Key points

  • Japan's first Corporate Governance Code was published on March 5, 2015, and became effective from June 1 of the same year. It is a principles-based soft law that is operated through the TSE's listing rules rather than laws.
  • The 2015 edition consisted of 5 basic principles, 30 principles, and 38 supplementary principles (73 items in total). Listed companies will implement each principle or, if not, explain why.
  • Principle 4.8 requires companies listed on the First and Second Sections of the Tokyo Stock Exchange to appoint at least two independent outside directors. This became an important standard for changing the Japanese board of directors, which used to be dominated by people from within the company.

How the code was born

The 2015 Code is one of the corporate governance reforms positioned as the "third arrow" of Abenomics. The Japan Revitalization Strategy, revised in June 2014, set out a policy to formulate a corporate governance code in order to promote sustainable growth and increase corporate value over the medium to long term.

The aim was to increase the accountability and oversight of boards of directors and improve the capital efficiency of Japanese companies. In designing the system, rather than using American-style rules that uniformly prescribe detailed actions, a British-style approach was adopted that allows companies to explain their responses to principles while acknowledging the circumstances of each company.

It was formulated by the “Expert Council on the Formulation of the Corporate Governance Code,” a joint secretariat of the Financial Services Agency and the Tokyo Stock Exchange. The committee was chaired by Professor Kazuto Ikeo of Keio University, and the OECD also provided advice. The composition of the 12 members is as follows.

  • Business world 4 people
  • Investor side 4 people
  • Legal researchers 1 person
  • Practicing lawyer 1 person
  • Accounting expert 1 person
  • Audit & Supervisory Board Association 1 person

The structure was structured so that the opinions of investors were reflected in the same number of people, rather than biased only toward companies. The meeting began in August 2014, the draft was published in December 2014, solicited opinions, and the final draft was compiled in March 2015.

Column — Why adopt a principles-based approach? If the same procedures were uniformly imposed on all listed companies with different industries, sizes, institutional designs, and shareholder compositions, red tape would likely increase. Therefore, the Code set out the principles of desirable corporate governance and adopted a principles-based approach in which each company chooses the implementation method according to its own circumstances. A company can remain within the Code’s framework without implementing a principle if it provides a reasonable explanation. The preamble to the Code states, “A principles-based approach will be adopted to enable effective corporate governance to be implemented in accordance with the circumstances of each company.”

5+30+38 structure

The 2015 Code consists of three tiers. The top level Basic Principles shows five ways of thinking that are common to listed companies. Below that, the Principles set out the responses required in each area, and the Supplementary Principles further specify disclosures and procedures.

A sentence-by-sentence summary of the five basic principles is as follows:

# basic principles Contents required of the board of directors
1 Ensuring shareholder rights and equality Protect the rights of shareholders, especially minority and foreign shareholders, and ensure substantive equality.
2 Appropriate collaboration with stakeholders other than shareholders Respect the rights and positions of employees, customers, business partners, creditors, local communities, etc., and cooperate appropriately.
3 Ensuring appropriate information disclosure and transparency In addition to the information required by law, we will disclose information that is useful for investment decisions in an accurate and easy-to-understand manner.
4 Responsibilities of the board of directors, etc. Provide strategic direction, create an environment that supports appropriate risk-taking, and supervise management.
5 Dialogue with shareholders Engage in constructive dialogue with shareholders even outside of general shareholders' meetings.

In practice, the numbers assigned to principles and supplementary principles are important. For example, independent outside directors are placed in principle 4.8, and CEO succession planning is placed in supplementary principle 4.1.3. The corporate governance report also describes each company's response according to this number.

In 2015, all 73 items of companies listed on the First and Second Sections of the Tokyo Stock Exchange were subject to compliance or explain requirements. For companies listed on Mothers and JASDAQ, a simple application of only the five basic principles was allowed.

What the 2015 Code Required

Basic Principle 5 stipulates the following regarding dialogue with shareholders.

"Listed companies should engage in constructive dialogue with shareholders outside of the general meeting of shareholders. In doing so, senior management and directors (including outside directors) should listen to the voices of shareholders through such dialogue, pay due attention to their interests and concerns, and..."

  • Corporate Governance Code (2015 Edition) Basic Principle 5

This provision positioned dialogue with shareholders as the responsibility of management and the board of directors, rather than the sole responsibility of the IR department. Outside directors are also included in the dialogue, and investors' interests and concerns are required to be reflected in management.

Regarding the independence of the board of directors, Principle 4.8 indicates the specific number of board members.

"Listed companies should elect at least two or more independent outside directors...Irrespective of the above, listed companies that consider it necessary to elect at least one-third or more of independent outside directors, comprehensively considering the industry, size, business characteristics, organizational design, environment surrounding the company, etc., should disclose their policy for this purpose, regardless of the above."

  • Corporate Governance Code (2015 Edition) Principle 4.8

The requirement for “two or more independent outside directors” became the starting point for systematically introducing outside perspectives into Japanese boards of directors, which were often composed only of internal directors.

How Comply or Explain Works

The Code is not the Companies Act or the Financial Instruments and Exchange Act itself. It is applied through the TSE securities listing regulations and listing agreement. Each company's response will be disclosed in the Corporate Governance Report prescribed by the TSE. If there are any changes to important matters such as the composition of the board of directors or policies, the report will be updated from time to time.

For each principle, listed companies choose one of the following:

  1. Comply - Explain how the principles are being implemented, along with specific systems, policies, and achievements.
  2. Explain the reasons for not implementing it --- Explain why you chose a different method based on your company's circumstances and how that method will achieve the purpose of the principle.

Not implementing a Code principle does not, by itself, constitute a violation. What is important is the content of the explanation. Investors, proxy voting advisory firms, and exchanges evaluate whether explanations are specific, reasonable, and address the spirit of the principles. TSE's “Corporate Governance Information Service” allows you to search for each company's reports, making it possible to compare explanations of the same principles between companies.

Column - Code and company law are different things. The Companies Act sets out legal minimum standards that companies must adhere to. The Corporate Governance Code is a soft law that requires listed companies to implement desirable corporate governance. Although failure to implement the Code itself does not directly lead to civil or criminal liability, failure to provide the necessary explanations could result in problems under listing rules. Furthermore, the quality of explanations has a direct impact on the exercise of voting rights and dialogue with investors.

Applicability as of 2015

Issuer classification (as of 2015) Subject to Comply or Explain
TSE 1st section Total 73 items (5 basic principles + 30 principles + 38 supplementary principles)
TSE 2nd section Total 73 items
mothers Basic principle 5 only
JASDAQ Basic principle 5 only

By applying all the principles to the first and second sections, and applying only the basic principles to emerging markets, we have struck a balance between the minimum standards required for listed companies and the burden commensurate with company size. The application relationship for each category will be reviewed in line with the market reorganization in April 2022.

Implications for IR practice

  1. Use key principle numbers to explain. Link the question to the relevant principle, such as supplementary principle 4.1.3 for CEO succession planning and principle 4.8 for independent outside directors. It becomes a common language both within the company and when communicating with investors.
  2. Regularly inspect the corporate governance report. Confirm that there are no discrepancies in the description with IR materials and integrated reports, and that changes in the composition of the board of directors and committees are reflected.
  3. Write a detailed explanation of "implementation". Investors cannot judge effectiveness just by saying that it is being implemented. Show the system, person in charge, frequency of meetings, and even the most recent results.
  4. If not implemented, provide reasons and alternatives. Rather than simply stating that it is "under consideration," explain the current thinking, alternative methods that meet the purpose of the principle, and future prospects.
  5. Treat the report as a working document that will be updated. This is not a document that is created only once a year. If there are any important changes, it will be updated as needed, and the latest version submitted to TSE will be the standard for external explanations.

Source/reference materials

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