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Corporate governance blossoms in Japan – Stewardship in the land of the rising sun

The introduction of the Stewardship and Corporate Governance Codes in Japan has added momentum to our engagement in Japan although challenges remain.

Setting the scene

Japan formally made huge strides in corporate governance and stewardship in recent years. In 2014, led by its government and driven by the regulator, the country published its stewardship code, the Principles for Responsible Institutional Investors, in an effort to foster sustainable, longer-term growth and attract foreign investors. The development of the principles-based code by Japan’s financial services industry represented a sea change for Japanese companies, which were used to hard laws and rules. In 2015, the country followed suit with the introduction of its first ever Corporate Governance Code in order to improve the governance structure of Japanese companies. Through our engagement with the relevant regulators and our response to the consultations, we were involved in the development of both codes and contributed towards their implementation.


One of the main issues we have come across in our engagement in Japan is the lack of accountability of company boards to shareholders. Although access is improving at some companies, it remains difficult for investors to engage directly at the board level. This is in part a cultural legacy, with the CEO and chair often assuming the role of sole decision-makers for a company.

We therefore continue to press for enhanced dialogue between companies and shareholders, including for direct contact with nonexecutive directors. This would enhance accountability and could change the mind-set of such directors. Moreover, it would allow shareholders to assess their effectiveness.

Independence of board directors

Another prominent corporate governance challenge Japan still battles with today is the limited level of independence on its company boards. The Corporate Governance Code requires Japanese companies to have two independent directors. From the moment it came into force in June 2015, companies have been obliged to comply with this requisite or explain why they do not have the required number in place. Research by the Tokyo Stock Exchange indicates a high compliance rate, with nearly 80% of listed companies stating that they comply with 90% of the principles. Many of them rushed to have the required two independent directors in place when the Corporate Governance Code took effect.

However, for us, engagement on the independence of board directors is not over yet. We still have doubts about their quality and genuine independence, as sometimes directors are declared independent when in reality they are affiliated with the company, which reduces their effectiveness. They can, for example, originate from a major shareholder or businesses the company has a relationship with. This has in part been due to the loose definition of independence by the Tokyo Stock Exchange published in December 2009. In its listing rules, the stock exchange initially required companies to appoint at least one independent director or one independent statutory auditor.

Unsurprisingly, most opted for the weaker statutory auditor. However, this has since been revised to one independent director. Still, there is no clear definition of independent directors in the Companies Act and the Japanese concept of a board is more akin to that of a senior management committee that meets regularly to make operational decisions than an entity with strategic oversight of the company.

We assess on a case-by-case basis whether we believe two independent directors are sufficient or whether we should encourage the company  to go beyond this minimum requirement set by the Corporate Governance Code and strive for best practice. In our view, a large company should aim for an independence level of one third. In addition, companies should ensure that the board comprises directors with the right mix of skills, backgrounds and experience, although this is not specifically mentioned in the Corporate Governance Code.

Board size

In our engagement with Japanese companies, we also often address the appropriate size of company boards. Until recently, Japanese companies typically had large boards because these were positioned as management committees, consisting of senior executives from various parts of the business. Being invited to serve on the board of a company has traditionally been viewed as the ultimate accolade in social status, which is why companies have struggled to reduce the size of their boards by limiting the scope for such promotion. This has resulted in the creation of executive officer roles at many companies in the past few years to limit the influx of board members. As they are supposedly of equal high status, these senior management roles help to decrease the size in the board while at the same time ensuring a pipeline of talent. Although we welcome the reduction in the board size, we continue to engage with companies to ensure that the creation of executive officer positions adds value and leads to the genuine separation of monitoring and executive functions and improved efficiency of the board.

Depending on the size of the company, we believe a company board should contain no more than 15 members. Anything above is likely to be too large to be effective.


Large listed Japanese companies traditionally own shares in each other, the practice of which is known as cross-shareholding. This is a result of the post-World War 2 break-up of the industrial and financial conglomerates whose influence and size allowed control over significant parts of the Japanese economy.

However, to us cross-shareholdings are not an efficient use of shareholding capital and potentially contribute to poor governance at investee companies. The main reason why companies have cross-shareholding in other companies is to maintain or strengthen relationships with their business partners and suppliers and ensure preferential treatment, for example in sourcing and distribution. This also means that companies with cross-shareholdings tend to support management of the investee companies instead of exercising their voting rights appropriately to hold management to account.

The Corporate Governance Code asks companies to disclose their policy on cross-shareholdings. In addition, it says the board should examine the mid- to long-term economic rationale and future outlook of major crossshareholdings on an annual basis, taking into consideration associated risks and returns. The annual review should result in the board’s detailed explanation of the objective and rationale behind cross-shareholdings.

However, while some companies try to justify their cross-shareholdings, they do not understand that fundamentally investors are not supportive of this practice and ultimately would like to see it disappear.

At Hermes EOS, we believe that business partners should be elected on the quality of services rather than shareholder relationships, which is a questionable use of capital. While the trend to cross-shareholdings is indeed declining and major Japanese banks have announced plans to sell many of these, questions remain about the extent of this, as well as about such holdings by other financial institutions and companies.


Part of our engagement agenda is to improve the diversity of company boards. An increasing body of research1 shows that greater diversity leads to better performance of companies and different forms of diversity bring values, change corporate risk-taking behaviour and may even have an impact on the likelihood of fraud. In our engagement with companies, we have called for greater diversity on boards in order for their members to provide a different perspective necessary to challenge senior executives and non-executives, as well as to counter groupthink and unconscious biases that might dominate decision-making.

This is particularly crucial in Japan which has one of the poorest track records in terms of gender equality of the developed countries. It does not fare much better in terms of nationality, background and expertise and to date, the majority of company boards are still made up of predominantly Japanese men.

The Corporate Governance Code calls for the promotion of diversity of personnel, including the active participation of women. However, for Japanese companies a lack of talent pool can be a genuine problem. Traditionally, graduates would enter employment at one company and remain at the same organisation until retirement. People moving across companies is still not common practice in Japan, resulting in a less liquid talent pool, in particular for women in senior positions. The number of companies looking to appoint outside directors in 2015 added to the pressure on the already limited candidate pool.

Case study

At the start of our engagement with telecommunications company KDDI in 2012, its board consisted of 12 directors, made up of 10 executive and two non-executive directors. While presented as outsiders by the company, in reality the two non-executive directors represented the two major shareholders of KDDI. We believed that the interest of minority shareholders would therefore not be adequately addressed. The board also lacked diversity, which added to our concerns.

In a number of meetings and calls with the company, we argued persistently that the interests of the affiliated directors could differ from that of minority shareholders and that the board needed genuinely independent elements to protect the latter. At KDDI’s AGMs, we thus continued to withhold support for the affiliated directors.

In a meeting in 2013, KDDI for the first time told us that its board was considering appointing independent directors. This was a reflection on the result of the previous AGM where the two affiliated directors received a significantly lower level of support than the rest of the board members. As the company said it struggled to find suitable candidates from the telecoms industry, we shared our views that non-executive  directors do not necessarily all need to have industry experience.

We explained that individuals with backgrounds in different business sectors could also add significant value. In 2014, we welcomed the appointment of KDDI’s first truly independent director. Pleased to learn that messages from investors and other stakeholders, including ourselves, had influenced the decision, we encouraged the company to consider enhancing the level of the board’s independence further. We applauded the subsequent appointment of a new female independent director to the board in 2015, which was in line with our request to increase board independence and diversity.


While we do not have much concern about the quantity of remuneration of executives in Japanese companies, the link between pay and performance is often unclear. In our engagement, we have therefore pressed companies to improve the disclosure on their remuneration policy and metrics.


As a result of the introduction of the Stewardship and Corporate Governance Codes, asset owners and fund managers have become more active in their engagement with Japanese companies. We understand from our discussions that local private pension funds and insurance companies would like to engage for change and are looking for ways to achieve this.

We have contacted the council of the Financial Services Agency in Japan in charge of following up on Japan’s Stewardship and Corporate Governance Codes to deliver our messages regarding the effective implementation of the codes. Welcoming the comply-or-explain approach employed by the codes, we shared our views on effective interpretation of the requirements and the meaningful explanation companies are expected to provide in case of non-compliance.

Positively, the influential Government Pension Investment Fund signed up to the UN-backed Principles for Responsible Investment in 2015 and has hired staff with particular responsibility for stewardship. This has set a good precedent to others.

The launch of the Stewardship and Corporate Governance Codes has helped to pave the way for better corporate governance at Japanese companies. Together with increasing pressure from shareholders, the outlook for more impactful engagement and better corporate governance is positive. We continue to call on companies in Japan to provide shareholders with better access to senior management and members of the board whom they elect, including independent directors, to enable them to discuss strategy, capital policy and corporate governance.

  1. 1Diversity Matters, McKinsey 2015.The Business Case for Equality and Diversity, UK Government 2015. Is Board Diversity Important for Firm Performance and Board Independence, Monetary Authority of Singapore 2012. Gender Diversity and Fraud, Cumming, Leung and Rui 2015. Diversity of Corporate Board Committees and Financial Performance, Carter et al 2004. The Difference: How the Power of Diversity Creates Better Groups, Firms, Schools and Societies, Scott E Paige 2007. Women as Drivers of Japanese Firm Success, Nakagawa and Schreiber 2014. Corporate Governance, Board Diversity and Firm Value, Carter, Simkins and Simpson 2003.

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