New Corporate Governance Principles
Japan Corporate Governance Forum
Published at Dec. 15th, 2006

Contents
ForeWord

21

1

General Rules

25

Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

25

1.1.1 Corporate Governance and CSR . . . . . . . . . . . . . . . . . . . . . . . . .

26

1.1.2 CSR and Stakeholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

26

1.1

1.2

Purpose of the Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

26

1.3

Position of the Principles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

27

Detailed Rules

28

Shareholders and the General Shareholders’ Meeting . . . . . . . . . . . . . . .

28

2
2.1

2.1.1 Operation of the General Shareholders’ Meeting. . . . . . . . . . . . . . . .

28

2.1.2 Voting by Major Shareholders and Institutional Shareholders . . . . . . . . .

29

2.2

Board of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

30

2.3

Outside Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

32

2.4

Statutory Auditors, Board of Auditors and Audit Committee . . . . . . . . . .

33

2.5

Compensation for Company Oﬃcers . . . . . . . . . . . . . . . . . . . . . . . .

34

2.6

Corporate Governance and the Role of Employees . . . . . . . . . . . . . . . . .

35

2.7

Internal Control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

36

2.7.1 Establishment of a System of Internal Control and Ensuring its Eﬀectiveness36

2.7.2 Operation of the Internal Control System . . . . . . . . . . . . . . . . . . . .

37

2.8

Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

37

2.9

Audits of Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

39

2.9.1 Ensuring the Independence of Accounting Auditors . . . . . . . . . . . . . . .

39

2.9.2 Compensation for Accounting Auditors. . . . . . . . . . . . . . . . . . . . .

40

Handling of “Abnormal Situations (When a Conﬂict of Interest has Materialized)”

42

3.1

Response to Deterioration of Performance . . . . . . . . . . . . . . . . . . . . .

42

3.2

Response to Hostile Takeover Bids . . . . . . . . . . . . . . . . . . . . . . . . .

42

3

i

ForeWord

New Corporate Governance Principles
Foreword
A joint stock corporation is an organization established using investment from shareholders, which creates new value by organically combining labor and equipment, together withaccumulated technology, capital and credit. The shares issued by a company circulate in themarket and the shareholders that own these shares are granted a variety of rights to secure
their own economic interests such as claiming distribution of proﬁts and claiming the divisionof residual assets from the company, while also engaging in management by voting in generalshareholders’ meetings for the company’s interests and achievement of its goals. Directors andexecutive oﬃcers are people who shareholders have entrusted with the duties of maximizing
the company’s proﬁts, and have not been given control of the company.
However, the current state of aﬀairs in Japan is far from this ideal. Hampered by factors
such as cross-holding of shares between companies and insuﬃcient disclosure of information,
general shareholders have few opportunities to be involved in management, and it was noteven desirable for shareholders to directly hold accountable the directors and executive oﬃcers
entrusted with management.
This state of aﬀairs in Japan was torn apart by the collapse of the bubble economy, an
economic downturn lasting over ten years, the growth of institutional investors such as pension
funds and the internationalization of the securities market. The distortions of managementthat had previously been painted over with high share prices were exposed and numerous
companies collapsed or were faced with scandals. Calls from shareholders inside and outside
Japan to redeﬁne the shape of management overturned the traditional practice of accepting
checks by boards of directors, statutory auditors and accounting auditors to be nothing morethan formalities, resulting in frequent occurrences of shareholder derivative litigation, which
in turn led to revisions to the Commercial Code being made almost every year. This trend
picked up momentum in the 21st century, and hostile takeovers taking control through stockacquisitions and proxy battles ﬁghting for majorities in general shareholders’ meetings havebecome reality.
As a nonproﬁt academic research group in which businesspeople and academics work handin hand to conduct the organization’s activities, in May 1998, the Japan Corporate Governance Forum previously released the Corporate Governance Principles presenting a model for
Japanese companies faced with increasing internationalization. In October 2001, the organiza-

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ForeWordtion drew up the Revised Corporate Governance Principles*1 based on factors such as a greater
understanding of corporate governance, the widespread use of executive oﬃcer systems, theestablishment of consolidated accounting, and new trends in the revision of the Commercial
Code. In order to make the regulation of operating oﬃcers eﬀective, emphasis was placedon ensuring the functions of supervisory organizations, and the separation of supervision andexecution of operations. This led to the introduction of companies with committees in the2002 amendment to the Commercial Code, but this philosophy put forward in the 2001 revised principles should continue to be upheld as the premise of corporate governance theory
in Japan in the future.
Changes in the ﬁve years since the drafting of the revised principles have been far greaterthan the Forum had expected. In addition to the increase in hostile takeovers mentioned above,quarterly disclosure has been introduced, accountability of audit ﬁrms has been clariﬁed, andcompanies with committees made up principally of outside directors have been recognized dueto the revision of the Commercial Code. Furthermore, the Company Law was established
to combine relevant legal ordinances such as the Commercial Code, the Limited Liability
Company Law and the Law for Special Exceptions to Commercial Code Concerning Audit. In
the United States where systems for supervising management have become well-established,irregular accounting was revealed in companies such as Enron and WorldCom, resulting in theenactment of the Sarbanes-Oxley Act incorporating strict regulations on directors and audit
ﬁrms. Similar movements are also gaining momentum in Europe, with one such example being
the revision of the Combined Code in the United Kingdom.
Meanwhile, CSR (corporate social responsibility) that looks out for not only shareholders
but also relationships with many stakeholders has been gaining much attention and there isstrong demand to arrange this in relation to conventional corporate governance. To begin with,adjustments of interests between various stakeholders is basically left to the market mechanism,
but steps from a CSR perspective are essential for problems such as environmental issues inwhich the market mechanism is not applicable. Furthermore, defense measures (poison pills,etc.) used by boards of directors against hostile takeovers have become widely known. It has
become less common to view joint stock corporations as single entities, and viewing companies
in group units has become established not only with regard to accounting but managementin general. It can also be said that there is a deeper awareness of the importance of internal
control.
One point that should be noted here is that the Company Law enacted in May 2006 stipulates*1 http://www.jcgf.org/en/revised-principle.html

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ForeWord
employees’ compliance to the law and the articles of incorporation as one of the components
of a basic framework for internal control that should be implemented by large companies.
One argument in debate on corporate governance places employees outside the true scope ofcorporate governance, but based when assuming the provisions in the Company Law, the roleof employees cannot be overlooked for realizing fair and eﬃcient management.
With deregulation and downsizing of public institutions going forward, private enterprises
and especially publicly-held joint stock corporations are growing in importance in the Japanese
economy. Moreover, as international investment spreads, there have been strong demands
to establish highly transparent rules of conduct for company management in Japan. The
Organization for Economic Co-operation and Development (OECD) made up of 30 developed
countries also revised its own corporate governance principles in 2004, showing that thesechanges are occurring worldwide.
Based on these changes, the Forum has decided to revise the Corporate Governance Principles that have been drawn up twice in the past, and it is needless to say that the above idealsof the 2001 revised guidelines will also be carried over to the greatest extent possible. These
Corporate Governance Principles maintain the foundations incorporated in the principles revised in 2001 such as the “Mission and Role of the Board of Directors’ and “Reporting to
the Shareholders and Communicating with Investors”, while also incorporating new aspects
such as CSR, internal control, auditing of accounts and the role of employees in establishingcorporate governance to contribute to the future advancement of the joint stock corporation
system. However, it must be noted that these principles do not take the stance that the measures shown below for improving corporate governance are absolutes. This is because methods
for improving corporate governance and increasing its eﬀectiveness can never be considered tobe complete. Therefore, the speciﬁc measures shown in these principles are those considered
to be best at the present time and it will be necessary to make the appropriate revisions asnecessary based on theoretical and practical developments.
These principles have been prepared using the following terminology.
•Company oﬃcer This refers to directors, statutory auditors and executive oﬃcers.
•Operating oﬃcer The term “executive manager” was used in the 2001 revised principles,but here this refers to representative directors, executive directors, executive oﬃcers
and CEOs (i.e. chief executive oﬃcers and presidents).
•Large companies This basically refers to large publicly-held companies, but may also include
companies with a small number of shareholders if they have many stakeholders.
•Independence As stated in Principle 4-2 of the previously revised version, this refers to aperson who “does not hold any interest with respect to the company.” See Principle

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ForeWord
4-2 of the 2001 revised principles for details.

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1

GENERAL RULES

1 General Rules
1.1 Corporate Governance• Corporate governance is a mechanism to ensure company oﬃcers entrusted with responsibilities by shareholders fulﬁll the entrusted responsibilities.
The companies envisaged in these principles are large companies, in which it is assumed
that shareholders do not handle management themselves, but instead much of management
is entrusted to operating oﬃcers and carried out by operating oﬃcers in accordance with theduty of care of a good manager, the duty of loyalty and the “principle of executive decisionmaking.” Here, entrusted responsibilities mean a company oﬃcer carrying out duties for the
purpose of increasing long-term shareholder proﬁts.
If this is ampliﬁed, in companies with a board of auditors, a company oﬃcer that is a director
is required to contribute to long-term shareholder proﬁt by participating in decisions on theexecution of company operations as a member of the Board of Directors, while also performing
supervisory functions of the Board of Directors over other operating oﬃcers. Directors that arealso representative directors or other executive directors must make arbitrary decisions about
day-to-day business and carry out the decisions of the Board of Directors and the generalshareholders’ meeting with the aim of improving long-term shareholder proﬁts. Moreover,auditors perform their prescribed function as checks on management by auditing the executionof business by the Board of Directors as independent bodies or through the board of auditors.
In contrast, in companies with committees, directors appointed by the general shareholders’meeting are required to perform their duties of supervision as a member of the board of
directors, which supervises operating oﬃcers. In particular, outside directors are expected tosupervise the execution of operations by executive oﬃcers from the perspective of improving
long-term shareholder proﬁts through the exercising of voting rights in the board and throughthe nomination committee, the audit committee and the compensation committee. Executiveoﬃcers must execute operations of the company including the authority granted to them by
the Board of Directors with the aim of improving long-term shareholder proﬁts.
Corporate governance not only includes the aspect of ensuring company oﬃcers’ entrusted
responsibilities in normal situations, but also includes the aspect of preparing in advance forabnormal situations that are situations in which potential conﬂicts of interest for the company
materialize.

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1 GENERAL RULES

1.1.1 Corporate Governance and CSR• CSR refers to business activities being conducted in accordance withthe law and social norms with the awareness that the company is both a
trading entity in the market and a member of society at the same time.
A company is both a trading entity in the market and a member of society, and not only
has an economic impact on society, but is also subject to social norms and social restrictions.
Because of this, CSR is required of a company by society when conducting business. However
this does not mean recognizing the use of CSR as a substitute for corporate governance.
Here, CSR not only refers to contributing part of the proﬁts obtained as a result of businessactivities, but also to observing laws and social norms in the process of conducting businessactivities.

1.1.2 CSR and Stakeholders• CSR means that a company should conduct sustained business activities
with the primary goal of increasing long-term shareholder proﬁts while
also building cooperative relationships by giving consideration to theinterests of other stakeholders.
A company has relationships with a diverse range of stakeholders. These include not only
shareholders and investors, but also creditors, employees, consumers, clients, governments andregional communities. Therefore, a company is required to conduct sustained business activities primarily aimed at increasing long-term shareholder proﬁts while also building cooperative
relationships by giving consideration to the interests of other stakeholders. In this respect,
CSR is an important issue in management. Needless to say, CSR means it is not acceptable
for an operating oﬃcer to utilize company resources for personal gain or interest or to behavewith disregard to shareholders under the pretense of this being “for society”.

1.2 Purpose of the Company• As the large companies covered by these principles are basically required
to be going concerns, the purpose of the company is to increase long-term
shareholder proﬁts.
Here, long-term shareholder proﬁts include ﬁnancial assets, intangible assets, prestige andrelationships with other stakeholders generated in business activities. Because of this, in-

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1

GENERAL RULES

creasing long-term shareholder proﬁts is not inconsistent with increasing stakeholders’ proﬁts,
and is actually achieved by giving consideration to all stakeholders. However, when conﬂicts
actually occur between long-term shareholder proﬁts and the interests of other stakeholders,the former is given preference.

1.3 Position of the Principles• These principles indicate what the Forum believes to be best practices
regarding corporate governance and call for their adoption by the companies covered.
The principles do not call for revisions to the current legal system, but are positioned as
showing a better direction and a universal framework required for companies to establish
corporate governance within the framework of the current legal system.
• If for some reason, a company that has adopted the principles deems that
adopting measures that diﬀer in part from the content of the principles
will bring about a desirable eﬀect in the realization of the company’s goalof increasing long-term shareholder proﬁts, the company may adopt thediﬀerent measures after showing the reasoning for the move through anopportunity to indicate its own approach to corporate governance.
Examples of “an opportunity to indicate its own approach to corporate governance” include materials for general shareholders’ meetings and business reports that are the disclosure
documents stipulated in the Company Law, documents such as securities reports, semiannual reports, and internal control reports stipulated in the Financial Products Exchange Law,
reports on corporate governance required by the Stock Exchanges and abbreviated ﬁnancial
statements announced following the end of the ﬁscal year.

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2 DETAILED RULES

2 Detailed Rules
2.1 Shareholders and the General Shareholders’ Meeting
2.1.1 Operation of the General Shareholders’ Meeting• In addition to its function as a decision-making organ for forming a
consensus among shareholders, the general shareholders’ meeting is also
eﬀectively utilized as a stage for dialogue between shareholders and management.
The general shareholders’ meeting is positioned as the highest decision-making organ of acompany in the Company Law, and is the cornerstone of corporate governance making decisions for the company regarding the appointment and dismissal of company oﬃcers, etc.
(except executive oﬃcers in companies with committees) and on fundamental matters regarding the company. There is no doubt that the ordinary general shareholders’ meeting isimportant not only as a place for reporting on the company’s accounts and reporting on its
businesses, but also as a place for dialogue between the directors and executive oﬃcers entrusted with the company’s management, statutory auditors that act as auditing organs, andshareholders. From this perspective, attention must be given to the following points regarding
the convocation and operation of general shareholders’ meetings.
First, the date and location of the general shareholders’ meeting must be set to ensure
attendance by the greatest number of shareholders possible. The purpose of the date is toensure shareholders have the opportunity to attend by avoiding concentrations of ordinary
general shareholders’ meetings of companies closing their books in March as was previously
seen in Japan. The Company Law does not include any provisions limiting the location to thelocation of the company headquarters or an adjacent region unless otherwise stipulated in thearticles of incorporation, enabling free choice, but arrangements must not make it diﬃcult forshareholders to attend the general shareholders’ meetings.
Second, considering the general shareholders’ meeting’s purpose as a place for forming shareholder consensus, convocation notices and related information must be sent to shareholders as
far in advance of the statutory deadline as possible. The qualiﬁcations for the proxy exerciseof the voting rights of shareholders are not restricted.
Third, under the Company Law, a company may set the deadline for voting in writing orelectronically to be a date before the general shareholders’ meeting on the condition that there
is an interval of 2 weeks from the time the convocation notice is sent, but the deadline must
be within 48 hours from the time the general shareholders’ meeting is held.

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2

DETAILED RULES

Fourth, the companies covered by these principles are basically envisaged to be companies
with accounting auditors, and as a special rule for such companies, the Company Law allows
approval of accounting documents at the ordinary general shareholders’ meeting to be replaced
by approval by the board of directors when certain conditions are met, in addition to recognizing the distribution of surplus funds only with a resolution by the board of directors whencertain conditions are met. As a result, the ordinary general shareholders’ meeting is mainly
a place for the appointment of directors and statutory auditors, meaning that the generalshareholders’ meeting mainly functions as a place for gauging the conﬁdence of shareholders
in company oﬃcers. Considering such functions of the general shareholders’ meeting, thescope of explanations given by directors, statutory auditors and executive oﬃcers in response
to questions from shareholders is not limited to agenda items and reported items shown inthe convocation notice, but extends to all matters related to the company that are deemed
to reasonably considered as being of general interest to shareholders including management
policy.

2.1.2 Voting by Major Shareholders and Institutional Shareholders• Major shareholders and institutional shareholders (institutional investors) should exercise their voting rights appropriately.
Major shareholders and institutional shareholders should exercise their voting rights appropriately by giving consideration to the matters put before the general shareholders’ meeting, inaddition to giving suﬃcient consideration to the company’s objective of increasing long-term
shareholder proﬁt. In particular, institutional investors have been entrusted with the dutyof achieving the best proﬁts for trust investors and beneﬁciaries、 pension beneﬁciaries andinsurance policyholders, and exercising voting rights for shares under management is part ofperforming entrusted duties. The state of shareholder rights and especially voting by institutional shareholders is extremely important as the interests of stakeholders in large companies
are reﬂected in the company’s management if institutional investors fulﬁll their entrusted duties by exercising voting rights. Meanwhile, as the voting rights held by major shareholders
and institutional shareholders often have an impact on company management due to theirsize, attention must be given to ensure that the exercise of shareholders’ rights typiﬁed byvoting rights do not cause conﬂicts of interest with other general shareholders, etc. consider
the objective of increasing long-term shareholder proﬁt of shareholders of the company as agoing concern.

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2 DETAILED RULES

2.2 Board of Directors• The board of directors should appropriately perform the desired functions as an organ for carrying out decision-making on company operations and overseeing the bodies conducting business. The steps required
to implement such functions should be carried out with regard to thecomposition and operation of the board of directors, together with thedivision of authority among the board of directors, the representative
director and other executive directors or executive oﬃcers.
For both a company with a board of directors and a company with a board of auditors,
the board of directors of a large company is an organ that makes certain decisions regarding
company operations while also overseeing the performance of duties by operating oﬃcers.
From this perspective, ﬁrst, the board of directors periodically evaluates the performance of
operating oﬃcers based on the basic management policy it has created, dismissing operatingoﬃcers and taking other prescribed steps as required. Therefore, the directors that are members of the board of directors must have an accurate awareness of their duties and take thegreatest care and do their best to appropriately fulﬁll their duties regardless of whether they
are executive directors, executive oﬃcers concurrently acting as directors or outside directors.
Second, as the board of directors must be able to eﬀectively execute their authority ofoverseeing operating oﬃcers, supervision and execution must be separated. Therefore, evendirectors other than outside directors are not permitted to concurrently serve as employees not
only in companies with committees for which the law does not permit directors also serving
as employees, but also in companies with a board of auditors, which are not subject to any
legal restrictions. The majority of the members of the board of directors in a company withcommittees is made up of independent outside directors. The board of directors in companies
with a board of auditors is not legally required to have outside directors, but it is preferable forat least two independent outside directors to be included to ensure the supervisory functions
over the board of directors.
Third, both companies with committees and companies with a board of auditors should
generally separate the functions of the chairman of the board of directors from those of thepresident and the CEO. One way of achieving this is for an independent outside director
to be appointed as the chairman of the board of directors, but a past president may act
as the chairman of the board of directors as an exception on the condition that there is aneﬀective division of duties such as the chairman of the board not being directly involved in
the execution of operations. At any rate, the president, other executive directors or executive

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2

DETAILED RULES

oﬃcers concurrently acting as directors should not concurrently hold the position of chairman.
As the chairman of the board of directors is in charge of the agenda of meetings of theboard of directors and has inﬂuence over the operation and state of the board of directors,
separating the representative director and president who is the operating oﬃcer subject tosupervision by the board of directors from the chairman of the board of directors should
contribute to the supervisory functions of the board of directors. In addition to companies
with committees, the appointment of outside directors is also conceivable in other companies,
but from the perspective of outside directors’ check and balance functions over operatingoﬃcers, the chairman in charge of the board of directors should be a person that can workwith outside directors to supervise operating oﬃcers instead of being a person subject tosupervision by outside directors.
Fourth, written resolutions in the board of directors and reporting may be omitted on thecondition that certain requirements in the Company Law are met, but this measure is only
treated as an exception and meetings of the board of directors are generally held periodically.
Fifth, even a company with a board of auditors should establish a compensation committee, a nomination committee and other committees that are arbitrary institutions, and themembers should generally be chosen from among directors by board resolution. However, external experts independent from operating oﬃcers may be appointed as committee members
if necessity dictates. The compensation committee should be made up of no less than threemembers and a majority should be outside directors. The compensation committee carries
out the distribution of director compensation as determined by the articles of incorporation
or resolution of the general shareholders’ meeting, also taking into account assessments ofthe performance of the board of directors. Incidentally, in actual practice, it is not rare that
executive oﬃcer systems are used in companies with a board of auditors and executive oﬃcers
are nominated. Compensation for executive oﬃcers is not subject to the oﬃcer compensation
system under the Company Law, but it is preferable that the compensation committee isinvolved in determining compensation for executive oﬃcers.
The nomination committee should be made up of no less than three members and a majority should be outside directors. A majority of the member of the nomination committee
should be directors other than executive directors, and is responsible for drafting motions forappointing directors and for the board of directors regarding the appointment and dismissalof operating oﬃcers. The board of directors makes decisions on proposals for the appointment
of directors on the appointment and dismissal of operating oﬃcers based on drafts preparedby the nomination committee.

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2 DETAILED RULES

2.3 Outside Directors• Outside directors should not be limited to meeting the requirements
stipulated in the Company Law for the people playing the principalrole in the function of the supervision of the board of directors, butalso be eﬀectively independent.

A company should appoint multiple

outside directors. Outside directors should periodically hold meetings
only made up of outside directors. On that basis, outside directors should
fulﬁll their supervisory responsibilities by voting in board meetings andproviding shrewd suggestions on not only legality, but also a wide varietyof perspectives including appropriateness and eﬀectiveness.
According to the Company Law, outside directors are expected to have supervisory functions
over the operating oﬃcers in the board of directors and play an important role in ensuring
fair decisions are made by the board of directors not only in companies with committees thatare required to appoint outside directors, but also in other companies that appoint outside
directors voluntarily. Because of this, ﬁrst, although the board of directors of a company witha board of auditors is not legally required to have outside directors, at least two independent
outside directors should be included to guarantee the supervisory functions of the board of
directors. The majority of the board of directors of a company with committees is made up
of independent outside directors.
Second, outside directors not only need to meet the requirements for outside directors stipulated by the Company Law, but also have eﬀective independence*2 suited to their roles.
Therefore, directors and employees of parent companies or major clients should not be outside
directors in subsidiaries and especially listed subsidiaries, the mutual dispatch of directors
should be avoided and the term of outside directors should not exceed 5 years.
Third, outside directors should hold discussions in periodic meetings only made up of outside directors (hereinafter referred to as the outside directors’ council) as a place for ensuring
cooperation and for sharing and updating understanding and awareness about company management. A head outside director is selected in the outside directors’ council, and that director
reports the details of discussions in the outside directors’ council to the board of directors as
required. The outside directors’ council may be attended by operating oﬃcers or other persons
deemed as necessary by the outside directors’ council.
*2 See the Principle 4 of Revised Corporate Governance Principles (October 26, 2001) and the Independent

Director Code (October 13, 2005) by the Outside Directors Committee of the Japan Association of
Corporate Directors regarding the criteria for determining independence. These principles require outside
directors to be eﬀectively independent.

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2

DETAILED RULES

Fourth, outside directors should fulﬁll their supervisory responsibilities by understanding
the operations and goals of the joint-stock corporation, together with the internal and external
circumstances surrounding the joint-stock corporation, voting in board meetings and providing
shrewd suggestions regarding the execution of operations from a broad range of perspectives
including not only their legality, but also their appropriateness and eﬀectiveness.
Fifth, outside directors are expected to fulﬁll their management supervisory function as
members of the board of directors. The reason for the Enforcement Regulations of the Company Law stating that publicly-held companies are an exception and requiring that business
reports on outside directors disclose whether an outside director also holds the position ofan operating oﬃcer in another company, the relationship between the joint-stock corporationand the other company in question and whether an outside director also serves as an outside
director in another company is to guarantee the eﬀective functions of the outside director bydisclosing to shareholders whether attempts are being made to create an environment suitable
for the performance of duties by the outside director in question. Therefore, outside directors
themselves are required to make an eﬀort to secure suﬃcient time for carrying out their duties,
and to refrain from taking positions that inhibit their eﬀectiveness.

2.4 Statutory Auditors, Board of Auditors and Audit Committee• Statutory auditors, the board of auditors and the audit committee should
prepare audit policies for appropriately carrying out their duties, conduct audits of the performance of the duties of directors and executiveoﬃcers based on these, and pay attention to preparing an environment
for carrying out duties as statutory auditors and audit committee members.
First, the operational audits conducted by statutory auditors, the board of auditors andthe audit committee are to be conducted by incorporating the perspective of whether theoperations of the company are consistent with the company’s goals and basic philosophy.
Second, as the independence of statutory auditors and audit committee members is a condition for ensuring the duties of statutory auditors, the board of auditors and the audit
committee are carried out appropriately, they play an active role in selecting candidates for
new statutory auditors and audit committee members, in addition to the determination ofcompensation for statutory auditors and audit committee members.
Third, at least one statutory auditor and audit committee member should have considerable
understanding and knowledge of accounting, or work to acquire this.
Fourth, in accordance with the law, employees are only engaged to assist the performance

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2 DETAILED RULES
of duties of statutory auditors if there has been a request from the statutory auditor, but theboard of directors should establish audit operations assistants such as a statutory auditor’soﬃce made up of staﬀ independent from operating oﬃcers unless there has been a separate
statement of intent from a statutory auditor. The statutory auditor’s operational assistants
should be employed full time in that position only whenever possible, and the appointment
shall be made by the board of directors after consulting with the statutory auditors.
Fifth, statutory auditors and the audit committee should work with statutory auditors andaudit committee members in group companies and take the steps such as introducing a groupaudit council required to ensure that the execution of operations of the group as a whole arein compliance with the law, the articles of incorporation and other related regulations.

2.5 Compensation for Company Oﬃcers• The details of compensation for company oﬃcers are determined by thecompany in accordance with the Company Law, and should correspondto the performance and duties of the company oﬃcers, and be reasonableconsideration of the execution of duties of company oﬃcers. Compensation in the form of stock options shall not be granted to statutory
auditors, audit committee members or outside directors. The company
should individually disclose and take other steps required to increase thetransparency of compensation for company oﬃcers.
As the Company Law provides the procedures and requirements for determining the compensation of company oﬃcers, these provisions must naturally be adhered. Necessary steps
must also be taken to ensure that this is reasonable consideration for performance and theduties carried out. From this perspective, even companies with a board of auditors, for which
there is no system for the establishment of compensation committees, should establish a compensation committee made up of at least three members, a majority of whom are outside
directors. This committee considers the performance and the duties carried out by directors
and distributes compensation for directors that is included in the compensation of company
oﬃcers stipulated by the articles of incorporation or resolution by the general shareholders’meeting. In contrast, for compensation for statutory auditors, if the total or maximum amountfor all statutory auditors is determined by the articles of incorporation or a resolution passedby the general shareholders’ meeting, the compensation of each statutory auditor is determined through consultations with statutory auditors in accordance with the Company Law inorder to maintain the independence of statutory auditors.
Second, the compensation policy should require that the compensation of company oﬃcers

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DETAILED RULES

is linked to the duties performed by the company oﬃcers who are the recipients of the compensation, and must not impede the independence of statutory auditors or the audit committee.
Therefore, the compensation of directors of companies with a board of auditors and of executive oﬃcers of companies with committees should not be limited to ﬁxed amounts and may
include compensation linked to company performance in the form of stock options, etc. The
company should design the details of this as reasonable incentive compensation taking into
consideration the performance and the duties performed by the director or executive oﬃcer
in question. In contrast, statutory auditors, audit committee members and outside directors
should not be granted performance-linked compensation such as stock options. Third, thepolicy for determining compensation and the speciﬁc details of compensation for company
oﬃcers should be disclosed in the business report by breaking down the details into categories
according to the type of compensation and providing an explanation on the duties performedby each person and performance during the period covered by the compensation.

2.6 Corporate Governance and the Role of Employees• Shareholders and company oﬃcers must be aware that management of a
joint-stock corporation is also collaboration with its employees. Employees should contribute to increasing the value of the company by having ashared awareness with shareholders and company oﬃcers about the company’s business goals, management policies, management philosophy andmanagement targets.
Although there are some exceptions, management of a large joint-stock corporation cannot
be conducted by company oﬃcers alone, and is carried out with the cooperation of employeesthat have the appropriate skills and experience. Therefore, the contributions of shareholders,company oﬃcers and employees who play a part in the company’s operations are required
for the improvement of corporate governance. First, company oﬃcers are required to takesteps to share awareness about business goals, management policies, management philosophy
and management targets through dialogue with employees and disclosure of information toemployees.
Second, based on the necessity and importance of the contribution and cooperation of employees for the improvement of corporate governance, it is necessary for employees themselves
to be clearly aware of the role they play, and they should present issues and provide suggestions aimed at actively improving company management. In order to achieve this, company
oﬃcers and particularly operating oﬃcers should take responsibility in the creation of an environment and framework enabling the facilitation of communication between company oﬃcers

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and employees within the company.
Third, as employees’ illegal behavior, irregular behavior and inappropriate responses in
the current phase of company management may endanger the continuation of the company’sbusiness, employees must be aware of the potential that their actions or inaction may determine
the fate of the company and necessity and importance of acting in accordance with the law
and articles of incorporation and of complying with the company’s management policy andmanagement philosophy in the performance of their duties. Furthermore, when an employee
discovers misconduct or matters in violation of the law or articles of incorporation within theirdepartment, the information should be conveyed to the person responsible without delay byusing a helpline or internal reporting system.
Fourth, company oﬃcers and especially operating oﬃcers should work toward encouraging
employees to have compliance awareness and understanding of the company’s management
policies and management philosophy through dialogue with employees, the disclosure of information and the establishment of a Code of Conduct, in addition to creating internal reporting
systems. Furthermore, evaluations of compliance and corporate ethics should be included inpersonnel evaluations as a means for making such moves more eﬀective.

2.7 Internal Control
2.7.1 Establishment of a System of Internal Control and Ensuring its Eﬀectiveness• A company’s board of directors should create systems for ensuring theperformance of duties by directors and executive oﬃcers is in compliancewith the law and the articles of incorporation and that other company
operations are appropriate, in addition to ensure ﬁnancial reporting is
conducted in an appropriate and timely fashion in accordance with theCompany Law directives from the Ministry of Justice, Financial Products Exchange Law and directives from the Cabinet Oﬃce, and is responsible for ensuring these systems function eﬀectively.
A company’s board of directors should appropriately create systems for ensuring the performance of duties by directors and executive oﬃcers including risk management of the company
and the group to which it belongs is in compliance with the law and the articles of incorporation and that other company operations are appropriate, in addition to ensure ﬁnancial
reporting is conducted in an appropriate and timely fashion in accordance with the Company
Law and other related laws and is responsible for ensuring these systems function eﬀectively.
In order to do this, ﬁrst, the board of directors should appoint one or more directors as
directors responsible for internal control, and periodically monitor the eﬀectiveness of internal
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control through these directors.
Second, the board of directors should create a system in which operating divisions provide
periodic and exhaustive reports in an attempt to secure and facilitate the conveyance of
information in the internal control system. The internal reporting system shall be incorporated
into the internal control system as part of its reporting system, and reports shall be made to
the bodies conducting business and must also be made to either the board of auditors or theaudit committee.
Third, auditors and the board of auditors or the audit committee should directly audit
the eﬀectiveness of the internal control system as part of their auditing duties, and include
this evaluation in their audit reports. The internal control system includes a mechanism fordirectly conveying all relevant information to the board of auditors or the audit committee.

2.7.2 Operation of the Internal Control System• Key operating oﬃcers such as the CEO should take a leading role in
the prevention of corporate scandals, and be held accountable for thehandling of such scandals.
The companies covered by these principles are generally required to create an internal control
system (Company Law Article 348-3(4) and -4, Article 362-4(6) and -5, Article 416-1(1)b ande). Key operating oﬃcers such as the CEO should implement the framework for the internal
control system stipulated by a resolution of the board of directors, and be responsible formaking it function. As part of this, keeping employees, etc. informed about complianceapproaches is included in taking a leading role in the prevention of scandals.

2.8 Disclosure• A company is required to disclose accurate information on its ﬁnancial
situation, management performance, shareholder composition, systems
for eﬀecting corporate governance, risk factors and negative informationsuch as scandals using an appropriate method at the appropriate time.
Shareholders entrust the management of the company to operating oﬃcers. Company ofﬁcers entrusted with responsibility have the obligation to prove they are fulﬁlling their responsibilities. This is accountability, and disclosure is an important means for carrying itout.
The disclosure of company information is essential for ensuring fair price formation of marketable securities the company issues. Through trading, the stock market determines the price37/44

2 DETAILED RULES
of marketable securities issued by the company. Put diﬀerently, it has the function of identifying the appropriate value of the company. To ensure that this functions properly, the scopeof disclosure should extend to all information contributing to accurate decisions on aspects
such as the current state of management and future risks, and should not be limited to thescope stipulated by the law.
Disclosure is extremely important not only for shareholders, but all stakeholders such as
creditors and clients in decisions on matters such as whether to continue or terminate businessand the exercising of rights. As famously stated by US Justice Brandeis, “Publicity is justly
commended as a remedy for social and industrial diseases. Sunlight is said to be the best of
disinfectants; electric light the most eﬃcient policeman,”*3 this also leads to the preventionof fraudulent behavior by the company.
It is not mandatory to disclose information such as advanced management strategies thatshould not be released in order to ensure the company stays competitive, but this must not be
an excuse for company oﬃcers to protect themselves by concealing scandals or deteriorating
performance.
• The disclosure of company information must not be limited to the company as a single entity, but instead include the entire corporate groupto which the company’s inﬂuence extends, such as subsidiaries.
The scope of consolidation is already becoming an actual standard due to reform to theaccounting system. Moreover, the lifting of the ban on simple holding companies and introduction of a corporate divestiture system have further increased the importance of viewing
companies as corporate groups including subsidiaries and aﬃliates since the 1990s. Information needs to be disclosed based on this. Active disclosure of investment funds, etc. eﬀectively
under the control of the company is also required.
As the safeguarding of the rights of minority shareholders is extremely important for listed
subsidiaries, disclosure of information such as transactions with the parent company and thelevel of inﬂuence on management achieved by dispatching a CEO, etc. is required.
• The announcement of a company’s CSR activities is also preferable in theform of documents such as environmental reports, sustainability reports
and CSR reports. Disclosing the state of eﬃcient and fair activities toshareholders, employees, consumers and regional communities leads toan increase in company value.

*3 Brandeis, Louis D. ’Chapter V: What Publicity Can Do’,’ “Other People’s Money”, Harper’s Weekly,

Dec. 20, 1913

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In recent years, companies have become aware of corporate social responsibility, and its
implementation has come to be required. Environmental reports are principally issued toward
investors who are shareholders or potential shareholders, but they should also be made available to other stakeholders. Deepening the understanding of stakeholders and obtaining theirsupport makes a company more competitive by expanding the consumer base of products andservices and increasing the morale of employees.

2.9 Audits of Accounts
2.9.1 Ensuring the Independence of Accounting Auditors• To ensure the accounting auditor of a company carries out its duties
appropriately, a company should take the steps required to ensure theindependence of the accounting auditor from a company with an accounting auditor and its operating oﬃcers.
To ensure the accounting auditor of a company carries out its duties appropriately, a company must take steps to ensure cooperation between the accounting auditor and statutory
auditors or the audit committee, while also guaranteeing the independence of the accounting
auditor. As part of this, ﬁrst, a company should replace the certiﬁed public accountant or audit ﬁrm used as the accounting auditor if the term of engagement exceeds a certain number ofyears (7 or 5), and engage a diﬀerent certiﬁed public accountant or audit ﬁrm as the accounting
auditor*4 . However, obligatory replacement of the accounting auditor is limited to audit ﬁrms
able to provide account auditing operations to companies that have international operations,and this has been indicated as potentially leading to the position simply being passed aroundamong major accounting ﬁrms that eﬀectively enjoy an oligopoly. It is a fact that many arestrongly opposed to this in Japan and debate about its validity continues in the United States
for reasons such as the reduction of auditing capabilities caused by the replacement, the decline
in urgency near the end of an audit ﬁrm’s term and the diﬃculties faced by new audit ﬁrms
unfamiliar with the audited company in the handling of audits on internal control. However,considering the importance of the auditing of accounts, the establishment of appropriate terms
for the replacement of accounting auditors eliminates the development of cozy relationships
with management, and has the signiﬁcant beneﬁt of examining the company’s problems froma new perspective. It is assumed that the board of directors is independent from the audit*4 According to the Company Law, if an audit ﬁrm is appointed as the accounting auditor, the person for

performing duties of the accounting auditor is chosen from among the ﬁrm’s employees (Company Law
Article 337-2), and replacement of the accounting auditor refers to replacing the audit ﬁrm with anotheraudit form, and does not simply refer to the employee performing duties of the accounting auditor being
replaced without the audit ﬁrm appointed as the accounting auditor being replaced.

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committee and board of auditors, providing appropriate supervision and guidance over theaccounting auditor.
Second, companies with accounting auditors are not generally permitted to receive nonaudit services in the company or its relations with its parent company or subsidiaries fromthe certiﬁed public accountant or audit ﬁrm engaged as the company’s accounting auditor.
In cases where non-audit services are received in addition to accounting audit services, thecertiﬁed public accountant or audit ﬁrm must take steps to ensure the independence of theaudit personnel.

2.9.2 Compensation for Accounting Auditors• The details of compensation for accounting auditors are determined by
the company in accordance with the Company Law, and should correspond to the duties of the accounting auditors, and not hinder the independence of the accounting auditors. Accounting auditors should not be
granted performance-linked compensation such as stock options. Whenthe company pays consideration to the accounting auditor for non-audit
services, the details of the non-audit services should be disclosed and thepart of consideration for audit services should be distinguished from thepart of consideration for non-audit services.
As the Company Law provides the procedures and requirements for determining the compensation of accounting auditors, these provisions must naturally be adhered to when determining
the compensation of the company’s accounting auditors. Necessary steps must also be taken
to ensure that this is reasonable consideration for the duties carried out by the accounting
auditors and these must not impede the independence of the accounting auditors. Therefore,
the company’s accounting auditors should not be granted performance-linked compensationsuch as stock options.
When the company pays consideration to the accounting auditor for services other than
auditing (non-audit services), the details of the non-audit services should be disclosed in thebusiness report (Article 126-3 of the Enforcement Regulations of the Company Law), and thepart of consideration for audit services should be distinguished from the part of consideration
for non-audit services in disclosure of the compensation of the accounting auditors.
If the replacement of accounting auditors is made mandatory, a shift to a standard compensation format based on factors such as the size of the company is conceivable of compensation
for accounting auditors, and even in such cases, the ﬁnal value of compensation is determinedaccording to the details of the services provided each year.

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3 HANDLING OF “ABNORMAL SITUATIONS (WHEN A CONFLICT OF INTEREST
HAS MATERIALIZED)”

3 Handling of “Abnormal Situations (When a Conﬂict of Interest
has Materialized)”
3.1 Response to Deterioration of Performance• A key operating oﬃcer such as the CEO should reveal the reason for the
decline or deterioration of performance, indicate the steps that will betaken, and take responsibility for the implementation of these. The CEO
is responsible for explaining the reason for the deterioration in performance and the policy in dealing with the matter to stakeholders such as
shareholders. Outside directors, etc. should evaluate the performanceof operating oﬃcers based on the explanation by the CEO.

3.2 Response to Hostile Takeover Bids
• A place should be established to ensure judgments on bids to acquire thecompany are made from a viewpoint independent from operating oﬃcers
based on the perspective of the company’s objective of increasing longterm shareholder proﬁts.
Operating oﬃcers can have a conﬂict of interest with bids to acquire the company. Therefore,
the eﬀective decision of whether the bid will increase the long-term shareholder proﬁts must be
made by an independent external auditor or a person with a view from outside the company
who is not an operating oﬃcer.
• Defense measures against takeover bids should be designed to ensure
they do not hinder bids that are aimed at increasing the long-term
shareholder proﬁts.

Full explanations must be given to shareholders

when introducing defense measures.
Suﬃcient explanations on the details and expected eﬀect of takeover defense measures mustbe given to shareholders when they are being introduced. By providing the company withmeasures for defending against takeover bids that clearly violate long-term shareholder proﬁts
and with opportunities to present alterative proposals for increasing the value of the company,
takeover defense measures provide shareholders who are the ultimate decision-makers withinformation required for making decisions and ensuring that they have time to consider thematter.

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3 HANDLING OF “ABNORMAL SITUATIONS (WHEN A CONFLICT OF INTEREST
HAS MATERIALIZED)”The intent of shareholders must be respected when implementing takeover prevention measures, but obtaining approval from the general shareholders’ meeting is not required. The ﬁrst
reason is that the implementation of takeover defense measures is not necessarily a matter
falling under the authority of the general shareholders’ meeting when looking from the perspective of the division of authority between the general shareholders’ meeting and the boardof directors. The second is that there is a risk that requiring approval from the general shareholders’ meeting for implementing takeover defense measures could give operating oﬃcers afree hand based on the excuse of having approval from the general shareholders’ meeting.

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Japan Corporate Governance Forum Working Groupon the Revision of Governance Principles
Hiroshi Ogino

Editorial Writer, The Asahi Shimbun Co.
(Member of the Steering Committee of JCGF)

Nobuyuki DemiseProfessor, School of Commerce, Meĳi University(Member of the Steering Committee of JCGF)

Nobuo Nakamura

Professor, Faculty of Commerce, Waseda University(Member of the Steering Committee of JCGF)

Toshihiko Matsumura

Associate Professor, Institute of Social Science, University of Tokyo

Masahiro Maruyama

Research Jurist, Socio-economic Research Center, CRIEPI(Member of the Steering Committee of JCGF)
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