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Prof. Ruth Taplin
November 2008

Thinking of investing in Japan? As the tendency of Western companies for mergers and acquisitions accelerates, and some Japanese companies adopt poison pill takeover defense strategies, tensions are being created that challenge Japanese corporate governance and company law, with intellectual property investments possibly facing a similar impact.

Japanese companies are traditionally interconnected through family-run Zaibatsu’s, not shareholders: one example is the Mitsui group which began in the 16th century. After the Second World War, following the American-led dissolution of the family-operated monopolies that broke anti-trust law, a new type of large conglomerate—the sogo shosha/keiretsu—emerged in Japan. These complex institutions are not family-owned and have their own banks and internal financial systems.

A system of cross shareholdings has long been central to traditional corporate governance in Japan. This defense mechanism kept foreigners out, except at the extreme margins of the business world. Commercial law in Japan, which had governed corporations since the Meiji Era, remained unchanged until the Koizumi government initiated widespread reforms from 2001 to 2006, aiming to make Japan more globally competitive. New laws have been introduced to promote transparency and accountability in the Japanese corporate sector, and these have brought about a decline in cross shareholding.

New measures, including the poison pill, have been introduced to defend Japanese companies from hostile takeovers by other Japanese or foreign companies, or from the recent triangular mergers. There is also a potential for such protectionism to be extended against foreign filings for patents.¹

Horizontal and Vertical Groupings
Japanese corporate groups can be divided into two different forms: horizontal and vertical. The former is based on the old zaibatsu family-owned grouping, with cross shareholding central to its makeup. Crossholding of shares has developed to prevent member companies being subject to a hostile takeover. Main members of the company groups gather at monthly meetings of the groups’ Presidents called shachokai. Such meetings enable important information concerning the entire group to be shared, and decisions to be discussed informally. This is quite a feat of organization when considering these corporate groups can have more than 30 main companies and 200 subsidiary companies!

Cross shareholding is diminishing in the horizontal company groups, largely because recent banking regulation does not allow latent gain from shares to raise the equity ratio. Cross shareholding has been the main reason why a cap, usually amounting to less than 5 per cent, was put on the amount of foreign share ownership. With the decline of crossholdings the poison pill strategy (see below) has emerged as a protection against hostile takeovers in mergers and acquisitions (M&A)²

Current value accounting is another pressure on traditional crossholding arrangements. This is being encouraged increasingly by the International Accounting Standards Board (IASB), and may be causing a fall in profit when the re-evaluation of the cross-ownership shares occurs.

The Japanese Generally Accepted Accounting Principle (GAAP) enables Japanese companies to operate within the IASB’s requirements, for example in regards to transparency, but also to work within their own culture of accounting. Pressure from the IASB, and from Japan’s own need to become a full-fledged member of the global economy, is making both the corporate governance system and the banking system more transparent and open to foreign investment.

Japan was initially reluctant to commit to the IASB through convergence, but this changed with the signing in 2007 of the Tokyo Agreement to accelerate convergence between Japanese GAAP and International Financial Reporting Standards. A project plan based on this was published on 6 December 2007, outlining the steps made by the Japanese accounting organization towards achieving convergence with the IASB. The Keidanren, the Japanese employers’ organization and the top representatives of the four major auditing firms in Japan have been all positive towards the Tokyo Agreement.

Sir David Tweedie, Chairman of the IASB, pointed out on 25 December 2007 that Japanese accounting standards are moving towards the same direction as global standards and, importantly, that there is now an expectation that Japan will participate fully in the development of global standards. He noted further that Japan’s participation has encouraged the US to set a date to switch to IFRS International Financial Reporting Standards (IFRS). With Japan now supporting the IASB and China, India and Korea moving in the direction of meeting international standards, Japan is keen to be involved in setting the standards. This was confirmed in the most recent joint ASBJ and IASB meeting held in Tokyo on 8 and 9 April 2008, and progress towards convergence according to the project plan is on schedule for 2011.³

Essential changes to the Commercial and Company Codes
Company law in Japan has been a target of great reform under the Koizumi government stewardship. Since 2002, the Working Group on Company Law of the Legislative Council (which is the consultative body of the Ministry of Justice) has led a drastic reform of company law which also includes Part 2 of the Commercial Code, the Limited Liability Company Law and the Law of Exceptional Provisions to the Commercial Code Concerning the Audit of Stock Companies. The Working Group published the results of their deliberations in February 2005 and it was submitted to the Diet for approval. With a few amendments it was approved by the Diet on 29 June 2005.

The basic reforms that have taken place under the Koizumi government include;

• securing the realization of corporate governance
• bringing the law into line with the internationalization of corporate activity
• modernizing terms and consolidating the company law
• bringing the law into line with the highly developed information society
• improving fundraising measures

One of the most fundamental tasks of the 2005 reform was similar to what occurred in the intellectual property field: modernization of the old language to remove an impediment to doing business. Much of Japan’s company, IP, economic and trade laws have been archaic, and foreign potential investors were frustrated not simply due to cultural and language differences, but also by the use of unintelligible old language that prevented foreigners in particular from understanding their essence. For example the Commercial Code was written in the original language of the Meiji Era until the 2005 reforms!

In accordance with the current social and economic situation, the reformed company law requires all companies to have at least a shareholders’ meeting and a board of directors. Apart from this requirement, the structure of corporate governance differs between a Company with Committees and a Company with a Corporate Auditor. The Exceptional Provisions provide different auditing system rules depending on the size of the company:

• larger companies were not seen as a concern in relation to how close the shareholders are to the management —although see below how defence mechanisms are used and needed, especially when protecting inefficient management.
• smaller closely held companies were a source of concern as the relationship between the management and shareholders is very close, which can bias decisions and may even open it to criminal elements. Therefore, the main focus of the corporate governance reforms were concerned with the role of shareholders and directors.⁴

The poison pill
One of the main defense strategies developed to support Japanese companies through the power of shareholders, and to limit the influence or activities of foreign shareholders from M&A to IPR, is the poison pill. This strategy in essence gives Japanese companies the option to issue stock warrants to dilute the stake of a fund or company pursuing a hostile takeover, enabling Japanese management to be supported by Japanese shareholders when voting against foreign influence. Shareholder support may take the form of putting forward arguments that the foreign investor’s ideas or merger/acquisition bid will be at the detriment of the Japanese company—stopping the foreign company from instituting any plans independently or gaining more controlling shares.

Summary
Japan’s current reforms, which are still evolving, have drawn together changes affecting IP, corporate governance and company law. The main change has been to archaic language which has enables both company law and intellectual property to become more transparent and readily accessible to potential foreign investors. The development of the poison pill strategy to diminish the influence of foreign investors among shareholders and in relation to M&A, could spread to the IP sector to ward off unwanted domination of foreign filings in particular fields. However, at this point it seems to be an unlikely outcome.

Notes
Much of the material in this article may be found in Ruth Taplin’s forthcoming book: Intellectual Property and the New Japanese Global Economy, Routledge. N.B. See this new book for detailed explanations of poison pill defenses and triangular mergers.

1. See Ruth Taplin, Decision–Making and Japan—A Study of Corporate Japanese Decision-Making and Its Relevance to Western Companies, Japan Library 1995. Re-issued 2005 by Routledge.
2. Eiji Takahashi,“Japanese Corporate Groups under the new Legislation”, in European Company and Financial Law Review pp 287-310, Berlin.
3. From ASBJ newsletter 25 December 2007 (Inaugural Preparatory Issue).pp 1-12 and ASBJ Newsletter 7 July 2008. pp. 1-13
4. Eiji Takahashi and Madoka Shimizu “Does the 2005 Reform Improve the Japanese Economy? The Current of Japanese Corporate Governance Reform”, in Ruth Taplin (ed) The Journal of Interdisciplinary Economics Vol. 17 NO. 1&2 (2006) pp 25-57. (A special issue concerning international corporate governance, guest editor, Eiji Takahashi).

About the author
The Centre for Japanese and East Asian Studies, of which Prof. Taplin is Director, won Exporter of the Year in Partnership in Trading/Pathfinder for the UK in the year 2000. She received her doctorate from the London School of Economics and is the author/editor of 14 books and over 200 articles. Prof. Taplin's next book, due to be published by Routledge in April 2009, is "Intellectual Property and the New Global Japanese Economy". She can be reached at Ruth.Taplin@btinternet.com

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