Three Models of Corporate Governance from Developed Capital Markets

Key Players in the Japanese Model 

      The Japanese system of corporate governance is many-sided, centering around a main bank and a financial/industrial network or keiretsu. 

      The main bank system and the keiretsu are two different, yet overlapping and complementary, elements of the Japanese model.⁴   Almost all Japanese corporations have a close relationship with a main bank.  The bank provides its corporate client with loans as well as services related to bond issues, equity issues, settlement accounts, and related consulting services.  The main bank is generally a major shareholder in the corporation. 

       In the US, anti-monopoly legislation prohibits one bank from providing this multiplicity of services.  Instead, these services are usually handled by different institutions:  commercial bank - loans; investment bank - equity issues; specialized consulting firms - proxy voting and other services. 
 
 
 

⁴ See Bergloef, Eric,  1993. “Corporate Governance in Transition Economies: The Theory and its Policy Implications.” in Masahiko Aoki and Hyung-Ki Kim, editors, Corporate Governance in Transitional Economies: Insider Control and the Role of Banks. Washington, D.C.: The World Bank.

 

      Many Japanese corporations also have strong financial relationships with a network of affiliated companies. These networks, characterized by crossholdings of debt and equity, trading of goods and services, and informal business contacts, are known as keiretsu. 

      Government-directed industrial policy also plays a key role in Japanese governance. Since the 1930s, the Japanese government has pursued an active industrial policy designed to assist Japanese corporations. This policy includes official and unofficial representation on corporate boards, when a corporation faces financial difficulty. 

      In the Japanese model, the four key players are: main bank (a major inside shareholder), affiliated company or keiretsu (a major inside shareholder), management and the government. Note that the interaction among these players serves to link relationships rather than balance powers, as in the case in the Anglo-US model. 

      In contrast with the Anglo-US model, non-affiliated shareholders have little or no voice in Japanese  governance. As a result, there are few truly independent directors, that is, directors representing outside shareholders. 

The Japanese model may be diagrammed as an open-ended hexagon: 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

The base of the figure, with four connecting lines, represents the linked interests of the four key players: government, management, bank and keiretsu. The open lines at the top represent the non- linked interests of non-affiliated shareholders and outside directors, because these play an insignificant role. 

Share Ownership Pattern in the Japanese Model 

      In Japan, financial institutions and corporations firmly hold ownership of the equity market. Similar to the trend in the UK and US, the shift during the postwar period has been away from individual ownership to institutional and corporate ownership. In 1990, financial institutions (insurance companies and banks) held approximately 43 percent of the Japanese equity market, and corporations  (excluding  financial  institutions)  held  25  percent.  Foreigners  currently  own approximately three percent. 

      In both the Japanese and the German model, banks are key shareholders and develop strong relationships with corporations, due to overlapping roles and multiple services provided. This distinguishes both models from the Anglo-US model, where such relationships are prohibited by anti- trust legislation. Instead of relying on a single bank, US and UK corporations obtain financing and other services from a wide range of sources, including the well-developed securities market. 

Composition of the Board of Directors in the Japanese Model

 

      The board of directors of Japanese corporations is composed almost completely of insiders, that is, executive managers, usually the heads of major divisions of the company and its central administrative body. If a company’s profits fall over an extended period, the main bank and members of the keiretsu may remove directors and appoint their own candidates to the company’s board. Another practice common in Japan is the appointment of retiring government bureaucrats to corporate boards; for example, the Ministry of Finance may appoint a retiring official to a bank’s board. 

      In the Japanese model the composition of the board of directors is conditional upon the corporation’s financial performance. A diagram of the Japanese model at the end of this article provides a pictorial explanation. 

      Note the relationship between the share ownership structure and the composition of Japanese boards. In contrast with the Anglo-US model, representatives of unaffiliated shareholders (that is, “outsiders”) seldom sit on Japanese boards. 

      Japanese boards are generally larger than boards in the UK, the US and Germany.  The average Japanese board contains 50 members. 

Regulatory Framework in the Japanese Model 

      In Japan, government ministries have traditionally been extremely influential in developing industrial policy. The ministries also wield enormous regulatory control. However, in recent years, several factors have weakened the development and implementation of a comprehensive industrial policy. First, due to the growing role of Japanese corporations at home and abroad, policy formation became fragmented due to the involvement of numerous ministries, most importantly, the Ministry of Finance  and  the  Ministry  of  International  Trade  and  Industry. Second,  the  increasing internationalization of Japanese corporations made them less dependent on their domestic market and therefore somewhat less dependent on industrial policy. Third, the growth of Japanese capital markets led to their partial liberalization and an opening, albeit small, to global standards. While these and other factors have limited the cohesion of Japanese industrial policy in recent years, it is still an important regulatory factor, especially in comparison with the Anglo-US model. 

      In contrast, government agencies provide little effective, independent regulation of the Japanese securities industry. This is somewhat ironic, because the regulatory framework in Japan was modeled on the US system by US occupation forces after the Second World War. Despite numerous revisions, the core of Japan’s securities laws remain very similar to US laws. In 1971, in response to the first wave of foreign investment in Japan, new laws were enacted to improve corporate disclosure. The primary regulatory bodies are the Securities Bureau of the Ministry of Finance, and the Securities Exchange Surveillance Committee, established under the auspices of the Securities Bureau in 1992. The latter is responsible for monitoring corporate compliance and investigating violations. Despite their legal powers, these agencies have yet to exert de facto independent regulatory influence. 
 
 
 
 

Disclosure Requirements in the Japanese Model 

      Disclosure requirements in Japan are relatively stringent, but not as stringent as in the US. Corporations are required to disclose a wide range of information in the annual report and or agenda for the AGM, including: financial data on the corporation (required on a semi-annual basis); data on the corporation’s capital structure; background information on each nominee to the board of directors (including name, occupation, relationship with the corporation, and ownership of stock in the corporation); aggregate date on compensation, namely the maximum amount of compensation payable to all executive officers and the board of directors; information on proposed mergers and

 

      

restructurings; proposed amendments to the articles of association; and names of individuals and/or companies proposed as auditors. 

      Japan’s disclosure regime differs from the US regime (generally considered the world’s strictest) in several notable ways. These include: semi-annual disclosure of financial data, compared with quarterly disclosure in the US; aggregate disclosure of executive and board compensation, compared with individual data on the executive compensation in the US; disclosure of the corporation’s ten largest shareholders, compared with the US requirement to disclose all shareholders holding more than five percent of the corporation’s total share capital; and significant differences between Japanese accounting standards and US Generally Accepted Accounting Practices (US GAAP). 

Corporate Actions Requiring Shareholder Approval in the Japanese Model 

      In Japan, the routine corporate actions requiring shareholder approval are: payment of dividends and allocation of reserves; election of directors; and appointment of auditors. 

      Other common corporate actions which also require shareholder approval include capital authorizations; amendments to the articles of association and/or charter (for example, a change in the size and/or composition of the board of directors, or a change in approved business activities); payment of retirement bonuses to directors and auditors; and increase of the aggregate compensation ceilings for directors and auditors. 

      Non-routine corporate actions which also require shareholder approval  include mergers, takeovers and restructurings. 

      Shareholder proposals are a relatively new phenomenon in Japan. Prior to 1981, Japanese law did not permit shareholders to put resolutions on the agenda for the annual meeting. A 1981 amendment to the Commercial Code states that a registered shareholder holding at least 10 percent of a company’s shares may propose an issue to be included on the agenda for the AGM or EGM. 

Interaction Among Players in the Japanese Model 

      Interaction among the key players in the Japanese model generally links and strengthens relationships. This is a fundamental characteristic of the Japanese model. Japanese corporations prefer that a majority of its shareholders be long-term, preferably affiliated, parties.  In contrast, outside shareholders represent a small constituency and are largely excluded from the process. 

      Annual reports and materials related to the AGM are available to all shareholders. Shareholders may attend the annual general meeting, vote by proxy or vote by mail. In theory, the system is simple; however, the mechanical system of voting is more complicated for non-Japanese shareholders. 

      Annual general meetings are almost always pro forma, and corporations actively discourage shareholder dissent.  Shareholder activism is restricted by an informal yet important aspect of the Japanese system: the vast majority of Japanese corporations hold their annual meetings on the same day each year, making it difficult for institutional investors to coordinate voting and impossible to attend more than one meeting in person. 

_{The German Model}⁵ 
 

⁵ The German model governs German and Austrian corporations. Some elements of the model also apply in the Netherlands and Scandinavia. Furthermore, some corporations in France and Belgium have recently introduced some elements of the German model.

 

 

      The German corporate governance model differs significantly from both the Anglo-US and the Japanese model, although some of its elements resemble the Japanese model. 

      Banks hold long-term stakes in German corporations⁶, and, as in Japan, bank representatives are elected to German boards. However, this representation is constant, unlike the situation in Japan where bank representatives were elected to a corporate board only in times of financial distress. Germany’s three largest universal banks (banks that provide a multiplicity of services) play a major role; in some parts of the country, public-sector banks are also key shareholders. 

      There are three unique elements of the German model that distinguish it from the other models outlined in this article. Two of these elements pertain to board composition and one concerns shareholders’ rights: 

      First, the German model prescribes two boards with separate members. German corporations have a two-tiered board structure consisting of a management board (composed entirely of insiders, that is, executives of the corporation) and a supervisory board (composed of labor/employee representatives and shareholder representatives). The two boards are completely distinct; no one may serve simultaneously on a corporation’s management board and supervisory board. Second, the size of the supervisory board is set by law and cannot be changed by shareholders. 

      Third, in Germany and other countries following this model, voting right restrictions are legal; these limit a shareholder to voting a certain percentage of the corporation’s total share capital, regardless of share ownership position.⁷ 

      Most German corporations have traditionally preferred bank financing over equity financing. As a result, German stock market capitalization is small in relation to the size of the German economy. Furthermore, the level of individual stock  ownership in Germany is low,  reflecting Germans’ conservative investment strategy. It is not surprising therefore, that the corporate governance structure is geared towards preserving relationships between the key players, notably banks and corporations. 

      The system is somewhat ambivalent towards minority shareholders, allowing them scope for interaction by permitting shareholder proposals, but also permitting companies to impose voting rights restrictions.

      The percentage of foreign ownership of German equity is significant; in 1990, it was 19 percent. This factor is slowly beginning to affect the German model, as foreign investors from inside and outside the European Union begin to advocate for their interests. The globalization of capital markets is also forcing German corporations to change their ways. When Daimler-Benz AG decided to list its shares on the NYSE in 1993, it was forced to adopt US GAAP. These accounting principles provide much greater financial transparency than German accounting standards. Specifically, Daimler-Benz AG was forced to account for huge losses that it could have “hidden” under German accounting rules. 

Key Players in the German Model 

       German banks, and to a lesser extent, corporate shareholders, are the key players in the German corporate governance system. Similar to the Japanese system described above, banks usually play a multi-faceted role as shareholder, lender, issuer of both equity and debt, depository (custodian 
 

⁶ The German term for joint stock corporation is Aktiengesellschaft; German and Austrian corporations use the abbreviation AG following their name, for example, Volkswagen AG.

⁷ In 1994, some 10 major German banks and corporations still had voting rights restrictions, although the recent trend in European Union (EU) countries has been to repeal them.

 

bank) and voting agent at AGMs.  In 1990, the three largest German banks (Deutsche Bank AG, Dresdner Bank AG and Commerzbank AG) held seats on the supervisory boards of 85 of the 100 largest German corporations. 

      In Germany, corporations are also shareholders, sometimes holding long-term stakes in other corporations, even where there is no industrial or commercial affiliation between the two.   This is somewhat similar, but not parallel, to the Japanese model, yet very different from the Anglo-US model where neither banks nor corporations are key institutional investors. 

      The  mandatory  inclusion  of  labor/employee representatives on  larger  German supervisory boards further distinguishes the German model from both the Anglo-US and Japanese models. 

Share Ownership Pattern in the German Model 

      German banks and corporations are the dominant shareholders in Germany. In 1990, corporations held 41 percent of the German equity market, and institutional owners (primarily banks) held 27 percent.  Neither institutional agents, such as pension funds (three percent) or individual owners (four percent) are significant in Germany. Foreign investors held 19 percent in 1990, and their impact on the German corporate governance system is increasing. 
 

Composition of the Management Board (“Vorstand”) and Supervisory

Board (“Aufsichtsrat”) in the German Model 

      The two-tiered board structure is a unique construction of the German model. German corporations are governed by a supervisory board and a management board. The supervisory board appoints and dismisses the management board, approves major management decisions; and advises the management board. The supervisory board usually meets once a month. A corporation’s articles of association sets the financial threshold of corporate acts requiring supervisory board approval. The management board is responsible for daily management of the company. 

      The management board is composed solely of “insiders”, or executives.  The supervisory board contains no “insiders”, it is composed of labor/employee representatives and shareholder representatives. 

      The Industrial Democracy Act and the Law on Employee Co-determination regulate the size and determine the composition of the supervisory board; they stipulate the number of members elected by labor/employees and the number elected by shareholders. 

      The numbers of members of the supervisory board is set by law. In small corporations (with less than 500 employees), shareholders elect the entire supervisory board. In medium-size corporations (defined by assets and number of employees) employees elect one-third of a nine- member supervisory board. In larger corporations, employees elect one-half of a 20-member supervisory board. 

      Note these two key differences between the German model and the other two models. First, the size of the supervisory board is set by law and cannot be changed. Second, the supervisory board includes labor/employee representatives.