Japanese corporate governance: Quo Vadis?

Corporate governance in Japan has gone through twists and turns over decades, just like in many other jurisdictions.

The post-World War II corporate governance system in Japan, also known as the “company community”, was characterized by features such as the so-called “lifetime employment” system, a board of directors consisting mostly of those promoted from employees of the company, a network of management-friendly “stable shareholders” who were often trade partners of the company, and the so-called “main bank” system, and focused on the interests of employees and other stakeholders. This traditional system seems to have worked quite well until the mid-1980s, supporting Japan’s rapid economic recovery after World War II by enabling the management to focus on growth in the long term and incentivizing employees to make firm-specific human capital investments (see Shishido 2000).

With the bursting of the “Bubble Economy” in 1991, however, the Japanese economy entered a long period of low growth often dubbed as the “lost two decades”, and a view that excessive risk-aversiveness due to the employee-oriented governance system had been one of the causes of Japan’s structural stagnation gradually gained popularity among Japanese policymakers. In the meanwhile, the share-ownership structure of large listed corporations has changed dramatically, with less stable shareholders and more foreign institutional investors (see, Goto, 2014).

These developments resulted in a series of corporate governance reforms in the 2010s, which formed one of the main pillars of the so-called “Abenomics”. In particular, the Japanese Corporate Governance Code (adopted in 2015 and revised in 2018 and 2020) led to a significant increase in the appointment of outside/independent directors by Japanese listed companies (see Tokyo Stock Exchange, 2023),  while the Japanese Stewardship Code (adopted in 2014 and revised in 2017 and 2020) sought to encourage domestic institutional investors to take a tough stance against the management of their investee companies when necessary (see Goto, 2022). These reforms may not have succeeded yet in changing the attitudes of Japanese managers toward risk and investment, but have sparked more shareholder-oriented viewpoints in Japanese listed companies, in particular in terms of profit distribution (see Miyajima and Saito, 2021).

When Prime Minister Fumio Kishida took office in October 2021, some might have feared (or hoped) that his focus on “New Capitalism” could change the course of corporate governance reform in Japan. As Professor Takeo Hoshi has pointed out earlier in this blog, however, Kishida’s “New Capitalism” seems to be more rhetoric rather than an actual policy change. For example, while mandatory disclosure on matters relating to sustainability, in particular climate change and gender diversity in the workforce, was introduced in January 2023, it is based on the idea of single materiality, at least for now. Also, while statutory quarterly disclosure is expected to be abolished by a government-sponsored bill pending in the National Diet, quarterly earnings reports required by Tokyo Stock Exchange will be maintained. Regulation of share buybacks, in which PM Kishida initially showed some interest, has never materialized. In contrast, the draft Guidelines for Corporate Takeovers now being considered by the Ministry of Trade, Economy and Industry emphasize that directors should prioritise shareholders’ interests when receiving an unsolicited offer and that defensive measures should be implemented based on the will of shareholders. Also, Tokyo Stock Exchange, which often acts in cooperation with the Japanese government, requested its listed companies in March 2023 to pay more attention to the cost of capital and stock price, referring to the large number of companies with price-to-book ratio below 1.0. Overall, the pro-shareholder trend of corporate governance reforms in Japan is still in place.

One might question why Japan is still focusing on shareholders’ interests in this era of ESG and sustainability. To answer this question, it would be appropriate to cite a recent work by Prof. Dan Puchniak that “context matters”. As noted earlier, the traditional Japanese corporate governance system had been paying attention to the interests of stakeholders, in particular employees, much before the current wave of ESG woke up Anglo-American companies. Ironically, this focus on employees’ interests, which once contributed to Japan’s economic growth, was seen as one of the causes of the “lost two decades” and led to a series of reforms championing shareholders’ interests.

Such a Japanese context, however, does not necessarily mean that consideration of ESG issues is not important for Japan today. While the “lifetime-employment” system has protected the interest of full-time employees of Japanese large companies by securing their jobs until their mandatory retirement age (traditionally 60 years old), it has also caused problems as well. To begin with, Japanese companies tend to limit new hiring in times of difficulty to avoid laying off current employees, making young people seeking their first jobs suffer. Also, employees enjoying “lifetime employment” are in return subject to a wide discretion of employers over the content and the location of their work, including transfers to subsidiaries in different regions or trade partners. As mid-career job change is relatively uncommon under this system, the Japanese labor market has been illiquid, diminishing the bargaining power of employees against their employers. Harsh working environments that sometimes lead to death by overworking and average wages remaining flat for more than 30 years could be attributed to such an illiquid labor market. Also, long working hours and the possibility of sudden transfers have been unfriendly to the female workforce, particularly working mothers. With a declining population, promoting gender equality in the workplace is one of the top agenda items for Japan, not only for social justice but also as an economic policy.

Facing these challenges, the Japanese government has also attempted to reform its labor market/system. Most recently, the Kishida administration has placed measures to increase labor market liquidity on top of its annual economic policy (Basic Policy on Economic and Fiscal Management and Reform 2023 in Japanese) and announced its intention to set a non-binding goal for companies listed in the Prime Market of the Tokyo Stock Exchange to have 30% or more female executives/directors by 2030 (Basic Policy on Gender Equality and Empowerment of Women 2023).

Turning to the “E” issues, in particular climate change, Japanese listed companies might be less “woke” compared to their European or American peers, but this might be because the Japanese society itself is arguably less “woke”, even though Japan is also suffering from intense heat and increasing heavy rains and typhoons. One recent survey has shown that the ratio of Generation Z feeling guilt or anger about climate change is lower in Japan than in other countries, and young Japanese tend not to speak about climate change with others.

This “unwokeness” among Japanese society might have multiple causes, but one possible factor might be Japan’s stagnation over decades and a pessimistic view of the future, forcing people to prioritize their daily living. In other words, revitalizing the Japanese economy might be essential to gain public support for the fight against climate change.

Altogether, one thing seems to be quite certain. The case for reforming the traditional Japanese corporate governance system remains.

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By Gen Goto, Professor of Law at the Graduate Schools for Law and Politics, The University of Tokyo

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