Held Accountable

To read more about the history of corporate governance reform in Japan, click here.

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Tenure is usually associated with academic institutions, not particularly with the Far East. But as it turns out, tenure also is at the heart of the debate over corporate governance reform in Japan, where the country's seniority-wage system means employees are paid poorly in their early years in exchange for job security and excellent rewards toward the end of their careers.

In a system where longevity, rather than performance, governs take-home pay, it follows that management stands to gain little by increasing shareholder value. This, at least partially, explains the historical resistance of Japanese business to activist shareholders and hostile takeovers.

"In Japan, traditionally, shareholders do not oust management. Even though they have the power to, boards are not always independent and hostile takeovers are rare," says David Makman, counsel at Howrey.

So when Steel Partners, an American investor, deposed the CEO and the six inside directors of Japanese wigmaker Aderans in May 2008, it was big news in Japan, where shareholder activism, hostile takeovers and U.S.-style corporate governance are slowly edging into the mainstream.

"The Aderans shareholder vote demonstrates in the most meaningful way possible that shareholders in Japanese companies can hold management accountable for unacceptable returns on capital," Makman says. "And Aderans is just the tip of the iceberg."

Still, it's taken a long time for the tip to emerge.

"The type of investor activism we saw in Aderans was almost unthinkable in Japan five years ago," Makman says.


Rendering Reform

Before the turn of the century, the corporate auditor system characterized Japan's corporate governance regime. The corporate auditors' task was to look over the shoulders of the board. But difficulties arose because auditors were company employees traditionally appointed by the directors.

"There had been a lot of criticism of auditors over the years on the basis that they were not in a position to fully look after the interests of shareholders," says Richard Holbrook, counsel at Crowell & Moring.

Reforms to the Commercial Code in 2002 and 2005 were supposed to change all that by strengthening the independence of auditors.

The reforms also provided for a second, alternative U.S.-style form of corporate governance known as the committee system. The system featured audit, compensation and nominating committees, all of which were required to have a majority of independent directors.

"By 2007, however, only 3 percent of Japanese companies had adopted the U.S. system," Holbrook says.

But by that time, the slow uptake of the committee system, the lack of meaningful movement in the auditor system, and management's continued lack of commitment to enhancing shareholder value brought on a renewed governmental commitment to reform.

At its core was a realization that hostile takeovers, and the shareholder activism that characterizes them, are frequently the engines that drive good corporate governance.

Hostile takeovers have been rare in Japan for two reasons: The country has inadequate safeguards against arbitrary or discriminatory dilution by way of resorting to methods such as the poison pill; in addition, listed companies can issue new shares by way of private placement without making transparent disclosure about their actions.

"The mergers that have occurred in Japan are for the most part friendly mergers that were a result of economic pressures on one or both of the companies," says David Hill, a partner at Finnegan, Henderson, Farabow, Garrett & Dunner.

Protecting Shareholders

A major victory for activists, however, seemed to have occurred in 2005 when a small domestic company, Livedoor Co., bought a 30 percent share in Nippon Broadcasting Co. Nippon responded by issuing shares to Fuji Television to dilute Livedoor's holdings and prevent a takeover.

Uncharacteristically--Japanese business tends to avoid litigation--Livedoor went to court and got an injunction preventing the share issue by relying on the Commercial Code reforms.

"Although the case ultimately settled and did not result in a hostile takeover, it seemed that hostile takeovers were becoming a reality in Japan," Makman says. "But since then, there have been only a few takeovers that might be characterized as hostile. It was apparent that the revised law was not becoming the engine of change it was intended to be."

Highlighting the reforms' shortcomings was Steel Partners' failed attempt in 2007 to take over the Bulldog Sauce Co. In defense of the hostile bid, Bulldog exercised a poison pill that cost the company more than $18 million but diluted Bulldog's ownership share by 75 percent. The Japan Supreme Court refused to interfere.

Equally revealing of the reforms' limited effect was the highly publicized May 2008 failure of the Children's Investment Fund, a British activist investor, to increase its 9.9 percent stake in J-Power, a utility company.

Fortunately, the Ministry of Economic Trade and Industry recognized that further change was necessary. It established a Corporate Value Study Group, which in June 2008 issued a report, "Takeover Defense Measures in Light of Recent Environmental Changes."

"The report takes on many of the practices that have been adopted by Japanese management in order to avoid hostile takeover and proposes a framework that encourages such takeovers unless the target can show that the price offered is too low," Makman says.

Prepared by a multidisciplinary group of lawyers, academics and company representatives, the report also recommends the appointment of independent boards.

"The report demonstrates the growing breadth of Japanese society that supports hostile takeovers as a way to protect shareholder interests," Makman says. "And although the report is a guideline that is not binding, most Japanese judges have never practiced law but do have degrees in economics and won't be comfortable making decisions that run contrary to the report."

Activist shareholders are baring their teeth too.


Activist Impact

The Asia Corporate Governance Association, a group that includes substantial U.S. interests and represents $5 trillion worth of investment, released its own views in May 2008. The report, titled "White Paper on Corporate Governance in Japan," was severely critical of Japanese corporate governance. The system, the paper claimed, did not meet shareholders' needs because it failed to provide for adequate supervision of corporate strategy, protected management from the discipline of the market and failed to provide returns sufficient to protect Japan's pension system. Among its recommendations were the introduction of pre-emption rights for shareholders and the adoption of shareholders rights plans as an alternative to poison pills.

The proposed reforms and the newfound activism quickly had meaningful impact, evidenced in part by Steel Partners' success in ousting Aderans' management. Many Japanese companies also have raised their dividends in 2008 following pressure from shareholders. Perhaps most telling was the fact that listed Japanese companies set an all-time first-half record in 2008 by repurchasing shares to the tune of more than $21 billion.

"Like Aderans, these developments would have been almost unthinkable five years ago," Makman says. "You can be sure that foreign investors are noticing."

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Julius Melnitzer

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