Best Practice Regulatory Models and the Case for Divergence of Independent Directors in Japan

1. Best Practice Regulatory Models and the Case for Divergence of Independent Directors in Japan Matt Nichol Assistant Lecturer Department of Business Law & Taxation Monash University

2. Presentation Overview • Independent directors as a concept • Who promotes the global best practice model for independent directors? • The Japanese best practice model for independent directors (& auditors) • Limitations on the global best practice model for independent directors • Japan as evidence of divergence in a global best practice model for independent directors

3. A.Independent Directors as a Concept

4. Creating a Global Concept • Independent directors can be contrasted to non-executive directors, outside directors • difference is conflict of interest • Role of independent directors • act as a check on management; • represent shareholder interests (minority); • mediate interests between conflicting interests.

5. Independent Director Rules as ‘Soft’ Law • Independent director rules & corporate governance rules are found in securities exchange listing rules and codes of corporate behaviour - ‘soft’ law • Self regulation • Enforcement and penalties • Impact of consolidation of exchanges?

6. B. Who Promotes the Global Best Practice Model for Independent Directors?

7. Global Best Practice Model of Independent Directors • Anglo-American Model • rules located in securities exchanges • 50% of majority independent directors • Deviations in model • independent chair person • reporting non-compliance - annual report

8. Promoters of Independent Directors • Internationally - US & UK • Especially after corporate collapses eg. Enron • Japan - industry/‘big’ business • Ministry of Economics, Trade & Industry - METI • METI - Corporate Governance Study Report 2009 - recommended TSE introduce independent directors/auditors • Members of 2009 report included ‘big’ business and keidanren

9. C. The Japanese Best Practice Model for Independent Directors (& Auditors)

10. Hybrid System of Japanese Corporate Governance • Japanese corporate governance is based on the traditional German inspired kansayaku auditor system • New Company Law 2004 - introduced optional Company with Committees • initial low uptake - 3% • 50% outside directors/auditors • Two systems same problems • Sony - committees, foreign CEO • Toyota - retains kansayaku system

11. The ‘Japanese’ Model • Amendments in 2009 to TSE Securities Listing Regulations • Rule 436-2 - TSE listed company must have at least one independent director/auditor who must represent the interests of general shareholders • independent director/auditor to be selected from ‘outside’ director/auditor under the Company Law • protect directors from shareholder derivative action • non-compliance - advise TSE when providing notice of independent directors • no definition of ‘independence’

12. D. Limitations on the Global Best Practice Model for Independent Directors

13. Corporate Governance as a ‘Localised’ Product • Impact of culture, institutional structure, economics, politics, history and society on: • corporate governance practice; and • regulatory system • Anglo-American model of independent directors - 50% - not a good fit for Japan - too many outsiders

14. ‘Insider’ Corporate Culture in Japan • Post-WW II corporate governance • cross-shareholdings, ‘main bank’ holdings and lifetime employment = ‘insider’ firms • holdings decreased since 1990s BUT insider culture continues • Meiji period zaibatsu opened to outsiders • pragmatic - new legal rules - need people outside the family trained in rules regarding corporate structure and ‘modern’ practice • unlikely to be repeated - Japanese companies resisted outsiders for 10 years

15. Institutional Culture of Japanese Firms • Creating insider culture through mission statement • place posters or framed copy of mission statement in office • taught to employees in training • produced in a booklet or in-house magazines and distributed • new employees make pledges and affirmations • Group harmony and the apology • Shimatsusho and jidan • Tokugawa village and ostracism - murachibu

16. Formal Compliance with TSE • Split of independent directors and auditors • Independent auditors - 75% - 3,314 • Independent directors - 25% - 1,046 • Number of independent directors and auditors • 0 - 6.4% • 1 - 48% • 2 - 22.9% • 3 - 12.3% • 4 - 4.9% • 5 - 3.2% • 6 - 1.5% • 7 & 8 - 0.5% & 0.3%

17. E. Japan as Evidence of Divergence in a Global Best Practice Model for Independent Directors

18. Divergence? • Was the Anglo-American model adopted in Japan? • most firms still use kansayaku • one independent director/auditor • no independent chair • weak reporting for non-compliance • Formal compliance • 70% companies have one or two independent d/a • 2008 average size of board - 18.30 (down from 31.94 in 1988)

19. Exporting the Japanese Model • Japan as an Asian leader • despite economic problems countries still look to Japan’s quick economic success - Malaysia • western technology & concepts - China • FDI by Japanese companies in Asia • trade • establishing subsidiaries in cheap local labour markets • Japan’s model as an ‘Asian’ model • better cultural fit than Anglo-American model

20. Convergence? • Avoiding independent director rules? • Japan - legal rules • Singapore - institutional structure & politics