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Foreign Investors and Corporate
Governance in Japan
Sanford M. Jacoby
Japan’s distinctive corporate governance system developed during and
after the Second World War. The features of that system – insider boards,
cross-holding, enterprise unions, and main banks – rested on two as-
sumptions. One was that the company comprised a community of stake-
holders rather than being the shareholders’ property. The responsibility
of senior executives was to maximize the enterprise’s long-term value by
balancing the interests of shareholders as well as creditors, employees,
suppliers, and business group (keiretsu) members. The second assumption
had to do with trust in the selection and incentive systems for corporate
executives. Those who rose to the top were assumed to be competent,
honest, and hardworking. They were closely monitored only when there
was a marked decline in earnings, sales, or share price. In these instances,
the CEO might be ousted and sometimes an independent director was
placed on the board (Kaplan 1994; Kaplan and Minton 1994; Inagami and
Whittaker 2005).
Today the traditional system is under pressure to become more like the
US governance model that took hold in the 1980s and 1990s. The US
This is an updated, abridged version of an earlier paper “Convergence by Design: The Case
of CalPERS in Japan,”American Journal of Comparative Law, 55: 239–94 (2007). The author is
grateful to the publishers and editors of the American Journal of Comparative Law for
permission to draw on the earlier paper here. For financial support the author thanks the
Institute for Technology, Enterprise, and Competitiveness (ITEC) at Doshisha University, and
UCLA’s Institute for Research on Labor & Employment and its Price Center for Entrepreneurial
Studies. The opinions expressed here, as well as any errors or omissions, are entirely the
author’s.
93
model treats share price as the chief criterion for judging management
performance. Adherence to that standard is insured through boards com-
prised of independent directors, through stock-based executive compen-
sation, and through acquisitions – the market for corporate control – when
performance is poor (Dore 2000; Jacoby 2005a).
The pressure for change stems from Japan’s slow economic growth
between the early 1990s and 2002. The weak economy frayed ties between
banks and corporate borrowers and between members of the keiretsu,
causing sales of cross-held equity (Lincoln and Gerlach 2004). A second
vector for change is the Japanese government, which repeatedly has
revised Japan’s commercial law to facilitate implementation of the US
model (Ahmadjian 2000; Katz 2003; Gilson and Milhaupt 2005; Hall 2005).
Foreign investment, especially from the United States, is a third source
of change. Whereas foreign investors owned only 1 percent of Tokyo Stock
Exchange (TSE) shares in 1960 and 6 percent in 1992, the figure rose to 18
percent in 2000 and to 27 percent in 2007. Foreign owners are more likely
to trade their shares than domestic owners, thereby magnifying their
impact on share prices (Tokyo Stock Exchange 2005: 7–8, 60).
Some foreign investors in Japan merely buy and sell shares. Others are
activists seeking to repeat the governance transformations they wrought
in Europe and the United States. The activists include individuals, private
equity funds, and institutional investors. In Japan, the dominant institu-
tional investors are US pension funds, the largest of which is the California
Public Employees’ Retirement System or CalPERS. CalPERS, with pre-crisis
assets of around $240 billion, provides pensions to nearly 1.5 million
active and retired state, school, and public-agency employees in Califor-
nia. Many beneficiaries are current or retired union members.
1
CalPERS is often cited as the paradigmatic activist foreign investor in
Japan. It was among the first overseas pension funds to make major
investments in Japanese equities and remains one of Japan’s largest for-
eign investors. As early as 1992, when foreigners were beginning to ramp
up their Japan investments, CalPERS owned $3.7 billion in Japanese equi-
ties, a stake that constituted approximately 3 percent of the total value of
TSE shares owned by foreign investors. By 2000, many more foreign
investors had flocked to Japan so that CalPERS now constituted slightly
less than 1 percent of the total value of shares owned by foreign investors.
1
CalPERS is not, however, a “union”pension fund. See Schwab and Thomas (1998). On the
other hand, California’s public sector is heavily unionized, with a coverage rate of 58 percent
in 2005 versus 40 percent nationally. See data at http://www.trinity.edu/bhirsch/unionstats/.
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Sanford M. Jacoby
These figures are impressive but even with its vast holdings, CalPERS
remained a flea on the elephant.
2
So how could it have had an effect on
Japanese corporate governance?
One answer is that CalPERS was an aggressive advocate of change. During
its first phase of activism, it acted on its own. The second phase came when
CalPERS leveraged its stake by teaming with other foreign investors and
with domestic groups seeking to change Japanese corporate governance. In
the end, however, the fruits of CalPERS’ activities were modest. It had more
of an effect on changes related to transparency than on those related to
board structure, executive compensation, and control (takeover barriers).
Perhaps this is because disclosure is an add-on that can be adapted to the
existing Japanese system with minimal disruption; reconfiguring boards or
permitting hostile acquisitions requires more radical change of the sort
that many Japanese companies are still unwilling to initiate. CalPERS
blamed this resistance on self-serving, entrenched management. But
many Japanese corporate executives felt that the existing system per-
formed reasonably well and that the solution to Japan’s economic prob-
lems lay outside the corporate sector – in monetary and banking policies.
By 2002, CalPERS began to lose interest in leading the push for share-
holder-oriented governance in Japan. There were free-rider costs that it
was less willing to bear as more foreigners entered the Japanese market.
Also, CalPERS discovered that it could achieve better results by pressing for
change behind the scenes in companies where it held large stakes – the
relational investing approach – than by pursuing the same activities on a
marketwide basis. The combination of relational investing and lower
levels of activism marks the third phase of CalPERS’ involvement in Japan.
Last but not least, the economic environment changed. Flaws in the US
model became evident in the myriad scandals that followed the Enron
implosion in 2001. And in 2002, Japanese firms finally began to pull out of
their prolonged stagnation and, consequently, were less motivated to
appease foreign investors.
The following article presents the history of CalPERS in Japan. It shows
how institutional investors promote change in overseas corporate govern-
ance as well as the limits of foreigninfluence. Previous studies of Japan have
statistically confirmed an association between foreign ownership and
outcomes such as asset restructuring and downsizing. But the studies are
unable to determine whether causal links exist between foreign ownership
2
Calculations based on Tokyo Stock Exchange (2005: 60, 74), and CalPERS data supplied by
Susan Kane in letter to author (March 10 2005).
95
Foreign Investors and Corporate Governance in Japan
and observed outcomes. The present case study unpacks those causal
ambiguities by examining the actual processes by which CalPERS and
other institutional investors tried to change corporate governance and strat-
egy in Japan. It also provides data for the debate on the global convergence
of governance systems, emphasizing that there are political and distribu-
tional, and not only economic and efficiency, forces driving convergence.
CalPERS in the United States
To appreciate CalPERS in Japan, one must understand how the fund
evolved in the United States, not just for reasons of perspective but
because many of the policies CalPERS pursued in Japan had their origins
in its home country. CalPERS’ transformation from a sleepy public pension
fund to active institutional investor began in 1984, when California lifted
a requirement limiting CalPERS’ stock investments to 25 percent of its
portfolio. 1984 also was the year that the Bass brothers of Texas made a
hostile bid for oil giant Texaco. To stave them off, Texaco paid a premium of
$138 million for their shares – an instance of “greenmail.”Infuriated by the
deal was California State Treasurer, Jesse Unruh, who was a trustee of the
CalPERS board. Unruh tried but could not block the payoff. But he drew
from the episode two lessons: that executives cared more about their jobs
than about shareholder value, and that public pension funds needed to
coordinate their common interests (Stevenson 1991b; Castaneda 2004:
chapters 1, 7. For a legally-informed overview of the “shareholder value”
concept, see Deakin 2005).
In 1985, Unruh founded the Council of Institutional Investors (CII), an
association of public pension funds. Representing $132 billion in assets,
CII was a force to be reckoned with. Among its first acts was adoption of a
“shareholder bill of rights”calling for equal treatment of shareholders,
shareholder approval of key corporate decisions, and independent vetting
of executive compensation and corporate auditors (Castaneda 2004). The
CII was put to the test by another Texan, T. Boone Pickens, who was trying
to take over Phillips Petroleum. Although the bid failed, CII – because of its
collective clout – participated in meetings with company representatives.
CalPERS supported raiders like Pickens, even if it did not align itself with
them in every bid, because it believed that takeovers could raise share-
holder value. CalPERS professed to be interested in long-term value and
used the term “shareowner”instead of “shareholder”to transmit this
message. But according to disgruntled corporate executives, CalPERS was
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Sanford M. Jacoby
quick to abandon its philosophy if a raider offered a sufficiently juicy
premium for its shares (Stevenson 1991b; Castaneda 2004: chapter 7).
At the time around 80 percent of CalPERS’ US equities were in index
funds, a cheap way to track the market. Also, any above-average losses
incurred by CalPERS were sure to attract public criticism, so indexing
kept it free from blame. Because CalPERS could not sell its indexed
shares when a company performed poorly, it thought that the best way to
raise returns was to propose marketwide changes in corporate governance
(Castaneda 2004).
The thesis that corporate governance was responsible for poor perform-
ance was advanced with increasing regularity in the 1980s. The investing
community asserted that US companies had failed to respond effectively
to globalization because they subscribed to a managerialist system in
which executives and boards sought to balance the interests of corporate
stakeholders. This caused them to defer excessively to incumbent employ-
ees through takeover barriers, overly high wage and staffing levels, and
wasteful spending on unrelated acquisitions.
During the late 1980s, CalPERS began to openly criticize companies
with what it considered to be shareholder-unfriendly policies. It intro-
duced shareholder resolutions opposing poison pills and insufficiently
independent boards. CalPERS felt that the deck was stacked against share-
holder activism. So it sought broader shareholder rights: greater disclos-
ure, fewer barriers to dissident proposals, and advisory committees for
large shareholders (Wayne 1991; Stevenson 1991a; Smith 1996).
Around this time, CalPERS adopted a new approach. Instead of going
after companies with faulty corporate governance, regardless of perform-
ance, it took aim at companies with governance defects and that had poor
performance. Only companies in the bottom performance quartile (meas-
ured over five years) were targeted, because these companies could not
argue, as better performers sometimes did, that “if it ain’t broke, don’t fix
it”(Guercio and Hawkins 1999; Sailer 2000).
In the first year of targeting, CalPERS had a much higher “win”rate than
under its previous strategy. The names of targeted companies were shared
with the media, putting an unwelcome spotlight on their internal affairs.
Some members of the corporate community were furious about these
tactics and California Governor Pete Wilson, a Republican, responded
with a plan to pack the CalPERS board entirely with his appointees
(Stevenson 1991a; Gillan 1997). Although the plan was not implemented,
it chilled CalPERS’ aggressive tactics. Now, rather than publicly identifying
a targeted company, it first sent a confidential letter asking to meet with
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Foreign Investors and Corporate Governance in Japan
the CEO to discuss governance. At the same time it discreetly put into
motion the machinery for a shareholder proposal. If management agreed
to go along with CalPERS, even part way, CalPERS promised to halt the
machinery (Clowes 2000).
Research on Activism
As shareholders flexed their muscles, researchers began studying whether
activism had an effect on corporate performance. CalPERS touted a study
by Wilshire Associates showing an improvement in stock price at com-
panies targeted by CalPERS, a phenomenon dubbed “the CalPERS effect.”
The study, however, was marred by various methodological problems.
Wilshire Associates was also an investment advisor to CalPERS and may
have felt compelled to tell CalPERS what it wanted to hear (CalPERS 1995,
2005; also Nesbitt 1994; for a critique of Wilshire Associates’ methodology,
see Romano 2001).
Other studies are more ambiguous. Romano distinguishes between
activism based on shareholder votes and proposals, and that based on
nonproxy activity such as targeting and negotiations. The effect of share-
holder proposals on corporate performance is insignificant in all studies
she reviewed, including a study of CalPERS. Gillan and Starks find a nega-
tive effect of institutional proposals on share price. The evidence on non-
proxy activity is inconclusive. Of nine studies reviewed by Romano, five
show positive performance effects and four find insignificant or mixed
effects. Of these studies, two were based on CalPERS: one finds significant
performance effects; the other does not. A more recent study examines the
stock–price effect of CalPERS’ targeting and finds that it occurs immedi-
ately after targeting and dissipates within six months. Another recent study
finds that public disclosure by CalPERS of poor-performing companies
leads to a greater likelihood of CEO dismissal. The latest study – by Nelson
– claims that all previous studies were deficient because they failed to
control for contaminating events (e.g., positive news stories released
shortly before announcement of the CalPERS list) and for biases caused
by estimation during periods of known underperformance. Controlling for
these biases, he finds that, while there are positive effects of CalPERS
targeting during the 1990–3 period, there is no evidence of effects since
then (Smith 1996; Crutchley et al. 1998; Gillan and Starks 2000; Romano
2001; English et al. 2004; Wu 2004; Nelson 2006).
Given these ambiguous effects and the costs of targeting, CalPERS tried a
new approach. As part of its equity portfolio it acquired large stakes
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Sanford M. Jacoby
(5–10% or more) in a few underperforming companies and used those
holdings as leverage to effect changes such as divestitures and higher
payouts. This was “relational investing.”Like other types of block holding,
it allowed investors to focus directly on business decisions rather than, as
with governance reform, the methods used to reach those decisions (Gor-
don and Pound 1993; Berry 2004: 1; CalPERS 2004a; Business Week
2004b).
Another change was an effort to codify principles of corporate govern-
ance. In 1997, CalPERS issued its preliminary governance code, which
distinguished between “fundamental”and “ideal”principles. CalPERS
planned to grade companies on these principles, publicize the results,
and prod recalcitrants to change. But the code was met with a barrage of
criticism. A New York Times analysis of Fortune 1,000 companies found
only one, Texas Instruments, meeting the full range of CalPERS’ funda-
mental tests. In a statistical analysis, The New York Times did not detect any
pattern linking the principles to performance.
3
Research on Corporate Governance
Since then, there has been a plethora of academic research on the
governance–performance relationship. One widely cited study by
Gompers et al. finds a strong, positive relation between an index of
twenty-four governance rules and stock returns during the 1990s. Well
more than half the rules pertain to the absence of antitakeover
defenses such as staggered board terms and supermajority voting on
mergers. The others concern shareholder rights in proxy voting, share-
holder meetings, and bylaw amendment. While Gompers et al. did not
identify the rules most strongly associated with performance, a subse-
quent study finds that most of the performance effect derives from
rules facilitating takeovers. However, recent studies do not find a
casual relationship between takeover rules and performance.
4
Although elimination of takeover defenses is mentioned in the CalPERS
principles, the core is concerned with other issues such as monitoring
(board structure) and incentives (executive compensation). Here perform-
ance effects are difficult to find. In fact, the preponderance of evidence
3
“A Conversation with Richard Koppes,”1995, www.corpgov.net/forums/conversation/
koppes.html; Bryant (1997).
4
Gompers et al. (2003); Bebchuk et al. (2004). Not only do studies fail to find causality
between governance features and performance, some actually find positive share-price effects
associatedwith takeover defenses suchas golden parachutes. The inference is that entrenchment
99
Foreign Investors and Corporate Governance in Japan
shows that board independence and small board size, which CalPERS
repeatedly emphasized, are not associated with performance. There is
also no conclusive evidence that splitting the chairman and CEO positions
is associated with performance. However, board independence is associ-
ated with higher CEO dismissal rates during periods of poor performance
(Dalton et al. 1998, 1999; Romano 2001; Bhagat and Black 2002).
As for executive pay, CalPERS sought greater use of stock-based com-
pensation for boards and executives. There is no consensus regarding the
effect of board stockholding on performance; studies find positive and
null effects. Whether executive stock compensation improves perform-
ance is a vexed issue. Although some studies find a positive relationship
between performance and stock-based pay, other studies reveal a slew of
problems. Options create incentives to manipulate earnings and to extract
gains that benefit executives at the expense of shareholders. To its credit,
CalPERS criticized some of the more egregious practices related to options,
such as reloading in the face of a firm-specific decline, but remained an
enthusiastic proponent of equity-based pay (Mehran 1995; CalPERS 1999;
Dalton and Daily 2001; Romano 2001; Bebchuk and Fried 2004; Econo-
mist 2005; regarding option backdating, a potential source of fraud, see
Heron and Lie 2006). Part of the problem here is defining performance.
If one discards the efficient markets hypothesis, there can be a wedge
between share price and a company’s long-term prospects, so share
price may not be the best performance metric. Alternate measures of
performance, such as economic value-added (EVA), present problems of
their own (Rehfeld 1997; Kennedy 2001).
has not only costs but benefits: it prevents boards from being overly sensitive to uninformed
shareholders and permits boards to negotiate a better price with bidders. Also, the existence of
a stock premium associated with takeover-friendly governance does not mean that takeovers
or the threat of them improve efficiency. We know that takeovers are not associated with
preexisting governance or performance defects and that they do not lead to improved perform-
ance in the long term. One study can find no evidence of greater profitability nine years after
a takeover; in fact profitability declined. We do know, however, that hostile bids generate a
spike in stock prices immediately after the bid is announced. The spike reflects the tendency of
bidders to overpay for acquisitions (the hubris effect). It also reflects the expectation that the
takeover will lead to asset sales (asset sales command price premia because bidders are seeking
market power) and to tax benefits associated with the deal. Hence it is possible for takeovers
to boost share pricebut not efficiency. Takeovers cause a flow of resources to shareholders – from
customers, creditors, employees, and taxpayers – and lead to underspending on R&D and human
capital. This is what currently worries some investors, who think that US public companies are
endangering their long-term health by paying out too much cash. However, we do not
know precisely the extent to which stockholder gains are offset by losses of acquirers and of
stakeholders. See Jacoby (2007: note 31).
100
Sanford M. Jacoby
Early Days in Japan
Until the 1980s, US public-employee pension funds had strict rules limit-
ing their overseas investments. But the limits were relaxed after the stock
market crash of 1987. CalPERS was one of the first to invest heavily
overseas. It made an initial purchase of foreign equities in 1988 and
quickly ramped up after that. By 1991, 12 percent of its equity portfolio
was in foreign stock and this doubled to 24 percent in 2000. Japan was an
important investment target for CalPERS (CalPERS, various years).
CalPERS’ early days in Japan were rocky. It relied heavily on services
provided by Nomura and other local agents but was shocked when, in
1991, Nomura was swept up in a trading scandal. In response, CalPERS
suspended relationships with Nomura Securities in Japan and wrote to the
Minister of Finance, the late Ryutaro Hashimoto, asking for an investiga-
tion of trading practices. In 1993, CalPERS demanded that Nomura and
Daiwa Securities appoint outside directors to their boards and warned that
it might seek the same from other Japanese companies (Jiji Press 1991;
Stern 1991: 16; Wall Street Journal 1991; Business Week 1993).
Proxies
Proxy issues in Japan typically include approval of the income allocation
proposal (which includes dividends, directors’ bonuses, and allocations to
reserve accounts and retained earnings); director elections and statutory
auditor elections; directors’ retirement bonuses; and amendments to the
articles of incorporation (which can include everything from entering a
new business to adoption of a holding company structure). As in the
United States, an issue of concern to CalPERS in Japan had to do with
corporate boards: the paucity of independent directors and the large num-
ber of directors, such that a Japanese board with thirty or more members
was not unusual. CalPERS routinely would vote its proxies against internal
directors and against proposals to expand board size. Another concern was
executive entrenchment. CalPERS opposed the issuance of new equity if it
thought this was being done to defend against takeovers. In 1993, Japan
amended the commercial code to require companies to have at least one
independent statutory auditor. After this, CalPERS made it a policy of
voting against auditors who were judged to lack independence, such as
former company executives. CalPERS also opposed the re-appointment of
directors at companies whose corporate governance it deemed unsatisfac-
tory (Sterngold 1993; Business Wire 1994; IRRC 2001b: 1).
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Foreign Investors and Corporate Governance in Japan
Dividend levels were another matter of concern. Japanese companies held
more of their assets in cash than their US counterparts partly to accommodate
relatively larger bank loans. In spite of these cash hoards, dividends were
meager and based on par value rather than earnings. CalPERS wanted
Japanese companies to return more cash to shareholders either through
dividends or stock repurchases. But it knew that this was a sensitive issue
that could make CalPERS look greedy or indifferent to Japanese financial
norms. Therefore, CalPERS was careful to appear even-handed. It publicized
the fact that, although it had voted proxies against inadequate dividends and
was concerned about their generally low levels, it had also voted against
excessive dividends being paid by some unprofitable companies such as Nissan
(Kester 1991; Financial Times 1992; Sterngold 1994; Milhaupt and West 2004).
CalPERS announced in 1993 that it had selected Britain and Japan as
targets for a campaign to improve overseas corporate governance. The
following year it issued global proxy voting guidelines that emphasized
director accountability to shareholders; transparency of corporate infor-
mation; shareholder-friendly distribution of proxy materials; and publica-
tion of final proxy tallies. The concern about proxy distribution reflected a
problem that occurred in Japan during the previous proxy season, when
CalPERS’ “no”votes against more than 200 Japanese companies went
unrecorded. Sumitomo Trust said that CalPERS’ completed proxies were
received after the deadline, although the same glitch seems to have
affected other US institutional investors, a fact that CalPERS deemed
“very disturbing”(Economist 1993; Nikkei 1993; Sterngold 1993; on Cal-
PERS’ guidelines governing proxy voting, see CalPERS 2001).
Proxy voting is a noisy signal. A vote against the income allocation
proposal is subject to multiple interpretations that are based on knowing
the identities of voters and their specific concerns. Yet CalPERS did not
publicize its individual proxy votes nor did it publish a “target list”and
mount its own shareholder resolutions, as in the United States. Moreover,
because Japan has no legal provisions for ownership disclosure, companies
could not always identify the beneficial owners casting negative votes.
However, CalPERS sometimes sent letters to company management before
or after a vote to explain its actions.
5
Proxy voting was not an effectual way of inducing change. Rarely did
antimanagement votes exceed 30 percent of the total and, even then,
5
Interviews in Tokyo with Marc Goldstein, March 19 2005; Ariyoshi Okumura, March 15
2005; Kuny Kobayaschi, March 17 2005; and Raita Sakai, President, Multilateral Investment
Dev. Corp., March 18 2005. Interview with Dr. William D. Crist, Former President of CalPERS
and Chairman of the Board, 1992–2003, in Turlock, Cal., February 2005.
102
Sanford M. Jacoby
companies rarely announced the outcome, despite CalPERS’ requests that
they do so. Although CalPERS sought larger payouts to shareholders,
payouts actually declined during the 1990s. In addition, although Cal-
PERS voted against insiders who were nominated to be independent aud-
itors, the percentage of firms listing auditors whose outsider status was
questionable rose between 1994 and 1996, from 11 to 20 percent (IRRC
2001a: 1; Ryder 2005).
Black Ships
During the 1980s the Keidanren, the peak business association for Japan-
ese corporations, monitored US economic, legal, and social issues through
its Council for Better Corporate Citizenship (CBCC). In 1989, the CBCC
expanded its ambit to include monitoring of corporate governance issues
in the United States, such as “the influence of public pension funds and
other institutional investors.”CBCC wanted to know how the funds made
investment decisions, how they viewed the role of directors, and what
were their expectations for Japanese companies, especially with regard to
conflict between shareholders and other stakeholders. It led a study mis-
sion to the United States in 1993 seeking answers to these questions.
6
That same year, CBCC invited Bill Crist to visit Tokyo and address the
Keidanren. This was an historic event, widely reported in the Japanese
media. Some likened Crist’s visit to Admiral Perry’s “black ships.”In the
ensuing years, the Keidanren would prove to be an agile and ardent
opponent of changes promoted by CalPERS. Nevertheless, the group was
interested in hearing what Crist had to say, although, says Crist, “they
were interested in a very defensive way.”
7
Crist reminded his audience that CalPERS was not a speculative investor
but instead was interested in long-term returns. He reassured the Keidan-
ren that CalPERS’ leaders “are not crusaders – we do not want to make over
countries’ corporate structure.”Then, however, Crist laid out a detailed
proposal for changing Japanese corporate governance that was based on
the CalPERS program in the United States. Crist’s “wish list”for Japan
covered five areas:
1. Boards: More independent directors and smaller boards.
2. Payouts: Companies with limited growth prospects should return
excess cash to shareholders.
6
Council for Better Corporate Citizenship (1993); Crist interview.
7
Ibid.
103
Foreign Investors and Corporate Governance in Japan
3. Financial disclosure: Adoption of consolidated accounting and inde-
pendent auditors.
4. Investor relations: Create investor relations (IR) departments to relay
financial information to investors.
5. Proxy voting: Spread out shareholder meetings and give investors
more time to vote.
Crist cited no evidence that any of these changes would improve share-
holder value, although he did mention the Wilshire Associates study
showing a relationship between share price and CalPERS activism. With
respect to Japan, he criticized the fact that stable domestic shareholders
received deference from senior management while foreigners and other
minority shareholders were given “only cursory consideration”(Crist
1993). After the speech, Crist and others visited companies in the Tokyo
and Osaka regions. These and subsequent visits would be preceded by
letters and phone calls requesting to see the company’s president (shacho).
But except in a few rare instances, the requests were declined. CalPERS
would be told that the company only recognized registered shareholders
and that it had no record of CalPERS’ shareholder status. At best, the
CalPERS officials met with a relatively insignificant managing director for
overseas issues. Over time, however, Japanese corporations grew more
receptive to these visits. By the late 1990s, IR departments were becoming
ubiquitous. Companies even began to send their own delegations to Sac-
ramento to meet with CalPERS officials, some on a regular basis.
8
The meetings were uncomfortable because they included touchy topics
such as board structure and return of cash to shareholders. Starting in the
mid-1990s, CalPERS intentionally shifted its discussions to general prin-
ciples of corporate governance rather than a company’s performance, what
one participant described as “policy-oriented”as opposed to “financial-
oriented”issues. Crist would explain that CalPERS was a long-term
shareholder and that companies which produced long-term returns for
their shareholders would end up rewarding other stakeholders. Layoffs,
says Crist, were never on the table: “I hate to see that sort of Wall Street
psychology that layoffs are a good thing. And especially in Japan, where
the labor market is not liquid and it is hard for people to find new jobs.”
9
CalPERS was trying to build a different image – less adversarial and more
discreet – than it had in the United States or Europe. Its company visits
were never publicized nor did it publish target lists or sponsor shareholder
8
Learmount (2002); Sakai, Crist and Kobayaschi interviews.
9
Viner in Sterngold (1993); Sakai and Crist interviews.
104
Sanford M. Jacoby
proposals. CalPERS selected companies to visit based on stock perform-
ance and calculations of EVA. But EVA can rise merely as a result of
deferring profitable investments or shedding assets. Evidence shows that
companies using EVA as a performance metric are more likely to sell assets,
delay investments, and buy back shares. By encouraging companies to
target EVA, CalPERS gave a subtle nudge in favor of “shareholder value.”
(Fernandez 2002; Ahmadjian and Robbins 2005).
Local Partners
As CalPERS boosted its allocation for overseas equities, it redoubled efforts
to internationalize its governance programs. It conducted an in-house
study of how it could best bring the shareholder-primacy approach to
overseas markets. The study saw substantial benefits to adopting share-
holder activism overseas (this based again on the Wilshire Associates
study) but predicted that an uphill battle would occur in Japan. In 1996,
the CalPERS board voted to develop a new governance program focusing
on Britain, France, Germany, and Japan. The program had four parts:
specifying principles for each market; participation in local governance
debates; outreach to local media, governments, and academics; and
finding local partners. Local partners would give CalPERS legitimacy in
markets hostile to foreign interference while helping to adapt its message
to diverse national cultures (CalPERS 1996; Daily Yomiuri 1996).
Corporate Governance Forum
The entity that CalPERS initially partnered with in Japan was a small
organization called the Corporate Governance Forum of Japan (JCGF).
The JCGF was created in October 1994, one year after Crist’s speech to
the Keidanren. A key figure behind the JCGF was Ariyoshi Okumura, who
ran the asset management division of the Industrial Bank of Japan. Oku-
mura was familiar to CalPERS because he periodically made trips to Sacra-
mento to solicit CalPERS’ business in Japan. Another key figure was
Takaaki Wakasugi, then a finance professor at the University of Tokyo.
The JCGF’s board was made up of academics and business leaders commit-
ted to reforming corporate governance in Japan, such as Yoshihiko Miyau-
chi, president of ORIX.
Wakasugi drafted the JCGF’s corporate governance statement, a process
that started in 1996 and ended in October 1997 with the publication of an
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Foreign Investors and Corporate Governance in Japan
interim set of principles. The 1997 document is a marvel of diplomacy. It
consists of three parts: a philosophical introduction, principles to be
implemented in the short term (next five years) and principles for the
medium term (next ten years). The introduction acknowledges a stake-
holder approach but puts shareholders in a special category above other
stakeholders. It says that the board of directors’ job is to maximize share-
holder value and to represent the immediate interests of shareholders. On
the other hand, the board is also supposed to coordinate stakeholder
interests, provide information to stakeholders, and be accountable for its
actions to all stakeholders but particularly to shareholders.
Beyond that, the principles say nothing more about stakeholders. The
focus is on disclosure to shareholders and on monitoring. Regarding
disclosure, the report urges that information be provided to shareholders
in a timely fashion and on a quarterly basis, adjusted to global accounting
rules, and facilitated by an upgrading of the investor relations function. It
also calls for more dialogue at shareholders’ meetings and separate meet-
ings for major shareholders. Regarding monitoring, it urges the inclusion
of independent directors (short term) until boards are comprised of a
majority of independents (medium term). The principles call for a reduc-
tion in board size and separation of the CEO and chairman positions.
Boards should include more than one independent auditor (short term)
and an auditing committee comprised entirely of independent directors
(medium term). The principles strongly resemble the ideas promulgated by
CalPERS in Japan, and, as one scholar said, are “close in tone to that of an
assertive-type classical model”of corporate governance (Inagami 2001).
Four months after publication of the JCGF document, CalPERS issued its
own governance principles for Japan. The advantages of following on the
JCGF’s heels are obvious. Instead of being seen as an insensitive interloper,
CalPERS could – and did – give the impression that it was merely endorsing
indigenous ideas promulgated by Japan’s own leaders. As the CalPERS
principles stated, “The Corporate Governance Forum of Japan, a body
consisting of representatives from Japanese corporations, institutional
investors, and academia, has developed an interim report that promotes
a sensible two-step approach to changing Japanese corporate governance.”
The CalPERS principles listed all of the short- and medium-term proposals
contained in the JCGF report and noted, “CalPERS believes that Japanese
corporations that adopt the JCGF’s proposals sooner rather than later will
best be able to attract investor capital and contend with global
competitors.”However, the CalPERS principles did not include any of
the JCGF language concerning stakeholders. Included, however, were
106
Sanford M. Jacoby
two provisions not mentioned by the JCGF: an endorsement of stock
option plans for directors and executives, and reduction of
“unproductive”cross-shareholding. CalPERS sent Japanese translations
of its principles to all major interest groups in Japan, including the Liberal
Democratic Party (LDP), the Keidanren, and the Nikkeiren, the employers’
federation. Coming at a time when Japan was being rocked by bankrupt-
cies of major banks and brokerages, the principles received wide press
coverage (Jiji Press 1998; CalPERS 1998a, 1998b).
Crist introduced JCGF to other institutional investors through the Inter-
national Corporate Governance Network (ICGN). The ICGN’s origins go
back to the early 1990s, when Crist, Robert Monks, and other shareholder
activists discussed the creation of an international analogue to the CII, one
that would coordinate and legitimate activities of institutional investors
around the world. Crist and other institutional heavyweights met at the CII
in 1994 to form an international association. The ICGN officially was estab-
lished in 1995 at a conference attended by delegates from the AFL-CIO, the
Association of British Insurers, the CII, the National Association of Pension
Funds (United Kingdom), and various state and local public pension funds.
CalPERS envisioned the ICGN as a “clearinghouse for local market standards
of conduct and governance procedures. It could also be a conduit for cross-
border shareholder initiatives.”Concerned about the ICGN’s lack of Asian
involvement, Crist recommended that the JCGF be permitted to affiliate,
which occurred around 1996. Later, Ariyoshi Okumura of the JCGF was
elected to the ICGN’s board, the first board member from Asia.
10
The ICGN’s membership was broad, including not only pension funds
but also union representatives and financial companies. When it issued its
own governance principles in 1999, they endorsed shareholder value as
the corporation’s “overriding objective,”but followed the OECD’s prin-
ciples in calling for cooperation between corporations and stakeholders.
ICGN recommended employee participation to “align shareholder and
stakeholder interests.”This was more pluralistic than anything previously
published by CalPERS. While CalPERS incorporated the ICGN language in
its own Global Principles, it omitted any mention of stakeholders in any of
its country-specific guidelines (ICGN 1999).
The JCGF, the TSE, and the Pension Fund Association of Japan hosted
the annual ICGN conference in Tokyo in July 2001. It was a major media
event and, according to Okumura, was a “timely kick to deliver a positive
10
ICGN (1999); Koppes memo to CalPERS Board, August 1995, quoted in Kissane (1997);
Okumura and Crist interviews.
107
Foreign Investors and Corporate Governance in Japan
message to the Japanese corporate executives who were still somewhat
suspicious of corporate governance concepts imported from abroad.”Over
400 attendees listened to ORIX’s Yoshihiko Miyauchi call for a corporate
rating system to improve governance in Japan. Awards were handed out to
Sir Adrian Cadbury and Ira Millstein.
In charge of the ICGN Tokyo conference was Nobuo Tateishi, CEO of
Omron. Although Tateishi had become a board member of the JCGF, he
was also active in the Nikkeiren and Keidanren. His views on corporate
governance were more traditional than those of the JCGF or CalPERS, as
reflected in the 1998 report issued by a Nikkeiren special committee that
he chaired. The report presented the mainstream managerial view in Japan
that, while transparency in reporting to shareholders was desirable, “it
would be rather imprudent to think that British or American style corpor-
ate governance is the global standard.”The goal of governance change in
Japan should be “not to negate everything Japanese but to preserve those
basic features of Japanese management which are laudable,”presumably
including insider boards and a stakeholder orientation.
11
Perhaps Tateisi was the person responsible for inviting Hiroshi Okuda to
give the keynote address at the ICGN conference. Okuda was then chair-
man of Toyota and of the Nikkeiren. His speech was a polite rebuke of the
assertive shareholder-primacy model that CalPERS was promoting in
Japan. Okuda stressed the social dimension of corporate activity in
Japan. Any approach to corporate governance that failed to take this
into account, he said, “could cause major problems.”The commitment
of Japanese companies to stakeholders, he said, “is in our DNA.”While
acknowledging the importance of holding managers accountable, Okuda
said that this had to come from “different perspectives,”including banks
and enterprise unions, and not only from shareholders. As for share-
holders, who were then urging Toyota to hand over more of its cash,
Okuda said, “We prefer to aggressively promote R&D. We aren’t ignoring
ROE but we must balance it with R&D.”
12
Bill Crist was dumbfounded to hear Okuda express “almost identical”
words to those expressed by the Keidanren in 1993. The speech marked
the beginning of the end of CalPERS’ hopes that the JCGF would be a
vehicle for governance change in Japan. Crist believes that the Keidanren
had decided to use the Tokyo conference to publicize its views through
11
Nikkeiren International Special Committee report (1998), quoted in Inagami (2001:
229); see also IRRC (2001b).
12
The $10 Trillion Question, http://www.irmag.com/newsarticle.asp?articleID ¼1461; Benes
(2001b); Gourevitch and Shinn (2005).
108
Sanford M. Jacoby
Tateishi, who Crist calls “Mr. Inside/Mr. Outside”and a likely “mole [who]
keeps an eye on things”for the Keidanren. At the time of the conference,
the Keidanren was backing a Diet bill to limit director liability and to
quash rules facilitating appointment of independent directors.
13
Another theory of Crist’s is that the Keidanren backed the JCGF in its
early years as a foil against foreign pressure but that the JCGF fell out of
favor because it had failed to stop “this new bunch of crazy Japanese guys
at the Pension Fund Association.”Whatever the explanation, the fact is
that CalPERS’ alliance with the JCGF was yielding little fruit. The JCGF,
said Crist, was “very big on having meetings and putting out publications”
but it was “useless”as an instrument of transformation. Who, then, would
help CalPERS bring change to Japan? Perhaps it would be those “crazy
guys”at the Pension Fund Association.
14
Pension Fund Association
The Japanese pension fund system includes a first tier of old-age insurance
and a second tier of employer-provided pension plans (defined-benefit, as
well as some defined-contribution plans since 2001). One large quasi-
public fund is the Japan Pension Fund Association (PFA), which was
established by the Ministry of Health and Welfare in 1967 to pay benefits
to employees who had left corporate plans prior to vesting or whose
corporate plans had been terminated. The PFA is an umbrella for over a
thousand corporate plans and has assets of around $100 billion.
The PFA was lost in obscurity for most of its history. Its investments were
in the hands of asset managers who rarely challenged company manage-
ments. But the PFA began to change in the late 1990s as its unfunded
liabilities rose and new leaders took over. It published a white paper on
proxy voting in 1999 that called for an end to the taboo of voting against
management at shareholder meetings. The following year a Health and
Welfare advisory commission headed by Takaaki Wakasugi recommended
that public pension funds like the PFA hold their asset managers to fidu-
ciary standards including active proxy voting and promotion of share-
holder value.
15
13
Crist interview; Benes (2001b); Gourevitch and Shinn (2005); Suzuki (2005). On the
Keidanren’s position on independent directors and the “company with committees”law
which came into effect in 2003, see Chapter 2.
14
Crist interview.
15
IRRC (2002); Wakasugi (2003). Wakasugi further recommended that the Government
Pension Investment Fund (GPIF) be required to follow similar principles when investing its
109
Foreign Investors and Corporate Governance in Japan
The person in charge of pensions at the Health and Welfare ministry,
Tomomi Yano, became managing director of the PFA around the time of
Wakasugi’s report. Yano well knew the dire situation faced by Japan’s
pension funds. Due to slow population growth, the funds were projected
to show widening deficits as the ratio of retired to active citizens steadily
crept up. Japan’s stock-market woes also contributed to the problem. The
PFA, for example, had a 10 percent return in 2001, its first loss ever. Since
then it has posted negative returns in several other years (Amyx 2004;
Katsumata 2004; McClellan 2004).
Knowing that he would be running the PFA for only a few years, Yano
quickly created an aggressive program to raise the PFA’s portfolio returns
through shareholder activism. Yano’s model for transforming the PFA was
CalPERS. The two funds have cooperated in various ways over the years.
PFA representatives have visited Sacramento repeatedly and there have
also been meetings in Japan. When asked in 2003 if the PFA would become
like CalPERS, Yano responded, “We may turn out to be a Don Quixote, but
as a representative of pension funds in Japan we have no choice but to be
an active shareholder [like CalPERS].”
16
Yano’s first step was to introduce proxy voting guidelines for the PFA’s
asset managers in 2001. In keeping with Wakasugi’s report, the guidelines
required the PFA’s asset managers to designate staff responsible for proxy
voting, vote according to principles – favoring shareholders over manage-
ment if need be – and to report results back to the PFA. In 2002, Yano
started to internally manage some of the PFA’s domestic investments and
he initiated proxy voting on its passively-invested portfolio.
17
The most dramatic change came in 2003, when the PFA published its
proxy principles. Receiving the most attention was the PFA’s plan to vote
$1.4 trillion in assets. However, to avoid charges of political interference in business, the
decision was made to leave proxy voting in the hands of the GPIF’s asset managers with the
proviso that the managers were to “maximize long-term shareholder value.”Wakasugi’s
enthusiasm for shareholder primacy as a remedy for pension problems resurfaced in a May
2008 report of a panel of academic economists appointed by the Prime Minister. It recom-
mended that GPIF be split up into smaller funds several of which should be assigned to foreign
investment managers; urged removal of takeover defenses so as to attract foreign capital; and
asked that the TSE take the lead on this, an idea that Tomomi Yano of the PFA had been
pushing for several years (see main text, infra). The proposal was supported by the powerful
Ministry of Economy, Trade, and Industry (METI), which hoped that the GPIF would serve as a
battering ram, just as the Health and Welfare Ministry wanted the same from the PFA.
However, some in government were concerned about excessive risk-taking by public pension
funds and skeptical that takeovers would uncover hidden inefficiencies. Japan Times, May 24
2008; Nikkei Weekly, June 16 2008. Yano retired from the PFA later in 2008.
16
Crist interview; interview with Tomomi Yano in Tokyo, March 16 2005; Nikkei (2003c).
17
IRRC (2002): Benes (2001a); Tomomi Yano, “Corporate Governance Activities of Pension
Fund Association,”at http://www.usajapan.org/pdf/tyano_1104.ppt; Yano interview.
110
Sanford M. Jacoby
against renomination of, and retirement payments for, directors of com-
panies that had not paid dividends for three years or that had losses for the
previous five years.
18
The PFA developed its principles after culling ideas
from Anglo-American pension funds such as CalPERS, TIAA-CREF, and
Hermes (CalPERS’ partner in the United Kingdom) The PFA said that it
would vote proxies against companies whose boards had more than
twenty people; who failed to separate the CEO and chairman positions;
and who failed to hire independent statutory auditors and to nominate
independents for at least one-third of the board seats. The PFA met with
asset managers and told them to follow its principles (Pensions & Invest-
ments 2003; Nikkei 2003c, 2003d).
In light of proxy voting’s ambiguous effects in the United States, the
PFA’s emphasis seems a bit surprising. But proxy voting is partly a means to
the larger end of promoting a shareholder-primacy ethos. Yano envisioned
the creation of a broad coalition of institutional investors in Japan. In the
meantime, the PFA was setting an example by voting against over 40
percent of all management proposals, including votes against noninde-
pendent directors and paying them bonuses. While this was a high rate of
antimanagement voting as compared to other Japanese pension funds, it
was relatively modest as compared to US funds like CalPERS and TIAA-
CREF. In 2004, US pension funds in Japan voted against director appoint-
ments at a 93 percent rate versus 49 percent for the PFA, leading one to
suspect that the PFA’s bite might be milder than its bark.
19
After 2003, Yano took a page out of CalPERS’ book and held a greater
number of private discussions with under-performing and under-paying
firms. Yano said that this kind of pressure got better results than proxies,
yet Yano lamented the fact that CalPERS had better access to CEOs of
Japanese companies than did the PFA.
20
Yano relished confrontation with complacent managers and the ensu-
ing publicity. When the proxy battle between corporate raider Yoshiaki
Murakami and Tokyo Style heated up, Yano supported Murakami’s unsuc-
cessful bid to have Tokyo Style distribute to shareholders its hoard of
nearly $1 billion in cash and securities. Yano publicly excoriated one of
PFA’s asset management companies for opposing Murakami.
21
18
The PFA’s current criterion is to oppose director renomination at firms with return on
equity of less than 8 percent for three years.
19
Yano interview; Pensions & Investments (2003); IRRC, unpublished voting data, June
2004, courtesy of Kuny Kobayaschi.
20
Reuters Asia (2002); Yano interview.
21
Nikkei (2002b). In 2007 Murakami was given a two-year prison sentence for insider
trading (New York Times, July 20 2007: 20).
111
Foreign Investors and Corporate Governance in Japan
It made sense that the PFA became CalPERS’ favorite partner in Japan.
Both were public pension funds; both were aggressive with a flair for
publicity. Crist called Yano “a good friend”and said that Yano was willing
to shake things up in a way that the JCGF never could because the PFA was
outside the business system. After leaving CalPERS, Crist founded an
organization called the Pacific Pension Institute, which held conferences
for institutional investors from Asia and the United States. At one such
conference, Ted White, then in charge of CalPERS’ corporate governance
program, explained the fund’s relationship with the PFA. CalPERS was best
suited to a “macro”approach to governance change in Japan, one that
involved “exerting pressure on regulatory or legislative bodies. This
included guidelines for best practice.”But the “micro”approach, which
was company by company, was better carried out by local entities like the
PFA. In the micro area, CalPERS preferred to be “a facilitator where it can
assist and mobilize Japanese investors to take the lead role in enacting
change.”Whereas CalPERS had a focus list in the United States, it was
difficult for CalPERS to be publicly critical of individual Japanese com-
panies. But, said White, “this type of tool can readily be mimicked by
foreign players such as the PFA.”While CalPERS did not publicize its proxy
votes for Japanese companies, the PFA was not shy to do so. Even the kind
of “macro”change that CalPERS sought, such as urging more dispersed
shareholder meetings, might better come from a group like the PFA in the
form of a domestic-led initiative, said White.
22
CalPERS has also established a relationship with Chikyoren, the giant pen-
sion fund for local government employees. Chikyoren is part of the Council
of Public InstitutionalInvestors that was launched in 2002 as a way for public
pension funds to discuss issues of mutual interest, including governance
change. Members include the PFA, the Government Pension Investment
Fund, and several others.Thus far, however, the Council has resisted requests
that members coordinate their proxy votes, as CalPERS does with CII.
CalPERS has also reached out to Japan’s corporate pension funds. Heretofore,
most corporate pension plans have ceded authority to asset managers with
little direct involvement. The asset managers often were complacent because
of their dual role of managing pension fund assets and selling products to
the companies in which they invest, as in the United States. Recently,
however, some asset managers have become more assertive.
23
22
Crist and Okumura interviews; White (2003).
23
Pensions & Investments (2002); Nikkei (2003c, 2004a); Crist interview; Borrell (2003: 14);
Taylor (2006); Yano interview.
112
Sanford M. Jacoby
Thus it may turn out that the most effective proponents of governance
change in Japan will be, as in the United States, domestic institutional
investors, especially public pension funds. How present trends unfold will
depend on how many funds imitate Yano’s aggressive stance and whether
his successor at the PFA will be cut from the same cloth. One must be
careful, however, not to exaggerate Yano’s influence. For example, the TSE
had a corporate governance advisory committee that included Yano, aca-
demics, consultants, and Keidanren representatives. Yano wanted the TSE
to create a code of best governance practice, including independent
boards and reduced takeover barriers, that would be attached to listing
requirements. But due to resistance from the corporate community, the
idea went nowhere. At the microlevel, the PFA has not had many notable
successes, perhaps because the balance of power at many Japanese com-
panies remains in the hands of management-friendly investors. Also, the
PFA is hamstrung by social norms regarding appropriate behavior. Noting
that CalPERS has on numerous occasions proposed a CEO dismissal, Yano
said, “PFA cannot do such a thing yet, though we want to. If we do, we will
be criticized in the Japanese society. We cannot be such an activist as
CalPERS.”
24
Withdrawal
CalPERS’ visibility in Japan has declined markedly since 2002: no new
governance initiatives, few visits by CalPERS officials, and, until recently,
near-invisibility in the Japanese media and business forums. The reasons
for the withdrawal are complex, having to do with internal changes at
CalPERS, diminishing returns on activism, and new investment strategies.
One internal factor is the diversification of CalPERS’ overseas portfolio.
Japan holdings fell from 45 percent of the portfolio in 1993 to 20 percent in
2005. Also, Bill Crist’s retirement from the board was significant in that
Crist had a strongercommitment to Japan than his successor, Sean Harrigan,
a former official of the retail workers’ union. Harrigan was interested in
domestic policy issues, especially those in which shareholder activism and
labor-movement interests coincide. His successor, Rob Fechner, has as yet
shown little interest in overseas investments.
25
24
Kobayaschi interview; Whitten (2003).
25
Pensions & Investments (2000); Sakai and Crist interviews; CalPERS, “Written Testimony
of Sean Harrigan to the U.S. Senate Commerce Committee,”May 20 2003; Los Angeles Times
(2004); CalPERS data as of October 31 2005, courtesy of Mary Cottrill.
113
Foreign Investors and Corporate Governance in Japan
By 2003, CalPERS faced diminishing returns to its “macro”approach of
promoting the shareholder-primacy model. Ten years after Crist made his
speech to the Keidanren, the governance principles he espoused had
become widely known in Japan. Several had been adopted into the Com-
mercial Code, such as rules facilitating share buybacks (1994, 1997, 1998),
issuance of stock options (2001), and the “company with committees”
system (2003). The latter, known in Japan as the “American system,”gives
companies the choice of doing away with statutory auditors if they
appoint a majority of outside directors on three key board committees
and if the board eschews operational responsibilities (see Chapter 2). At
the “micro”level of firm-by-firm monitoring, CalPERS experienced some
of the same problems that had cropped up in the United States. It rarely
held more than one percent of a company’s stock and, even when it did, it
faced a free-rider problem in that other investors were happy to have
CalPERS incur the cost of active shareholding while they reaped any
benefit. As the head of international corporate governance for TIAA-
CREF said, “Why bother to expend any effort on behalf of monitoring
portfolio companies, when someone else will do it for you without cost to
yourself?”(Hashimoto 2002; Clearfield 2005).
Robert Monks (2003) and Michael Porter ( 1994) had foreseen this prob-
lem years earlier. Monks understood that public pension funds were polit-
ical entities whose boards could not or would not maintain pressure on
individual companies for the long term. Both Monks and Porter proposed
as a solution that institutional investors increase the size of their stakes and
pool their enlarged holdings in “relational”or “turnaround”funds that
target underperforming companies. Since 2000, CalPERS has invested $12
billion with Relational Investors and similar funds in the United States
and Europe. Relational investing mitigates the free-rider problem and its
usually substantial returns help CalPERS to “beat the index.”This, in turn,
reduces the incentive to pursue macrogovernance change, which may
explain why CalPERS’ public activism has declined as its stake in these
funds has grown. It has increasingly been the hedge funds, rather than
CalPERS itself, which have applied direct pressure to companies.
The first relational investments in Japan came in 2002, when CalPERS
invested $200 million (a 20% stake) in Sparx Value Creation Fund. Since
then it has invested several hundred million more with Sparx.
26
Sparx
was started by Shuhei Abe, a former Nomura analyst and admirer of
26
CalPERS Press Release, “CalPERS Turns Up Corporate Governance Heat,”November 15
2001; Financial Times (2002); Nikkei (2002).
114
Sanford M. Jacoby
Warren Buffett. Abe and his analysts take large stakes in undervalued mid-
sized companies and then “influence”their managements to restructure
operations and raise shareholder returns. According to Abe, “Many Japanese
CEOs don’t know why they have to improve their return on equity because
they have no sense of ownership and no sense of being part of the market.”
27
Before CalPERS invested with Abe it vetted him to make sure that he
wasn’t “a raider like Murakami.”As compared to Murakami, who was
insensitive to social norms and prone to making outrageous public state-
ments, Abe is relatively low key, although he is consistently contemptuous
of Japanese CEOs. While the Sparx fund has not pursued hostile takeovers,
its approach of pressuring companies to return cash to shareholders is not
very different from what Murakami attempted at Tokyo Style. Abe’s time
horizon is shaped by the fact that the fund will exist for ten years. Of $365
million invested in one of his funds, $200 million was distributed to the
partners in the first two years. In at least one case, Sparx bought shares in a
small company, Miyairi Valve, and sold all of them six months later.
One observer says that Sparx is “using the corporate governance idea
but not following it. . . . it’s rather hard to call them long-term investors.”
Crist defends the Sparx approach, saying that “nothing is pure”and that
the bulk of CalPERS’ investments in Japan remain long-term, passive
holdings.
28
Another relational outfit in which CalPERS invests is Taiyo Pacific Part-
ners, which is managed by two gaijin (non-Japanese). One is Wilbur L.
Ross, a New York-based billionaire who helped reorganize Continental
Airlines in the 1980s and more recently has been a private equity investor
in mature, unionized US industries such as coal, steel, textiles, and auto
parts. The other is Brian Heywood, a onetime missionary who later worked
for Citibank in Japan. CalPERS signed a deal with Taiyo in 2003 and
invested $200 million, a 20 percent stake. Taiyo’s approach is similar to
Sparx’s. It wants to avoid Murakami-like controversy, while invoking the
possibility of takeovers to induce managers to raise shareholder payouts.
The fear of hostile takeovers is genuine. A recent survey found that execu-
tives at 70 percent of Japanese companies were concerned about them.
Taiyo tries to persuade companies that it can help them avoid the clutches
of raiders like Steel Partners by working cooperatively to boost payouts.
Agreeing to partner with Taiyo doesn’t mean that a company has accepted
27
Nikkei (2003a); CalPERS (2004); “SPARX Founder Shuhei Abe on ‘Why He’s Bullish On
Corporate Japan”’ October 1 2003, Japan Society, New York at http://www.japansociety.org/
corporate/event_corp_note.cfm?id_note ¼191080341; DiBasio (2004).
28
Interviews with Crist, Sakai and Kobayaschi.
115
Foreign Investors and Corporate Governance in Japan
shareholder-primacy principles, however. Says Heywood, “In general the
mindset is not so much, ‘I’ve been converted to governance,’ but ‘I’m
afraid of being taken over so I’ve got religion.’ ”
29
Once Taiyo takes a stake in a company, it trims “bloated”balance sheets
by selling unrelated assets and returning cash to shareholders. The fund’s
major success story is an auto-parts firm called Nifco. Nifco had diversified
into a variety of unrelated businesses such as ballpoint pens, Australian
real estate, and media properties (including The Japan Times). Taiyo is
helping Nifco get ride of noncore assets that do not meet a hurdle rate of
return. At Maezawa Kasei, maker of plumbing fixtures, Taiyo zeroed in on
the firm’s cash hoard. Said Heywood, “They had a lot of cash sitting there
doing nothing. We said, ‘Lots of cash makes you a target.’ ”
30
The firm has
since raised its dividends. At Nifco, Taiyo recommended that the company
send out press releases in English to explain that the divestments were not
made willy-nilly but were driven by a focus strategy. Taiyo told Maezawa
Kasei to establish ties to investment analysts and make sure that they
covered the relatively obscure company. Many of these moves were in-
tended to attract foreign investors, the one group that has consistently
been buying Japanese equities in recent years. While Taiyo says it is not
seeking a quick buck, its time horizon is far from the long term touted by
CalPERS. Ross’ biggest deal in Japan came in 2003, right before Taiyo was
formed. Ross sold his shares in Kansai Sawayaka Bank for double his initial
investment, having held the shares for a little over two years. Ross bristles
at the “vulture fund”label and prefers to describe Taiyo as a “phoenix”
(JETRO 2002; New York Times 2003b; Financial Times 2004; Nikkei
2004b).
While the majority of CalPERS’ Japanese investments are passive, its
interest in securing good returns on alternative investments has inevitably
skewed CalPERS’ focus more to the short-term horizons of hedge and
private equity funds. Over 10 percent of its Japan assets are in these
vehicles. Ironically, the funds do not require firms in which they invest
to adhere to the CalPERS governance principles. Neither are they seeking
to affect economywide governance practice. This is of little concern to
Heywood, who says, “We don’t need to change the whole market.”
31
29
Nikkei (2004b); Financial Times (2004); see also Milhaupt (2005).
30
Heywood quoted in Wiseman (2004).
31
New York Times (2003a); Financial Times (2004); Joncarlo Mark to author, December 27
2005. Other public pension funds followed CalPERS’ lead and boosted their target allocations
for alternative investments such as private equity, hedge funds, and real estate: Business Week
(2006).
116
Sanford M. Jacoby
The Consequences of CalPERS
CalPERS sedulously sought to change Japanese law and public opinion. It
regularly appeared in the media while working closely with domestic
norm entrepreneurs such as the JCGF and the PFA and indirectly with
government ministries such as METI and MHLW. The results of its labors
were – at least in part – the various commercial code revisions consistent
with positions originally espoused by CalPERS. However, it is difficult to
assess the extent to which CalPERS was a catalyst for legal reforms or
whether government officials used pressure from CalPERS as a justification
to adopt them, an old tactic in Japan known as gaiatsu. Some officials saw
governance change as a fiscally neutral way to jump-start the Japanese
economy; others, such as the economists working at METI, were – and
are – keen to achieve the efficiency gains they attribute to shareholder
primacy. The Ministry of Foreign Affairs hopes that commercial code
changes will reduce economic friction between the United States and
Japan. The US government has repeatedly pressured Japan to Americanize
its governance system, starting in 1989 with the Structural Impediments
Initiative (SII) talks, which have continued since then. The SII’s most
recent incarnation was the Bush administration’s “Investment Initiative,”
whose objective is to facilitate foreign direct investment in Japan, includ-
ing foreign acquisitions (State Department 2006).
However, CalPERS’ influence at the macrolevel was curtailed by business
groups like the Keidanren, by skeptics in government, and by organized
labor. The Keidanren tried to preserve internal boards, to maintain cross-
holdings as barriers to hostile acquisitions, and to keep TSE listing stand-
ards free of mandatory criteria. It worked to ensure that most of the
commercial code revisions were permissive rather than mandatory. Also,
the revisions lacked enforcement mechanisms, leaving companies free to
stick with the status quo or to adopt changes that met the letter but not
the spirit of the law by, for example, claiming quasi-insiders as independ-
ent directors and statutory auditors (Gilson and Milhaupt 2005; Buchanan
and Deakin 2008 and Chapter 2). The Nippon Keidanren (as it has now
become) hasn’t been opposed to all changes. In recent years, it has urged
Japanese companies to improve auditing, control, and disclosure prac-
tices. As noted, these changes are relatively easy to graft onto existing
governance structures.
32
32
Dore (2000); Crist interview; Patrick (2004); Nippon Keidanren (2001). The Keidanren
has accepted proposals that benefit incumbent managers, however, such as stock options.
117
Foreign Investors and Corporate Governance in Japan
CalPERS has more sway in the United States, where it need not worry
about an “ugly American”image and so is able to use a panoply of
influence tactics. It also has more power in emerging nations that depend
heavily on foreign capital. CalPERS carefully rates emerging nations on
factors such as corporate governance, political stability, and openness. It
consistently reminds countries – and their leaders – that adherence to
international governance standards will make them more attractive to
international investors. CalPERS repeatedly advanced this argument in
Japan. The difference, however, is that while Japan welcomes foreign
investors, it hardly suffers from capital scarcity.
33
At the microlevel CalPERS has greater leeway to exert pressure in Japan,
although its concerns here have more to do with boosting shareholder
returns than with specific governance practices. In fact, studies show an
association between foreign ownership of Japanese companies and subse-
quent restructuring via asset divestments, as is true of US companies
targeted by CalPERS. Foreign ownership of Japanese companies also is
associated with a propensity to downsize.
34
To what extent have Japanese companies adopted the CalPERS govern-
ance model? It helps to break the model down into four parts: disclosure
and transparency; boards and directors; shareholder rights and minority
protection; and control (absence of takeover barriers). Of the four, by far
the most prevalent part is disclosure, which includes accounting stand-
ards, publishing reports and disseminating information, meeting with
analysts, creating IR departments, and so forth. This is also the area
where statutory reforms – such as consolidated accounting, fair-value
accounting, and disclosure of takeover defenses and internal controls –
have become mandatory instead of permissive. The 2006 law known as
J-SOX, passed in the wake of the Horie and Murakami scandals, requires
public companies to strengthen internal controls and disclosure (Nakata
and Takehiro 2001; Miyajima 2007).
Less prevalent have been changes in boards and directors. In 2003, the
average number of outside board members in the Nikkei 225 companies
33
Hebb and Wojcik (2003). In 1993, Crist had predicted that Japanese corporations would
pay more attention to shareholder value as their need for capital “forces them to woo foreign
sources of capital”(Crist 1993). CalPERS made a similar argument when it released its 1998
Japan principles: CalPERS (1998b).
34
Miyajima (2007); Ahmadjian and Robbins (2005: 451); Coffee (2002). A recent study
finds that domestic financial ownership is positively associated with Japanese downsizing,
which is consistent with the main-bank monitoring hypothesis, but that foreign ownership
has no significant effect on layoffs, hiring, or pay cuts, contrary to the aforementioned studies:
Abe and Shimizutani (2005).
118
Sanford M. Jacoby
was one; it was less than one for the 1,500 companies on the TSE’s first
section. These numbers reflected the fact that nearly two-thirds of publicly-
traded companies had no independent directors. An investor group in 2008
lamented the fact that most Japanese firms still lack independent directors.
Board size has declined since 1990, from an average of seventeen to fifteen,
although some of this reflects a cosmetic change associated with adoption
of the executive officer system, which formalizes the preexisting division of
the board between a core group that makes strategic decisions (the Jomukai)
and a larger group that discusses (and often rubber stamps) them. The
company with committees system is not catching on, with successively
fewer companies adopting it each year (see Chapter 2). However, since
2000, stock options have become more popular, with 35 percent of large
Japanese companies reporting their use, especially in large firms with high
foreign ownership. As a proportion of CEO pay, however, options and
related types of equity compensation are far less important than in the
United States (Takaya 2003; Hayakawa 2004, and communication to
author; Nikkei 2004d; Abe and Shimizutani 2007; Towers Perrin 2005: 6;
2006: 24; Miyajima 2007: Appendix 1; AGCA 2008).
Shareholder rights have strengthened since the late 1980s. Change de jure
has been modest partly because Japanese law regarding shareholder rights
has always been protective and in conformance with global standards. The
big change has come in practice. There are more votes against management
at shareholder meetings than in the past. Executives now are peppered with
difficult and sometimes embarrassing questions. There are more share-
holder derivative suits than before 1990, when there were hardly any. The
number of companies holding shareholder meetings on the same day has
fallen. In other respects, however, the pace has been glacial. Minority share-
holders filing derivative lawsuits still find it difficult to obtain information
and usually can win only if there are criminal charges involved. Shareholder
meetings remain concentrated in the same period during June, if not on the
same day. Few companies use electronic mail for meeting notifications or
voting, although both are permissible. There are more foreign shareholders
in attendance at meetings but less than 1 percent of large companies provide
simultaneous English translation. In 2007, foreign shareholder activists
failed to win majority support from other shareholders for a single one of
several resolutions calling on firms to raise dividends. The press announced
vote results with headlines such as “Foreigners Shut Out.”
35
35
Kester (1991); West (2001); Utsumi (2001); Miyajima (2007); Givens (2007); Goldstein
interview.
119
Foreign Investors and Corporate Governance in Japan
The fourth element in the CalPERS model was removing barriers to
managerial entrenchment so that higher payout rates and a market for
corporate control could flourish. Without doubt, dramatic and unpreced-
ented hostile actions have occurred recently, including highly publicized
bids to raise dividends in 2008 by Steel Partners at Bull-Dog Sauce and a
shareholder fight by TCI to double dividends at J-Power. However, both
efforts were thwarted by domestic shareholders and by the courts, as was
the case with several other foreign activist interventions (Higashino 2004;
Business Week 2004a; Tokyo Stock Exchange 2005; Jacoby 2005a: 73;
Miyajima and Kuroki 2007; Chapters 2 and 3).
Just as cross-shareholding accelerated in the 1950s to stave off foreign
takeovers, so today a new set of barriers is being erected. The government
revised the commercial code to permit foreign firms to use their own stock
(or a local subsidiary’s) to acquire Japanese firms, effective May 2007.
Concerned that Japanese companies are undervalued and lack adequate
takeover defenses, the government included provisions for firms to issue
special class shares, golden shares, and related poison pills, all of which are
being used more heavily. Japanese companies are erecting defenses such as
expanded cross-holding and issuance of new shares (Nikkei 2004c, 2005,
2006; Whittaker and Hayakawa 2007; Economist 2008; Chapters 2 and 3
in this volume).
It is also worth asking what the implications are of the CalPERS model
for corporate performance in Japan. Miyajima recently examined the
relationship between performance and different types of governance
change in Japan. He found that disclosure was the only type significantly
associated with stock-market returns (Tobin’s q, the ratio of a company’s
market value to its asset value) and with accounting measures of perform-
ance (ROA, return on assets). Neither board structure nor shareholder
rights show an association with performance.
36
Miyajima also considers antitakeover practices in Japan, such as block
holding by a parent corporation and cross-shareholding by banks and
other corporations. He finds that the sole antitakeover measure that is
negatively associated with performance is shareholding by banks, which
has declined sharply in recent years. Similarly, in the United States and the
United Kingdom, antitakeover measures do not have a consistent associ-
ation with performance, contrary to the entrenchment thesis. Speaking
36
Miyajima (2007: Table 4–10); Miwa and Ramseyer (2005). On another matter of concern
to CalPERS – cross shareholding – the evidence shows a positive effect of concentrated
ownership on profitability of Japanese companies: Gedajlovic and Shapiro (2002).
120
Sanford M. Jacoby
conservatively, we can say that efficiency gains from takeovers and from
low barriers to their occurrence are unproven (Shleifer and Vishny 2003;
Miyajima 2007: Table 4; Miyajima and Kuroki 2007).
In short, the most widely adopted governance reforms in Japan – con-
cerning information and disclosure – are positively related to perform-
ance. Changes whose link to performance are weak or unproven – in board
structure, shareholder rights, and takeover barriers – have been less exten-
sive. Hence the Keidanren was not far off the mark when it insisted that
the CalPERS principles were a poor fit to Japanese business practices.
Why, then, have foreign investors so doggedly pursued governance
change in Japan? One explanation is hubris: investors watched what hap-
pened in the United States, where efforts to change corporate governance
were followed by an equity boom, and thought that they could repeat
these events in Japan and elsewhere. Believing that governance change
had caused share prices to rise and economic growth to accelerate (and, by
extension, that the absence of shareholder primacy had depressed stock
prices and hindered economic growth in Japan) is an instance of post hoc
ergo propter hoc reasoning.
37
Another answer is that investors suffered from
economic ethnocentrism: to the extent that the CalPERS principles were
valid in the United States, the assumption was made that they were
equally valid in other economies. The problem, however, is that the
average Japanese company is unlike its US counterpart with respect to
factors that determine governance effectiveness, such as incentives
(executives are lifers who are motivated by duty, reputation, and trust)
and business strategy (in Japan strategy is relatively resource-based and
relational) (Jacoby 2005a: chapter 2). The third explanation is that investors
are myopic. Even professional managers at the helm of pension portfolios
have short-term biases. What matters is not how to maximize the corporate
pie tomorrow, an uncertain recipe at best, but how it is sliced today: more
for current shareholders; less for bondholders, creditors, employees,
customers, taxpayers, and future shareholders. That is, shareholder primacy
is not about creating value but extracting it (Kaplan 1989; Benartzi and
Thaler 1995; Jensen 2005; Jacoby 2005a; Jacoby 2008).
In short, governance change has been modest. Foreign investors
remain critical of Japanese companies for resisting takeovers and for
37
An alternative interpretation is that US economic growth was caused by fiscal policies,
which stimulated markets and set off a speculative boom resulting in spiraling share prices.
Corporate governance was orthogonal to growth, although it played a role in spurring the
stock bubble. For evidence refuting the notion that Japan’s stagnation was related to corporate
governance, see Jacoby (2000) and Ramseyer and Miwa (2001).
121
Foreign Investors and Corporate Governance in Japan
“hoarding”cash. In May 2008, a White Paper was issued by the Asian
Corporate Governance Association, a consortium of nearly seventy
foreign institutional investors, including giants such as CalPERS, CalSTRS,
Hermes, and Fidelity. Harking back to the 1990s, the White Paper blasted
Japanese companies for mistreating foreign owners, erecting takeover
defenses, and for hoarding cash instead of paying it to shareholders
(AGCA 2008). Tout c¸a change, tout c’est la me
ˆme chose.
However, although the structure of Japanese corporate governance is
inertial, its distributional outcomes are changing. From 1999 to 2006,
dividends and other shareholders payouts rose much more rapidly than
labor payments (211% versus 11%), although shareholder payments
started from a lower base. In other words, firms are cutting their labor
costs by substituting part-time for regular employees and using a portion
of the savings to raise shareholder payouts. Even so, foreign shareholders
remain enormously dissatisfied and continue to demand more.
38
The fact that CalPERS and its allies in Japan have not made more
headway usually is explained as the result of resistance from entrenched
and pampered executives, in particular those represented by Nippon
Keidanren. This is the argument made by Yano and Crist as well as by
foreign investors. The entrenchment argument is overstated in light of the
relatively modest salary and perquisites associated with executive status in
Japan, where CEO compensation is one-fourth of US levels (Mishel et al.
2005: Table 2.49). If anything, Japanese executives would, based on US
experience, make out better under a shareholder-primacy approach,
although there would be a risk that some might lose their positions after
a takeover.
39
The other – and more important – explanation of modest
change is the Demsetz–Lehn thesis that corporate governance is endogen-
ous and that there is no one-best way of structuring it (Demsetz and Lehn
1985). Japanese corporations have adopted only those changes that are a
good fit with their existing incentives and institutions, which is to say,
those that have an unambiguous relationship to performance (Dore 2000;
Fisman et al. 2005).
38
Nikkei Weekly, June 16 2008.
39
Recall that US executives opposed shareholder primacy until the early 1990s, when stock
options and a bull market caused a shift in their orientation (see Jacoby 2005b). What makes
such a shift less likely in Japan are two factors: first, Japanese shares remain concentrated in
the hands of domestic investors who are reluctant to rock the boat; second, the options
scandals in the United States have made domestic owners wary of claims from foreign
investors that options are a panacea. If and when domestic institutional investors follow the
lead taken by the PFA in the 2000s, the system might quickly change.
122
Sanford M. Jacoby
Conclusions
Institutional investors are an important mechanism for transmitting US
governance principles to overseas markets. In Japan, CalPERS worked with
other institutional investors and domestic norm entrepreneurs to pro-
mote shareholder primacy in corporate governance. CalPERS was most
successful in affecting aspects of corporate governance with a clear rela-
tionship to performance, such as disclosure. It was less successful, but not
without influence, in other areas.
CalPERS officials well understood, as should we, that corporate govern-
ance is grounded not only in efficiency considerations but also distribu-
tional politics. The manifest objective of the CalPERS program was to
redesign governance institutions to improve performance; the latent intent
was to reallocate corporate resources to current shareholders. When
CalPERS’ own power was insufficient, it sought alliances to bring about
change. CalPERS chose to ignore evidence that its principles could not be
verified according to its stated objective of bolstering long-term perform-
ance. One can surmise various reasons for this, including strong ideological
support for the CalPERS principles from the wider investment community.
The CalPERS principles were not fixed in a vacuum but instead reflected
the prevailing wisdom among US investors and financial economists.
Agency theory views managers (agents) as prone to self-serving or
irrational behavior at the expense of shareholders (principals). While any
single shareholder may not be rational, dispersed ownership creates finan-
cial markets whose collective wisdom promotes efficiency when managers
are incentivized to pursue shareholder interests. Reinforcing agency theory
is a law-and-economics movement that seeks to reorient legal thinking to
agency theory and related doctrines. The merger wave of the 1980s and the
US bull market of the 1990s provided vindication for practices derived
from agency theory; so too did the mediocre performance of shareholder-
wary economies in continental Europe and Japan (Jensen and Meckling
1976; Jacoby 2000).
Economic ideas come and go; agency theory today is under assault by
the new behavioral approach to economics and finance. The behavioral
approach is grounded in empirical anomalies: between rational-choice
predictions and actual behavior, and between theoretical explanations of
how institutions operate and their actual performance. The presumption
that financial markets are efficient and that shareholders are more rational
than managers has been replaced by the hypothesis, consistent with
empirical evidence, that financial markets are prone to mispricing and
123
Foreign Investors and Corporate Governance in Japan
that shareholders often are less rational than managers. Hence behavioral
finance offers justification for institutions held suspect by agency theory,
ranging from insider boards and takeover defenses to government regula-
tion. Another assault has come from team-production theory, which is
based on the idea that the corporation is a cooperative endeavor whose
members all have made firm-specific investments, not only shareholders.
A few law-and-economics doyens recognize the challenges and have
responded defensively.
40
What is missing from contemporary discussions of corporate govern-
ance is the recognition that the shareholder–executive relationship is not
the sole interdependency that organizations must balance. Also critical are
relations between headquarters and subunits, and between the corpor-
ation and its employees, creditors, customers, suppliers, and regulators.
The variety of relationships suggests the infeasibility of a single best way to
structure corporate governance (Fligstein and Freeland 1995).
Agency theory, which treats shareholders as residual claimants, favors a
distribution of rents that privileges shareholders; behavioral theory, while
agnostic on distributional issues, is compatible with the notion that
shareholders do not consistently promote the firm’s best interests or
even their own. Team-production theory suggests that the board’s role is
to allocate rents; no stakeholder has primacy in receiving them (Blair and
Stout 1999). Mark Roe has a view closer to my own that emphasizes how
politics – normative and distributional – drives corporate governance
and law.
41
The recent economic crisis has put a dent in claims that the Anglo-
American financial system, which includes mechanisms for corporate
governance, is superior to different systems, such as those found in
Japan. Japanese banks, with lots of cash on hand (ironically cash that
Western shareholders previously had demanded be paid to them) have
swooped in and purchased various pieces of the Wall Street wreckage. At
this time, nonfinancial companies like Toyota are weathering the crisis
more successfully than their counterparts in the United States and the
United Kingdom. Hence the future of national governance systems is
unlikely to be the result of market forces selecting an optimal model.
40
On this, see Korobkin and Ulen (2000); Shleifer (2000); Baker et al. (2007); Bebchuk and
Fried (2004); and for a law and economics approach which is critical of the mainstream
position, Blair and Stout (1999).
41
Roe (2003); see also Fligstein (1990); Roy (1997); Gourevitch and Shinn (2005); Okazaki
and Okuno-Fujiwara (1999). There is also an emerging neoclassical approach to governance
and politics but it tends to see politics as an anti-market activity rather than a means by which
markets are constituted. See Rajan and Zingales (2003).
124
Sanford M. Jacoby
Instead, the CalPERS story suggests that the evolution of corporate
governance will be shaped by historical actors committed to contending
definitions of the corporation’s legal, social, and economic responsibil-
ities. There is no one best way; there never was and never will be.
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