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日本法トピックス「時の話題」No.2 “Amendment to the Company Law and Corporate governance Reform of Listed Companies”(中村 信男(比較法研究所研究員、商学学術院教授))

Current Topics of Japanese Law (Commercial Law)

Amendment to the Company Law
and Corporate Governance Reform of Listed Companies

Professor Nobuo NAKAMURA
(Research Staff, Faculty of Commerce)
(on 15 April 2014)

1. Introduction

The Legislative Council of the Ministry of Justice reported to the Minister of Justice regarding the Recommendation for Company Law Reform (hereinafter referred to as the “Company Law Reform Recommendation”) in September 2012.

In response to this report, an amendment was made to the then-current Company Law, which had been established in 2005. The main purposes of the Company Law Reform Recommendation were to review the corporate governance of large-sized public limited companies and to initiate arrangements for regulation of combined enterprises, including the adoption of multiple representative actions or suits. The Company Law Reform Recommendation is a noteworthy landmark for the study of comparative laws.

Here, I provide an introductory look at the adoption of “companies with audit & supervisory committees” in order to improve the corporate governance of large-sized public limited companies, which is one of the measures included among the items listed in the Company Law Reform Recommendation.

 

2. Governance System of Large-Sized Public Limited Companies under the Current Company Law

In essence subject to the current Company Law in Japan, under the governance system for large-sized public limited companies (and listed companies are typical of such a category) in Japan, a board of directors and an audit and supervisory board are established under a general meeting of shareholders as the highest decision-making bodies for such a company. The former body oversees company operations, while the latter acts as a supervisory body and is composed of three or more members (half of which must be selected from outside the company). The structure of large-sized public limited companies characterizes the most common form of companies with auditors on their audit and supervisory boards.

It is necessary for a company with an audit and supervisory board to appoint external audit and supervisory board members. However, such a company is not forced to appoint external directors with voting rights to the board of directors. Alternatively, by choosing to establish a board of directors under a general meeting of shareholders, a large-sized public limited company is instead able to form a nomination committee, a compensation committee, and an audit committee as bodies that are subordinate to the board of directors. A large-sized public limited company may choose the form of a company with nomination, compensation, and audit committees with one, two, or more executive officers of the company appointed by the board of directors to perform operations as one unit. In these cases, such a company must appoint auditors, but they are not allowed to assign audit and supervisory board members. In this connection, a company with nomination, compensation, and audit committees is required to appoint at least two external directors to such committees. External directors are able to execute their voting rights to the same degree as the members of the board of directors.

As described above, under the current law, each large-sized public limited company is allowed to select one of two options for its governance system. However, 97.8% of listed companies on the Tokyo Stock Exchange (2,226 out of 2,275 companies) are companies with audit and supervisory boards, and such companies rarely decide to have nomination, compensation, and audit committees (Tokyo Stock Exchange, White Paper on Corporate Governance 2013). It is also not expected that the number of listed companies using nomination, compensation, and audit committees will increase in the future. It should be remembered that audit and supervisory board members are not directors at a company with these boards. Thus, such members do not have voting rights. They are not entitled to rights to appoint or dismiss representative directors or directors in charge of operations who execute operations under the supervision of the board of directors. The management monitoring function in companies with audit and supervisory boards is not as strong as that in companies with nomination, compensation, and audit committees. Additionally, there exist many managerial issues that must be resolved by the board of directors. Thus, prompt managerial decision-making and the implementation of the resulting decisions are inferior at companies with audit and supervisory boards, compared to companies with nomination, compensation, and audit committees. This problem has been pointed out, which has resulted in making it a point of contention concerning governance of Japanese companies.

 

3. Adoption of Company with Audit & Supervisory Committee

Given these facts, the Company Law Reform Recommendation proposes that the system of companies with audit and supervisory committees be adopted as a new corporate governance system. It will thereby attempt to solve the aforementioned problems that are experienced by companies with audit and supervisory boards. Under the recommended system, first, the general meeting of shareholders would separately appoint directors who make up the board of directors as a body intended solely to perform operations, and three or more non-executive directors who make up the audit and supervisory committee as a body to monitor operation execution. The board of directors would appoint representative directors and executive directors among the aforementioned members, and delegate responsibility for the execution of decisions to the board of directors, as well as responsibility for decision-making and execution relating to daily operations. Non-executive directors, who make up the audit and supervisory committee, would not be able to execute operations, and a majority thereof would have to be external directors. Simultaneously, such directors would also be members of the board of directors. Therefore, non-executive directors would be able to exercise proposal and voting rights concerning appointment and dismissal of representative directors and executive directors by the board of directors. Thus, the management monitoring functions of such non-executive directors would be enhanced in comparison with those of the audit and supervisory board members of a company with an audit and supervisory board, particularly compared with those of external audit and supervisory board members. The audit and supervisory committee structure is scheduled to be used by all stock companies. The appointment of two or more external directors and auditors would be required by law. Thus, it is expected that in actuality use of such a company form would be limited to large-sized public limited companies.

Secondly, in order to preserve the independence of non-executive directors, the right to appoint and dismiss non-executive directors who are members of the audit and supervisory committee would be assigned at the general meeting of shareholders. Further, in order for representative directors to submit to the general meeting of shareholders a proposal for the appointment of non-executive directors, consent of the audit and supervisory committee would be required. Additionally, compensation for non-executive directors would be determined at the general meeting of shareholders separately from that of other directors. Thus, economic independence will also be preserved.

Third and finally, the monitoring function of the audit and supervisory committee against the body that performs operations would be enhanced. Thus, in the case where external directors account for a majority of the total number of directors, or even in the case when external directors are under half of the total number of directors, if required by the Articles of Incorporation, many of the matters determined by the board of directors can be delegated to representative directors and executive directors to the same degree as is possible in a company with nomination, compensation, and audit committees. Therefore, a company with an audit and supervisory committee will be able to achieve prompt management.

 

4. Future Prospects

It is expected that an amendment to the Company Law in response to the Company Law Reform Recommendation will be seriously considered and initiated at the extraordinary Diet session in Fall 2013. However, even if the amendment to the Company Law is completed and companies adopt the audit and supervisory committee system, it is not clear how many stock companies will actually use such a system. This may result in the same mistakes as those made in the previous cases of companies with nomination, compensation, and audit committees. At the same time, in regard to the future form of the governance system for large-sized public limited companies, the current choice system will be abolished and only companies with audit and supervisory committees adopted through an amendment to the Company Law starting in the next period will be used. This concept is widely understood. In this respect, it will be necessary in the future to review measures for promoting the adoption of the system described above.

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