Governance | US vs. Japan—Part One
WAKING THE SLEEPING GIANT
Shhh! Shareholders in Japan actually have a lot of power
By Nicholas Benes
I am often asked to compare corporate governance in Japan and the US. The truth is that the two systems are so different in structure and practice that it is a bit like comparing apples and pineapples.
Since the modern corporation is less than 200 years old, and corporate governance has existed as a concept for only half that time at most, in terms of governance we are still in the age of the Neanderthals. So, rather than engaging in rivalry—my rock axe is better than your wolf tooth club—we desperately need to learn from each other.
To do this, we must understand what needs be improved, and identify areas in which each country may be able to learn more effective practices and structural concepts from the other.
We should begin by understanding that—surprisingly to some—the Company Law of Japan is generally much more shareholder-friendly than is its US equivalents when it comes to US public companies. This is particularly true in areas where it most matters: shareholder proposals and voting.
Conversely, the US corporate governance system tends to be more board-centric on a variety of key issues than is the case in Japan. Accordingly, it has more sophisticated practices and legal rules related to the proper functioning of the board.
Superficially, to submit a shareholder proposal in the United States, you only need to have held, continuously for one year, either 1 percent of the company’s shares, or stock with a market value of $2,000.
In Japan, the hurdle is also not very high. You are required to hold, for six months or more, either 1 percent of the company’s shares or 300 units of stock, whichever figure is lower.
The big difference is that in the United States, shareholders do not have “proxy access”, which allows one to nominate director candidates and have their names included on the proxy statement. There, the incumbent board gets to choose the candidate names that appear on the proxy statement.
Thus, for all practical purposes, US shareholders cannot make proposals about some of the things they most care about, such as nominating new directors or terminating existing ones, and about policies that conflict with those that incumbent management is submitting to shareholders at the same time. This is because they do not have the right to have their proposal included in the proxy materials, namely, to get it on the ballot.
Japanese shareholders, however, do have “proxy access.”
The result is that, in terms of procedure, most US shareholder meetings are a bit like North Korean elections. There is only one slate of directors described in the proxy materials, so only one slate of candidates that one can vote for or against, with no alternatives for any candidate.
What’s more, at most US companies each director does not even need to be supported by a majority of voting shareholders in order to be elected. All he or she needs is a plurality of votes, which is to say, more votes than any alternative candidate—of which there are none. One vote is enough if there is nobody else.
So, it’s best to not embarrass yourself by claiming that we have shareholder democracy in the United States. What we have is a very board-centric system.
Why is this, and what does “proxy access” really mean? In modern financial markets, some 99 percent-plus of all voting of shares is done in advance. Almost all shareholders send in a proxy form (his or her votes) in advance, after having read the proxy materials explaining the proposals to be voted on.
So, if you are making a shareholder proposal and you want to stand a chance of attracting the attention (and possible votes) of 99 percent of investors, for practical purposes you absolutely must get your proposal included in those proxy materials. You need to have “access to the proxy”, or you will lose from the start.
You can stand up in the shareholder meeting and ask less than 1 percent of the shareholders to vote for your candidates, but you will already have lost many weeks earlier, when the other 99 percent plus of shareholders voted for or against the only prospects they saw: the candidates in the proxy statement, which did not include your candidates.
Your only alternative would be to engage in a proxy fight by spending millions of dollars on lawyers’ fees and for media coverage.
This is all because the Securities and Exchange Commission’s (SEC’s) Rule 14a-8(i) permits management to exclude from the proxy statement proposals relating to director elections (whether nominations, terminations or procedural proposals) that would affect the outcome of the election of directors, or that directly conflict with a company proposal to be submitted at the same meeting.
By contrast, in Japan, proposals to nominate or terminate directors or statutory auditors are deemed perfectly valid, and management has no right to exclude them from the proxy materials. Further, they are easy to submit. Shareholders who meet the minimal requirements described earlier, will automatically have their proposals included in the proxy materials, and therefore will have a low-cost, easy opportunity to get the attention (and possible votes) of the 99 percent-plus of shareholders who vote by proxy, in advance.
Moreover, in Japan there is no such thing as election by a plurality. Directors and statutory auditors in Japan must be elected by an absolute majority of voting shareholders.
(Note that recently, the SEC relaxed its rules so that shareholders can propose to any particular company that it change its Articles so that they be given access to the proxy. While not an easy route, this sets the stage for so-called “private ordering” with a range of different rules for access).
Another major difference between the two systems is that in the United States, the vast majority of proposals must be precatory, that is advisory, in nature. In other words, most proposals make a recommendation to the board, but are not binding on it.
But in Japan, as in the United Kingdom and most Continental jurisdictions, proposals are always binding on the board. If a proposal is not sufficiently clear as to exactly what it is asking the board to do, it can be excluded from the proxy materials for that reason.
It should be noted that the US system differs from that of Japan in that the vast majority of directors on US boards (at a minimum, the majority) are independent directors, who bear significant reputational and liability risk if they do not do what is arguably best for the company, and it is they who make up the director nomination committees at companies.
Managerial influence is, thus, offset to a significant extent, ensuring that most directors who appear on the proxy statement meet minimum standards of experience, knowledge, and independence, as well as have the right mind-set. Most of them are not just close buddies of the CEO who have no rigor and little to add.
But there are still far too many exceptions to this statement. As is the case for many other countries, the United States needs to pursue more director professionalization and track past records to enforce accountability.
In Japan, it is almost always an insider-controlled board that is proposing a slate of board candidates that will likewise be insider-controlled, with one or two friends as outsiders—all in reality hand-picked by the CEO, regardless of whether the company claims a nomination committee did the selecting.
In a statutory auditory committee-style company—the governance format chosen by 98 percent of Japanese public companies—nomination committees don’t have any legal validity or role. Moreover, often the CEO sits on the nomination committee.
Interestingly, despite Japan’s very shareholder-friendly company law, because of cross-shareholdings and cultural reluctance of shareholders and potential outside director candidates, there have not been many shareholder proposals to appoint outside directors to boards.
The main reason is that this would be seen as a hostile thing to do, making it hard to find a candidate who might be elected. Therefore, even in Japan there is almost always only one director slate to vote for, and it mostly comprises internally promoted executives.
In some ways, the end result is similar to that in the United States, but for different reasons. Even if the slate includes outside directors, you can be pretty sure that they have been selected because they are friends of senior management (or were vouched for by close friends) and generally are expected to go with the flow on the most important and sensitive issues. Sorry if this seems cynical … . But if Japanese shareholders ever wake up to their legal rights, and Japanese companies realize that high-quality, independent director candidates proposed by sophisticated, understanding investors can add great value to their companies, things could change very rapidly in Japan, in a win-win cycle.
In small ways, this is starting to happen. Japanese shareholders are a sleeping giant who is starting to waken. •
Nicholas Benes is representative director of The Board Director Training Institute of Japan.
The Company Law of Japan is generally much more shareholder-friendly than is its US equivalents.”
If you are making a shareholder proposal and you want to stand a chance of attracting the attention (and possible votes) of 99 percent of investors, for practical purposes you absolutely must get your proposal included in the proxy materials.”