The Journal The Authority on Global Business in Japan

Governance | US vs. Japan—Part Two

October 2013
By Nicholas Benes
In a previous article, published in the ACCJ Journal for September 2013, I made the point that—contrary to popular belief—Japan gives stronger rights to shareholders than does the United States, but the latter has a system that is much more board-centric than that of Japan. On a comparative basis, it is in the boardroom that the US system excels.

By board-centric, I mean that US courts and regulatory rules focus more on requiring or encouraging boards to act optimally. This is based on the view that shareholders cannot be expected to know all the details and confidential information needed for difficult corporate decisions, so almost all important decision making should be done by the board.

Over many decades, US courts have developed a detailed body of case law (and resulting legal rules), from which an equally rich base of best practice standards has arisen. These rules and practices seek to ensure that what the board does behind closed doors is aligned with the interests of the shareholders who cannot be present—not senior executives who could otherwise influence the process.

Although perhaps not everyone is totally satisfied with the result thus far, US courts and regulations have made a concerted effort to address the “agency problem.” This is caused by the separation of ownership and control, which creates the risk that hired executives—who may own little, if any, stock—will not always do what is best for shareholders.

The most well known of these rules is the requirement that boards of US public companies have a majority of independent, outside directors.

This requirement did not arise from any initial mandatory rule, or even the belief that a company’s operating performance would improve if it were monitored by outsiders. Rather, it arose because in the 1970s, 1980s, and 1990s, the United States experienced a number of hostile acquisitions, takeover defenses, leveraged buyouts, management buyouts (MBOs), and other transactions in which the interests of executives conflicted with the best interests of the company for which they worked.

Thus, for instance, a CEO might want to deploy takeover defenses in order to entrench himself in his position; or, in an MBO, managers might prefer a low price, even though shareholders deserved the highest price possible.

Many of these situations had a huge impact on shareholder value—much more than a few quarters’ earnings.

Courts in Delaware, the leader in developing corporate law, devised a clever principle to deal with problems related to self-interested managers. In a series of cases, they developed the concept that, if executive board members (managers) would be unable to make a given decision in good faith and the honest belief that it was in the company’s best interests, then the board should base its judgment on the advice of a committee solely comprising independent outside directors.

If the board did this, the court would not question the decision, as long as it was grounded in a proper process of ascertaining and analyzing the facts.

However, if a board did not delegate the decision to such a committee, all of its members would be held to a higher standard of due care, making them much more likely to be sued, and more likely to lose if sued.

Personal liability risk is a strong incentive. Very quickly, law firms started advising their clients that it would be a good idea to have independent directors on hand. Thus, most of the US shift to appoint large numbers of independent outside directors took place without any statutes or regulations requiring it.

Likewise, other practices were developed to harness the neutrality provided by independent directors, in areas where managerial self-interest might skew things.

Best practices and regulations arose to require independent committees for audit review, to nominate new directors, or determine executive compensation.

Because of the large volume of case law in the United States that referred to the use of such independent committees, their use became a concept that was legally recognized, even encouraged, by the courts.

Thus committee members were aware that their fiduciary duties could apply to decisions they made in such committees, and they were advised to use proper formalities, such as writing up minutes for each meeting. Further, they were acutely aware that they could be sued, and the spotlight of potential liability was on them, rather than dispersed across the entire board.

Further, since implementation of the Sarbanes-Oxley Act of 2002, audit committee members have been required to be financially literate. Companies now must disclose whether one member is a financial expert—the NYSE and NASDAQ require at least one expert.

In contrast, Japan has not created much legal infrastructure to improve board decision making.

The country has no rules requiring that there be independent directors at any listed company.

Moreover, for the 98 percent of Japanese listed enterprises that are statutory audit committee-style companies, there are no legal or regulatory rules with respect to outside directors, or the formation or use of committees. This means that, in most Japanese companies, executives who essentially monitor themselves account for 90 percent of board directors. It also means that Japan has no legal mechanism or incentive to protect the best interests of shareholders when resolving situations in which managerial self-interest might adversely influence the decision. This is so in the case of takeover defenses, MBO price-setting, nominations, dramatic restructuring, sale of the company, or in the case of spin-off opportunities.

Unfortunately, as in the United States, many of these processes are matters that influence corporate value significantly, and quickly.

But problems do not exist in Japan merely because the number of outside directors is usually very small (fewer than one in 10). Even in a Japanese company that has multiple outside directors, the absence of basic infrastructure for committees and their operation results in loose board practices. Thus, we find the following:

  • A management-controlled board will essentially negotiate the MBO price and terms with itself, in a process that outside board members do not control and where the acquiring executives simultaneously wear two hats. (Which hat do you think influences their decisions more?).
  • There is a superficial (non-legal) nominations committee, with the CEO as chair. Message to all executives: always agree with the CEO—or you won’t be nominated (promoted) to be a director.
  • The board cannot decide whether to sell the company, or its non-core divisions, until it is too late and they have no value or go bankrupt. The topic is avoided and put off. Reason: the board would have to discuss the sale of the company, or Mr. X’s division, right in front of Mr. X and a large number of executives who are responsible for the present state of affairs.
  • The board sets up a takeover defense plan, which ensures that the company can never be sold to a hostile acquirer, no matter how bad current management might be, or how big the synergies are. Reason: there is nothing to prevent them. Only outside directors who would rubber-stamp the plan are appointed.
  • Statutory auditors, whose duty it is to conduct accounting audits and monitor the legality of directors’ execution of duties, are not required to know anything about accounting or law.

Sloppy practices like these are unconstrained by any rules at all, particularly since Japan has no corporate governance code. In contrast, in many European and other Asian countries, “soft law” corporate governance codes are promulgated by the stock exchange or financial regulator, setting forth rules for board practices, committees, and director training that are backed by “comply or explain” suasion. Should a company not comply, it must disclose this fact and give its reason.
In its establishment law, Japan’s Financial Services Agency has all the authority—nay, the duty (ninmu)—that it needs to lead the formulation of a corporate governance code of best practice, if it thought that would help protect the interests of investors. But the agency has not done so.

Nicholas Benes is representative director of The Board Director Training Institute of Japan (, a non-profit public interest organization.

Nicholas Benes is representative director of The Board Director Training Institute of Japan (, a non-profit public interest organization.