What are the Regulations for "Large Companies" in Japan and What Should You Note if Applicable?

The Japanese Companies Act (Kaisha-hō) employs a system of differentiated regulation, tailoring legal requirements to the specific characteristics of a company. Beyond the distinction between public and non-public companies, another critical categorization is based on corporate size, specifically identifying what constitutes a "Large Company" (taigaisha). Falling into this category triggers a distinct set of obligations, primarily concerning accounting audits and corporate governance structures. For U.S. businesses operating in Japan, particularly those whose subsidiaries are experiencing growth, understanding the definition of a Large Company and the ensuing regulatory implications is vital for ensuring compliance and sound corporate management.

Defining a "Large Company" (Taigaisha) under the Japanese Companies Act

The Companies Act provides a clear, quantitative definition for a Large Company. According to Article 2, item 6, a Kabushiki Kaisha (K.K., or joint-stock company) is classified as a Large Company if it meets either of the following criteria based on its balance sheet for the most recent business year:

1. Stated Capital Test: Its stated capital (shihonkin) is JPY 500 million or more; OR
2. Total Liabilities Test: The total amount of its liabilities (fusai) is JPY 200 billion or more.

It is important to note that these are alternative tests; meeting just one is sufficient to be categorized as a Large Company.

Rationale for the Criteria

The choice of stated capital and total liabilities as the defining metrics reflects an intention to gauge the scale of a company's financial operations and its potential impact on a wider range of stakeholders.
Stated capital generally represents the cumulative amount of capital raised through share issuances. Total liabilities indicate the extent of a company's borrowings and other obligations. Together, these figures provide an indication of the financial resources managed by the company and, by extension, its economic footprint.

Other potential metrics for size, such as annual revenue or number of employees, were not adopted for this primary classification. Revenue can be highly volatile from year to year, potentially causing a company to frequently switch between classifications. The number of employees presents definitional challenges, such as whether to include non-regular staff, which can vary significantly across industries. Thus, the more stable balance sheet figures of capital and liabilities were chosen as the primary determinants.

The term "final business year" (saishū jigyō nendo) refers to the most recently concluded fiscal period for which financial statements have been finalized and approved. This ensures that the classification is based on relatively current and verified financial data.

Key Regulations Applicable to Large Companies

Once a K.K. meets the definition of a Large Company, several specific regulations come into play, significantly impacting its auditing and governance framework.

1. Mandatory Appointment of an External Auditor (Kaikei Kansanin)

The most significant requirement for Large Companies is the mandatory appointment of an external auditor (kaikei kansanin) (Companies Act, Article 328, paragraphs 1 and 2). This external auditor must be a certified public accountant (CPA) or an audit firm (kansa hōjin).

• Rationale:
  • Increased Stakeholder Interest: Large Companies, due to their scale, typically have a larger number of stakeholders, including creditors, investors, and employees. These stakeholders have a heightened interest in the company's financial health and performance.
  • Ensuring Reliability of Financial Information: To protect these diverse interests, the law mandates that the financial statements of Large Companies be audited by independent accounting professionals. This external audit provides an objective verification of the company's financial reporting, enhancing its credibility and transparency.
  • Complexity of Financials and Capacity to Bear Costs: The financial affairs of Large Companies are often complex. An audit by qualified professionals is deemed necessary to ensure accuracy. It is also presumed that Large Companies have the financial capacity to bear the costs associated with a professional audit.

2. Impact on Corporate Governance Structure (Organ Design)

The requirement to appoint an external auditor has direct consequences for the internal governance structure of a Large Company.

• Mandatory Appointment of Statutory Auditor(s) (Kansayaku): If a company appoints an external auditor (which Large Companies must do), it is also generally required to appoint one or more statutory auditors (kansayaku), unless it is a "Company with an Audit and Supervisory Committee" or a "Company with a Nominating Committee, etc." (Companies Act, Article 327, paragraph 3).
  • Rationale: This requirement aims to ensure the independence of the external auditor and to prevent collusion between the directors (management) and the external auditor. The statutory auditor(s) act as an internal check, overseeing the audit process and the duties of both directors and the external auditor.
• Mandatory Audit & Supervisory Board (Kansayaku-kai) for Large Public Companies: If a Large Company is also a public company (kōkai kaisha – meaning its shares are not all subject to transfer restrictions), it faces an additional governance requirement: it must generally establish an Audit & Supervisory Board (kansayaku-kai), unless it is a Company with an Audit and Supervisory Committee or a Company with a Nominating Committee, etc. (Companies Act, Article 328, paragraph 1).
  • An Audit & Supervisory Board is a collective body composed of at least three statutory auditors, the majority of whom must be outside statutory auditors (shagai-kansayaku)—individuals who meet specific independence criteria from the company's management.
  • Rationale: For companies that are both large in scale and have broadly held shares (public companies), a more robust and independent oversight mechanism is considered necessary. The Audit & Supervisory Board, with its emphasis on outside members, is designed to provide a higher degree of independent monitoring of management and the audit function.

3. Financial Reporting and Disclosure

While the core financial statements are required for all K.K.s, Large Companies face heightened expectations and, in some cases, specific obligations regarding financial reporting.

• Consolidated Financial Statements: Large Companies that are also subject to the reporting requirements of the Financial Instruments and Exchange Act (typically listed companies and their parents) are required to prepare consolidated financial statements (renketsu keisan shorui) (Companies Act, Article 444, paragraph 3). This reflects the economic reality that many Large Companies operate as part of a corporate group.
• Internal Control Systems: Large Companies are mandatorily required to establish a basic framework for their internal control systems by a resolution of the board of directors (or by directors if no board exists) (Companies Act, Article 348, paragraph 4; Article 362, paragraph 5). This includes systems to ensure the appropriateness of operations for the entire corporate group, including subsidiaries. While all K.K.s are encouraged to have sound internal controls, the explicit legal mandate for establishing the "basic policies" of such systems is placed on Large Companies.

Interaction with Other Company Classifications (e.g., Public Companies)

It's crucial to understand that the "Large Company" classification is distinct from, though often overlaps with, the "public company" / "non-public company" classification.

• A company can be a Large Company but still a non-public company (e.g., a large, family-owned business with transfer restrictions on all its shares). Such a company would be required to appoint an external auditor but might not need an Audit & Supervisory Board if it's not also a public company.
• Conversely, a company can be a public company (e.g., a newly listed smaller venture) but not yet meet the criteria for a Large Company.
• The most stringent governance requirements generally apply to companies that are both Large Companies and public companies, often necessitating a board of directors, an Audit & Supervisory Board (with a majority of outside statutory auditors), and an external auditor.

Implications for U.S. Companies with Japanese Subsidiaries

For U.S. corporations with subsidiaries in Japan, the "Large Company" regulations have several practical implications:

• Monitoring Growth and Thresholds: It is essential to monitor the Japanese subsidiary's financial status (stated capital and total liabilities) to anticipate when it might cross the thresholds to become a Large Company. This transition is not based on group-level consolidated figures of the U.S. parent but on the individual Japanese subsidiary's balance sheet.
• Increased Compliance Burdens and Costs: Upon becoming a Large Company, the subsidiary will face new mandatory obligations, most notably the appointment of an external auditor. This entails selection processes, audit fees, and the internal resources needed to support the audit. If the subsidiary is also a public company, the requirement for an Audit & Supervisory Board adds further complexity to its governance.
• Adjustments to Governance and Internal Controls: The parent company may need to work with the subsidiary to adjust its governance structure to meet the requirements (e.g., finding and appointing suitable statutory auditors, potentially outside ones). The mandatory establishment of basic policies for internal control systems will also require attention and resources.
• Enhanced Parent Company Oversight: While the subsidiary itself bears the direct legal obligations, the U.S. parent company, as part of its own governance and risk management, will need to ensure that its Japanese subsidiary is compliant. This might involve more detailed reporting from the subsidiary and closer oversight of its financial and governance matters.

Conclusion

The "Large Company" classification under the Japanese Companies Act represents a significant regulatory threshold, imposing specific duties related to financial auditing and corporate governance. These regulations are designed to enhance transparency, accountability, and the protection of a broader range of stakeholders commensurate with the company's increased economic scale and societal impact. For U.S. companies operating or investing in Japan, particularly those with growing subsidiaries, a proactive understanding of what defines a Large Company and the specific legal and operational adjustments required upon reaching this status is crucial for sustained, compliant, and successful business operations in the Japanese market. Early awareness and preparation can help mitigate compliance risks and ensure a smooth transition into this heightened regulatory environment.