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date: 26 May 2019

Western versus Asian Laws on Corporate Governance: The Role of Enforcement in International Convergence

Abstract and Keywords

This chapter examines the issue of when laws do and do not converge in the field of corporate governance, with particular emphasis on the cost of enforcement and the role of enforcement in international convergence. Focusing on Western versus Asian laws on corporate governance, it considers when, how, and why legal rules change and whether transplantation of legal rules from Western countries has been successful. It also explores the relationship between enforcement and substantive legal rules, mainly by comparing laws in Japan and the United States. Finally, it discusses three areas relating to corporate governance: the regulation of insider trading, financial disclosure and accounting rules, and corporate law rules on governance.

Keywords: corporate governance, enforcement, legal rules, Japan, United States, regulation, insider trading, financial disclosure, accounting, corporate law

1 Introduction

1The volume of academic research on corporate governance is immense. Not only corporate governance in Western countries but also that in emerging economies in Asia and other regions has been explored in recent years.

Developing countries often import laws and regulations from developed countries. However, today, we observe a variety of laws and regulations throughout the world. In this chapter, I will discuss when laws do and do not converge in the field of corporate governance by emphasizing the cost of enforcement. In general, there are three familiar questions: (1) when, how, and why legal rules change; (2) whether transplantation of legal rules from Western countries has been successful; and (3) how enforcement interacts with substantive legal rules. In this chapter, I will focus on the first and the third questions by looking at situations where Asian jurisdictions import laws on corporate governance from Western jurisdictions.2 Because of my limited knowledge, I will mainly compare Japanese law with US law, but I hope the general discussion in this chapter will be more generally applicable in the broader context where Asian jurisdictions import laws from Western jurisdictions.

(p. 722) More generally, a companion to the three questions noted above is the well-known inquiry of whether legal rules are converging around the world. Indeed, very often, Asian countries import laws from Western countries. For instance, Japan imported corporate law from the US in 1950.3 In the process of legal transplantation, we sometimes observe persistence or resistance.4 However, in my view, one aspect that has not been considered seriously in the past research on legal transplantation is enforcement. Thus, in this chapter, I will discuss the enforcement aspect of legal transplantation regarding corporate governance. I will limit my discussion to large publicly held business corporations. In section 2, I will present the general theme that the cost of enforcement affects the convergence of substantive legal rules. In section 3, I will discuss a few examples. In section 4, I will briefly discuss the convergence of enforcement. In section 5, I will briefly address whether and how the cost of substantive legal rules affect the convergence of enforcement. Section 6 is the conclusion.

2 When Laws Change: Interactions between Enforcement and Substantive Legal Rules

Every country has its own legal developments, and such developments are the result of cultural, social, political and historical contingencies. Thus, for instance, the legal rules regarding the liability of managers and directors (and regarding shareholder derivative actions) seem to be developing quite uniquely in Japan.5 For instance, shareholder derivative actions were unknown to the original Japanese corporate law codified as the Commercial Code of 1899, and were transplanted from the US in the amendments to the Commercial Code in 1950. The Japanese system is structured similarly to the US counterpart. In both (p. 723) countries, typically shareholders are entitled to sue directors who are liable for damages to the company. Historical developments after 1950, however, have made the rules in both countries quite different. Just to illustrate one point of difference, most states in the US have recognized the dismissal of a derivative action where a special litigation committee of disinterested directors is set up and decides that the action is not for the benefit of shareholders,6 while in Japan that type of dismissal is unknown and the plaintiff shareholder is entitled to maintain the action no matter what decision is made by a litigation committee or the like, or even by majority shareholders.7 There are mechanisms that have been developed in Japan to disallow strike suits, but it is noteworthy that a single shareholder is entitled to maintain a derivative action even where most shareholders do not want the action.

In this chapter, however, I am inclined to argue, generally, that unique developments are producing non-unique results, and that the state of Japanese corporate law today is more, rather than less, similar to that of other countries’ corporate law. In shareholder derivative actions, I am inclined to think that cases where derivative actions would be dismissed in the US would very often result in court decisions holding that the defendant directors should not be held liable. In this chapter, I focus on the interactions between enforcement and substantive legal rules.8

2.1 Legal Rules as a Component of a System

Any social system can be viewed as consisting of components or sub-systems, and legal rules are an important example. Thus, for instance, a corporate governance system consists of a variety of components or sub-systems, such as the firm size, the ownership structure, the financial system, the capital market, the labor system, the culture, and the law.

Legal rules, as a component or sub-system, have several distinctive characteristics. First, they are brought into a system automatically without any action by the parties who are subject to them. Second, many such rules may be brought into a system even if the parties do not want them (although there must be a decision by a state adopting and implementing such legal rules). Third, legal rules often must be enforced by courts or through other institutional mechanisms, which means that many legal rules are not self-enforcing.

From an economic standpoint, it is interesting to see how the coexistence of a sub-system that has these characteristics and one that does not shapes and affects the system. It is also interesting to see how this affects the behavior of the parties who are subject to the legal rules in question.

Legal rules, like other sub-systems, change over time. In a perfect world, other things being equal, there must be pressure in the marketplace or politically to make an inefficient (p. 724) legal rule a more efficient one. A system with an inefficient rule as a component is of course less efficient than a system with an efficient rule as a component, because the overall value of the system is the sum of the values of each component; a system with an inefficient rule is at a competitive disadvantage and has to adjust. In reality, however, we observe different legal rules in different corporate governance systems, and legal rules sometimes converge and sometimes do not.

This is quite simply due to the fact that the world is not perfect and that other things are not equal. This also indicates that different components of a corporate governance system cannot be considered in isolation. In theory, there are at least two general explanations as to why the legal rules component of each corporate governance system differs from that of other corporate governance systems, and why they do not converge.

First, one theory providing an analytical tool to understand corporate governance more deeply is the idea of substitutabilities. This theory—though not uncommon in traditional legal scholarship—suggests that one component of the system often serves as a substitute for other components. For instance, where the market for corporate control is active, as is or has been the case in the US and the UK, there is less need for other monitoring mechanisms. Similarly, a country having less developed capital markets might have stronger bank monitoring or, if bank monitoring does not work, something else might supplement capital markets, such as a strong board of directors or a controlling shareholder (including state ownership). Thus, France and Italy, for instance, have histories of heavy monitoring by the government. Indeed, the state has been the controlling shareholder in many major corporations. It is also possible for various components to combine in substitution for another component. In Germany, both banks and families as controlling shareholders substitute for capital markets. The theory holds even if nothing seems strong in isolation, as appears to be the case in Japanese corporate governance. In this particular situation, one can still argue that each of the various components serves some monitoring role, even if not necessarily a strong one, so that in total the system functions.

Second, another interesting theory concerns complementarities.9 The idea is that various components (or sub-systems) of a given system are complementary to one another in certain situations. Where complementarities exist, the value of the system is not equal to the simple sum of the standard values of individual components. The integrated value of each component may vary, depending on the degree to which the component, as a whole or in part, is complementary to another component of the system. Thus, any given legal rule might have a different effect on the value (and efficiency) of the system. A legal rule that would have to be considered inefficient on a stand-alone basis is not necessarily a bad thing as part of a system if there are complementarities with its other components. This suggests that the same mechanism—bank monitoring, for instance—can have different effects in different corporate governance systems, depending on the complementarities it has with other components of the given system. Where (as in Germany) most firms are small or medium sized, bank (p. 725) monitoring is more effective and thus plays a more important role than where (as in the US) firms are mostly very large or very small. On the other hand, where (as in France) state influence pervades both lender and debtor decision making, bank monitoring is all but meaningless, despite the fact that loans are the major source of financing. Japan can serve as a further example, because in Japan, employees under the lifetime employment system are dominant in the firm’s decision making, and managers (who are former employees) are relatively familiar with respect to daily business activities, and thus information provided by banks and other business partners might be more valuable to them, which increases the value of bank monitoring. Finally, where (as in the UK) managers who come from outside are relatively good at using valuable information supplied by banks and other business partners, as a relative matter, the value of monitoring by banks and other business partners diminishes when lifetime employees, as opposed to outsiders, become managers.

Thus, given the existence of substitutabilities or complementarities, the fact that different systems have different legal rules should not be a surprise. To date, however, little attention has been paid to the interaction between legal rules and enforcement; if so, there must be insufficient understanding of the role and function of legal rules in corporate governance. In the following discussion, I will focus on the third characteristic of legal rules noted at the outset, namely that legal rules must be enforced. My central argument is that substantive legal rules sometimes converge, but sometimes they do not, and that they can even diverge because of the cost of enforcement. Enforcement is thus an important variable in the convergence or divergence of substantive legal rules.

For instance, the value of monitoring by shareholders should increase in conjunction with the reduction in the cost of enforcing legal rules regulating capital markets. This suggests that monitoring by shareholders should function better in the US than elsewhere, because the US has the class action system and other law enforcement mechanisms that are more effective than those of other major countries. In addition, I propose that the linkage between substantive legal rules and enforcement can operate the other way. Namely, the degree of convergence in substantive rules can affect the level and cost of enforcement.

2.2 Enforcement Affects Convergence of Substantive Legal Rules

With differing historical, cultural, and legal peculiarities, mechanisms and levels of enforcement are expected to vary from country to country, especially because of differences in the cost of enforcement relative to its value to enforcers.

Although substantive legal rules must be enforced, variations in enforcement costs do not necessarily affect the value of the legal rules component of a corporate governance system, if the component has substitutabilities or complementarities with other non-legal components. Thus, in a given corporate governance system, a component such as the structure of ownership might substitute for the legal framework. In that case, difference in the cost of enforcement might not be relevant, so long as the structure of ownership does not change. Similarly, variations in enforcement cost might simply reflect different complementarities. For instance, bank monitoring might be improved by a lower level of enforcement of manager liability by shareholders.

(p. 726) On the other hand, within the legal framework component, enforcement necessarily interacts with substantive legal rules. Because substantive legal rules must be enforced, the cost of enforcement affects the value of any substantive legal rule. In this sense, enforcement has complementarities to substantive rules. This suggests, first, that other things being equal, substantive legal rules do not converge when the cost of enforcement is different among jurisdictions. Second, we can expect convergence in substantive legal rules where the cost of enforcement is low. In such a situation, courts and regulators will develop substantive legal rules without worrying about their enforceability. This also holds where substantive legal rules are self-enforcing. Third, I submit that rules do change when enforcement is too costly. Indeed, there is then reason to think that market and other forces might arise to make substantive legal rules change to those that are enforceable at lower costs.

Simple numerical examples might be helpful to illustrate these points. First, suppose that the cost of enforcement for Rule A in Country X is 50, that that for Rule B in Country Y is 80, and that their substantive legal rules, Rule A and Rule B, differ from one another. Assume that the value (defined as how efficient the rule is to the system concerned, aside from the cost of enforcement) of Rule A is 100 and that that of Rule B is 120. Disregarding complementarities and the like, other things being equal, the situation in Country Y is worse because the combined value of the legal rule (the value of Rule A or Rule B minus enforcement cost) is 50 in Country X and 40 in Country Y. If complementarities exist, however, this might not be so, because the combined value of the rule in Country Y might be more than 40: say, 50. If that is the case, both countries might well stay as they are by maintaining different rules and different enforcement situations.

Second, suppose that the cost of enforcement for each of Rule A and Rule B is zero. In this environment, Country X, if it knows Country Y’s situation, might well change Rule A to Rule B. The value of Rule B is higher than that of Rule A.

Third, suppose that the cost of enforcement for Rule B in Country Y is 10,000. We then would hardly believe that complementarities would offset the disadvantage of Country Y having the too costly enforcement situation. In such situation, because enforcement of Rule B is too costly, Rule B might change. Similarly, if Country Z, having a different substantive legal rule, Rule C, with the value of 110, has an excessively costly enforcement situation—say, with an enforcement cost of 10,000—one might expect that Rule C would change too. Thus, since both Country Y and Country Z might change their rules to those that would be enforceable at lower costs, the rules of the two countries might well converge.

In the following discussion, I will briefly examine three areas relating to corporate governance and focus on these points: the regulation of insider trading, financial disclosure and accounting rules, and corporate law rules on governance.

3 Examples

3.1 Insider Trading

The regulation of insider trading is a good and straightforward example showing that substantive legal rules do not converge where the cost of enforcement differs. The basic purpose (p. 727) of the substantive legal rule on insider trading is similar in most jurisdictions (which is the prohibition of trading of stock based on material non-public information), but the exact rule varies from jurisdiction to jurisdiction. For instance, the exact rule in the US is different from that in Japan. In short, the Japanese rule is narrower, as insiders and inside information (known as “material facts”) are both defined in the statute more restrictively than in the US.10 For instance, a recipient of insider information from a corporate insider (such as an officer or director of the relevant firm) is subject to prohibition, but a further recipient of the information from the first recipient (known as a “tippee” in the US) is not.11 Additionally, even if a certain fact materially affects the stock price, if that particular type of fact is not on the statutory list, then trading based on that information is not prohibited.12 Additionally, because this Japanese rule was adopted as late as 1988, the indication is that rules are not converging between the two countries.

The rule in the US developed on the basis of court cases concerning civil remedies under the SEC’s Rule 10b-5, which was promulgated under Section 10(b) of the Securities Exchange Act of 1934. While there are several criminal cases on this point, the dominance of civil cases produced by private litigation is noteworthy in the US and resulted in continuous expansion of the basic prohibition stated by Rule 10b-5.

By contrast, in Japan, there have been no civil cases on this point at all, and all existing cases involve criminal sanctions and administrative fines. In fact, when the rule was adopted in 1988, it was designed to be enforced via criminal sanction, not civil sanction. Given the general importance of private action for enforcement, this necessarily implied a lower level of enforcement in Japan than in the US. Japan introduced administrative fines in 2005, and since then several insider trading cases have been dealt with by this means.13 Yet, today, the lack of civil enforcement in Japan still makes the US and Japan different.

Thus, the difference between the US and Japanese enforcement mechanisms somewhat neatly explains the difference in the substantive legal rule between the two countries.

I might add that certain securities regulation, such as the regulation of insider trading, needs a strong enforcement agency, such as the US Securities and Exchange Commission, in addition to courts. A study of the data on the budgets and staffing of public enforcers shows that public enforcement is not so bad.14 This also suggests that the cost of enforcement is quite different among jurisdictions, and if so, it is no surprise from my argument here that the substantive legal rules are different in the US and Japan.

(p. 728) 3.2 Financial Disclosure and Accounting

Financial disclosure and accounting rules, particularly those for “hard” information such as data in the firm’s financial statements, are often enforceable at low cost. If a publicly held company keeps supplying false accounting numbers in its financial statements, it is most likely to be uncovered and penalized in the marketplace.

Thus, contrary to the rule on insider trading, legal rules on financial disclosure and accounting are often self-enforcing. This implies that it is the value of the substantive legal rule itself that matters, and not so much the cost or level of enforcement. In that situation, there is reason to expect that various jurisdictions’ financial disclosure and accounting rules will converge in a more efficient direction.

This simple statement needs a few cautions. First, we have found some cases of accounting fraud all over the world. Enron in the US15 and Olympus in Japan16 are well-known examples. These cases may show that disclosure rules are not self-enforcing. However, for the purposes of this chapter, I submit that in both cases, the fraud was ultimately uncovered and dealt with by heavy legal sanctions, so that, overall, the cost of enforcement of disclosure rules is rather low compared to other regulations.

Second, over the decades, there have been efforts to develop an international accounting or financial reporting standard, called the International Financial Reporting Standards (“IFRS”), by an international body, called the International Accounting Standards Board,17 yet, to date, accounting standards throughout the world have not completely converged into IFRS or any other uniform standards. This might be contradictory to the theme I present above. However, as substantive legal rules, what matters is not the detail of the contents of the accounting standards but the mandatory disclosure of financial statements, and basic accounting figures in financial statements are not drastically different among jurisdictions in the world. Indeed, it is fair to say that the detailed contents of the accounting standards throughout the world have been converging, rather than diverging, in the past. If so, overall, I am inclined to argue that in financial disclosure, the low cost of enforcement has been stimulating convergence of substantive legal rules in this field.

3.3 Corporate Law

Corporate law rules seem more complex than rules on insider trading or on financial disclosure. There is a wide variety of rules, from voting rules, to monitoring devices such as board systems, and to shareholder litigation. This diversity, coupled with differences in enforcement mechanisms across jurisdictions, implies that corporate law rules might and might not converge. As noted before, convergence is more likely to occur with respect to two categories of rules: rules whose value does not depend on enforcement (self-enforcing rules) and rules having no value because of the low level of enforcement in the relevant jurisdictions. (p. 729) Convergence is less likely to occur with respect to the rules having a value determined by complementarities with the applicable enforcement mechanism.

For instance, rules regarding management duties have a value which varies depending upon rules regarding shareholder litigation, such as rules regarding shareholders’ derivative actions. Consequently, there are complementarities with the enforcement mechanism, and if enforcement levels vary among jurisdictions, one should expect a lack of convergence in substantive rules about management duties. As far as Japan is concerned, the popularity of shareholder derivative actions today seems to suggest that the cost of enforcement in this area has changed in the past 20 years and that it is quite low today in Japan.18 If so, my analysis suggests that substantive legal rules tend to converge toward those of other jurisdictions where such rules are enforced at low cost, as in the US.19 By contrast, in transition or emerging economies where there is no solid judicial system and the level of enforcement is low, there might be pressure to adopt rules that have a value independent of enforcement (self-enforcing rules) or that are enforceable with little involvement of the courts. As a matter of fact, and quite unsurprisingly, we observe the dominance of voting rules and other more self-enforcing rules in these economies. In other words, the low level of enforcement makes substantive rules tend to converge.

My convergence proposition can be tested by considering two areas in which corporate law rules differ markedly among major industrialized jurisdictions. One is the area of corporate takeovers, and the other is that of board structures (one-tier versus two-tier board systems). Regarding rules on takeovers, the test is rather easy: such rules have more value in jurisdictions where there is both a well-developed capital market (inter-component complementarity) and a high level of enforcement (intra-component complementarity). Indeed, the value of substantive legal rules on corporate takeovers, including those on defensive measures by incumbent management, particularly depends on how the market for corporate control operates. In the US, the well-developed capital market and the well-functioning judicial system led to quite distinctive features of detailed substantive rules on corporate takeovers. This situation is unique, especially insofar as the level of enforcement is concerned. For this reason, one cannot expect a convergence of rules in the near future on corporate takeovers among major jurisdictions in Europe and the US. This conclusion might not, however, be relevant in the longer term. Indeed, substantive rules on corporate takeovers have changed in the US over the past decades, and the market for corporate control was sometimes strong and sometimes weak. As a vast quantity of scholarship suggests, the value of the US corporate governance system was probably maintained (or possibly improved) over time because of the emergence of substitutes: institutional investors served as substitutes for the market for corporate control. The same has been happening in Europe, which would make divergence in the legal framework component of little importance.

In Japan, laws on takeover defenses are complicated. Securities regulation, codified as the FIEA, regulates tender offer processes, while most of the defense measures raise legal issues under corporate law, codified as the Companies Act (effective from May 1, 2006 as a successor of the Commercial Code with respect to business corporations), and not the (p. 730) FIEA. In this sense, the distinction between the FIEA and the Companies Act roughly corresponds to that between the federal (and state) securities law and state corporate law in the US. The validity of some of the defenses was challenged before the courts, and in those cases the relevant issues were the ones under the Companies Act, not the FIEA.20 In fact, the current tender offer regulations under the FIEA permit the target company to adopt defensive actions even after the commencement of a tender offer by a hostile bidder. Thus, like in Delaware, case law under the Companies Act shapes the landscape, although the substance of the case law is not identical between Delaware and Japan.21

In Japan, the Companies Act is important for the critical issues in the area of hostile takeovers and defenses, and courts play an important role in applying the relevant rules under the Companies Act. The Tokyo Stock Exchange also plays an important role in shaping the landscape in this area, since such issues are not directly regulated by the FIEA.

The existing variety of substantive rules on board structures does not fit into my analysis very well. Enforcing substantive rules on board structures does not seem to be costly. Rather such rules seem to be self-enforcing. If this is true, then rules on board structures should converge. The fact is, however, that we observe quite different rules on board structures across jurisdictions.

One might be inclined to say that differences in rules on board structures might be explained by the existence of substitutes or other components of the system having complementarities. One might also try a different argument. For instance, apparent differences in substantive rules might not be important, because different rules can solve the same problem without perceptible effect; or more bluntly, having a one-tier or a two-tier board might not matter, as firms with one-tier boards need to institute executive boards to make operational decisions. This argument is supported by the fact that major jurisdictions seem to be converging on what is the most important of structural features: the existence of an independent committee or body. Major jurisdictions tend to require the establishment of an independent monitoring body, such as an audit committee, for each publicly held firm, regardless of whether such firm has a one-tier or two-tier board system.

Japan imported the board of directors system from the US in the amendments to the Commercial Code in 1950, but did not abolish the statutory auditor system noted below. Since the amendments in 2002, a choice is permitted between a two-board company and a one-board and three-committee company. In the former, a board of directors and a board of statutory auditors are required, while in the latter, there are no statutory auditors and the board of directors is required to have three committees: a nominating committee, an audit committee, and a compensation committee. This latter form was introduced by the amendments to the Commercial Code in 2002 (effective from April 1, 2003), and more (p. 731) than half of each of the committees’ members must be “outside” directors. For two-board companies, at least half of the members of the board of statutory auditors must be “outside” statutory auditors, but the board of directors does not have to have outside directors. In practice, one-board and three-committee companies are not popular given the number of firms that have adopted that form. Only 2.2% of the listed firms on the Tokyo Stock Exchange (TSE), as of September 10, 2012, are one-board and three-committee companies.22

A brief further note on two-board companies may be worthwhile, because statutory auditors are not well known outside Japan. For a two-board company, there must be at least three directors. Directors are elected at the shareholders’ meeting, and form the board of directors. The board elects representative directors, the Japanese counterpart of US officers or executives. There must be at least one representative director. Representative directors are the management, and they run the company. The Companies Act requires that the board of directors make important corporate decisions and supervise the management. Each director, as a member of the board, owes a duty of care and loyalty to the company.

A two-board company must have a “kansayaku,” often (somewhat misleadingly) translated as a statutory auditor. Statutory auditors are elected at the shareholders’ meeting, and do not have to be accountants or other professionals. A “large company,” which is defined under the Companies Act as a joint-stock company having either legal capital in the amount of 500 million yen or more, or total debt (on the balance sheet) in the amount of 20 billion yen or more, must have at least three statutory auditors, and at least half of them must be “outside” statutory auditors. An auditor is “outside” where he or she does not, and did not in the past, serve as a director or employee of the company or its subsidiary. In a large company, there must be at least one full-time auditor.

In addition, a large company must have an accounting auditor, who must be a certified public accountant or certified auditing firm. An accounting auditor is elected at the shareholders’ meeting, and is responsible for auditing the company’s financial statements annually before they are submitted to the annual shareholders’ meeting, where the audit opinion is also submitted. In contrast, a statutory auditor is responsible for overseeing the activities of management. This is understood to mean confirming the legality of management’s activities. The Companies Act requires collaboration between accounting auditors and statutory auditors, providing complex rules, the details of which are beyond the scope of this article.

A two-board company may elect an outside director, although this election is not mandatory. If the company has an outside director, the Companies Act permits some special treatment. For instance, decision making on certain important matters may be delegated from the board of directors to a smaller special board. A director is “outside” where he or she is not, and was not, an executive director or employee of the company or its subsidiary.

There are two recent trends in this area. First, the Tokyo Stock Exchange today requires listed firms to have at least one “independent” director or statutory auditor, and (p. 732) the TSE has adopted a policy that encourages all listed firms to have independent directors. Second, as noted below, the Companies Act was amended in June 2014 (the amendments went into effect in May 2015). Under the 2014 amendments to the Companies Act, the definition of “outside” is stricter in two respects.23 In addition to the requirement of lack of an employment relationship with the company or its subsidiaries, lack of an employment relationship with the company’s parent firms will be required. Also, lack of a family relationship will be required. Note, however, that lack of a business or trade relationship, required by the current TSE rule for independence, will not be required under the new regime of the Companies Act. Aside from this, having an outside director is encouraged by a “comply or explain” rule. Specifically, two-board companies are to be subject to a rule where they must explain the reason why they do not have an outside director, if they do not have one, at the annual shareholders’ meeting.24

In addition, under the 2014 amendments, a new type of company will be introduced allowing for a type with a one-board and one-committee structure (where there are no statutory auditors and the majority of the committee members must be outside directors).25 As a result, listed firms will have the choice of three board structures: (1) two boards; (2) one board and three committees; and (3) one board and one committee. This one-board and one-committee structure is intended to encourage listed firms with a two-board structure to move to that structure and thereby have outside directors.

At any rate, it is noteworthy that enforcement alone does not seem to explain the non-convergence of substantive rules on board structure.

4 Convergence of Enforcement

My discussion thus far has assumed that enforcement mechanisms do not converge. This assumption, however, is not plausible, at least in theory. Like a legal rule, an inefficient enforcement mechanism must face pressure to change.

In this line of thinking, one important point must be made. Unlike substantive rules, the value (or cost) of enforcement can be defined in a straightforward way. That is, it is most efficient when the enforcement cost is zero. Viewed this way, talking about convergence of enforcement appears misleading because as far as the cost of enforcement alone is concerned, the lower the better. However, one could still discuss the level of enforcement. A rule is enforced up to the point where the cost of enforcement outweighs the cost of non-enforcement. Thus, a certain institutional mechanism, say, the court system, might be better or worse than another mechanism, say, the arbitration system, so that one could discuss convergence or divergence of enforcement mechanisms in this vein. Similarly, one could argue that if the number of judges and private attorneys is decreasing in one country and increasing in another country, the enforcement systems are converging. However, insofar as the area of corporate governance is concerned, I am inclined to make an empirical assumption that (p. 733) enforcement mechanisms have too many hurdles to converge, and will leave the discussion on convergence of enforcement to further research in the future.

5 Convergence of Substantive Legal Rules Affects Enforcement

My discussion thus far has examined how enforcement affects substantive rules. In theory, one can think of the reverse linkage between enforcement and substantive rules: how convergence of substantive rules affects enforcement. For instance, if certain substantive rules are similar in two jurisdictions, judges in one jurisdiction might borrow precedents from the other jurisdiction, so that similar substantive rules might result in quicker and cheaper court decisions. If so, convergence of substantive rules affects the level of enforcement. Similarly, when a jurisdiction prepares a new enforcement mechanism, if a similar substantive rule is adopted, the jurisdiction might be able to prepare a new enforcement mechanism rather quickly and easily by importing it from elsewhere. I believe that this phenomenon is in fact observed in the areas of consumer protection and environmental law. In corporate governance, this can happen where a large-scale law reform is considered in any given jurisdiction; for instance, where Asian jurisdictions attempt a large-scale law reform on corporate governance by introducing a new monitoring mechanism.

Indeed, when European countries introduced or strengthened the regulation of insider trading, there was pressure to adopt a US style of substantive rule, which operated as pressure for enforcement mechanisms to converge. Ultimately, the path to establish an enforcement agency like a US Securities and Exchange Commission was not imposed on the EU Member States, but to date, the discussion on the enforcement mechanism has continued.26 Additionally, convergence of financial disclosure and accounting rules toward a more stringent standard has forced jurisdictions to give a higher legal profile to professional accountants and auditors as an additional monitoring body to facilitate the self-enforcing character of the relevant financial disclosure and accounting rules.

6 Preliminary Conclusion

In this chapter, I have examined the interrelationship between substantive legal rules and enforcement. I have shown that the cost of enforcement affects convergence or divergence of substantive legal rules in corporate governance. I have submitted a hypothesis that where enforcement costs are very low or too high, there is reason to expect that substantive rules will converge. Otherwise, differences in enforcement predict differences or divergence in substantive rules. As the cost of enforcement becomes lower in certain jurisdictions, there (p. 734) is more chance that their substantive legal rules will converge. I have also touched briefly upon the reverse linkage between rules and enforcement: convergence of substantive rules may affect enforcement. In my view, enforcement should be paid more serious attention in the research on comparative corporate governance. A proper focus on enforcement would shed new light on the issue and justify revisiting the familiar debate on convergence or divergence of substantive legal rules in world corporate governance systems. I hope the framework presented in this chapter will provide for a better understanding of the situations in which Asian jurisdictions import laws on corporate governance from Western jurisdictions.


(1) Professor of Law, University of Tokyo (until 2016); Fellow, European Corporate Governance Institute. I thank Professor Wolf-Georg Ringe for his helpful comments and suggestions.

(2) For the second question, see, e.g., Hideki Kanda & Curtis J. Milhaupt, “Re-Examining Legal Transplants: The Director’s Fiduciary Duty in Japanese Corporate Law”, 51 Am. J. Comp. L. 887 (2003).

(3) See, e.g., Mark D. West, “The Puzzling Divergence of Corporate Law: Evidence and Explanations from Japan and the United States”, 150 U. Pa. L. Rev. 527 (2001).

(4) See papers in Convergence and Persistence in Corporate Governance (Jeffrey N. Gordon & Mark J. Roe eds., 2004) and Convergence of Corporate Governance: Promise and Prospects (Abdul Rasheed & Toru Yoshikawa eds., 2012). On the convergence of legal rules, the case for convergence of corporate law has been advocated in Henry Hansmann & Reinier Kraakman, “The End of History for Corporate Law”, 89 Geo. L. J. 439 (2001). See also Henry Hansmann, “How Close Is the End of History?”, 31 J. Corp. L. 745 (2006); Henry Hansmann & Reinier Kraakman, Convergence of Corporate Governance: Promise and Prospects, in Rasheed & Yoshikawa supra. For “functional” convergence, see Ronald J. Gilson, “Corporate Governance and Economic Efficiency: When Do Institutions Matter?”, 74 Wash. U. L. Q. 327 (1996); Ronald J. Gilson, “Globalizing Corporate Governance: Convergence of Form or Function”, 49 Am. J. Comp. L. 329 (2001). For inquiries into divergence, see, e.g., Lucian Bebchuk & Mark J. Roe, “A Theory of Path Dependence in Corporate Ownership and Governance”, 52 Stan. L. Rev. 775 (1999). For a more recent study, see Bernard Black, Antonio Gledson de Carvalho, & Erica Gorga, “Corporate Governance in Brazil”, 11 Emerging Markets Review 21 (2010). For the importance of ownership structure, see Lucian Bebchuk, “The Elusive Quest for Global Governance Standards”, 157 U. Pa. L. Rev. 1263 (2009).

(5) See Hideki Kanda, “Understanding Recent Trends regarding the Liability of Managers and Directors in Japanese Corporate Law”, 17 Zeitschrift fur Japanisches Recht 29 (2004).

(6) See William T. Allen, Reinier Kraakman and Guhan Subramanian, Commentaries and Cases on the Law of Business Corporations 392 (4th ed. 2012).

(7) See Tomotaka Fujita, Transformation of the Management Liability Regime in Japan in the Wake of the 1993 Revision, in Transforming Corporate Governance in East Asia 15 (Hideki Kanda, Kon-Sik Kim, & Curtis J. Milhaupt eds., 2008). For a recent study on shareholder derivative actions in Asia, see The Derivative Action in Asia: A Comparative and Functional Approach (Dan W. Puchniak, Harald Baum, & Michael Ewing-Chow eds., 2012).

(8) The following discussion draws on Gerard Hertig & Hideki Kanda, Rules, Enforcement, and Corporate Governance (unpublished draft 1998).

(9) For the idea of complementarities, see Paul Milgrom & John Roberts, “Complementarities and Systems: Understanding Japanese Economic Organization”, 1 Estudios Economicos 3 (1994). See also Masahiko Aoki, The Japanese Firm as a System of Attributes, in The Japanese Firm: The Sources of Competitive Strength 11 (Masahiko Aoki & Ronald Dore eds., 1994); Ronald J. Gilson, “Reflections in a Distant Mirror: Japanese Corporate Governance through American Eyes”, 1998 Colum. Bus. L. Rev. 203 (1998).

(10) See Arts. 166 and 167 of the Financial Instruments and Exchange Act in Japan (Act No. 25 of 1948, as amended) (“FIEA”). The FIEA was introduced in 1948 (then it was called the Securities and Exchange Act) as an import of the US Securities Act of 1933 and Securities and Exchange Act of 1934.

(11) See Art. 166(3) of the FIEA.

(12) See Art. 166(1)(2) of the FIEA. There are catch-all provisions for inside information (see Art. 166(2)(iv)(viii)(xiv)), but they are not discussed here.

(13) Through March 31, 2014, the Securities and Exchange Surveillance Commission recommended to the Financial Services Agency that administrative fines be imposed in 172 cases of insider trading. See (in Japanese).

(14) Howell E. Jackson & Mark J. Roe, “Public and Private Enforcement of Securities Laws: Resource-Based Evidence”, 93 J. Fin. Econ. 207 (2009).

(15) See John C. Coffee, Jr., Gatekeepers: The Role of the Professions and Corporate Governance (2008).

(16) See Bruce E. Aronson, “The Olympus Scandal and Corporate Governance Reform: Can Japan Find a Middle Ground Between the Board Monitoring Model and Management Model?”, 30 UCLA Pacific Basin L. J. 93 (2012).

(17) See the website of the IFRS at

(18) See, e.g., Mark D. West, “Why Shareholders Sue: The Evidence from Japan”, 30 J. Leg. Stud. 351 (2001); Fujita, supra note 7. For the situation in Asian jurisdictions, see Puchniak et al., supra note 7.

(19) See generally Kanda, supra note 5.

(20) See, e.g., Hideki Kanda, Takeover Defenses and the Role of Law: A Japanese Perspective, in Perspectives in Company Law and Financial Regulation 413 (Michel Tison et al. eds., 2009).

(21) See Curtis J. Milhaupt, “In the Shadow of Delaware? The Rise of Hostile Takeovers in Japan”, 105 Colum. L. Rev. 2171 (2005); Jack B. Jacobs, “Implementing Japan’s New Anti-Takeover Defense Guidelines, Part II: The Role of Courts as Expositor and Monitor of the Rules of the Takeover Game”, 3 U. Tokyo J. L. & Pol. 102 (2006). See also John Armour, Jack B. Jacobs, & Curtis J. Milhaupt, “The Evolution of Hostile Takeover Regimes in Developed and Emerging Markets: An Analytical Framework”, 52 Harv. Int’l. L. J. 219 (2011).

(22) See Tokyo Stock Exchange, “White Paper on Corporate Governance 2013”, TSE-Listed Companies (February 2013), available at See also Ronald J. Gilson and Curtis J. Milhaupt, “Choice as Regulatory Reform: The Case of Japanese Corporate Governance”, 53 Am. J. Comp. L. 343 (2005).

(23) See Art. 2(xv) and Art. 2(xvi) of the Companies Act (amended in 2014).

(24) See Art. 327-2 of the Companies Act (added in 2014).

(25) See Art. 399-2 through Art. 399-14 of the Companies Act (added in 2014).

(26) The European Securities and Markets Authority is not given much power of enforcement. See its website at