Navigating Best Practice Models for Independent Directors: Japan's Unique Divergence

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