Japanese Corporate Governance: Time for the Third Arrow to Fly?
- Neville White
- Feb 17
- 4 min read
Since its United States drafted constitution came into force in 1952, Japan has had over 35 governing administrations, some lasting barely a year. This historically turbulent churn is strange given Japan’s widely viewed ‘de facto one-party state’; with only two exceptions, the Liberal Democratic Party (LDP) has governed Japan since its formation in 19551. Moreover, just two Japanese administrations in over 70 years have achieved a working ‘supermajority’ in the House of Representatives with over 300 seats – the first in 1986 under Prime Minister Yasuhiro Nakasone, lasting a little over four years, and the current administration under Mrs Sanae Takaichi following her February landslide2. Takaichi’s extraordinary achievement of re-energising her stolid party and leading it in a snap election to a landslide super-majority is of global significance. In a traditional ritual-led society, her achievement in delivering this result as a woman, the first ever to hold administrative power as Prime Minister in Japan, warrants reflection given her now unprecedented ability to legislate with power and conviction. Takaichi is a scion of the highly regarded late Prime Minister Shinzo Abe, whose longest period in office (2012-20) saw the development of his ‘three arrows’ philosophy designed to revitalise Japan’s sluggish economy.
The third of these arrows ‘structural reform’ focused on deregulation, corporate governance reform, increasing the number of women in the workforce and increasing foreign labour and private investment. Economists generally agree that whilst there was some success in meeting the aims of the first two arrows (aggressive monetary policy and flexible fiscal policy), the third arrow landed far short of Abe’s expectations, and has been the most resistant to reform.
To foreign investors, Japan may appear inscrutable, isolated and ‘distant’; distant in governance as well as geography. Language is of course an issue; few Japanese companies, notably mid-cap and smaller firms, troubled to translate key investor documents or make their business open to foreign enquiry. UK investors are more likely to gain exposure to Japan from specialist Funds or Investment Trusts than via active stock picking*. Traditional Japanese governance saw all-male, internally facing Boards with little skills-led, gender-based diversity or international experience, operating under a tight-knit system known as keiretsu. These networks were characterized by cross-shareholdings between firms, with close ties to the banking system that provided working capital. These structures typically emphasized employment, consensus based decision-making, and long-term stakeholder interests over short-term shareholder interests. It most obviously excluded female empowerment at Board level. A 2023 survey carried out by the Tokyo Stock Exchange (TSE) found just 13.4% of Japanese executives were female – well below developed market levels3.
Change began slowly in 2005, with a key milestone being revision of the Companies Act of Japan, which modernized corporate law and expanded disclosure requirements. However, it wasn’t until a decade later in 2015, that the first Japanese Corporate Governance Code was introduced by the TSE, operating on a “comply or explain” basis, and requiring listed companies to appoint independent outside directors, enhance board diversity and strengthen shareholder relations.
An emphasis on ‘independent’ directors marked a significant cultural shift; outside directors were almost unheard of in Japan. It has taken time, but most modern Japanese Boards today appoint at least two independent directors. Moves to improve diversity have been far slower, and international expertise remains a scarce exception rather than the rule4.
Another significant development that proved attractive to foreign investment was the unwinding of cross-shareholding arrangements. In a strongly ritualised culture, these cemented relationships and served to deter takeovers, thereby protecting management from activist pressure to deliver superior returns.
Complementing Japan’s Corporate Governance Code is the Stewardship Code, which actively encouraged institutional investors to monitor and engage portfolio companies. Asset managers have exercised the traditional levers of Stewardship to uphold and expand governance standards, voting policies, and environmental, social, and governance (ESG) issues. One effect this has had is to slowly break down the practice of Japanese companies all holding their AGMs on the same day. In the 1990s over 90% of companies with a March year end held their AGMs on a single day in June; this has now reduced to around a third5.
Despite advances, challenges remain. Documents and websites continue to exclude foreign investors with language a natural barrier. Boards, whilst having an element of independence, have often not moved to appoint executives with global perspectives. Critics argue compliance is often ‘formal’ rather than real. Independent directors can often lack authority to challenge entrenched and inward facing management. The Japanese way observes harmony and consensus rather than a focus on maximising performance and shareholder returns.
Since Abe left office, Japanese corporate governance has settled on a hybrid model that values long-term stakeholder relationships, consensus and stability, whilst incorporating a degree of transparency, accountability, and shareholder engagement. With Mrs Takaichi’s whirlwind ascendency, it is now reasonable to ask whether she will pick up her mentor’s ‘third arrow’ and promote deeper market reforms that open Japan genuinely to foreign investment, thereby making the third arrow truly fly.
*WHITEFRIARS owns specialist funds that are invested in Japan and developed Asia
Notes
1 The Liberal Democrats have ruled 1955-1993; 1996-2009 and from 2012 to the present.
2 LDP leader Yasuhiro Nakasone won the 1986 election with 300 of the 512 seats in the House of Representatives; Mrs Takaichi won 316
4 Sony is a compelling exception, which has been led by a European, and currently has several non-Japanese directors on the Board
