The Abe legacy: unfinished business

Shinzo Abe’s recent death offers an opportunity to consider his legacy in corporate governance and capital market reform, writes ACGA Secretary General Jamie Allen.

The recent assassination of Shinzo Abe marked a profoundly sad end for one of Japan’s boldest reforming prime ministers of recent decades. In power for the second time from 2012 to 2020, Abe presided over a structural and philosophical rethink of corporate governance and introduced policies thought impossible only a few years earlier. Part of his government’s genius was to link CG reform not to risk reduction—as in most markets where governance is a corrective to excessive corporate risk taking—but to the long-term growth of companies and the revitalisation of the underperforming Japanese economy. Refreshingly, Abe and his officials saw Japan as part of an international capital market whose changing standards should be respected, not as a special case that needed to be indulged. What has been his legacy and how much of it will remain?

CG before Abe

In fairness to earlier governments, CG reform in Japan did not start with Abe. The first decade of this century brought new ideas such as the “three committee (3C) system”, which introduced outside directors and board committees (audit, nomination, compensation) for the first time. There were attempts to make the country’s traditional “statutory auditor” (Kansayaku) board more impartial and less beholden to the company president. The government also promulgated a local version of the Sarbanes-Oxley Act (SOX) of the US, called J-SOX, that raised the bar for corporate financial reporting and auditing.

These were all important reforms but none of them brought a fundamental change in management thinking on corporate governance. Modern CG was something that foreigners played with, not serious Japanese companies with a strong engineering bent. “How can outside directors say anything useful if they haven’t worked in my company for 20-30 years?”, was a question one heard often at the time. It was no surprise then that the 3C system failed to gain much traction—and being labelled the “US-style system” did not help either. Further attempts to push reform faced implacable resistance from the Keidanren, the conservative Japan Business Federation, while the concept of the independent director remained in the deep freeze thanks to many of the country’s best-known companies, including Toyota and Canon, declaring against them.

Such was the chilly environment into which ACGA released its “White Paper on Corporate Governance in Japan” in 2008. The paper made a series of recommendations in six areas of CG reform: recognising shareholders as owners; the efficient use of capital; independent supervision of management; pre-emption rights; poison pills (anti-takeover devices); and fairness and transparency in shareholder voting. With the exception of pre-emption rights, huge progress has been made in all these areas—and much of the thanks should go to the Abe government. 

But before he took power, credit must be given to the relatively short-lived Democratic Party of Japan (DPJ) government from 2009 to 2012. In March 2010 it proposed a series of rule changes on non-financial disclosure covering the counting of AGM votes, executive remuneration above ¥100m, and large cross-shareholdings. Against opposition from the Keidanren and others, the Financial Services Agency (FSA), the country’s main financial regulator, stood firm and pushed ahead. Just a few months before, in December 2009, the Tokyo Stock Exchange (TSE) made its first tentative foray into board independence by requiring listed companies to appoint at least one independent director or one independent statutory auditor (Kansayaku).

The Abe era

Like the darling buds of May, CG blossomed after Abe took power in December 2012. Reforms, new policy ideas, and civil society participation arrived in a heady rush: the Japan Stewardship Code of February 2014; the Ito Review that put ROE and corporate competitiveness on the map in  August 2014; the Corporate Governance Code of June 2015; a new third system of board governance, the Audit and Supervisory Committee Company, in 2015; the growth of sustainability reporting, strongly encouraged by the FSA and the Ministry of Economy, Trade and Industry (METI); the emergence of new director training institutes; an official set of Guidelines for Investor and Company Engagement in June 2018; new METI guidelines on group governance in June 2019; and on and on. 

One element of this broad-based effort was an attempt to adopt new approaches to corporate governance never tried before in Japan, notably the soft-law concept of “comply or explain”, which first appeared in the Stewardship Code of 2014. Another feature was the need to catch up with developed market practice on CG Codes—national policy documents that set aspirational governance standards for boards of directors. The first such code globally was the seminal Cadbury Report from the UK in 1992, while most Asian markets had adopted them by the early 2000s following the region’s financial crisis of 1997-98. Japan was, therefore, very late to the party.

In contrast, Japan has led the way in Asia on investor stewardship codes. Revised twice—in 2017 and 2020—the Japan Stewardship Code has steadily raised the bar for institutional investors, both domestic and foreign, and provided a more open framework for company-investor dialogue. It has spurred the huge Government Pension Investment Fund (GPIF) and other local asset owners to take their roles as owners of companies seriously. And it has sought to tackle the conflicts of interest inherent in banks and insurers by requiring their asset management arms to disclose how they vote on each and every resolution. Managed by the FSA, the Stewardship Code now has 323 signatories.

The overlay to all this has been a drive to make Japanese companies more competitive and profitable, to provide more value to shareholders (a group which includes the country’s growing body of pensioners), and to revitalise the economy. Results have of course been mixed, since much depends on each company’s leadership, culture, and management skill. But few would doubt that the Japanese capital market is in better shape today than before Abe. 

Taking a more micro view, the mindset change among many companies towards corporate governance has exceeded even my optimistic expectations. When we released our White Paper in 2008, one company executive said he was shocked by the audacity of our proposal for three independent directors. One independent director may be bearable, but surely not three? Today such directors are commonplace and, as of April 2022, as many as 80% of TSE Prime Market companies had at least one third of them. This does not mean all are doing a good job and deserve their positions. Box ticking remains alive and well. Yet companies that select such directors thoughtfully tell ACGA that they do get value from them.

Unfinished business

Where next for Japan in CG reform? The Abe government achieved a great deal, but it would be fair to say that it did much more for soft than hard law. Two new codes, both revised twice. The introduction of “comply or explain”. Mandatory CG reports under TSE listing rules. Numerous guidelines from METI and the FSA, not to mention dozens of official study groups. The encouragement of investor forums and so on.

What is missing is an equal focus on hard-law legislative and regulatory change. It is not that nothing has happened. The FSA did, for example, strengthen non-financial disclosure in annual securities reports in 2019 and 2020. The issue is that there are several areas where shareholder rights and protections are either well behind other developed markets or unnecessarily complicated. This was a major reason for Japan’s fall in ranking in our CG Watch survey from 4^thin 2016 to equal 7^thwith India in 2018. 

One challenge for investors is the interaction between the 5% large shareholding report, the Act of Making Important Suggestions, and rules on joint holders or concert parties. The net effect has been to stifle the growth of collective engagement, something ostensibly encouraged in the revised stewardship code of 2017. New guidance and some regulatory change is urgently needed

Investors would also like to see an overhaul of takeover rules to ensure that all shareholders are treated fairly and equally in mergers and acquisitions. A higher bar for gender diversity on boards, especially Prime Market companies. A more unified system of corporate disclosure, with the annual securities report published before the AGM. Less clustering of annual general meetings. Firmer rules on director training and board evaluation. A stronger legal basis for nomination and remuneration/compensation committees, most of which are still only advisory. A more robust audit committee system. Rules against auditors staying on for decades. The list could go on…

The Kishida era

Will Japan’s new prime minister, Fumio Kishida, attack these challenges with gusto? While it is still early days, this seems unlikely. The policy zeitgeist has shifted from building a more robust capital market to creating a new form of capitalism that addresses inequality and meets the needs of all stakeholders. Although laudable in principle, the fear is that this may lead in practice to a new round of anti-shareholder policies. So far the damage has been limited, thanks to negative reaction to the prime minister’s perceived anti-market comments on such things as share buybacks and capital gains taxes. It also appears that a proposal to remove quarterly reporting has been shelved for now.

On a more positive note, it is equally hard to see the reforms of the past 10 years being unwound. Japan is an ageing society and its pensioners need the best possible returns from well-managed and well-governed companies. Companies have forged new and more positive relationships with their shareholders. Both sides benefit from the enhanced dialogue. And numerous regulatory and ministerial officials continue their work on deepening governance, disclosure, securities enforcement, and auditing practices in Japan. It was for all these reasons that Japan’s CG Watch ranking moved back up from equal 7^thin 2018 to equal 5^thin 2020. Abe’s legacy seems secure.

For more information, please contact jamie@acga-asia.org