What is a "Company with Audit and Supervisory Committee" in Japan? How Does It Differ from a Company with an Audit & Supervisory Board?

Japanese Attorney at Law - Bengoshi L.L.

• 8 min read

As part of its ongoing efforts to enhance corporate governance and provide flexibility in structuring oversight mechanisms, the Japanese Companies Act (Kaisha-hō) introduced the "Company with Audit and Supervisory Committee" (Kansa tō Iinkai Setchi Kaisha) model in its 2014 amendment. This structure offers an alternative to the traditional board-plus-statutory-auditor (kansayaku) system and the "Company with Nominating Committee, etc." model. It aims to strengthen the board's oversight function by integrating audit responsibilities directly into a board committee composed primarily of outside directors, while potentially allowing for greater delegation of business execution to management. This article explores the features of the Company with Audit and Supervisory Committee, its key characteristics, and how it compares to the more traditional Audit & Supervisory Board (Kansayaku-kai) structure.

Overview and Rationale of the "Company with Audit and Supervisory Committee" Model

The introduction of the Company with Audit and Supervisory Committee was driven by a desire to offer Japanese companies, particularly listed ones, another viable option for robust corporate governance that aligns more closely with certain international practices, while still being adaptable to the Japanese context.

Legislative Intent and Objectives:

  • Strengthening Board Oversight: A core objective was to enhance the supervisory function of the board of directors by making audit and oversight an integral part of the board's own structure and responsibility, rather than relying on a separate body of statutory auditors.
  • Leveraging Outside Directors: The model places significant emphasis on the role of outside directors, who must constitute a majority of the Audit and Supervisory Committee. This is intended to bring greater independence and objectivity to the audit and oversight process.
  • Facilitating Agile Business Execution: By potentially allowing for greater delegation of important business execution decisions from the board to individual directors or executive officers (under certain conditions), the model aims to enable more nimble management while maintaining strong oversight.
  • Providing an Alternative to the "Company with Nominating Committee, etc.": While the "Company with Nominating Committee, etc." model also emphasizes board oversight and outside directors, its mandatory three-committee structure (nominating, audit, compensation) was perceived by some as too rigid or complex. The Company with Audit and Supervisory Committee offers a somewhat simpler committee-based alternative focused on audit and supervision.

Key Structural Features:

  1. Audit and Supervisory Committee (Kansa tō Iinkai): This is the defining feature. It is a committee of the board of directors, responsible for auditing the execution of duties by directors and executive officers, and for preparing audit reports.
  2. Composition of the Committee: The committee must consist of three or more directors, and a majority of its members must be outside directors (shagai torishimariyaku).
  3. Members are Directors: Unlike statutory auditors (kansayaku), the members of the Audit and Supervisory Committee are themselves directors, elected by shareholders to serve on this specific committee.
  4. No Statutory Auditors (Kansayaku): Companies adopting this model do not appoint statutory auditors or establish an Audit & Supervisory Board.
  5. Mandatory External Auditor: These companies must appoint an external accounting auditor (kaikei kansanin).

A company can opt to become a Company with Audit and Supervisory Committee by a resolution of the shareholders' meeting amending its articles of incorporation (teikan).

The Board of Directors in a Company with Audit and Supervisory Committee

The board of directors retains its ultimate responsibility for overseeing management and setting basic corporate policy, but its operational dynamics and scope of delegation can differ from other K.K. models.

Composition and Role:

The board includes directors who are members of the Audit and Supervisory Committee and other directors (referred to as non-Audit and Supervisory Committee Member Directors).
The board's primary functions include:

  • Determining basic management policies.
  • Supervising the execution of duties by directors (including Audit and Supervisory Committee members in their capacity as directors) and executive officers (if appointed).
  • Making decisions on important business execution matters that are not delegated.

Delegation of Business Execution (Article 399-13):

A significant feature of this model is the potential for the board of directors to delegate a substantial portion of its authority regarding important business execution decisions to individual directors (typically representative directors or other executive directors).

  • Conditions for Broad Delegation: Such broad delegation is permissible if:
    1. A majority of the company's directors are outside directors; OR
    2. The articles of incorporation explicitly provide for such delegation (Article 399-13, paragraph 6).
  • Non-Delegable Matters: Even with such delegation, certain fundamental matters remain reserved for the board's decision, similar to those in a Company with Nominating Committee, etc. (e.g., basic management policy, establishment of internal controls, matters requiring shareholder resolution proposals).
  • Impact: This potential for broader delegation aims to allow for more agile and efficient management by empowering executive directors, while the board, particularly through its Audit and Supervisory Committee, focuses more intensely on oversight.

The Audit and Supervisory Committee (Kansa tō Iinkai)

This committee is the heart of the audit and oversight function in this governance model.

Composition (Article 331, paragraph 6; Article 335, paragraph 2)

  • Number of Members: Must consist of three or more directors.
  • Majority Outside Directors: The majority of the members must be outside directors. This is crucial for ensuring the committee's independence and objectivity.
  • Full-time Member(s): The committee may (and often practically needs to) select one or more full-time members from among its ranks to facilitate its day-to-day audit activities.
  • Non-Executive Status of Members: Directors who are Audit and Supervisory Committee members cannot concurrently serve as executive directors (gyōmu shikkō torishimariyaku – directors responsible for executing business), or as directors or employees of the company's subsidiaries who are involved in business execution (Article 331, paragraph 6, applying mutatis mutandis Article 331, paragraph 3, item 2 and 3). This restriction aims to prevent conflicts of interest and maintain their focus on oversight.

Appointment and Term of Office of Committee Member Directors

  • Appointment: Directors who are to be Audit and Supervisory Committee members are elected by the shareholders' meeting separately from other directors (Article 329, paragraph 2; Article 341). Their remuneration is also determined separately from other directors (Article 361, paragraph 2).
  • Term of Office: The term of office for directors who are Audit and Supervisory Committee members is two years (Article 332, paragraph 4). This is shorter than the four-year term for traditional statutory auditors but longer than the one-year term for other directors in this governance model (whose term is one year under Article 332, paragraph 3). The term cannot be shortened by the articles of incorporation.

Powers and Duties (Article 399-2 et seq.)

The Audit and Supervisory Committee is vested with extensive powers to fulfill its audit and supervisory responsibilities:

  1. Audit of Directors and Executive Officers: Auditing the execution of duties by directors (who are not Audit and Supervisory Committee members) and executive officers (if any). This includes audits for both legal compliance and the appropriateness/reasonableness of business decisions.
  2. Preparation of Audit Reports: The committee prepares an audit report to be submitted to the shareholders' meeting.
  3. Oversight of External Auditor:
    • Determining the content of proposals to be submitted to the shareholders' meeting regarding the appointment, dismissal, or non-reappointment of the external accounting auditor (Article 399-2, paragraph 3, item 1; Article 344, paragraph 1).
    • Consenting to the remuneration of the external accounting auditor (Article 399).
  4. Investigative Powers: Similar to statutory auditors, the committee and its designated members have broad powers to investigate the company's and its subsidiaries' business operations and financial condition, and to request reports from directors, employees, and subsidiaries (Article 399-3).
  5. Reporting to the Board: Duty to report any misconduct or material violations of law/articles by directors to the board of directors (Article 399-4).
  6. Demanding Cessation of Director's Acts (Injunction): If a director is engaging in acts that violate laws or the articles of incorporation and there is a risk of substantial harm to the company, the Audit and Supervisory Committee can demand cessation of such acts, and if necessary, seek a court injunction (Article 399-6, applying mutatis mutandis Article 360, which is analogous to the kansayaku's injunction power).
  7. Representing the Company in Actions Against Directors: In lawsuits between the company and its non-Audit and Supervisory Committee Member Directors, a director selected by the Audit and Supervisory Committee represents the company (Article 399-7, applying mutatis mutandis Article 353 and Article 364).
  8. Stating Opinions on Director Appointment/Dismissal/Remuneration: The committee (or a member designated by it) can state its opinion at the shareholders' meeting regarding the appointment, dismissal, or remuneration of directors who are not Audit and Supervisory Committee members (Article 399-2, paragraph 3, item 2; Article 342-2, paragraph 4; Article 361, paragraph 6). This gives the committee a voice in shaping the composition and incentives of the executive team.

Operation

The Audit and Supervisory Committee operates through meetings, and its decisions are typically made by majority vote of the members present, with specific quorum requirements. Each member has one vote.

How Does It Differ from a Company with an Audit & Supervisory Board (Kansayaku-kai)?

While both systems aim to provide oversight, there are fundamental structural and operational differences:

  1. Nature of Auditors:
    • Audit & Supervisory Board System: Composed of statutory auditors (kansayaku) who are officers of the company but are not directors. They form an independent organ separate from the board of directors.
    • Audit and Supervisory Committee System: Composed of directors who are specifically elected by shareholders to serve on this committee. The audit function is integrated into the board structure.
  2. Independence from Management:
    • Kansayaku: Enjoy a high degree of formal independence due to their separate status, longer terms, and higher thresholds for dismissal.
    • Audit and Supervisory Committee Members: While a majority must be outside directors, they are still directors and part of the board's collective decision-making on matters not specifically delegated to the committee. Their independence relies heavily on the quality and resolve of the outside directors and the overall board culture.
  3. Scope of Board Authority in Business Execution:
    • Audit & Supervisory Board System: The board of directors itself is more directly involved in making important business execution decisions, with fewer matters typically delegable to individual directors compared to the potential for delegation in an Audit and Supervisory Committee company.
    • Audit and Supervisory Committee System: As mentioned, under certain conditions, the board can delegate a broader range of business execution decisions to executive directors, aiming for more agile management.
  4. Directorial Powers of Auditors:
    • Kansayaku: Have no directorial powers; their role is purely audit and oversight.
    • Audit and Supervisory Committee Members: Are directors and thus participate in board deliberations and vote on board resolutions (except potentially on matters where they have a direct conflict due to their committee role, though this is less common than for executive directors). They contribute to the board's decision-making beyond just audit matters.
  5. Simplicity and Perceived Effectiveness:
    • The Audit and Supervisory Committee model is sometimes seen as potentially simpler to operate than managing two entirely separate top-level organs (Board and Audit & Supervisory Board).
    • Proponents argue that integrating audit into the board can lead to more informed and effective board oversight, as audit findings are directly channeled into board discussions by fellow directors.
    • Critics might argue that the formal separation of kansayaku provides a stronger guarantee of independent scrutiny compared to a committee whose members are also part of the board they are overseeing.

Since its introduction in 2015, the Company with Audit and Supervisory Committee model has seen a relatively faster rate of adoption among listed Japanese companies compared to the Company with Nominating Committee, etc. This suggests that many companies find its balance of strengthened board oversight (through a majority-outside-director committee) and potential for agile management appealing.

Conclusion

The "Company with Audit and Supervisory Committee" provides a distinct and increasingly popular governance alternative in Japan. By embedding the audit function within a board committee predominantly composed of outside directors, it seeks to enhance board-level oversight while potentially allowing for more streamlined decision-making by executive management. It differs fundamentally from the traditional Kansayaku system by making auditors (in this case, committee members) part of the board itself, and it offers a less complex committee structure than the "Company with Nominating Committee, etc." model. For U.S. companies and investors analyzing Japanese corporate governance, understanding the nuances of this model—particularly the enhanced role of outside directors on the Audit and Supervisory Committee and the potential for broader delegation of executive powers by the board—is crucial for evaluating the effectiveness of a company's oversight mechanisms and its overall governance posture.