary by Stephen Bohrer of Nishimura & Asahi)

“From June 7, 2020, overseas investors may no longer be able to purchase shares of certain Japanese companies. The Japanese government passed amendments to its foreign direct investment laws that lower the government approval threshold from 10% to a mere 1% for share acquisitions of publicly traded companies that engage in a broad range of business activities deemed critical to national security, public safety, public infrastructure, or Japan’s economy (the “FDI Amendments”). The Japanese government claimed that its foreign direct investment laws required a major overhaul because it lacked legislation to effectively screen foreign direct investment to the same recent extent as other developed countries. In particular, Japan’s Ministry of Finance noted the 2018 passage of the Foreign Investment Risk Review Modernization Act in the United States and European Union regulations adopted in 2019 establishing a framework for monitoring foreign direct investments as examples of how Japan’s foreign direct investment regime lagged behind international standards. As a result, practically every share acquisition by an overseas investor of a publicly traded company now deemed critical to Japan will require government approval, unless an exemption applies.

This edition of the Corporate Counselor outlines the broad reach of the FDI Amendments and the exemptions that curtail its application, and then proceeds to highlight issues that prospective overseas investors should consider through a question and answer format. Given the complexity of the FDI Amendments, decision tree diagrams are included in annexes to provide a visual flow of how the FDI Amendments apply to a transaction.

Why Modern Corporate Structure Results in Large Ethical Lapses

I was recently asked by the Japan Society of Greater Cincinnati to give the keynote speech at their conference event on the theme of “Why Good People Do Bad Things”. I decided to liven things up a bit by attempting to answer the self-posed question: “how might we design corporations if we were inventing them today [not in 1600 -1900]… in an age of huge capital pools, global warming, and an increasing number of other large externalized risks and informational (and other) asymmetries?”

See what you think of my “concept for discussion” on pages 16-19, and my reasons for throwing it out for consideration on the earlier pages. I realize some people will think this concept is a strange and unnecessary, as if the basic legal structure of the corporation is immutable, or hoping ESG integration by itself will solve most of the problems it is concerned with. However, I suspect that in the next few decades corporate law will be evolving much more so as to address the issues and concerns that I raise… even if it addresses them in a different manner. I do not believe that the present legal form of “the corporation” itself is sustainable. Over the past 100 years, too many agency problems, market distortions, asymmetries, and externalities have emerged.

Allow Japanese Citizens to Sponsor Foreign Domestic Workers

Prime Minister Abe’s requests to close schools nationwide, tele-work from home, and cancel sports events and public gatherings, have caused a great deal of strain on working mothers. More than ever before, now is the time when the Government of Japan (the GOJ) should be accelerating its stated policy to allow Japanese households to sponsor Foreign Domestic Workers (FDWs).

Women are being encouraged by the government to enter the labor force, with the expectation that they will become executives and join Boards of Directors. If the government expects to reach its own goal for women to constitute 10 percent all corporate directors during this year (2020), it will need to rapidly increase the range of “options” that women have for childcare and elderly care.

A Guide to Understanding Carlos Ghosn’s “Not Guilty” Plea

by Sachiko Ichikawa
Comment by Nicholas Benes

Carlos Ghosn held a press conference on January 8, 2020 to present his “not guilty arguments” regarding the alleged crime of making, or not preventing, misrepresentations in Nissan’s Security Reports. He had already disclosed the testimony he made at the Japanese court which was considering his bail in 2019. So this was the second time that he has defended himself in public.

Mr. Ghosn spent more than one hour for his presentation, and even showed many slides and materials, but his logic for insisting on his innocence was not easy to understand. To me, his 2019 testimony in court was better than his 2020 televised presentation.  In an attempt to connect the dots, this article will explain my own interpretation of what Mr. Ghosn really wanted to say.

Results of CFA Society Japan and CFA Institute survey regarding amendments to the Foreign Exchange and Foreign Trade Act

Almost 70% of respondents do not agree with the amendment and 86% showed their concern that the amendment might give a negative impact on the investment into the Japanese equity market.

Results of CFA Society Japan and CFA Institute survey regarding amendments to the Foreign Exchange and Foreign Trade Act

“Japan’s Unfinished Corporate Governance Reforms”, by Nicholas Benes

My article on Japan’s unfinished reforms is online now. Lest the Abe administration and regulators “declare victory” when they are only half done, I describe seven specific measures that Japan needs to adopt in order to bring its market up to a global standard for a developed nation:

  1. Detailed rules for an independent committee
  2. A clear requirement for a majority of independent directors on the board
  3. Codifying the role and responsibilities of executive officers
  4. Consolidation of overlapping disclosure reports
  5. Protection of minority shareholder rights
  6. Enhancing transparency to reduce entrenchment and enhance inclusiveness
  7. Strengthening stewardship throughout the investment chain

I stress the reality that in all of these, strong political leadership from the Prime Minister and other senior parliamentarians will be needed. “Thus, is it essential that the Tokyo Stock Exchange (JPX/TSE) and the various regulatory agencies keep up reform momentum. However, one senses a desire from these groups to ‘declare victory’, and they have a tendency to not fully coordinate with each other. If Prime Minister Abe’s cabinet did more to make the key players coordinate their efforts in key areas, meaningful governance change (and protection of investors) would accelerate….

Activist Shareholders and Directors, Beware! (Nishimura & Asahi)

When exiting minority holdings, not only beware about insider trading rules, but also short-swing profit rules. “Similar to the securities laws of other jurisdictions, Japanese securities laws also have short swing profit rules that require directors (and equivalents thereto) or 10% or greater shareholders to disgorge profits earned from matching buy-sell transactions (i.e., purchases and sales occurring within a six month window of each other, subject to certain limited exceptions) regardless of whether they are in possession of material non-public information. To avoid a costly surprise, an investor should confirm that it has not acquired any Public Company shares during the six month period leading up to the proposed share sale in order to avoid the perfunctory short swing profit disgorgement rules under Japanese securities laws. “

Some Simple Questions for Softbank

For companies with Softbank Group’s corporate governance structure (a company with Board of Statutory Auditors), Article 362 of Japan’s Company Law stipulates the following:

…..(4) [the] Board of directors may not delegate the decision on the execution of important operations such as the following matters to directors: [which means: “may not delegate these matters to directors or anyone else with executive responsibilities. In other words, the board must approve the following: ]
(i) The disposal of and acceptance of transfer of important assets;
(ii) Borrowing in a significant amount;
(iii) The appointment and dismissal of an important employee including managers;
etc. “”

Because of this language in the law, companies draft up “criteria for board decisions” (“fugi kijun”) , and have them approved by the board. These criteria define numerically (and in other ways if necessary) what will be considered “important” under each of the categories set forth above and therefore will require board approval, e.g. purchases of real estate larger than 1.0 Billion Yen (about $10 million), investments or acquisitions larger than 2 Billion Yen ($20 million), etc. – a “limit amount” referred to below as “X” .

Discussion in Japan About “Clawback Clauses”

In Western countries, many companies have introduced “clawback clauses” that require executives to return performance-linked compensation to the company in certain cases. In Japan, very few companies have such clauses. There are dissident voices saying things like “compensation of Japanese executives is less than in Western companies, so there is no need to do that,” or “if you want to demand the return of paid compensation, you can file a derivative lawsuit.” In this article, I would like to review the arguments that have been made so far about clawback clauses, and consider the arguments that should be made in the future.