Waseda University Institute of Comparative Law

     1) In Japan, the “Companies Act” was established on June 29, 2005. During the period of stagnant economy from early 1990s to the late 2002, the Japanese Government relaxed many regulations (particularly labor law) with the slogan, “economic recovery by easing of regulations.” The Companies Act was no exception. The Law fully accepted the demand for easing of regulation by business community (such as Nippon Keidanren (Japan Business Federation) and small and medium-sized enterprise organizations). By the implementation of this Law, many systems and regulations were either abolished or amended (for example, Yugen Kaisha (private limited company) system was abolished). Companies Act that used to be the basic economic law was thrown into the position as a mere tool of government policy.

     Even after the promulgation of the Companies Act on March 1, 2006, a large number of corporate scandals is occurring successively. Due to such events, people’s confidence in corporations and the market has diminished significantly. It is urgently needed to implement measures to stop illegal and arbitrary actions of corporate management. In relation to this issue, two major points that have been a topic of debate in recent years are explained in the following:

     2) The first debate is regarding strengthening of regulations on capital increase by third party allocation of shares. Behind this is the fact that the following incidents have been frequently happening in the emerging securities markets (in the 6 emerging markets, 1322 companies are listed as of the end of 2008). (1) Y approaches the management of Company X, A, who is having cash-flow problems and suggests him to increase capital by issuing shares to the company or investment fund operated by Y. Following Y’s advice, A decides to issue shares of his company. In response to the announcement by Company X that it will get financing, the share price of Company X goes up. However, in most cases, the fund for capital increase is never paid, or even if paid, it soon drains outside the company. As a result, cash flow of Company X does not get better and eventually X goes bankrupt. In this scenario, Y or those who become a controlling shareholder by subscribing for shares gain profits through trading of shares and eventually get the company's assets in their pocket (for details, see Weekly Diamond, January 31, 2009 issue, pages 32-65, 68-73; Nikkei Newspaper, January 26, 2009, page 16 (Shingo Miyake)). Consequently, general shareholders, creditors and workers will suffer. (2) Company X’s manager, A, increases his company’s capital by allotting a large number of shares to a friendly Company Y for a price lower than its market price to protect his own position from hostile takeover, and Company X becomes a subsidiary of Company Y. This causes a drop of value per shares, and general shareholders of the company will suffer a loss.

     Systematic basis that allows this situation to happen includes the fact that the Companies Act allows “public companies” (defined in Article 2, item 5 of the Companies Act; hereinafter the articles cited without the name of statute are those of the Companies Act) (listed companies are included in this concept) to issue their shares up to the number of shares authorized to be issued (Articles 37 and 98) by resolution of the Board of Directors alone (see also Articles 201 and Article 113, paragraph 3) and that the parties to whom shares are allotted can be also determined by the Board of Directors alone (Article 202, paragraph 3, item 3). In response to this problem, the Tokyo Stock Exchange is said to be planning to require listed companies, in the case of capital increase by allotment of shares to third parties that causes changes to major shareholders, to disclose reasons for the selection of parties to which shares are allotted. However, such disclosure is not sufficient to prevent the above scenario from happening. It is necessary to revise the aforementioned provisions of the Companies Act (for example, when a company intends to issue shares, if such issuance will change its major shareholders or the shares to be issued exceed certain percentage, make it mandatory to obtain a special resolution of the general meeting of shareholders).

     (3) The second debate is regarding outside directors. Directors of a company owe the duty of care (Article 330 and Civil Code Article 644) and duty of loyalty (Article 355). Directors, as members of the Board of Directors, also owe the duty to supervise the execution of the duties of the representative directors (Article 362, paragraph 2). However, in reality, due to the fact that most directors in Japan are internal staff (workers) promoted to the post, it is difficult for those directors to stop the representative director and president or chairperson who holds real power from pursuing their own interest at the expense of company’s interest. Under these circumstances, outside directors (Article 2, paragraph 15) are expected to perform the duty to supervise more effectively than directors who were workers of the company. However, the Companies Act defines outside director broadly, and thus even directors of parent companies, affiliated companies or business partners can become outside directors. Currently, an average number of outside directors per company of the companies listed on the Tokyo Stock Exchange (2,323 companies as of June 2008) is only 0.86, and 55% of these listed companies do not have outside directors at all. Therefore, institutional investors and others are now strongly demanding that at least one-third of directors should be required to be outside directors and that independence of outside directors should be strengthened. “Study Group” established in the Financial Services Agency is now discussing about, among other issues, making it mandatory for listed companies to have outside directors, strengthening of their independency and requiring the chair of the Board of Directors to be an outside director. But Nippon Keidanren is opposed to requiring companies to have outside directors. Even if these discussions head towards mandatory installment of outside directors and strengthening of their independence, there is still a question of whether such requirements are imposed by a revision of the Companies Act or self-imposed regulation of a stock exchange. In consideration of frequent occurrence of corporate scandals, self-imposed regulation will not meet our expectations in terms of effectiveness.