(Next Prime Minister Candidates – in no particular order)
Chief Cabinet Secretary Yoshimasa Hayashi, Minister for Foreign Affairs Yoko Kamikawa, Minister of Economy, Trade and Industry Ken Saito, Minister for Digital Affairs Taro Kono, Minister for Economic Security Sanae Takaichi, Secretary-General Toshimitsu Motegi, LDP House of Representatives Member Shigeru Ishiba, LDP House of Representatives Member Shinjiro Koizumi, LDP House of Representatives Member Takayuki Kobayashi, LDP House of Representatives Member Seiko Noda, LDP House of Representatives Member Katsunobu Kato

CC: Prime Minister Fumio Kishida, LDP Deputy Chair of the Policy Research Council Masahiko Shibayama, LDP Parliamentary Secretary for the Ministry of Health, Labour and Welfare Akihisa Shiozaki, LDP Deputy Secretary-General Seiji Kihara, LDP Kenji Nakanishi

Japan’s Corporate Governance Code (CGC) and investor stewardship must function like “two wheels of a car.” As I have long advocated,[1] when I had the opportunity in 2014 to propose the establishment of the CGC to the Liberal Democratic Party, I emphasized that the most important point was to “promote disclosure that allows verification of governance structures and their substance.”

“A board of directors in which a majority are truly independent and qualified independent directors is more likely to achieve effective governance and oversight.” This principle had already been recognized in many countries around the world as of 2014. I believed at the time that once corporate disclosure and stewardship were functioning properly, Japan—as a developed country—would naturally adopt a similar stance within about five years.

However, even ten years later, serious discussion on these two issues has still not taken place.

Precisely because investors are paying close attention to the Japanese stock market now, I believe it is time to confront this core issue and accelerate reform by taking the following steps.

Mandatory appointment of a majority of truly independent outside directors

The average PBR of companies listed on the Prime Market is around 1.5, and the total shareholder return (TSR) from 2014 to 2023 is only about 8%. However, in companies with six or more outside directors, these figures rise to 2.07× and 8.6%, respectively. Among these, companies where a majority of directors are disclosed as “independent directors” according to each company’s own standards see the figures increase further to 2.29× and 9.3%. Moreover, when considering only companies in which directors judged “independent” under the (stricter) Tokyo Stock Exchange independence criteria account for over 40% of the board, the figures rise again to 2.57× and 10.5%, significantly exceeding the averages for the entire Prime Market.

Clarification of the Meaning of Corporate Value and the Responsibilities of the Board of Directors

In the FSA’s action plan, it is noted that the Tokyo Stock Exchange has requested listed companies to pursue management that takes capital cost and stock price into account. The follow-up is intended to ensure that companies do not merely engage in formal compliance but manage with awareness of profitability and growth potential. However, the current Corporate Governance Code does not clearly define “corporate value,” and, more specifically, the board of directors’ role in enhancing stock price remains ambiguous.

Regarding corporate value, a clear definition should be established in Principle 4 [Responsibilities of the Board of Directors], based on the “Guidelines for Actions in Corporate Acquisitions” formulated by the Ministry of Economy, Trade and Industry (METI) on August 31, 2023. The guidelines explicitly state that, from the perspective of a company’s sources of capital, corporate value is represented as the sum of shareholder value (market capitalization) and debt value.

In addition, as a responsibility of the board of directors, it should be explicitly stated that an important role of the board is to enhance the company’s market capitalization—that is, its stock price—over the medium to long term, which constitutes the main component of corporate value. In many cases, this is not clearly recognized even in dialogues with shareholders.

Annual Disclosure of Director Training Results

As the number of newly appointed outside directors has increased, many board members now have limited experience and have never received proper training. Japan is currently facing a serious shortage of “experience and knowledge” on corporate boards.

I once submitted a memorandum to the Financial Services Agency in 2014 offering advice on the contents of the Corporate Governance Code. In that memo, I wrote the following:

“Training for Directors and Statutory Auditors:
All newly appointed directors and statutory auditors should receive comprehensive and appropriate induction training when joining the board. This training should include an explanation of fiduciary duties and responsibilities, and how these duties are to be fulfilled, as well as an orientation program designed to familiarize them with the company’s business and governance practices.
Companies should provide directors and statutory auditors who lack prior experience in similar roles at listed companies with training delivered by independent experts on the Companies Act, the Financial Instruments and Exchange Act, accounting, finance, M&A, risk management, governance best practices, and, as necessary, other legal, audit, or industry-specific knowledge.”

Unfortunately, the drafters of the CGC did not use the phrasing “should attend” but instead adopted language stating that companies “should provide or facilitate training opportunities and support the associated costs.” The minimum action a company is expected to take—declaring a policy to “offer opportunities” as a reimbursement of training expenses if a director humbly requests it—gives the impression that this alone is sufficient. Such a “policy” is fundamentally different from actually ensuring attendance.

In the same memo, I further proposed the following: “Every year, listed companies should disclose an overview of the training (or pre-training) provided to directors and auditors in the previous year.” Had this requirement been incorporated into the CGC, the current challenges of “lack of experience and knowledge” would not be as pronounced.

Achieve convergence among the three governance structures of listed companies.

There is no other advanced country where the use of three governance structures, as in Japan, causes such confusion for investors and inefficiencies in engagement. To first establish a foundation for convergence, the following steps should be taken:

Establish “executive officers” as statutory bodies under the Companies Act for companies with audit & supervisory committees and companies with statutory auditors, who are subject to the duty of care of a prudent manager. This has long been my proposal and is essentially the content of the opinion submitted by METI to the Corporate Law Council in 2017. In particular, even when a company with an audit & supervisory committee delegates authority, the fact that the establishment of executive officers is not mandatory under the Companies Act reflects an incomplete implementation of the monitoring model. Compared with companies with nominating committees, etc., which also aim for a monitoring model and consciously delegate authority to executive officers to separate oversight and business execution functions, there is a significant divergence. This may appear anomalous to investors trying to understand the law. When a company delegates substantial authority to executives, those receiving significant powers should bear a heavy duty of care.

As noted in the memo submitted by METI to the Corporate Law Council [2], there is currently a widespread issue in the market whereby individuals tasked with business execution—such as so-called “executive officers,” who are legally considered “employees” under the Companies Act—are being appointed, resulting in a reduction in the number of “executive directors” who bear the statutory duty of care under the Companies Act.

In the case of a company with a Nomination Committee, if independent directors meeting the TSE’s independence criteria constitute a majority of the board, it should be possible for the board of directors to amend the appointment or dismissal proposals determined by the Nomination Committee through a board resolution. Otherwise, the CEO could exert hidden influence over the composition of the Nomination Committee (i.e., the selection of its members), potentially undermining the committee’s objectivity.

Disclosure of Share Transactions by Officers

In Japan, when a director of a listed company buys or sells shares of that company, investors cannot know about the transaction until the next securities report is filed, which may take up to about a year.

In contrast, in the United States, such information must be reported to the SEC, and the details are made publicly available through free sources like Yahoo! Finance. Large sales of company shares by management are interpreted by the market as a negative signal. Prompt disclosure of this information enhances the overall efficiency and transparency of the market.

It is indeed puzzling why such valuable information is not disclosed promptly in Japan.

Enhancement of Disclosure on Beneficial Shareholders

Disclosure by investors must also be expanded. In the United States, not only the top 10 shareholders of a listed company but also institutional investors managing substantial assets (for example, over ¥15 billion) are required to disclose detailed information about their holdings—including investments representing less than 5% of the company—on a quarterly basis, and this information is publicly available.

As a result, in the United States, anyone can use the Internet to identify, without paying any fees, who the actual major shareholders of a listed company are and what percentage of the company is held by institutional investors. This information serves as a highly valuable “signal” for the market.

Enhancing disclosure of actual shareholders, like the disclosure of executives’ stock transactions, improves overall market efficiency and transparency. However, in Japan, collecting this kind of information is very difficult. If such information were available, individual investors could often invest with greater confidence in mid-sized listed companies by confirming the presence of institutional investors. Policies establishing such “disclosure rules that make investing easier” are one of the strengths of the U.S. market. Japan should also make this type of information publicly available.

Further Enhancing Information Disclosure to Improve Stock Market Efficiency

As noted above, information on major beneficial shareholders should be made publicly available through EDINET. In addition:
(a) Not only the top 10 shareholders, but also investors managing substantial assets (e.g., over ¥30 billion) should be required to promptly register and publicly disclose information on holdings that are not for short-term trading;
(b) Large investors engaging in frequent, high-volume trading should be required to promptly register and disclose their transactions;
(c) Transactions by individuals considered “insiders” (directors, executive officers, lawyers, and other company advisors) should also be promptly registered and publicly disclosed.

In the United States, such rules are already well established, so for example, through Yahoo! Finance, both other institutional investors and individual shareholders can easily and freely access this information. I cannot understand why the Financial Services Agency does not require such disclosure. If the information were posted on EDINET, anyone could access it via Yahoo! Finance. Especially in this era of “engagement” and NISA, such transparency is indispensable for market efficiency.

Improving the comparability of institutional investors’ voting records

The Stewardship Code (SC), in principle, requires asset managers to disclose the results of their voting on individual agenda items for each stock they hold (Principle 5-3). However, currently, no standardized format for this data is specified, nor is it centrally managed. As a result, it is extremely difficult for asset owners to compare and analyze the voting activities of asset managers, which becomes an obstacle to the activation of the investment chain.

As it stands, the value expected from SC disclosures will not be realized. The data should be standardized in a unified format and centrally managed on EDINET.

Establishment of a Japanese Version of ERISA to Protect Pension Beneficiaries

In Japan, there is no law like the U.S. ERISA that regulates asset owners and investment managers to protect corporate and other pension beneficiaries, and enforcement by the Ministry of Health, Labour and Welfare regarding existing laws is weak. Some may recall that following the AIJ scandal, the Liberal Democratic Party’s investigative committee proposed a “Japanese version of ERISA.” I have also advocated for this to politicians, the Ministry of Health, Labour and Welfare, and the Prime Minister for nearly 20 years, and I still believe that the enactment of a “Japanese ERISA” is necessary.

The enactment of a Japanese version of ERISA would clearly instill the concept and awareness of fiduciary duty for asset owners’ directors and investment managers, as well as issues of conflicts of interest within corporate groups, establishing a legal standard that is clear and stringent for “asset management,” in contrast to ordinary civil agency contracts.

The Japanese version of ERISA would also offer the following benefits:

・It would grant beneficiaries the right to directly sue the pension fund’s board members or asset managers (currently, claims can only be made indirectly through the company).

・With the rapid increase in opportunities such as ESG investing, private equity, and venture capital, the adoption of a “prudent man rule” as in ERISA would make it clear that these can be considered beneficial for portfolio diversification.

・It is said that among the “deemed strategic shareholdings” listed in securities reports, there are cases where assets set aside for retirement benefits—and in some instances even corporate pension assets—are entrusted in a trust while the parent company retains control over the voting rights. If this is the case, the company—and, where applicable, the pension fund—should clearly disclose this to investors and beneficiaries, providing full details, explanations, and justifications.

If a Japanese version of ERISA existed, the Avon Letter rule—which requires that voting rights be exercised in accordance with fiduciary duty—would obligate pension funds and their delegated asset managers to proactively fulfill their fiduciary responsibilities. In the case of a pension fund, this would make it a violation for the parent company to control the exercise of voting rights.

The same principle should apply when assets for retirement benefits or corporate pension assets are placed in a trust. Securities reports should disclose whether the company controls the exercise of voting rights or whether an independent third party controls both the voting and the selection of securities. Since “retirement benefits” are a system unique to Japan, a Japanese version of ERISA should also cover such cases of “trusts for retirement benefit assets.”

開示書類の機械可読性の改善

The current Tokyo Stock Exchange emphasizes the need to improve the “quality” of information disclosure. While this appears to be a sincere declaration, if it is truly committed to addressing the issue, the XBRL taxonomy should be revised so that the “Corporate Governance Reports” submitted to the Tokyo Stock Exchange can be read by machines in a detailed, itemized format.

現状は、報酬や指名に関する方針など11以上もの異なるトピックに関する開示が十把一絡げにされ、単一のXBRLタグの下に詰め込まれている。これでは各項目を切り離すことができず、複数の企業の比較分析はとても困難である。

As a result, although the original concept was the “two wheels” of governance and the idea of comparative analysis, investors’ ability to analyze and compare remains insufficient. Because rigorous comparative analysis has not been conducted on these items, which are critical to achieving the objectives of the CGC, the content and quality of disclosures made by listed companies remain inadequate. Against this backdrop, investors naturally say that “there is no point in rigorously analyzing low-quality disclosure information.” This is nothing but a vicious cycle. Despite being in the era of big data, the current situation is misaligned with the direction the Tokyo Stock Exchange should be pursuing.

I strongly hope that Japan’s leaders will break free from their traditional inward-looking tendencies, quickly learn from the capital markets of other countries, and address the fundamental issues in order to accelerate meaningful reforms.

That’s it.

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[1] “See the memo titled ‘No Budget Needed: The Third Arrow That Will Be Most Valued’ in ‘How I Came to Propose a Governance Code Addressing Diversity’ (2013), available at https://bdti.or.jp/cgcp/.”

[2] ‘Issues Regarding the Regulation of Corporate Governance, etc.’ (April 26, 2017), available at https://www.moj.go.jp/content/001237422.pdf.