M&A in Japan: Key Corporate Governance Considerations for US Acquirers or Targets

Japanese Attorney at Law - Bengoshi L.L.

• 9 min read

Mergers and acquisitions (M&A) involving Japanese companies, both inbound by foreign entities and domestic consolidation, have become increasingly prominent. For US acquirers eyeing Japanese targets, or US companies finding their Japanese counterparts or subsidiaries involved in M&A, navigating these transactions successfully requires a deep understanding of Japan's unique corporate governance landscape. Robust governance practices are not just a matter of compliance; they are critical to ensuring fair value, managing risks, and achieving strategic objectives for all parties involved.

M&A transactions in Japan are primarily governed by the Companies Act (会社法 - Kaisha-hō), with additional regulations from the Financial Instruments and Exchange Act (FIEA) (金融商品取引法 - Kin'yū Shōhin Torihiki-hō) for listed companies (e.g., tender offer rules, disclosure requirements), and the Antimonopoly Act (独占禁止法 - Dokusen Kinshi-hō).

Beyond these statutes, Japan's Corporate Governance Code (CG Code) and Stewardship Code significantly influence board conduct and shareholder engagement during M&A:

  • CG Code: Emphasizes the board's fiduciary duty to act in the best interests of the company and common interests of shareholders, the importance of independent outside directors in overseeing material transactions (including M&A), and the need for transparency in decision-making.
  • Stewardship Code: Encourages institutional investors to engage with investee companies on significant matters, including M&A proposals, to ensure they contribute to sustainable corporate value.

Common M&A structures in Japan include statutory mergers (合併 - gappei), share acquisitions (株式取得 - kabushiki shutoku, often via tender offers - 株式公開買付け - kabushiki kōkai kaitsuke for listed companies), business transfers (事業譲渡 - jigyō jōto), and share exchanges (株式交換 - kabushiki kōkan). Each structure has specific approval requirements, typically involving both board resolutions and, for significant transactions, shareholder approval.

II. Key Governance Considerations for the Target Company's Board

When a Japanese company becomes an M&A target, its board of directors faces critical governance responsibilities.

A. Fiduciary Duties of Directors:
Directors of the target company must act in accordance with their fundamental fiduciary duties:

  • Duty of Care (善管注意義務 - zenkan chūi gimu): They must diligently evaluate any M&A proposal, gather sufficient information, and make informed decisions. This includes assessing the strategic rationale, financial fairness, and potential risks and benefits of the transaction.
  • Duty of Loyalty (忠実義務 - chūjitsu gimu): They must act in the best interests of the company and its shareholders as a whole, avoiding conflicts of interest. The primary goal is typically considered to be the maximization of corporate and shareholder value.

B. Role of Independent Outside Directors:
Independent outside directors (shagai torishimariyaku - 社外取締役) are expected to play a pivotal role in M&A situations:

  • Objective Evaluation: Providing an independent perspective on the merits of a proposal, free from potential management bias.
  • Managing Conflicts of Interest: Their oversight is particularly crucial in management buyouts (MBOs), transactions involving controlling shareholders, or situations where executive directors might have personal interests at stake.
  • Ensuring Procedural Fairness: Overseeing the process to ensure it is fair, transparent, and designed to achieve the best possible outcome for all shareholders.
  • The CG Code reinforces their importance in supervising such material transactions.

C. Information Gathering, Deliberation, and Professional Advice:
The board must ensure it is adequately informed. This often involves:

  • Thorough due diligence on the offer and the offeror (in the case of a friendly bid).
  • Engaging independent financial advisors (IFAs) to provide valuation analyses and fairness opinions on the financial terms of the proposal.
  • Seeking advice from independent legal counsel on fiduciary duties, legal compliance, and procedural matters.
    The board's deliberations should be robust, with active participation from all directors, especially independent ones.

D. Ensuring Fairness of Price and Process:

  • Rationality and Appropriateness: The board must assess the rationality of the M&A's purpose and the appropriateness of the proposed methods and terms.
  • Fair Price Determination: A key responsibility is to strive for a fair price for shareholders. This involves careful consideration of valuation analyses, market conditions, and the company's standalone prospects.
  • Fairness Opinions: Obtaining a fairness opinion from an independent financial advisor is a common practice, especially for significant transactions, to support the board's conclusion that the terms are fair from a financial point of view to the company and its shareholders.

E. Responding to Different Types of Bids:

  1. Friendly Transactions: In negotiated deals, the board's focus is on due diligence, negotiation of terms, and ensuring a fair process leading to a recommendation to shareholders.
  2. Unsolicited/Hostile Bids and Takeover Defense Measures (敵対的買収に対する防衛策 - Tekitai-teki Baishū ni Taisuru Bōeisaku):
    • The board has a duty to carefully evaluate any bona fide offer, even if unsolicited.
    • Adoption of Defense Measures: Japanese companies can adopt various takeover defense measures (e.g., poison pills or rights plans). However, such measures are subject to scrutiny to ensure they are adopted and triggered for proper corporate purposes (i.e., protecting or enhancing corporate/shareholder value) and not primarily for management entrenchment.
    • Shareholder Approval and Disclosure: The introduction of many potent defense measures often requires shareholder approval, or at least a mechanism for shareholders to abolish them (sunset clauses, shareholder votes). Full disclosure of the terms and conditions of defense measures is critical.
    • Role of Independent Directors/Special Committees: When considering or activating defense measures, it is best practice, and often expected by investors and under guidelines, for the decision to be made with significant involvement from independent outside directors, or by a special committee composed mainly of such directors, to ensure objectivity.
    • "METI Guidelines" (Fair M&A Guidelines): The Ministry of Economy, Trade and Industry (METI) first published "Fair M&A Guidelines" (公正なM&Aの在り方に関する指針 - Kōsei na M&A no Arikata ni Kansuru Shishin) in June 2019, which were subsequently revised (e.g., August 2023, with further principles for MBOs and acquisitions by controlling shareholders). These non-binding guidelines aim to enhance the fairness and transparency of M&A processes, including principles related to the board's conduct in takeover situations, the appropriate use of defense measures, and ensuring minority shareholder protection. They emphasize that the board should focus on enhancing corporate value and shareholders’ common interests.

F. Management Buyouts (MBOs) and Transactions with Controlling Shareholders:
These situations inherently involve significant conflicts of interest, demanding heightened governance measures:

  • Independent Review: It is considered best practice, and strongly encouraged by the CG Code and METI Guidelines, for the target board to establish a special committee composed of independent outside directors (or other independent experts) to negotiate terms, evaluate the fairness of the proposal, and make recommendations to the full board.
  • Fair Price for Minority Shareholders: Ensuring a fair price and process for minority shareholders is paramount. This includes obtaining independent valuations and fairness opinions.
  • Squeeze-out Procedures (スクイーズ・アウト - Sukuīzu Auto): If the acquirer (e.g., management in an MBO, or a parent company) aims to acquire 100% ownership, Japanese law provides several mechanisms for squeezing out remaining minority shareholders (e.g., through a demand for share cash-out by a special controlling shareholder holding 90% or more, or through a share consolidation combined with a cash payment for fractional shares).
    • Minority Protection in Squeeze-outs: Minority shareholders have rights, such as the right to demand that the company purchase their shares at a fair price (appraisal rights - 株式買取請求権 - kabushiki kaitori seikyūken) if they dissent from certain M&A transactions or are being squeezed out. They can also petition the court to determine a fair price if they are dissatisfied with the offered price. The METI Guidelines emphasize the importance of ensuring fairness to minority shareholders in these processes.

III. Key Governance Considerations for the Acquiring Company (Especially US Acquirers)

For US companies looking to acquire Japanese entities, several governance considerations are crucial:

A. Governance Due Diligence on the Japanese Target:
This goes beyond financial and legal due diligence and should include a thorough assessment of:

  • The target's current board structure (e.g., company with statutory auditors, committee-based system) and its actual functioning.
  • The composition of the target's board, the independence and qualifications of its outside directors and statutory auditors.
  • The target's corporate governance policies, code of ethics, and compliance history.
  • The existence and nature of any significant policy shareholdings (cross-shareholdings).
  • Any existing shareholder agreements or relationships with major shareholders that could impact the transaction or post-merger integration.
  • The quality of internal controls and risk management systems.
  • Past related-party transactions and potential conflicts of interest.

B. Navigating Japanese Board Processes and Culture:

  • Decision-Making Dynamics: While becoming more aligned with global practices, Japanese board decision-making can sometimes involve a greater emphasis on consensus-building (nemawashi - 根回し, or informal groundwork) before formal board meetings. Understanding these dynamics can be important for effective negotiation and interaction.
  • Engagement with Target's Board: Building a relationship with the target's board, particularly its independent directors, can be beneficial, especially in friendly transactions.
  • Disclosure and Transparency: Acquirers should be prepared to provide sufficient information about their strategic intentions for the target to facilitate the target board's evaluation.

C. Post-Merger Integration (PMI) – Governance Aspects:

  • Board and Management Structure of the New Entity: Careful planning is needed for the board composition, committee structure (if any), and management team of the acquired or merged entity, respecting local legal requirements and aiming for effective governance.
  • Integration of Corporate Cultures: Merging different corporate cultures and governance philosophies can be a significant challenge and requires careful management.
  • Employee Relations: In Japan, employee interests are often a significant consideration for boards (as stakeholders). Acquirers need to be mindful of how the M&A will impact employees and engage appropriately, as this can indirectly affect board-level support and long-term success.

IV. Shareholder Approval and Engagement in M&A

Shareholder involvement is a key aspect of M&A governance.

  • Shareholder Approval Thresholds: Many significant M&A transactions, such as statutory mergers, demergers, share exchanges, and substantial business transfers, require approval by a special resolution of the shareholders' meeting of the target company (and sometimes the acquirer). A special resolution typically requires a quorum of shareholders holding a majority of voting rights and approval by at least two-thirds of the votes cast.
  • Disclosure to Shareholders: Companies involved in material M&A transactions have extensive disclosure obligations under both the Companies Act and FIEA (for listed companies). This includes providing shareholders with detailed information about the transaction, its rationale, terms, and potential impact to enable them to make informed voting decisions.
  • Engagement with Major Shareholders: Reflecting the principles of the CG Code and the Stewardship Code, proactive engagement with major institutional investors and other significant shareholders by both the target and acquirer regarding the strategic rationale and terms of major M&A deals is increasingly common and expected. This dialogue can help secure shareholder support and address concerns early.

V. The Role of Independent Committees and Advisors

The use of independent bodies and external advisors is crucial for ensuring fairness and robust decision-making in M&A.

  • Special Committees: As mentioned, special committees composed mainly or exclusively of independent outside directors are increasingly used by target boards to evaluate M&A proposals, particularly in MBOs or transactions involving controlling shareholders, to mitigate conflicts of interest and enhance the credibility of the board's decision.
  • Independent Financial Advisors (IFAs): Both target and acquiring companies often retain IFAs to provide financial analysis, valuation services, and fairness opinions. The independence and qualifications of these advisors are important.
  • Independent Legal Counsel: Engaging experienced legal counsel specializing in Japanese M&A and corporate governance is essential for navigating the complex legal and regulatory landscape.

The M&A governance environment in Japan continues to evolve:

  • Increased Emphasis on Board Independence: There is a heightened focus on the role of independent outside directors in scrutinizing and approving M&A deals.
  • Shareholder Activism: Shareholder activism in Japan is on the rise, with activists sometimes challenging M&A terms, opposing deals they deem unfavorable, or pushing for strategic alternatives.
  • Evolution of Takeover Defenses: While still permitted, the use of takeover defense measures is subject to increasing scrutiny regarding their alignment with shareholder interests, with a trend towards requiring more direct shareholder approval or endorsement.
  • METI's Fair M&A Guidelines: These guidelines are playing an influential role in shaping best practices for boards, encouraging more robust processes to ensure fairness, especially in MBOs and acquisitions by controlling shareholders. They emphasize the importance of independent special committees, obtaining fairness opinions from independent third parties, and ensuring that minority shareholders are treated fairly. The guidelines also touch upon best practices for acquirers.
  • Focus on "Corporate Value" and "Shareholders' Common Interests": There's a strong narrative that M&A decisions, including the adoption or triggering of defense measures, must be demonstrably aimed at enhancing overall corporate value and the common interests of all shareholders, not just benefiting incumbent management or specific stakeholders.

Conclusion

Mergers and acquisitions in Japan are complex undertakings where corporate governance considerations play a pivotal role for both acquiring and target companies. The Japanese framework, blending Companies Act requirements with the principles of the Corporate Governance Code and evolving best practices like the METI Fair M&A Guidelines, emphasizes the fiduciary duties of directors, the critical oversight function of independent board members and committees, and the importance of fair processes and prices, particularly for minority shareholders. For US companies and professionals involved in Japanese M&A, a thorough understanding of these governance dynamics, coupled with diligent due diligence and expert advice, is indispensable for navigating transactions successfully and achieving desired strategic and financial outcomes.