Director Elections (Japan)

Background and Overview

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Japanese companies can choose either a traditional statutory auditor board system, or a U.S.-style board with a three-committee structure. Companies with a statutory auditor board system, accounting for 98 percent of listed companies, have no legal obligation to appoint outside directors, while companies with three committees are required by Japan's Corporate Law to appoint at least two outside directors.

For companies with a statutory auditor board system, ISS does not believe recommending a vote against an outside director nominee for the mere lack of independence is in the interests of shareholders, because if the nominee is voted down, he or she may not be replaced, and the board may end up losing one outsider. On the other hand, at companies with a three-committee board structure, we recommend voting against outside director nominees if their independence is questionable, because the company will be required in any event to appoint at least two outside directors.

Regardless of the governance structure, we oppose the reelection of the top executive* at any listed subsidiary company that has a publicly-traded parent company, if the board after the shareholder meeting would not include at least two independent directors based on ISS independence criteria for Japan. (However, as an interim measure for 2010, ISS does recommend votes against the reelection of executive as long as the board includes at least one independent director. Starting in 2011, we will recommend against the top executive if the company does not have at least two independent outsiders on the board.)

*In most cases, the top executive will be the “shacho” (president). However, there are companies where the ultimate decision-making authority rests with the “kaicho” (executive chairman) or “daihyo torishimariyaku” (representative director) as well.

Independent outsider requirement

Starting in June 2010, the Tokyo Stock Exchange introduced a new rule that all companies must appoint at least one "independent outside" director or statutory auditor who is "independent" based on the listing rules. Currently, ISS does not have a specific policy for director nominees appointed as "independent outsiders" because of problems associated with obtaining information on which individuals are designated as "independent".

As to the treatment of independent outsider designations, we will continue to take the current approach, where we will not use the company’s independence designation information in our vote recommendation. Information on a company's appointment of "independent outsiders" is usually not disclosed in its proxy materials, and is instead disclosed on stock exchange websites only a few days before the shareholder meeting, making it practically impossible to use the independence designation information for proxy voting.

Furthermore, as the rules require companies to designate at least one independent outsider, some companies take the rules at face value and report only one independent outsider even when they have other outsiders who can in fact meet the rules' independence criteria. On the other hand, some companies choose to report all outsiders they believe can be regarded as independent. Therefore, at this moment, using companies’ independence designations in vote decisions can send a misleading and confusing message to issuers.

Key Changes Under Consideration

1.  Apply a majority independent board standard at companies with a three-committee structure when determining whether or not to recommend against affiliated directors. ISS currently recommends against all outside director nominees at these companies who do not meet our criteria for independence. However, with the proposed change, if a majority of the directors on the board after the shareholder meeting are independent outsiders, ISS will not recommend votes against the appointment of affiliated outsiders.
    
2. Modify the definition of listed subsidiaries by replacing "publicly-traded companies" with "controlling shareholders" when determining whether or not to recommend against top executive. ISS currently recommends against the top executive at listed subsidiary companies that have publicly-traded parent companies, where the board after the shareholder meeting does not include at least two independent directors based on ISS independence criteria for Japan. However, with the proposed change, ISS will recommend against the top executive at listed companies that have controlling shareholders, where the board after the shareholder meeting does not include at least two independent directors based on ISS independence criteria for Japan.

Intent and Impact

The intent of the first change, to apply a majority independent board standard at companies with a three-committee structure, is to take into account overall board composition in determining votes on individual non-independent directors. As long as a board has sufficient independence, it can be argued that affiliated outsiders can contribute to board deliberations by drawing on their knowledge of the company. By taking a holistic approach, the proposal is expected to encourage companies to build a better board with participation from outsiders who have knowledge of the company through business relationships, while the policy requires a certain overall board independence level to ensure the interests of independent shareholders are protected. With the proposed change, we expect less than a dozen companies will be affected.

With respect to the change on the definition of listed subsidiaries, the current policy is only applicable to listed subsidiaries which have publicly traded parents. However, regardless of whether or not controlling shareholders are publicly traded companies, the protection of minority shareholders of controlled companies is critically important. The proposed change is intended to better reflect this concept. With the modified definition, we expect the number of companies to which we apply the policy to increase from the current 331 to about 500 (representing 17 percent of ISS’s Japanese research universe).

Request for Comment

Please feel free to add any additional information or comments on the proposed policy change.  In addition, ISS is specifically seeking feedback on the following:

• For companies with a three-committee structure, would you support the appointment of affiliated outside directors if a majority of the directors on the board after the shareholder meeting are independent outsiders? Or, in light of the fact that so few Japanese companies have majority-independent boards, would you be willing to support the appointment of affiliated outside directors as long as, for example, at least one third of the board is independent; or as long as at least one-half of the board is independent?
   
• Do you believe that companies with poison pills should be treated under the same proposed policy framework as companies with controlling shareholders, such that IS recommends against the reelection of top executives at companies with poison pills if the board does not meet a specified independence level?

To submit a comment, please send via e-mail to policy@issgovernance.com. Please indicate your name and organization for attribution. While ISS will consider all feedback that it receives, comments will not be published without attribution.

All comments received will be published as received, unless otherwise requested in the body of the e-mail submission.