Institutional Investors, Activists and Legal Reforms Begin to Change Japanese Corporate Governance | Skadden, Arps, Slate, Meagher & Flom LLP
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- Shareholder activism continues to grow in Japan, with domestic institutional investors becoming increasingly receptive to shareholder proposals and board nominations.
- Even when activist proposals are eventually rejected, the growing percentage of affirmative votes may impact the attitudes of target councils in future negotiations on governance issues.
- In 2021, a significant number of attempted unsolicited takeover bids were successful. The companies have implemented protective measures (for examplethe Japanese version of poison pills), but their effectiveness remains uncertain, as court rulings have varied when defenses have been challenged.
- Japan’s foreign direct investment regime could still be a barrier to hostile takeover bids and foreign activists, due to the government’s efforts to ‘protect national economic security’ in so-called ‘core designated business areas’ .
Activism gains momentum as institutional shareholders become more receptive
The rise in shareholder proposals in Japan, including by activists, continued in 2021 (see also our 2020 Knowledge trending article). Notably, some of these proposals, including the election of outside directors appointed by the shareholders, obtained the support of the required majority of shareholders.
Japanese institutional shareholders, responding to the 2017 and 2020 revisions to the stewardship code, have increased disclosure of their voting policies and actual votes. Even institutional shareholders with categorically passive investment strategies hold themselves accountable to their own investors, who now often welcome constructive engagement with the companies in which institutions hold stakes.
Some asset managers have issued detailed guidelines on the types of shareholder proposals they will generally vote for, and a significant number of institutional shareholders have supported proposals consistent with their policies. In short, we can no longer rely on institutional shareholders to vote against proposals simply because they do not come from management.
Companies are slowly opening the door to talks with activists
Until recently, Japanese companies were generally seen as having little incentive to negotiate and reach agreements with shareholder activists, even when the latter appointed or recommended outside directors. However, we have seen several cases in recent years where companies have negotiated and ultimately reached agreements with activists. In one example, the target company has agreed to nominate an activist-appointed outside director as part of the board’s proposal for its shareholders’ meeting.
The background and terms of these agreements have generally not been made public, so the trend cannot be confirmed. However, with growing support from institutional investors, shareholder proposals are expected to gain momentum. In addition, meaningful negotiations on shareholder rights issues are now a feasible option for both shareholders and target companies.
Unsolicited tender bids face poison pills, subject to court review
Another recent trend has been an increase in unsolicited tenders and attempts to open the market to build large stakes in publicly listed Japanese companies, a significant number of which have been successful. In 2021, we also saw targeted company boards vote to install the Japanese version of the poison pills in response to an ongoing or threatened takeover bid or market takeover attempts. Some of these poison pills have been challenged in court, with varying results.
Japanese law offers a relatively wide range of safeguards against unsolicited takeover bids, including the Japanese version of poison pills, which can be introduced even after a takeover attempt has begun. . The overall structure of these poison pills is similar to American practice, but in Japan it is commonly accepted that some form of shareholder approval is required, such as a simple majority shareholder vote to introduce or trigger poison pills, depending on the situation.
Courts tend to determine whether such tactics are applicable on a case-by-case basis. The 2021 decisions were split, with the outcome apparently depending, among other factors, on when the board considered the defense or whether it won an affirmative vote at a shareholder meeting. There are still only a limited number of decided cases in Japan to provide some insight into the viability of poison pills. Companies should proactively assess the enforceability of pills on a case-by-case basis when introducing them taking into account the factors discussed above.
The foreign direct investment regime can be used against foreign activists and other
As described in detail in our 2020 Knowledge survey, Japan’s foreign direct investment regime, the Foreign Exchange and Foreign Trade Act (FEFTA) and other relevant regulations and ordinances were significantly amended in 2019 and 2020. In introducing the revisions, the government clarified that he had no intention of preventing the activities of shareholder activists.
However, the government’s enforcement of FEFTA since then has been widely criticized, and government ministers responsible for administering FEFTA have allegedly abused their discretion regarding the investment activities of non-Japanese activists. In particular, the Ministry of Economy, Trade and Industry seems particularly interested in the protection of sensitive technologies (for examplenational defense, nuclear power generation, semiconductors, telecommunications and cybersecurity) from foreign activist shareholders who tend to make large acquisitions and exercise voting rights.
Given ministers’ wide discretion under FEFTA, it remains unclear to what extent they will interfere with the activities of foreign activist investors or proposed transactions by foreign investors involving a target company in so-called ” basic designated trade areas”. (See “CFIUS Goes Global: New FDI Review Processes Proliferate, Old Ones Grow.”)
The Japanese government’s efforts to “protect national economic security” are also evident in the ongoing development of relevant new legislation, which is expected to be submitted to the Diet in 2022. In addition, new Prime Minister Fumio Kishida, during from the formation of his initial cabinet in October 2021, appointed a new minister in charge of Japan’s “national economic security”. In conjunction with these government efforts, FEFTA can be a tool for Japanese authorities to coerce foreign activists into targeting domestic companies engaged in “basic designated trade sectors”. As such, analysis of any impact of FEFTA is essential from the perspective of foreign investors and the Japanese target company.