What is a "Company with Nominating Committee, etc." in Japan? Differences from U.S. Governance Models?

Japanese Attorney at Law - Bengoshi L.L.

• 8 min read

The Japanese Companies Act (Kaisha-hō) offers several distinct corporate governance structures for Kabushiki Kaisha (K.K., or joint-stock companies), allowing companies to choose a model that best suits their needs and objectives. One such sophisticated option is the "Company with Nominating Committee, etc." (Shimei Iinkai tō Setchi Kaisha). This model, originally introduced in 2003 as the "Company with Committees" (Iinkai tō Setchi Kaisha) and subsequently refined, represents a significant departure from Japan's traditional board-plus-statutory-auditor system. It emphasizes a clearer separation between the board's oversight functions and the executive management's operational responsibilities, placing a strong emphasis on the role of outside directors within key committees. While it bears similarities to committee-centric governance structures common in U.S. listed corporations, there are uniquely Japanese legal features and practical nuances. This article explores the structure, rationale, and key characteristics of this governance model and compares it with common U.S. approaches.

Overview and Rationale of the "Company with Nominating Committee, etc." Model

The "Company with Nominating Committee, etc." was introduced into Japanese corporate law with several key objectives in mind:

  • Enhancing Management Transparency and Fairness: By separating oversight from execution and involving outside directors in critical decisions regarding nominations, audits, and compensation, the system aims to increase the transparency and objectivity of corporate governance.
  • Aligning with International Governance Standards: The model was, in part, a response to calls for Japanese corporate governance to align more closely with practices in other major economies, particularly the U.S., to attract foreign investment and improve corporate accountability.
  • Strengthening Board Oversight through Outside Directors: A central tenet is the empowerment of outside directors to play a more substantial role in supervising management.

Key Structural Features:

  1. Board of Directors Focused on Oversight: The board of directors (torishimariyaku-kai) primarily focuses on determining basic management policies and supervising the execution of duties by executive officers and directors.
  2. Delegation to Executive Officers: Significant authority for business execution is delegated to executive officers (shikkō-yaku).
  3. Three Statutory Committees: The board must establish three mandatory committees: a Nominating Committee, an Audit Committee, and a Compensation Committee. A majority of the members of each committee must be outside directors.
  4. No Statutory Auditors (Kansayaku): Companies adopting this model do not have statutory auditors or an Audit & Supervisory Board; their functions are subsumed by the Audit Committee and the board's oversight.
  5. Mandatory External Auditor: These companies must appoint an external accounting auditor (kaikei kansanin).

Adoption Status:

Initially, only "Large Companies" could adopt this structure. While this direct size restriction was later removed, the complexity and nature of the model mean it is still predominantly considered and adopted by larger, often publicly listed, companies. However, despite its introduction over two decades ago, the actual number of Japanese companies that have transitioned to this model remains relatively limited. Several factors contribute to this, including the deep-rooted familiarity with the traditional Kansayaku system and the initial challenges in sourcing a sufficient number of qualified outside directors.

The Board of Directors in a Company with Nominating Committee, etc.

While still a central organ, the role and powers of the board of directors in this model are distinct from those in a traditional K.K. with statutory auditors.

Composition:

The board is composed of directors, some of whom will also serve on the statutory committees. The number of directors must be sufficient to populate the three committees, each requiring at least three members.

Primary Role: Oversight and Basic Policy Setting (Article 416, paragraph 1)

The board's principal responsibilities include:

  1. Determining the company's basic management policies.
  2. Supervising the execution of duties by executive officers and directors.
  3. Appointing and dismissing executive officers (though the Nominating Committee plays a key role in proposals for directors, and the Audit Committee may need to consent to certain executive officer dismissals or non-reappointments under specific circumstances if such powers are delegated to it).

Delegation of Business Execution (Article 416, paragraph 4)

A defining feature of this model is the board's ability to delegate substantial authority for business execution decisions to the executive officers. This delegation can be much broader than in a traditional K.K. with a board of directors, where many "important business execution" matters are non-delegable by the board.
However, certain fundamental matters remain exclusively within the board's purview and cannot be delegated. These typically include:

  • Matters that, by law, require a resolution of the shareholders' meeting (e.g., amendments to the articles of incorporation, mergers, dividends – the board resolves to propose these to shareholders).
  • Establishment of internal control systems.
  • Other matters specifically reserved for the board by the articles of incorporation or by law.

The board retains the ultimate responsibility for overseeing the executive officers to whom it delegates power.

Relationship with Committees:

The decisions made by the statutory committees within their mandated scope (e.g., a Nominating Committee's decision on a director nomination proposal, an Audit Committee's audit report, a Compensation Committee's decision on executive remuneration) are generally binding and cannot be overturned by the board of directors. The board acts based on the committees' decisions or reports in these areas.

The Three Statutory Committees (Sankai)

The establishment of these three committees, each with a majority of outside directors, is the hallmark of this governance structure.

General Requirements for Committees (Article 400)

  • Each committee must consist of three or more directors.
  • The majority of members of each committee must be outside directors. This is a critical requirement designed to ensure objectivity and independence in the committee's deliberations and decisions.

A. Nominating Committee (Shimei Iinkai) (Article 404, paragraph 1)

  • Functions: The Nominating Committee is responsible for determining the content of proposals to be submitted to the shareholders' meeting concerning the appointment and dismissal of directors and accounting advisors (kaikei san-yo, if any). It also has a significant say in the selection of executive officers, often by making recommendations to the full board.
  • Rationale: To enhance the transparency, objectivity, and fairness of the director and executive nomination and dismissal processes, moving away from selections potentially dominated by incumbent management.

B. Audit Committee (Kansa Iinkai) (Article 404, paragraph 2)

  • Functions: The Audit Committee assumes the primary audit and oversight responsibilities within the company, effectively replacing the role of statutory auditors. Its key functions include:
    1. Auditing the execution of duties by executive officers and directors, including both legal compliance and the appropriateness of business decisions.
    2. Preparing audit reports.
    3. Determining the content of proposals to be submitted to the shareholders' meeting concerning the appointment, dismissal, or non-reappointment of the external accounting auditor.
  • Powers: The Audit Committee is vested with extensive investigative powers, similar to those of statutory auditors, including the right to investigate the company's business and assets, request reports from executive officers and employees, and investigate subsidiaries.
  • Relationship with External Auditors: The Audit Committee works closely with the external accounting auditor, overseeing their audit work and receiving their reports.
  • Independence of Audit Committee Members: To ensure their independence, members of the Audit Committee cannot concurrently serve as executive officers, directors engaged in business execution for the company or its subsidiaries, or as employees of subsidiaries involved in business execution (Article 400, paragraph 4).

C. Compensation Committee (Hōshū Iinkai) (Article 404, paragraph 3)

  • Functions: The Compensation Committee is responsible for determining the policy regarding, and the content of, individual remuneration (including bonuses, stock options, etc.) for executive officers, directors, and accounting advisors.
  • Rationale: To ensure objectivity and transparency in setting executive and director compensation, preventing self-dealing by management, and aligning compensation with corporate performance and shareholder interests.

Executive Officers (Shikkō-yaku)

In a Company with Nominating Committee, etc., the execution of business is primarily carried out by executive officers.

Appointment and Role (Articles 402, 418)

  • Appointment: Executive officers are appointed by a resolution of the board of directors. An individual does not need to be a director to be appointed as an executive officer, although directors can also serve as executive officers (unless they are members of the Audit Committee and their role as an executive officer involves business execution).
  • Role: Executive officers are responsible for making decisions on business execution matters delegated to them by the board of directors and for actually executing the company's business in accordance with those decisions and the basic policies set by the board.

Representative Executive Officer (Daihyō Shikkō-yaku) (Article 420)

The board of directors must appoint one or more Representative Executive Officers from among the executive officers. The Representative Executive Officer(s) has the authority to represent the company externally and to generally manage and supervise the execution of business. This role is functionally similar to a CEO.

Duties and Liabilities

Executive officers owe the same duties of care (zenkan chūi gimu) and loyalty (chūjitsu gimu) to the company as directors. They are also subject to similar liabilities to the company for breach of these duties and to third parties under specific circumstances.

Reporting to the Board

Executive officers are required to report on the status of their execution of duties to the board of directors periodically (typically at least every three months, similar to directors in other K.K.s).

Comparison with U.S. Governance Models

The "Company with Nominating Committee, etc." model in Japan shares several conceptual similarities with common governance practices in U.S. public corporations, particularly those listed on major exchanges like the NYSE or NASDAQ, but also exhibits key differences.

Similarities:

  • Emphasis on Board Oversight: Both systems emphasize the board's role in overseeing management rather than being directly involved in day-to-day operations.
  • Use of Key Committees: The presence of audit, compensation, and nominating/governance committees is a standard feature in many U.S. public companies, driven by exchange listing rules and best practices.
  • Strong Role for Independent/Outside Directors: Both frameworks stress the importance of independent or outside directors, particularly on these key committees, to ensure objective decision-making and oversight.

Key Differences:

  1. Statutory Mandate for Three Committees: In Japan, the three committees (Nominating, Audit, Compensation) are statutorily mandated for companies adopting this specific governance model. In the U.S., while listing rules of major exchanges require such committees for listed companies, they are not typically mandated by state corporate law itself for all corporations.
  2. Committee Composition (Majority Outside Directors by Statute): The Japanese Companies Act explicitly requires that a majority of members of each of these three statutory committees be outside directors. U.S. listing rules also have stringent independence requirements for these committees (e.g., audit committees typically must be fully independent), but the Japanese requirement is embedded in the national corporate statute for this model.
  3. Executive Officers (Shikkō-yaku) vs. U.S. Officers: While Japanese shikkō-yaku are functionally similar to U.S. corporate officers (CEO, CFO, COO, etc.) in that they manage daily business operations under board delegation, their appointment by a board resolution and their specific duties and reporting lines to the board are clearly defined within the Companies Act as part of this distinct governance structure.
  4. Absence of Statutory Auditor (Kansayaku): This Japanese model does not have statutory auditors. Audit functions are entirely handled by the Audit Committee, which is closer to the U.S. model where the audit committee of the board oversees the external audit and internal controls.
  5. Board's Scope of Delegation: The board in a Company with Nominating Committee, etc. can delegate a broader range of business execution decisions to executive officers than a board in a traditional Japanese K.K. This is a key design feature intended to empower executive management while the board focuses on oversight.
  6. Relative Perceived Inflexibility: The statutory prescription of exactly three committees with defined core functions might be perceived as less flexible compared to the U.S. system, where companies (within the bounds of listing rules) might have more leeway in structuring their committee operations or establishing additional committees as needed.

Why This Model Has Not Been Widely Adopted in Japan

Despite its design goals of enhancing governance and international alignment, the "Company with Nominating Committee, etc." model has not seen widespread adoption in Japan. Several reasons have been suggested:

  • Entrenched Familiarity with the Kansayaku System: Many Japanese companies and their stakeholders are deeply familiar and comfortable with the traditional statutory auditor system, which has its own long history and perceived strengths in providing independent oversight.
  • Challenges in Securing Qualified Outside Directors: Especially in the early years after its introduction, finding a sufficient number of truly independent and qualified individuals willing to serve as outside directors on multiple committees was a practical challenge.
  • Concerns about Over-Empowerment of Executive Officers: The significant delegation of authority to executive officers led to some concerns among traditionalists that it might overly empower management at the expense of board (and by extension, shareholder) control, despite the formal oversight role of the board.
  • Emergence of the "Company with Audit and Supervisory Committee": The introduction of the "Company with Audit and Supervisory Committee" model in 2015 provided another, arguably more flexible, option for companies seeking to enhance board oversight with significant outside director involvement, without the full structural separation of the "Company with Nominating Committee, etc." This newer model has seen comparatively faster adoption.

Conclusion

The "Company with Nominating Committee, etc." represents a distinct and sophisticated governance option within Japanese corporate law, designed to foster a strong oversight-focused board and an efficient executive management team by clearly separating these functions and leveraging the expertise of outside directors through statutory committees. While it shares conceptual underpinnings with U.S. committee-based governance, its specific legal framework, including the mandatory nature of its three committees and the defined role of executive officers, is uniquely Japanese. Although its adoption has been limited, understanding this model is important for appreciating the diversity and ongoing evolution of corporate governance practices in Japan, offering insights into efforts to align with global standards while retaining distinct national characteristics.