Explanation of the System for Companies with Nominating Committees under Japanese Corporate Law

The Japanese Corporate Law offers several options for the governance structure of stock corporations, namely corporate governance. Among these, the “Company with Nominating Committee, etc.” represents an advanced institutional design aimed at enhancing management transparency and supervisory functions. This system originated from the “Company with Committees, etc.” system introduced by the amendment to the Commercial Code Special Provisions Act in 2002 (Heisei 14) and was adopted by the Japanese Corporate Law enacted in 2005 (Heisei 17). Unlike the traditional “Company with Board of Corporate Auditors” commonly found in Japanese companies, the “Company with Nominating Committee, etc.” is personalityized by a clear separation of the supervisory function of management from the business execution function. Specifically, the board of directors focuses on determining the basic policies of management and supervision, while the day-to-day business execution is handled by officers known as “executive officers.” Furthermore, it is mandatory to establish three committees within the board of directors: the Nominating Committee, the Audit Committee, and the Compensation Committee. These committees are responsible for making decisions from an independent and objective standpoint on particularly important matters in corporate governance, such as the nomination of directors, auditing of business execution, and determination of executive compensation. The requirement that a majority of the members of each committee must be independent external directors is a crucial mechanism to ensure the objectivity of this system. This article will provide a detailed explanation of the “Company with Nominating Committee, etc.” system, its structure, and roles, based on the provisions of Japanese Corporate Law. Specifically, we will clarify the functions of the directors and the board of directors under this system, as well as the authority and responsibilities of the Nominating Committee, Audit Committee, and Compensation Committee.

What Is a Company with Nominating Committee etc. Under Japanese Corporate Law?

A company with nominating committee etc. is a type of organizational design for stock companies defined in Article 2, Paragraph 12 of the Japanese Companies Act. Companies adopting this system are legally obligated to establish three committees: a nominating committee, an audit committee, and a compensation committee. The core purpose of this system is to separate “supervision” from “business execution” in the management of the company. As a result, the board of directors can distance itself from day-to-day business execution and focus on its role of objectively overseeing the performance of the management team. The actual business execution is then handled by “executive officers” appointed by the board of directors. This clear separation of supervision and execution enhances the transparency of management decision-making and strengthens accountability to stakeholders, including shareholders. Particularly, this governance structure is often valued by foreign investors as being close to international standards. In a company with nominating committee etc., the aforementioned three committees have significant authority over core management issues such as personnel affairs, auditing, and compensation. Moreover, according to Article 400, Paragraph 3 of the Japanese Companies Act, a majority of the members (committee members) of each committee must be “outside directors” who are independent from the company’s management team. This requirement aims to prevent personnel and compensation decisions based on the self-interest of the management team and to achieve objective and fair governance.

The Role of the Board of Directors in Companies with Nominating Committees in Japan

The role of the board of directors in Japanese companies with nominating committees significantly differs from those in companies with other organizational structures. The most important distinction is that the board of directors, in principle, does not directly execute the company’s business operations.

Article 416, Paragraph 1 of the Japanese Companies Act defines the authority of the board of directors in companies with nominating committees. According to this, the main roles of the board of directors are summarized into three key points:

1. Deciding on the basic policy of management
2. Determining necessary matters for the execution of duties by the Audit Committee
3. Supervising the execution of duties by executive officers

Firstly, the board of directors decides on fundamental policies related to the company’s management, such as formulating mid-term management plans or making decisions on large-scale investments, which are crucial to the company’s core. However, the execution of specific business operations based on these decided policies is not carried out by the board itself but is delegated to executive officers.

Next, the board of directors is responsible for establishing a system that ensures the Audit Committee can effectively perform its role in auditing the execution of duties by executive officers and directors.

The most critical role is the supervision of executive officers. The board of directors monitors whether executive officers are executing their duties appropriately in accordance with the basic policies and evaluates their performance. To make this supervisory function effective, the board of directors also has the authority to appoint and dismiss executive officers and directors (under Article 416, Paragraph 1 of the Japanese Companies Act). However, the nominating committee, which will be discussed later, determines the content of proposals for the appointment and dismissal of directors to be submitted to the shareholders’ meeting.

In this way, directors in companies with nominating committees serve not as business executors but as supervisors of management. This is a decisive difference from directors in companies with other organizational structures, who often also execute business operations themselves. Furthermore, based on Article 415 of the Japanese Companies Act, the board of directors can significantly delegate the decision-making of business execution to executive officers for matters not designated by law or the company’s articles of incorporation as requiring the board’s resolution. This ensures a clear separation between management supervision and execution within the legal framework.

The Three Committees and Their Common Organizational Requirements Under Japanese Corporate Law

The core of the governance in companies with nominating committees in Japan consists of three key committees: the Nominating Committee, the Audit Committee, and the Compensation Committee. These committees are institutions established within the board of directors, and each exercises important and independent authority.

There are common organizational requirements for the three committees as stipulated by Article 400 of the Japanese Companies Act. Firstly, each committee must be composed of three or more directors (Article 400, Paragraph 1). Secondly, and most importantly, a majority of the members of each committee must be external directors (Article 400, Paragraph 3). An external director refers to a director who is not an officer or employee involved in the execution of business of the company or its subsidiaries and who stands in an independent position from the management (Japanese Companies Act, Article 2, Item 15). This requirement ensures the objectivity and fairness of the deliberations and decisions within each committee.

The Nomination Committee Under Japanese Corporate Law

The Nomination Committee has the authority to determine the content of proposals for the appointment and dismissal of directors to be submitted to the shareholders’ meeting, as stipulated in Article 404, Paragraph 1 of the Japanese Companies Act. In other words, it is not the CEO or President who decides who should be nominated as director candidates or which directors should be dismissed, but rather this Nomination Committee. By having a Nomination Committee composed of a majority of external directors wield this power, it is possible to prevent so-called “self-serving personnel decisions,” where the top management appoints individuals convenient for themselves to the board. This ensures the objectivity and diversity of the board’s composition, leading to the strengthening of its supervisory function.

Audit Committees in Japan

The Audit Committee in Japan has the authority to audit the execution of duties by executive officers and directors and to prepare audit reports, as stipulated under Article 404, Paragraph 2, Item 1 of the Japanese Companies Act. This includes a broad authority to investigate the status of the company’s business and assets. The Audit Committee can demand reports on the business from executive officers and employees at any time and investigate the status of the company’s business and assets, as per Article 405, Paragraph 1 of the Japanese Companies Act. Additionally, if the committee discovers any illegal acts or significantly improper facts, it has the duty to report to the board of directors (the same article, Paragraph 2). Furthermore, the Audit Committee also has the power to determine the content of proposals regarding the appointment, dismissal, or non-reappointment of accounting auditors who perform the company’s financial audits, as per Article 404, Paragraph 2, Item 2 of the Japanese Companies Act. This ensures the independence of the financial audits. Compared to the Board of Corporate Auditors in companies with such a system, the powers of the Audit Committee are more robust, and as an internal organ of the board of directors, it is personalityized by its more direct involvement in the oversight of management.

Compensation Committee Under Japanese Corporate Law

The Compensation Committee holds the authority to determine the individual compensation and other remuneration for executive officers and directors as stipulated by Article 404, Paragraph 3 of the Japanese Companies Act. Under Japanese Corporate Law, “compensation and other remuneration” refers to monetary benefits received from the company as consideration for the execution of duties, including salaries, bonuses, and other forms of payment. The Compensation Committee makes concrete decisions on the remuneration amounts for each officer based on the company’s performance and the individual contributions of the officers, adhering to objective criteria. By ensuring that a majority of the Compensation Committee is composed of external directors, it prevents the possibility of excessively high officer remuneration and a lack of transparency in the decision-making process. The transparency and fairness of the officer remuneration decision process are of utmost importance in gaining the trust of shareholders, and the Compensation Committee plays a pivotal role in institutionally ensuring these qualities.

Comparing with Other Institutional Designs

To deepen the understanding of companies with nominating committees and similar structures, we compare them with the most common institutional design in Japanese companies, the company with a board of corporate auditors. The table below summarizes the main differences between the two.

As the table illustrates, companies with nominating committees and similar structures systematically separate supervisory and executive functions, and involve external directors strongly in the decision-making of critical matters such as personnel and compensation. This mechanism aims to achieve more objective and transparent governance, which is the essential difference from companies with a board of corporate auditors.

Summary

In this article, we have explained the framework of companies with nominating committees, etc., as stipulated by the Japanese Companies Act, including the systematic structure, the roles of each organ, and a comparison with other systems. Companies with nominating committees, etc., in Japan aim to enhance the objectivity and transparency of management by clearly separating the supervisory function of the board of directors from the business execution function of the executive officers, and through the establishment of three committees within the board of directors: nominating, auditing, and compensation. Particularly, the requirement that a majority of the members of each committee be external directors is a crucial element in gaining trust from international investors. For companies operating in Japan or considering transactions or investments with Japanese companies, understanding the governance structure of the counterpart company is essential.

Monolith Law Office boasts extensive experience and a proven track record in all aspects of business law, including the Japanese Companies Act. Our firm is staffed with professionals who are not only qualified as Japanese attorneys but also hold foreign legal qualifications and are proficient in both Japanese and English. We have provided practical and concrete legal advice to domestic and international clients on transitioning to companies with nominating committees, etc., appointing external directors, committee operations, and other complex issues related to Japanese corporate law. If you require assistance in establishing a robust governance structure in Japan or addressing related legal challenges, please do not hesitate to consult with our firm.