Discussion Paper Series No.53

CAN THE UK EXPERIENCE PROVIDE LESSONSFOR THE EVOLUTION OF SRI IN JAPAN?
Aris Solomon
Jill Solomon
Megumi Suto
November 13，2003

CAN THE UK EXPERIENCE PROVIDE LESSONS FOR THE
EVOLUTION OF SRI IN JAPAN?

Aris Solomon
BRASS1
Lecturer in Accounting
Cardiff Business School
Cardiff University
Jill Solomon
BRASS
Lecturer in Finance
Cardiff Business School
Cardiff University
Megumi Suto
Professor in FinanceFaculty of Economics
Chuo University
Japan

First draft August 2003
Second draft November 2003
This is a working paper, please do not quote without permission of the authors

This paper is supported by Economics Research Fund of Chuo University, the ESRC-funded ResearchCentre, BRASS (Business Relationships, Accountability, Sustainability and Society) at Cardiff University and
the Nuffield Foundation
Please address all correspondence to :Dr. Megumi Suto
Professor in the Faculty of Economics
Chuo University
742 Higashi-Nakano
Hachioji Tokyo Japan 192-0393
megumis@tamacc.chuo-u.ac.jp
This paper was presented at 6th International Conference on Corporate Governance and Board Leadership at Henley
Management College UK, 6-8 October, in 2003. We are grateful to useful comments and suggestions by participants.

1

BRASS is the ESRC-funded centre for Business Relationships, Accountability, Sustainability and Society at
Cardiff University.
1

ABSTRACTIn this paper we review the growth of socially responsible investment (SRI) in the UK and inJapan. We consider the various factors which have given rise to the growth of SRI in bothcountries. As SRI is currently more mature in the UK than in Japan, we consider ways in which
the UK experience may provide some lessons for the growth of SRI in Japan. Significantly, we
consider that the use of corporate governance mechanisms such as engagement and dialogue bylarge shareholders, to solve social, ethical and environmental (SEE) problems in companies is arealistic route for the development of SRI in Japan. However, these mechanisms need to be
designed so that they may operate more efficiently. Pension funds and other investment
institutions need to appreciate the value of engagement over screening as an SRI strategy.
Further, the disclosure of SRI strategies by pension funds in Japan may contribute to enhancing
consciousness about the responsibility of shareholders for the SEE outcomes of corporate
activities that they invest in indirectly. We acknowledge however, that this suggestion may bedifficult to implement in the near future2

Introduction
In the UK, recent years have witnessed socially responsible investment (SRI) move from themargin to mainstream institutional investment (Mansley, 2000). A similar growth has occurredin Japan, but at a different level: SRI in Japan has grown from being non-existent to being arecognised marginal form of institutional (and individual) investment. In this paper we review
the growth of SRI in the UK and Japan. We compare and contrast the growth of SRI in these two
major economies. We then consider ways in which the experience in the UK could help pave theway for future growth of SRI in Japan.

The Growth of Socially Responsible Investment in the UK
A recent study concludes that the UK SRI sector is becoming more powerful and influential,with the City taking an increasing interest in the area (Friedman and Miles, 2001). FT article.
This transformation seems to have been motivated by a number of factors, with evidence
suggesting that the main driver has been the activities of social/environmental lobby groups andinterest in SRI from the UK Government, as well as the desires of individual scheme members(Solomon, Solomon and Norton, 2002). Recent corporate cases of social, ethical orenvironmental (SEE) misconduct and mismanagement have also turned the spotlight on SEE
issues. The need for companies to become more accountable to a broader range of stakeholders
by managing SEE issues more carefully and increasing SEE disclosure has been a focus oflobbyists, Government and investors for a number of years (Peattie, Solomon, Solomon andHunt, 2002). Unless companies embrace corporate social responsibility (CSR) and improve theiraccountability and transparency they are unlikely to remain competitive in the future, as the risks
of unethical behaviour to their reputation have been recognised as significant (Wheeler andSillanpää, 1997). Further, if institutional investors, who represent the controlling shareholder
group in the UK, endorse SRI, this will be a significant factor influencing the attitudes ofcompany management towards SEE issues. There has been a dawning realisation in recent years
that the immense power of collectivised investment can be used or abused, and that pooled funds
may be wielded as a force for good.
The demand for SRI which has arisen from the institutional investor clientele (especiallyfrom pension fund members) demonstrates an increasing societal awareness of SEE issues andrequiring fund managers to consider the SEE implications of their investment choices. Recent
market research indicated that 77% of the UK public would like their pension funds to beinvested in a socially responsible way provided this did not reduce financial returns (Targett,2000). Another study indicated that almost 80% of pension scheme members required theirschemes to operate an SRI policy (The Ethical Investor, 1999). Interest from the institutional
investment community has been perceived as relatively weak with fund managers adopting an
SRI strategy in reaction to external pressure rather than on their own initiative. However in thelast couple of years their attitudes have changed dramatically. Institutional investors have started
to view SRI as an increasingly important issue in portfolio investment (Friedman and Miles,
2001). Rather than viewing SRI as an issue to be isolated to individual, specialist 'ethical' funds,social, ethical and environmental SRI has been adopted as an umbrella policy across almost all
major funds. Indeed, SEE issues constitute one of the main categories discussed in engagementand dialogue meetings between institutional fund managers and their investee companies (Jubb,
2002; Solomon and Solomon, 2003).

Why Has Socially Responsible Investment Grown in the UK?
The quintessential issue for the institutional investment community, when deciding whether or
not to adopt and SRI approach is whether or not there is a positive relationship between SRI andfinancial performance. However strongly investors desire to invest in a socially responsible
manner, the prospect of lower financial returns on socially responsible funds would act as a3

strong disincentive for SRI. Indeed, as SRI is rising it is likely that investors believe they will
make equal, if not higher, returns from socially responsible than from non-SRI and it seems thatinvestors and fund managers believe it is possible to make a difference while making a profit(Drexhage, 1998). There appears to be a growing perception within the UK institutional
investment community that SRI actually enhances investment return (Mayo, 2002). Indeed, themajority of institutional investors now operate an SRI overlay strategy which incorporates
engagement with investee companies on SEE issues as part of the integrated investment process(Solomon and Solomon, 2003). However, institutional investors are hungry for concrete
evidence and, although they are actively pursuing SRI strategies at present, still require as muchinformation on links with performance as possible. We now consider SRI in the UK from anumber of angles, each of which develops the case for adopting SRI on the basis of its
improvement to financial return.
(i) Academic Research
Existing academic empirical research has failed to find any statistically significant difference inthe returns of socially responsible funds (for example, Mallin, Saadouni and Briston, 1995).
Although this appears to be a negative result at face value, it actually represents a positive result
for the pro-SRI lobby, as evidence showing no significant difference between ethical and nonethical investment provides people with a costless choice of investing in a socially responsible
manner. A number of empirical studies have been performed to evaluate the financial
performance of UK socially responsible funds. Luther, Matatko and Corner (1992) isolated asample of socially responsible unit trusts and found that five of the trusts offered a higher total
return than the FT-All Share index. They found overall that half of the trusts studied
outperformed the market and half underperformed. However, the use of an appropriate
benchmark in such empirical work has raised concerns (see Luther and Matatko, 1994). Mallin,
Saadouni and Briston (1995) attempted to overcome this problem by using improved techniques
to compare the performance of UK SRI funds not only with a market benchmark but also with
non-SRI funds. Overall, they found that both socially responsible and non-socially responsible
trusts seemed to underperform the market. However, they provided some weak evidence thatsocially responsible trusts outperformed non-socially responsible trusts. They attributed theirfindings to a type of 'bandwagon' effect, "The weakly superior performance of ethical funds
evidenced in the sample may have been a temporary phenomenon caused by an increased
awareness and interest in ethical investment. This in turn led to increasing levels of demand forappropriate investment products establishing a premium in realised rates of return. Indeed, thisphenomenon may still be continuing as ethical investment gains in acceptance" (p.495). Usingsimilar techniques, the most recent econometric study on UK data, performed by Gregory,Matatko and Luther (1997) showed that both socially responsible and non-socially responsible
trusts underperformed the market but that underperformance was worse for socially responsible
trusts.
Although these findings are interesting they apply only to funds which are run solely onan ethical basis. As discussed earlier, the market has evolved now such that nearly all major
funds take account of SEE issues in their portfolio investment decisions. Therefore, this sort ofstudy is no longer applicable as there are no funds which could be termed completely 'nonethical'. A different approach needs to be developed to discover whether SRI has a positive or anegative impact on investment return.
(ii) Development of SEE Benchmark Indices
From a more practical perspective, the development of benchmark indices for evaluating socially
responsible fund performance should provide clarification on this issue. Williams (1999) statedthat one of the future trends in UK SRI would be the development of dedicated performance4

benchmarks. Indeed, there has been a recent emergence of SRI stock exchange indices in the UK.
EIRIS has developed five socially responsible indices, each of which indicates financial returns
roughly equivalent to the FTSE-All Share Index for the period 1991 to 1998. Also, in 1998, the
NPI Social Index was launched. It is likely that the emergence of new SRI indices will"...explode the myth that green and ethical investors have to accept that their investment
performance will be disappointing" (Holden-Meehan, 1999, p.35). Indeed, in the last couple ofyears both the UK and the USA have developed new SRI benchmark indices, the Dow Jones
Sustainability Indices (DJSI) in the USA and the FTSE4Good index in the UK. The firstindications are that the DJSI is performing well and the market is anticipating similar news for
the UK index (Martin, 2002).
(iii) The Risk-Based Approach to SRI
The institutional investment community in the UK has now acknowledged the potentiallydevastating effect that mismanagement of SEE issues can have on companies' reputation andhence on share prices and investment return. Following the publication of the Turnbull Report(1999) which provided recommendations to UK listed companies on how to operate an effective
system of internal control, there has been an increasing awareness of the significance of nonfinancial (SEE) issues to financial performance. A report by the Association of Chartered
Certified Accountants (ACCA) (2000) emphasised the importance of taking SEE issues into
account within a Turnbull framework of risk management and internal control. As well as
encouraging companies to develop improved risk management practices in the SEE area, theTurnbull Report (1999) has encouraged companies to disclose more information on their SEE
liabilities and risk management procedures. Indeed, the Association of British Insurers (ABI) has
developed a series of guidelines for listed companies on SEE disclosure, from a risk management
perspective. A report commissioned by the Association of British Insurers (ABI) demonstrates
that SRI reduces risks of financial loss and in fact adds to shareholder value (Cowe, 2001). The
institutional investment community has recognised that SRI has moved from being a strategy
based on companies' attempts to improve their marketing and personal relations to a serious
approach based on avoidance and management of reputation risk (Montagnon, 2002). A riskdriven approach to SRI acknowledges the risk of substantial corporate financial losses arisingfrom SEE mismanagement as,
Reputation, in our view, will be a key competitive differentiator for the successful company for the
next 50 years (ACCA, 2000, p.11).

It seems that shareholders are increasingly aware of the impact that reputation can have onshareholder value.
(iv) Cases of SEE Mismanagement and their Impact
The potentially devastating impact of corporate SEE mismanagement and abuse on share values
and consequently upon investment returns has been recognised for some time. Damage to
reputation arising from serious SEE incidents where internal controls and risks management in
the SEE have been weak has been demonstrated unequivocally by a number of highly publicised
cases. We now consider a umber of cases which provide anecdotal evidence that there is asignificant relationship between CSR and financial performance and therefore between SRI andfinancial return to investment.
The environment is one of the most high profile areas of SEE concern for companies andinvestors in which there have been a number of notorious cases resulting in companies suffering
substantial financial losses. One of the earliest and most influential cases was that of Exxon
Valdez where the accidental sinking of an oil tanker resulted in extensive pollution of seawater inan area of outstanding natural beauty. This resulted in the company being targeted byenvironmental lobbyists, divestment by major institutions and a plummeting share price. It was5this disaster which inspired the development of the Ceres Principles on corporate environmental
reporting.
More recently, the decision by BP to dump an outdated oil platform sparked a furor
environmental lobbyists. Greenpeace claimed that firstly the company had no right to discharge
waste into the deep ocean and secondly, that this was not an environmentally acceptable meansof disposing of the platform. After a period of mass media attention the company decided todispose of the platform in an alternative way. However, scientific research undertaken by thecompany showed that deep ocean disposal was in fact a more environmentally sound approach,calling into question Greenpeace's judgement. Institutional investors refer to this case in their
discussions of SEE issues and suggest that lobbyists are not always correct and that they should
not always act on pressure from environmental/social lobby groups. However, the other mainconcern raised by lobbyists about this case still holds. The issue of whether or not a company has
a right to make use of the ocean or any other natural resource in this way, when it does notbelong to them, is an issue which is widely debated.
In the area of human rights, there have been a number of high profile cases wherecompanies have been found to be operating 'sweat shops' in their foreign subsidiaries. There havebeen cases of child labour and abuse of employees' rights with workers operating in appalling
conditions for excessively long hours. Nike is a prominent example. Again, the unleashing of
information relating to these issues has resulted in swift and negative impacts on financial
performance with shareholders divesting to register their dissatisfaction.
Enron too presents a poignant case for improved management and control of SEE issues.
Not only has the company become a household name representing unethical business conduct
and financial mismanagement but the company was also the perpetrator of serious human rights
abuses several years before its ultimate demise. In the 1990s Enron was accused by human rights
activists of hiring security guards to watch its facility in India who subsequently attacked andseriously harmed protestors from the local community who were demonstrating against the local
impact of the site's operations. Not only does this indicate that Enron was demonstrating signs of
ethical and social misconduct well before the events of 2001 but this case also indicates that SEE
management is an indication of management quality. Indeed it is increasingly recognised that themanner in which company management deals with SEE risks and liabilities may be used byinstitutional fund managers and analysts as an indication of managerial quality and performance(Solomon and Solomon, 2002).
In the area of human rights and ethics, the decision by the Johannesburg Stock Exchange
to force listed companies by law to disclose the number of their employees affected by the HIV
virus is anecdotal evidence that mismanagement of SEE issues have a recognised and potentiallynegative impact on financial returns. Concerns that companies will be faced by unanticipatedfinancial liabilities as a result of employees becoming ill have forced the Government toencourage listed companies to disclose information relating to infection as a potential liability.
Huntingdon Life Sciences (HLS) has demonstrated a clear and negative relationshipbetween unethical behaviour in the area of animal rights and financial performance. Incidents of
unacceptable abuse of animal rights at the Oxford site of HLS were exposed through videos
taken by animal rights activists who infiltrated the company premises. These clips received mass
media exposure and resulted in an outburst of activity by animal rights activists and lobbyists.
The pressure on the UK financial community was so significant that all the institutional investors
divested their shares in HLS. In the following months HLS managed to obtain financial backing
from a major US financial institution but again in recent months this has also been withdrawn asa result of lobby pressure.
Clearly, these cases provide only anecdotal evidence that there is a substantial reputation
risks attached to SEE mismanagement. However, the cases have been important enough to worrycompany management and the institutional investment community.

6

(v) The Positive Results of Engagement and Dialogue
Another reason why SRI seems to be growing is the positive impact which engagement anddialogue between institutional fund managers and their investee companies have had on financial
performance and investment return. One traditional theoretical viewpoint on SRI is that any
reduction in the investment universe through screening (i.e. exclusion of companies in 'unethical'
industries) reduces the potential return to investment. This is inarguable and is couched in
portfolio theory (Boatright, 1999). However this argument against SRI only applies to fundmanagers employing a screening strategy. The early ethical funds in the UK relied on screening
and were individualised by their varying selection of ethical criteria. In the last few years, acompletely different approach to SRI has evolved, with fund managers moving away fromscreening towards a strategy of engagement and dialogue. This means that institutional investors
invest in shares across all industries but frequently select those that are 'best in sector'. In otherwords, companies are selected in all industries on the basis of the best performers in the SEE
area. Also, if there are any concerns about a company's SEE-related behaviour the fund manager
will engage directly with the company management in order to encourage a change in company
policy. For example, Friends, Ivory and Sime, a large institutional investor which has now
become 'Invensys', have been actually encouraging their investee companies in the clothing
sector to develop policies on employees' rights in foreign subsidiaries and have forced them todisclose information relating to their activities in foreign countries (Litvack, 2002). The growing
belief is that rather than restricting financial return to investment, this type of engagement
approach actually enhances return by reducing the risk of reputation damage, thereby stabilisingfinancial performance and in the long-run improving returns to investment. A series of in-depth
interviews with UK fund managers and investment directors has revealed that the SEE
engagement process in UK investment institutions is becoming formalised and is now largely
integrated into the mainstream investment process (Solomon and Solomon, 2003).
(vi) Institutional Changes: The Evolving Role of Pension Fund Trustees in SRI
A seemingly minor institutional change to pension fund law has had a significant impact on
pension fund trustees and on SRI in the UK. Since July 2000, an amendment to the Pensions Act(1995) has required all trustees of occupational and local government pension schemes to state
their policy on the extent (if at all) to which social, environmental or ethical (SEE) considerations
are taken into account in the selection, retention and realisation of investments. Therefore,
although trustees are not forced to practise SRI, they are now required to state whether or notthey do (EIRIS, 1999). Nevertheless, SRI is a difficult issue for trustees to deal with. Theirfiduciary duty obliges them to maximise future pension receivables (Cunliffe, 1997; Ellison,1997). This duty does not necessarily correspond to the potentially wider role in society that they
may take on by adopting SRI. Assessing whether or not these roles conflict is essential for the
future prosperity of pension fund members. Given the current situation, pension fund managers
are not keen to risk an SRI policy which might damage returns (Pensions Week, 10 June 2002).
Indeed, trustees are under extensive pressures due to the Myners Review (2001) whichconcluded that trustees did not possess the training and knowledge necessary for them to carryout their responsibilities effectively. Pressure to embrace SRI issues may be perceived as anadditional burden which trustees cannot even consider bearing (Solomon, Solomon and Norton,
2002).
Indeed, the role of the trustee in SRI seems to be evolving gradually, with Solomon andSolomon (2003) finding evidence from questionnaire data and interviews that trustees are
becoming more aware of, and interested in, SRI issues, despite concerns about their fiduciary
duty. SRI issues were now included on the agenda at trustees' meetings, whereas they weregenerally omitted before. However, the paper identified a number of organisational andcontextual factors affecting the level of interest in SRI among the trustee community. Indeed,7

they found statistical evidence that trustees from larger pension funds and those with a greater
proportion of equity in their asset allocation, were more interested in SRI issues. Further, thepaper showed how, hypothetically, this minor institutional change to pension fund law could leadto greater CSR, through a virtuous circle effect. Indeed, the new disclosure regulation for trustees
has been found to have had a significant impact, as,This requirement [the new SRI disclosure requirement] has had a significant and wide-ranging impact
on the investment community. The majority of trustees have incorporated reference to social, ethicaland environmental (SEE) issues in their annual statements in 2001. Most of them have delegatedresponsibility for implementing this to fund managers which has added significantly to the growing
Socially Responsible Investment (SRI) movement (Cowe, 2001, p.8).

It remains to be seen whether or not SRI will become more or less central to the trustee's role.
(vii) Sociological Factors
There are also a number of sociological factors which appear to have promoted the growth of
SRI in the UK. For example, a general increase in ethicality in UK society and a desire toachieve a consensus on moral and ethical issues may be a factor leading to greater interest in
SEE issues. Further, the growth in media exposure of all events, including those relating to SEE
issues has sparked interest among the general public (and therefore pension fund members andother clients of investment institutions) in SEE and ethical investment. Another sociologicalfactor contributing to the growth in SRI seems to be the heightened interest in risk and risk
management. These sociological factors in the UK are discussed in relation to SRI in McCann,
Solomon and Solomon (2003).

The Development of Socially Responsible Investment in Japan
In contrast with the UK experience, the first roots of SRI in Japan are considered to haveemerged in 1999, with the introduction of 'eco-funds', investment funds which focus specificallyon environmental issues. Table 1 summarises a series of events which have contributed to thedevelopment of SRI and CSR in Japan. Since August 1999, eleven SRI funds, including eight
eco-funds, have been formed. SRI by pension funds is at a far earlier stage of development.
However, the speed of change has accelerated since 2000. The Mutual Aid Association forTokyo Metropolitan Teachers and Officials was exceptional, as they quickly took up investment
in eco-funds and started to invest a small part of their fund into eco-funds in December 2000.
This pension fund began to adopt SRI as an aspect of its in-house fund management in April
2003, soon after the Ministry of Education and Science had lifted ban on fund management ofpension funds of teachers and officials associations of all authorized schools. New developmentof SRI has continued since then. At the end of July 2003, Sumitomo Trust Bank launched thefirst SRI fund for pension funds and two pension funds, belonging to KDDI and Shinsei Bank,
decided to entrust with Sumitomo Trust Bank Yen 25 billion to the SRI fund. Nevertheless, theamount invested according to SRI criteria remains small and no other pension funds haveadopted an explicit SRI policy to date. Also from Table 1, we can see that the Morning Star
company started to publish SRI index in July 2003. They suggested that the SRI market in Japanwas still at an early stage of development, but that its evolution was steady.
Insert Table 1 about here
A number of US and European SRI research-organisations have conducted questionnaire surveys
of Japanese companies, in order to discover whether or not these companies have been
approached for SEE information. However, many Japanese companies targeted in the domestic
market declined to respond to these questionnaires, as they felt that they were based on Westernethics and Western ideas of social justice. They considered that the Japanese should discover
their own solutions to CSR problems domestically. This is an extremely interesting issue as it
shows that domestic Japanese companies adhere strictly to notions of ethical relativism,

8

believing that different countries are associated with different sets of ethics and moral principles,
and that one country should not attempt to inflict their ethical beliefs on another (Wong, 1991;
Bowie, 2004). There was an extremely different response from companies conducting crossborder activities, as they appeared to be far more concerned about international perspectives on
CSR. They are clearly likely to be more sympathetic to other cultural norms regarding ethics, as
they need to conform in order to be internationally competitive. Since 1988, the Council for
Better Corporate Citizenship (CBCC)2 has been investigating SEE issues for multinational firms
and international standards of CSR, since Japanese companies faced various conflicts with
employees and local communities in the US in the 1980s.
Shareholder power is also relatively new in Japan. Indeed, Japanese institutional investors
have only started to execute their voting rights since the end of the 1990s. This was partly a
result of the major period of financial reform, named the 'Japanese Big Bang', which started in
1997. Furthermore, Japan is experiencing a rapid ageing of the population. Both thesustainability of society, as well as the restructuring of corporate management depends on theextent to which households shift their savings into the securities market. Not only pension fundmanagers but also their trustee bodies, which are trust banks and life insurance companies
entrusted by pension funds and legal shareholders in the Japan’s pension scheme,3 are beingpressured by society to improve investment performance. If they are asked to become moreaware of SEE issues in their investee companies at the same time, this is a difficult path to tread
and a hard balance to achieve.
As has been the case in the UK, in the near future, Japanese corporate pension funds arealso going to be confronted with the problem of balancing their fiduciary responsibility against aconsideration of SRI strategies. 4 It seems that engagement and dialogue may be acceptablemeasures of corporate governance for Japanese institutional investors, as both investors andcompanies like to cooperate their activities over the long-term. We discuss the current situationand potential development SRI in pension funds in Japan later in the paper.
CSR and SEE Issues in Japan
In Japan, SRI has remained an irrelevant issue until relatively recently. A number of high profile
cases of corporate SEE mismanagement in the area of health and safety and ethics have drawn
attention to SRI concerns. Japan does not have the religious background for ethical investment,
found in Western countries such as the UK, although there has been, historically, a corporate
culture of consideration to employees and regional community, with an emphasis on family andregional ties. Hence, it is likely that SRI, which encourages CSR through the capital market, hasbeen less familiar with the general public in Japan than in the Western countries - at least until
recently. This does not mean that Japanese society is unconcerned with SEE issues or that they
do not perceive the financial markets as a means to solving SEE problems. In January 1991, thePostal Service Agency of the Government, 5 which has 16,000 subsidiaries across Japan,
introduced Postal Savings for the International Volunteer Aid Program (see Table 1). According
to this programme, 20% of savings incomes is dedicated to NGOs for medical, educational,
agricultural and environmental activities in developing countries. These savings became popularamong the households soon after they had started, such that the amount of donation continued to
2

CBCC was founded in September 1989 with full backing of Keidanren (Japan Business Federation) in order tosolve the issues relating to the investment friction they faced in the U.S. and other markets. In June 1990, CBCC was
authorised as a designated public-benefit organization.
3
Suto (2002a) explained the Japanese pension funds scheme and government policy.
4
A fund manager of Government Pension Investment Fund (GPIF)published his strong objection to SRI bypension funds as a personal viewpoint because social investment criteria are contradict to financial criteria.
(Terada, 2003) GPIF is the largest pension fund in Japan.
5
The Postal Services Agency was transformed into an independent government company in April 2003.
9increase until the implementation of an extremely low interest rate policy during the prolonged
economic depression. 6
With respect to CSR, environmental problems have been particularly salient in Japan. Since
the end of the 1980s, the Government established laws for environmental protection. In 1997, theMinistry of the Environment requested companies to publish environmental reports. This had asubstantial impact. Indeed, the number of companies publishing environmental reports(including listed and unlisted companies) increased from 169 in 1997 to 579 in 2001. Further, thenumber of listed companies with established environmental management policies increased from
56.5% in 1998 to 71.4% in 2001 (Ministry of Environment, 2002a, chapter 2).
Further, CSR issues attracted the attention of the general public in 2001 following a
number of high profile cases of SEE mismanagement by established companies in the area of
health and safety, and ethics. In October 2001, the Ministry of Agriculture, Forestry and
Fisheries of Japan implemented a policy to buy beef produced in areas where several cows had
been discovered to have BSE. Yukijirushi Food Company and other foods companies committed
fraud in order to sell imported beef to the government. Following the BSE scandal, other
unethical activities by food companies were discovered, including deliberate mislabelling ofwhen and where the meat was produced. This resulted in severe criticism by the general public,
with consumers boycotting the companies' products. Yukijirushi Food Company, previously
established as leader in the food industry for several decades, went into liquidation and wasdelisted from the stock market. Further, Nihon Ham Company lost 60 % of sales during a month.
(Kawaguchi, 2002, p.9) Further in the Autumn of 2002, the leading electric power company,
Tokyo Electric Power, was accused of running one of its nuclear power stations for a number ofyears, despite having undisclosed information relating to health and safety problems in thestation.
Such cases of unethical behaviour by leading Japanese companies with hitherto immaculate
reputations, triggered widespread demand for increased CSR, not only in the areas of health &safety, and the environment, but also in relation to ethics and compliance issues. Until then,Japanese society had never devoted attention to corporate SEE issues (except pollution), since
they believed company reputation provided a true reflection of corporate behaviour. In responseto the increasing demand for CSR within Japanese firms, Japan Business Federation (Nippon
Keidanren)7 revised its Charter of Corporate Behavior and published a set of guidelines forcorporate ethics in October 2002, which urged its members to adhere to it, in order to recover
public confidence in business. These guidelines focused on strengthening CEO initiatives for
ethical behaviour, improvement of internal control, disclosure of policies on ethicalmanagement.8 In advance of these guidelines, in May 2002, the Council for Better Corporate
Citizenship (CBCC) published a report on the international standardisation of CSR which raised
the possibility of legislation on CSR in Japan.
Clearly, Japanese companies have been confronting a substantial demand for CSR both
domestically and from the international community. The recent cases of SEE mismanagement
suggest that the self-disciplining mechanism in the Japanese corporate system has been working
less efficiently than before. Further, the worst cases of unethical behaviour seem to have been
associated with large, established companies, with a long history of Japanese management. Thisis a particularly worrying issue for Japanese society, given the traditional high level of trust
invested in Japanese companies.

6

In 2001, about 26 million people participated the program and about ￥ 0.7 billion supported 132 NGOs.
Japan Business federation was born as a new business community in May 2002 by amalgamation of two
employers’ associations, namely Japan Federation of Economic Organization and Japan Federation of
Employers’ Association.
8
http://www.keidanren.or.jp.
710

The Japanese Government's Cabinet Office introduced guidelines for corporate
compliance from the perspective of consumers in April 2002 and the Financial Services Agency
published a report on disclosure of corporate governance issues including confirmation of theannual financial reports. This series of government policies could stimulate CSR disclosure by
Japanese companies.
Development of Socially Responsible Investment Funds and Consumer Activism
In August 1999, the first SRI investment funds dedicated to corporate environmental issues(termed 'eco-funds'), were introduced by Nikko Asset Management Company. Within six months,
four more eco-funds were introduced. By the end of February 2002, the number of SRI
investment funds stood at eleven, including eight eco-funds and three social and eco-funds, withapproximately 90% of their asset value held by individuals (Ministry of Environment, 2002b,p.55).
Insert Table 2 about here
As we can see from Table 2, at the end of October 2001, the total asset value of Japanese
investment in SRI funds amounted to Yen133.5 billion (Euro 1140 million)9 which represented ashare of 0.8 % of stock investment funds in Japan. The absolute scale of SRI funds in Japan is
not small in comparison to those of European countries. In Japan, investment funds amounted toonly 2.5 % of the total assets in the household sector at the end of September 200110. Therefore,
despite growing interest in CSR and SEE issues, SRI was negligible in financial assets of thehouseholds sector. This is partly because investment funds have been traditionally marginal
assets for households, given the bank-based financial system which has dominated in Japan. Also,
spread of securities investment was curtailed in the prolonged stagnant market.
One problem associated with Japanese SRI funds has been their positive screening ofenvironmental issues. A focus on the environment has stemmed not only from an interest inenvironmental protection due to globalisation of Japanese business in the 1990s, but also from a
growing awareness of environmental problems within Japanese society, since the Japanese'bubble' burst. Until then, corporate activities had been associated with environmental
degradation, with little concern from consumers who were impressed by massive profitability inthe bubble economy in the late 1980s. Eco-funds were made available to individual investors two
years after the Japanese Financial Big Bang in 1997, when financial reform created a moremarket-oriented system, and households began to focus more on securities investment. Four ecofunds were established in 1999 and the amount of eco-funds was more than Yen 200 billion at its
peak at the end of 1999 (Ministry of Environment, 2002b, p.55). Another eight funds were
established from January 2000 and June 2001. Unfortunately, since then, the stock market
continued to decline and eco-funds have also hovered at a low level.
Another problem with eco-funds has been their portfolio strategies. It is often highlighted
that eco-funds are predominantly constituted from investment in leading companies such as Sonyand Matsushita, which support their performance.11 Thus, SRI funds in Japan are still minority
in terms of quantity and immature in terms of screening. On the other hand, demand for CSR has
been growing steadily in society, with a greater variety of SRI funds being available to Japanese

9

The market value reduced to Yen 100 billion in July 2002 due to declining stock market.(Kawaguchi, 2002.
p.131, Table 23)
10
Financial assets held by household sector amounts yen 1454 trillion, including yen 37 trillion of investment
trusts (Bank of Japan).
11
For example, top ten stocks of Nikko Eco-fund shared 34.5% of total value of the fund are typical Japaneseestablished companies including Toyota, NTT Docomo, HOYA, Fuji Film, Matsushita Electricity, MitsuiSumitomo Bank , Honda and others. Total number of the stocks contained in the fund is 82. (Nikko Eco-fundMonthly Report, the end of October 2002, http://www.nikko-am.co.jp/pdf.data/m_nk_eco_sp.pdf.)
11

households. Some experiments for SRI have also carried out on private portfolios.12 SRI funds
have begun to attract considerable attention from the general public and fund managers.
Pension Funds Reform and Shareholders Activism—Institutional Changes
In an ageing society, long-term institutional investors such as pension funds and life insurancecompanies play a key role in solving corporate SEE problems in the framework of corporate
governance as leading shareholders. In Japan, institutional investors had been silent shareholders
until recently in the bank-based financial system under the government policy to prioritise
financial stability and order rather than competition in the financial services industry. As aconsequence, trusteeship has been restricted to trust banks and life insurance companies, with noin-house fund management being permitted. In addition, the asset allocation of corporate pension
funds has been strictly regulated, as corporate pension funds were designed in part tocomplement public pension funds. In this regulatory framework, there was no incentive for either
corporate pension funds or their trustee bodies to be active shareholders as long as economic
growth was sustained.
The situation changed after the 'bubble' burst. It became clear that the traditional system
was not sustainable for a rapidly ageing society, with a lower level of economic growth. Pension
fund reform started in the early 1990s, with deregulation of asset allocation, strengthened
disclosure of fund management activities, and enhanced competition in pension fund trusteeshipthrough the arrival of investment advisors (Suto, 2002a, pp. 261-264). In the late 1990s, thefiduciary responsibility of corporate pension funds became a key point for discussion in order toimprove financial performance in the prolonged economic stagnation. Table 3 shows the processof institutional change in pension fund attitudes towards shareholder activism. The Ministry of
Welfare introduced a set of guidelines for the fiduciary responsibility of corporate fund directors
in 1997, after the regulation of asset allocation by corporate pension funds was eventuallyabolished.13 Fiduciary responsibility of pension fund managers covers corporate governance ofinvestee companies as well as accountability of fund management.
Insert Table 3 about here
However, in Japanese pension fund management schemes, ownership and legal rights to control
companies are legally separated. Legal shareholders are trust banks and life insurance companies
which are trustee bodies, although actual shareholders are their customers, pension funds.
Pension funds themselves are not allowed to give instructions on individual investees to theirtrustees. So, except in-house management, there are no legal routes for pension funds directly to
execute their shareholders rights. All shareholders’ rights are delegated to their trustee bodies,while the pension funds bear the ultimate investment risk. If a pension fund wants to commit
corporate management as real shareholders in order to take fiduciary responsibility, they canshow their fund management policy explicitly to trustee bodies and put pressure on them to takeaction as shareholders on behalf of customers. Following the liberalisation of financial services
and the Ministry of Welfare's published guidelines on fiduciary responsibility of pension funds in
1997, trust banks and life insurance companies increasingly executed voting rights year by year
in enhancing competition in the pension funds trustee business.
A questionnaire survey of corporate governance in Japanese corporate pension funds and theirtrustee bodies was carried on in January 2001(Omura, Suto and Masuko, 2001). The results
revealed obvious changes in the attitudes of corporate pension funds and their trustee bodies
toward more active shareholders in transition toward more market-oriented system 690 of 1193
pension funds (58%) and 68 of 88 trustee bodies (77% ) considered that trustee bodies should
12

In February 2002, a social entrepreneur fund in limited partnership was organized by Mirai Securities
Company. That is SRI fund to explore unpublished firms with positive social screening.
13
Pension fund of Cooperative Association of Private Schools and Universities has been under the regulation of
the Ministry of Education. The regulation on assets allocation was abolished in April 2002.
12

execute voting rights as agents of pension funds. Another institutional change to stimulate
corporate pension funds as active shareholders was introduction of defined contribution plan,
named the Japanese 401K. The DC plan has been gradually adopted by corporate pension funds
since it started in October 2001. Though the number of companies which adopted the DC plan
was only 203 and about 10% of listed companies at the end of 2002, it was expected to enhancebeneficiaries’ consciousness as active shareholders and give them a stronger incentive to monitor
pension fund managers.
Actually, pension funds trustees bodies and in-house managers of the Pension Fund
Association began to demonstrate their agreement and disagreement through voting and blankvoting decreased dramatically in 2002, as Table 4 shows. This trend is more conspicuous forfund-management by corporate pension fund associations, as evidence by Table 5. They
disagreed with one fourth of the proposals at corporate general shareholder meetings. In this new
movement, the Pension Fund Association has increasingly led shareholder activism in Japan.
According to interviews which the Association conducted after the general shareholders
meetings of Japanese companies concentrated in June, they were told that the reason for a highlevel of votes 'against' management was that the corporate mangers had not answered theirquestions adequately. They also commented that the concentration of certain groups at thegeneral shareholders meeting was a major barrier to shareholder activism in Japan.
Insert Tables 4 and 5 about here
While the conventional Japanese-style corporate governance, characterised by monitoring by
main banks and internal disciplining by life-time employment with career concerns, has been
reducing its function in the 1990s, institutional investors have been seeking more active
involvement in corporate management. Facing corporate SEE issues in the 2000s, institutional
investors should have considered SRI and CSR in taking fiduciary responsibility as agents ofindividuals. SRI by pension funds has not been put into practice yet but pension fund managers
are facing strong demands for improved investment performance by enriching their fundmanagement competencies rather than developing SRI at the moment. However, it is reality thatpension funds managers in general are not concerned SRI and rather strongly question about
harmonization between fiduciary responsibility and social screening investee companies.14
Both pension fund managers and their trustee bodies do not seem to recognise the linkage
between corporate SEE issues and investment risks sufficiently in Japan. They realise that theexecution of shareholder rights is a part of their fiduciary responsibility but CSR issues are notrelated to their corporate governance activities. They should commit harmonisation of fiduciary
responsibility and financial performance considering CSR more explicitly so as to reduceinvestment risks in the long-run. Engagement and dialogue would be an acceptable measure ofcorporate governance for the institutional investors in Japan, where both investors andcompanies prefer collaboration to conflict in the markets in establishing relationships.
However, as mentioned earlier, the first socially responsible investment by pension funds
appeared in April 2003. The Teachers Aid Association for Tokyo Metropolitan Teachers andOfficials launched to manage a SRI portfolio screened with educational, environmental andgender criteria. At the end of July 2003, Sumitomo Trust Bank launched the first SRI fund fortwo pension funds, KDDI and Shinsei Bank.15 These are still very exceptional but it makes us

14

A fund manager of Government Pension Investment Fund (GPIF)published his strong objection to SRI bypension funds as a personal viewpoint because social investment criteria are contradict to financial criteria.
(Terada, 2003) GPIF is the largest pension fund in Japan.

15

It is announced that the SRI fund screens 250-300 investees based on CSR criteria and among them further
screens based on financial performance to 70-80 investees finally. The final portfolio includes Matsusita
Electric Company, JR, TOTO.
13

expect a new development of pension funds management focusing on corporate social
responsibility of investee companies.
Improvement in Disclosure of Corporate Governance and Risk Management
Responding to corporate SEE issues in Japan, improvement of corporate disclosure isindispensable from the viewpoint of public policy. The Financial Services Agency (FSA) started
to review disclosures focusing on internal governance and corporate risks in October 2002. Thereis an international trend to strengthen disclosure of governance information related to internal
control, risk management, and remunerations of managers. Risk information disclosure has been
unsatisfactory for investors’ decision- making in Japan. Disclosure of remuneration of Japanese
corporate managers has not been concerned by the investors as well as managers themselvesbecause it is well known that they are much less than the US, the UK and any other countries,
though international investors are concerned with it.
The FSA published Disclosure Working Group Report in December 2002, which says
governance information and risk information should be mentioned in each section independently
and clearly, and recommends COE to confirm disclosure report for appropriateness of thecontents. These disclosures are voluntary base with no legal obligation or penalty, and thegovernment keeps a stance to solve CSR problems in natural selection process of capital market.
This is just epoch-making improvement of for Japanese corporate disclosure because it explicitly
mentions that corporate managers have to be responsible for disclosure of internal governancesystem including risk management. Implicitly it suggests that corporate risks they manage anddisclose include social risks that the company faces.
New Development of SRI IndexesWith further corporate scandals arising in Autumn of 2001, a trend of social assessment ofcorporate behaviour has become more apparent in Japan, accompanied by an increasing demand
for social and ethical benchmarks to assess companies. In July 2001, Reitaku University
Business Ethics & Compliance Research Centre developed criteria of corporate valuation
focusing on compliance named R-BEC001. In November 2002, Morningstar, which is a ratingcompany for investment trusts, announced a new project to provide an SRI stock market index,
in cooperation with one of NPOs (non-profit organizations) think tank, the Public Resource
Centre16. This SRI index is screened by criteria selected in five fields of CSR: 1. governance andaccountability (governance, compliance, disclosure etc.); 2. market (attitudes to consumers,
attitudes to trading partners, customers’ satisfaction, procurement etc.); 3.
employment(employment relations, human resources, human rights etc.); 4. social contribution(contribution to regional society, cooperation with NGOs etc.); 5. environment(environment
management, protection of regional/global environment etc.).
As discussed above, in July 2003, a mainstream rating company, Morningstar started to
publish a SRI index, MS-SRI. These SRI benchmarks for Japanese firms have not widely
acknowledged by both corporate pension funds and among individual investors yet but future
development seems to be promising.

The Future Route for Socially Responsible Investment in Japan and the UK:
A Discussion
In the UK, it is widely recognised that management of corporate SEE issues is part of companies'
internal control and risk management systems, so that long-term institutional investors should
promote CSR in the framework of corporate governance by shareholders as agents of theircustomers as well as representative stakeholders of investee companies. They could contribute to16

Press release by Morningstar, ‘
14

increasing long-term benefits for their customers as well as those of the society as a whole. Thus,
disclosure of SRI policy of the pension funds is a public policy for promoting CSR throughnatural selection in the market, because SRI by institutional investors is expected to be a driving
force in realising socially responsible corporate activities. The use of corporate governancemechanisms such as engagement and dialogue by large shareholders to solve SEE problems is arealistic route for the development of SRI in Japan, which faces a rapidly aging society. However,there are some ways in which Japan can learn lessons from the UK experience in SRI.
Firstly, disclosure of SRI strategies of pension funds seems to contribute to enhancing
consciousness about the responsibility of shareholders for social and environmental outcomes ofcorporate activities that they indirectly invest in, but it does not seem realistic to be implemented
successfully at least in near future. According to experience of the UK, the reason why SRI
disclosure policy is successful depends on a wide range of non-profits organisations which play
important role as SRI information intermediaries, which link CSR demands with SRI drivers,
and finally supply of CSR by corporate managers. Development of such neutral intermediation isa determinant to promote SRI and CSR if the government chooses to solve SEE mismanagement
basically by market mechanism. While, development of NPO and NGO informationintermediaries are developed much less sufficiently in Japan.
Secondly, in the case of Japan, professional fund managers of trustee bodies, which aretrust banks, life insurance companies investment adviser companies, would play more importantrole to promote SRI by pension for Japanese pension funds more highly depend on external fundmanagers, though the UK experience suggests that development of SRI depends on not only
ability of pension funds managers but also main stream asset management industry in general.
Thirdly, hence, it might be more effective in Japan to implement a public policy for thefirms to disclose SEE issues as a part of internal risk management rather than to implement a
policy for long-term institutional investors to disclose SRI strategies. Disclosure of SEE policyof firms will give explicit information of their attitude about corporate risk management. As lesssufficient development of SEE intermediaries and less matured pension funds managers than theUK, the trustee bodies of Japanese pension funds could be actively execute shareholders’ rights
based on explicit SEE information disclosed by investees so as to assess corporate value in along perspective.
What about a recommendation based on the SRI disclosure regulation for trustees? The
deregulation has allowed trustees more freedom in asset allocation decisions. In Japan, thisfreedom could be used to improve decision and communication links between the pension fundmembers (society), the trustee bodies and the pension fund managers in order to experiment with,and build on, the positive financial benefits of an SRI policy.
Also, the benefits of engagement over screening need to be emphasised and applied inJapan. Screening in now an outdated form of SRI in the UK and should be sidelined in Japan inorder to make way for SRI investment overlay strategies across all major pooled funds.

15

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17

Table 1
Events Contributing to the Development of Corporate Social Responsibility andSocially Responsible Investment in Japan

Date

Event

1989

The Council for Better Corporate Citizenship (CBCC) was founded with full backing of the Japan
Federation of Economic Organization

1991

The Postal Service Agency of the Government started savings for the International Volunteer Aid
Program (January)

1999

The Mutual Aid Association for Tokyo Metropolitan Teachers and Officials published a statement on theinvestigation of investment in eco-funds (February)
The first eco-fund was issued (August)
ECS2000 (Ethics Compliance Standard) was published from the Business Ethics & Compliance Centre,
Reitaku University

2000

The first SRI investment fund was issued specialising in environmental and social issues (September)
The pension fund of the Teachers Association of Tokyo started to invest approximately Yen 1 billion in
eco-funds (December)

2002

CBCC published a report on the international standardisation of CSR (May)The Japan Business Federation revised its Charter of Corporate Behavior and the accompanying
guidelines (October)

2003

The Mutual Aid Association for Tokyo Metropolitan Teachers and officials started to manage part of its
pension fund according to SRI criteria, by screening 100 companies based on its own SEE standards,
Yen 2 billion from Yen 8.4 billion total assets (April)
The Morning Star started to publish an SRI index (MS-SRI), screening 150 company shares (July)
Sumitomo Trust Bank launched the first SRI fund for pension funds, which was entrusted Yen 25 billion
by the pension funds of KDDI and Shinsei Bank (July)

18

Table 2
International Comparison of Investment inSocially Responsible Investment Funds in 2001

Germany
FranceItaly
UK
Netherlands
Belgium
Swaziland
Total1
Japan2

NumberEuros(millions)

%

22
38
9
62
16
33
16
196
11

838
1917
1842
5910
989
1683
1368
15663
1140

0.10
0.22
0.43
1.03
1.45
1.18
1.47
0.43
0.80

Sources:
SRI Group, "Green social and ethical funds in Europe 2001" (www.srigroup.org)
Japan Investment Fund Association, Kawaguchi (2002)
Notes:
1. UC ITS funds in Europe
The asset values were calculated at the end of June, 2001
2. SRI funds in Japan were calculated at the end of October 2001 (Kawaguchi, 2002, Table 23)
The share is in the total amount of stock investment funds at the end of 2001.
The exchange rate was Euro 1: Yen 117.1

19

Table 3
The Development of Shareholder Activism by Pension Funds in Japan

Date

Event

1996

Partial relaxation of asset allocation regulation on pension funds

1997

Ministry of Welfare published guidelines for fiduciary responsibility of pension funds

1998

Abolition of regulation on asset allocation of pension funds

1999

The Pension Fund Association published basic policy for execution of voting rights

2000

Disclosure of net debts of pension funds on balance sheets of sponsor companies

2001

The 401k-type DC Plan was introduced (October)

2002

The Pension Fund Association released "Working Guidelines for the Exercise of Voting Rights"

2003

The Pension Fund Association published corporate governance criteria and started to execute voting
rights on in-house investment

20

Table 4
Execution of Voting Rights in Japan(2001 April-June; 2002, April-June)

2001

2002

Number of Proposals
Total
Agree
Disagree
Carte blanche
Abstain
Total
Agree
Disagree
Carte blanche
Abstain
Proposals from Shareholders
Total
Agree
Disagree
Carte blanche
Abstain

21206
10772
358
10037
39
34536
31499
1160
522
1355

%
100.0
50.8
1.7
47.3
0.2
100.0
91.2
3.4
1.5
3.9

1041
38
764
199
40

100.0
3.7
73.4
19.1
3.8

Source: Ministry of Health, Labor and Welfare
Notes: Excluding package reaction to a company

21

Table 5
Execution of Voting Rights by Corporate Pension Funds(2002, July-March)

Number of Proposals
Total
Agree
Disagree
Carte blanche
Abstain
Number of companies

970
732
234
0
0
212

%
100.0
75.5
24.1
0.0
0.0

Source: Pension Fund Federation
Notes: In-house investments by Pension Fund Association

22