Increased Shareholder Activism
There was a sudden spike in shareholder activism in Japan last year, with increases in unsolicited takeover attempts, investor proposals, and opposition to management proposals. This activism was in part a reaction to companies’ protectionist moves, and at the same time, the strengthening of corporate defenses was in part a reaction to the increase in activism. In 2007, all of the shareholder proposals were defeated, and none of the takeover attempts came close to fruition. In one of the most visible cases, U.S.-based Steel Partners unsuccessfully challenged a Japanese court ruling upholding a takeover defense that allowed condiment maker Bull-Dog Sauce to dilute Steel’s 10 percent stake. Steel Partners announced in April that it plans to sell off its remaining Bull-Dog shares, Business Week reported.

Steel Partners, The Children’s Investment Fund (TCI) of the United Kingdom, and other institutions also filed significantly more proposals in 2007 asking for greater dividends. Many Japanese companies have traditionally viewed large cash reserves as a sign of stability and a guarantee that they will be able to continue to pay a stable dividend in the event of a downturn. However, Japanese firms have begun to realize that these large reserves make them vulnerable to hostile takeovers. Shareholders also face a problem with dividend proposals. By Japanese law, proposals may only relate to the dividend for the fiscal year under review, and not future dividends; limiting proponents’ ability to structure the proposals in a way that would attract new investors looking for future income.

Though some companies are raising dividends on their own, frustrated shareholders have submitted proposals at firms such as Hibiya Engineering and Electric Power Development (“J-Power”). A proposal by TCI asking J-Power to double dividends is one of seven that the fund is asking investors to support this year. Others include a proposal to appoint at least three independent directors and one to oppose the re-appointment of current company President Yoshihiko Nakagaki, Bloomberg News reported. The company will decide by June 2 what items, if any, of the TCI proposal slate will be voted at the meeting, according to news reports.

Last year’s dividend proposals could be considered a partial success, as one forced Ono Pharmaceutical to promise to spend more on dividends and share buybacks--albeit on its own terms rather than those of the proponent. Annual proposals by the Japan-based investor group Kabunushi (Shareholders’) Ombudsman, asking electronics giant Sony for greater disclosure on executive compensation, regularly win the support of over 40 percent of shareholders.

In addition, shareholders have succeeded in blocking two merger proposals, at steel products company Tokyo Kohtetsu and supermarket chain CFS, in the past 15 months. These developments, as well as a market downturn that wiped out over a trillion dollars in value, ensure that activism will continue. Most of the investors who submitted shareholder proposals in 2007, including TCI and Brandes Investment Partners--which filed a dividend proposal last year--are doing so again this year.

Amendments to Articles of Incorporation
Many of the most significant voting items for Japanese shareholders take the form of amendments to corporate articles. Some of the most notable amendments in 2008 will cover areas such as shareholder rights, takeover defenses, and board structure.

Shareholder Rights. This year, a number of companies are proposing amendments to establish rules governing shareholders’ rights to submit proposals or call special meetings. Such rules may not negate any rights provided under Japan’s new Corporate Law, but could address issues not covered by the law. For example, the company might set a limit on the length of a shareholder proposal to be carried in the proxy circular. The old Commercial Code specified a limit of 400 characters (kanji characters), but that limit was not included in the Corporate Law. The new law allows a company to abbreviate or summarize long proposals, whereas under the old code, a company could simply reject a proposal that was over the 400-character limit. Some investors are concerned that companies, believing that a shareholder proposal could gain widespread support, could choose to impose restrictions on the length or format to limit the persuasiveness of investors’ arguments.

Poison Pills. Japanese companies believe that obtaining shareholder approval for a poison pill will put them in a stronger position in the event of a lawsuit by a bidder or another shareholder. However, pills are not traditional voting items, so many companies add language to their articles clarifying the basis on which they are seeking shareholder approval for the pill, or for the issuance of warrants pursuant to the defense. Unlike pills themselves, article amendments require a two-thirds majority vote, so if shareholders oppose the pill itself, they usually oppose the related article amendments to maximize the chance that the pill will be thwarted. Some companies may also add language to their articles specifically authorizing them to grant compensation to a hostile bidder, in exchange for denying the bidder the right to exercise the warrants granted to all shareholders. Bull-Dog Sauce used such a provision to compensate Steel Partners last year, subjecting itself to substantial criticism from Japanese investors.

Auditor Liability Limits. Japanese law allows two types of article amendments related to the liability of directors and statutory (corporate) auditors: one authorizes a company to impose limits on liability by way of board resolution, and the other lets a firm specify limits on liability in its contract with the outside director or outside statutory auditor. However, the new Corporate Law also allows companies to limit the liability of their audit firms. This provision may be particularly controversial in Japan, considering the recent instances of auditor malfeasance. Once the largest auditing firm in the country, Misuzu Audit was forced to cease operations last July after its auditors were implicated in the accounting fraud at consumer products company Kanebo. The firm also audited the books of Nikko Cordial, which was given Japan’s largest-ever fine for accounting irregularities--¥500 million ($4.8 million)--in June 2007.

New Share Classes. The new law gives companies the ability to issue new types of shares with differential voting rights, including so-called “golden shares,” provided they specify such authority in their articles.

Majority Vote Requirement to Remove a Director. A positive feature of the new Corporate Law is that the removal of a director, formerly categorized as a special resolution requiring a two-thirds vote, has been changed to an ordinary resolution requiring only a simple majority. However, companies are permitted to amend their articles to restore a supermajority requirement to remove a director from the board. Only a few companies have done so thus far, but other firms may consider this step.

Stock Option Plans
The rules governing stock option plans in Japan were overhauled in 2006. Under the old Commercial Code, options granted to directors and statutory auditors were not treated as compensation, but are classified as such under the new Corporate Law. The new rules allow companies to specify an annual monetary ceiling on option grants to directors and statutory auditors, with options valued according to models such as Black-Scholes. As long as each year’s option grants fall within this ceiling, the company does not need to seek shareholder approval for each year’s grants to directors and statutory auditors. (This is not true for grants to employees, however.) Although dilution from option grants in Japan has traditionally been quite low, dilution levels at some companies have been increasing, and in the case of “evergreen” plans for directors, shareholders need to be mindful of the potential impact of annual grants over many years.

Staff Writer L. Reed Walton contributed to this article.