Stalking the corporate corridors.

SHAREHOLDERS HAVE WATCHED FROM the sidelines as Japanese corporations have muddled through the last decade or so. The typical Japanese shareholder offers little or no dissent and often is forgotten or ignored by top executives. In short, he's been a non entity.

But years of wealth destruction and poor executive decisions have sown the seeds of discontent. Shareholder activism is on the rise in Japan, and a group of Osaka lawyers known as Kabunushi Ombudsman is leading the fight to force corporations make good their promises.

Every two weeks, reporters from the Nikkei and Asahi newspapers, the Kyodo wire and other large media organizations gather at a restaurant in Osaka to hear "the dirt" about Kansai area businesses. Their hosts

are the core members of Kabunushi Ombudsman, a group of activist lawyers founded in 1996 that is leading the charge to clean up corporate activity in Japan. KO, as the group is known, represents shareholders by monitoring corporate activities, criticizing companies that are less than forthcoming, praising those that share information and lobbying for progress at shareholder meetings. The group provides a voice for tire often voiceless Japanese shareholder.

One reporter says he comes to the bi-monthly dinners "to find out the latest scandal and gossip." KO, made up of 250 fee-paying members, including 20 core members, considers this part of its mission: letting the media know what's wrong with corporate Kansai.

In a country where many people still equate buying stock with betting on the horses, KO is a force to be reckoned with. The core members are mostly activist lawyers who grew disgusted with all the corporate scandals that arose during the 1990s. They decided to assert their rights as shareholders and get companies to shape-up.

Tokuo Sakaguchi and Tadashi Matsumaru started the group on an informal basis when they sued the major construction company Hazama in 1993 after it had been charged with bribing local government officials in Ibaraki prefecture. In 1995, they invited the current KO chairman, Koji Morioka, a professor of economics at Kansai University, to join them. Morioka was known as an activist in the movement against karoshi (death by overwork) at the time.

The group picked up new members after the jusen housing loan scandal began to unravel in the mid-1990s. Soon KO had brought together a group of lawyers that could represent shareholders in lawsuits. It then offered memberships to shareholders for the nominal fee of [yen] 5,000 a year. Members can rely on KO lawyers to provide free legal representation should they decide to sue a company in which they hold shares. This makes it much easier for shareholders to take legal action.

KO lawyers have represented members in lawsuits against 12 companies so far. In the suits, lawyers have generally implicated the audit firms involved, arguing that they permitted their clients to window-dress accounts. In the jusen case that got KO started, Asahi Audit was required to pay [yen] 20 million in compensation to shareholders. Other companies that have settled with KO lawyers include Takashimaya, Nomura Securities, Ajinomoto, the former Daiichi Kangyo Bank, Yamaichi Securities , Japan Airlines, Kobe Steel  and Mitsubishi Motors.

One member of KO, Kazuyoshi Yuoka, was the hero of a turning point in corporate history in Japan. The setting was the 1996 shareholder meeting of Sumitomo. The company was deep in a copper-trading scandal in which one trader had lost $1.8 billion over 10 years. Sumitomo's president at the time, Tomiichi Akiyama, expressed regret at the meeting, but he was less than forthcoming with the truth about how the losses occurred. Employees in the room yelled "No objection!" and "Next item!" to speed the board through the meeting, but just as the board was ready to close the proceedings, Yuoka spoke up. He called on Akiyama to take personal responsibility for the trader's actions and demanded public disclosure of the retirement bonuses of the directors concerned in the affair. The meeting ended without any response to Yuoka's questions--in fact, employees yelled to drown him out--but the age of the docile Japanese shareholder had officially come to a close.

Yuoka was not to be deterred. A hard man of the property business world, as well as a kendo master with a well-developed sense of samurai fair play, he took his case before the Osaka District Court. Although he failed to win, the court criticized shareholder meetings that were mostly staged and controlled by loud employees, warning that: "If a corporation arranges rehearsals for the meeting in order to expedite proceedings with shouting, such a shareholder meeting might be invalid." The legal opinion registered in corporate boardrooms, and many Japanese corporations have since stopped holding what are called "shah shan" ("clap clap") meetings. Meanwhile, Yuoka joined KO.

KO members try to attend shareholder meetings to raise issues, but there are still obstacles to doing so. KO lawyers cannot attend meetings as proxies for the actual shareholders, and shareholders have to hold a minimum of 300 units of shares (units are usually made up of 1,000 shares), which could easily equal an investment of upwards of [yen] 300 million given the often high price of single Japanese shares. In contrast, shareholders in the US only need $2,000 in stock to attend a meeting. Also, while KO members hold shares in 400 listed companies, many of these companies still hold their annual shareholder meetings on the same day in late June. This practice used to be the norm because companies said they wanted to limit the effect of sokaiya, or corporate extortionists who disrupt shareholders meetings, but today, more companies are scheduling their meetings at different times.

The KO raises funds through its membership fees ([yen] 5,000 a year), a small percentage of successful court settlements ("2 to 3 percent," says Morioka), donations and income from publishing and lectures. The total sum is very small, thus KO is far from deploying the resources available to shareholder crusaders like the former bureaucrat Yoshiaki Murakami, whose company, M&A Consulting, has a fund to acquire positions in companies that are failing to put shareholder interests first (see sidebar on page 42). Morioka dreams of having "enough money to buy shares in all the listed companies" so that KO can change more companies for the better.

Making companies change their ways is not easy. To get a company to adopt a new rule (which means changing its articles of incorporation), a shareholder resolution requires support from two-thirds of the votes cast. This discourages other shareholders from offering their support. The government committee that reviews the Commercial Code is aware of these problems but is in no hurry to change them, Morioka says, preferring to operate by what he calls the "Japan standard" rather than the "global standard."

KO has the added burden of being seen as a rebel in a conservative culture. Morioka admits that he has received anonymous phone calls in the past, reminding him to act like a university professor and keep his nose out of things. But he says he takes such intimidation lightly.

It will take more than anonymous phone calls to silence Morioka, Yuoka and the rest of KO. After all, the group honed its skills in one of the biggest scandals in recent memory--the jusen housing loan scandal. Government officials were proposing a bailout of some failed lenders despite numerous charges of corruption. In Osaka, KO set up a telephone hotline to receive complaints. After receiving over 100 calls from shareholders in the largest jusen, Nihon Jutaku Kinyu, it filed five resolutions at the company's annual shareholder meeting on June 26, 1996, calling on senior executives to disclose the truth and expressing opposition to the government bailout plan. Although the resolutions were ultimately rejected, nearly one-third of the shareholders supported them, shaking the jusen's sense of immunity.

KO's persistence has won it some valuable friends, including groups involved in the corporate social responsibility movement. Scandals such as the one involving Snow Brand [switching beef labels to hide their source of origin) and Tokyo Electric Power (falsifying reports on nuclear power defects) have prompted institutional shareholders to take a harder look at corporate social responsibility. One company offering a service to institutions in this area is IntegreX, which assesses companies' social responsibility through questionnaires (see

sidebar on page 42). KO has been conducting similar surveys, with the goals of highlighting problems as well as publicizing successes in a bid to encourage companies to serve as a model for others to follow. IntegreX ultimately plans to launch investment trust funds based on social responsibility investment criteria.

There are now several services that offer to rate the level of corporate governance at companies. US-based Standard and Poor's developed its system originally for emerging economies like Russia. It says the goal is "to reflect the assessment of a company's corporate governance practices and policies and the extent to which these serve the interests of the company's financial stakeholders, particularly shareholders." The scoring system is derived from a variety of guidelines and best practices around the world. The top score possible is 10. In the 2001-2002 survey, no Japanese company rated higher than seven.

The leading shareholder proxy service in the US, Institutional Shareholder Services [ISS), is also planning to provide a corporate-governance ratings service in Japan. The non-profit company advises institutional investors on how to vote at shareholder meetings based on its own research. KO has been in contact with ISS since 1996, and according to Morioka, ISS almost always supports KO's resolutions. ISS opened an office in Tokyo in 2000.

ISS decided to enter the Japanese market because companies were being offered more options to change their corporate governance systems. Legislation that took effect this April allows companies to implement US-style boards of directors. Under this system, companies must appoint a minimum number of outside directors to the board who, in principle, are directly accountable to shareholders, and to abolish the president's office ha favor of a CEO system. The key change is that it ends the practice of the president automatically selecting his own Successor.

The idea of outsiders deciding who will run a Japanese company, rather than the retiring president passing on an hereditary "title," is revolutionary. But the new system is voluntary. It may appeal to companies that operate globally and are exposed daily to US-style governance, like Sony, but most companies are likely to ignore the change. Morioka is pessimistic about the new rule. "I don't think it will produce the expected results. Toyota, for example, will retain the old-style Japan standard of corporate governance," he says. "To really work, the new law needs a representative of "middle Japan" like Toyota to embrace the system in order to encourage others to follow. In the meantime, the accounting scandals in the US have given Japanese companies more reason to maintain the "Japan standard."

Since the accounting scandals, there is new skepticism of the American Way, not only in Japan, but around the world. Arguably, things fell apart because of old-fashioned human greed, the common ingredient that united Wall Street and the booming communication-related stocks in which they invested. It is that kind of human greed, on the other hand, which Japanese-style corporate governance has been very good at restraining. Take the case of the shareholder resolution for the disclosure of director remuneration, which KO made at the Sumitomo Bank shareholders' meeting in 2000. KO succeeded in persuading the bank's management to publish details, but the shocking news, at least to an audience of US executives, was how little the directors awarded themselves. The highest salary was [yen] 45 million, less than $4 million. By contrast, Sandy Weill, chairman of Citigroup, was reported to have received total remuneration of $27 million in 2001, before the exercise of stock options.

The difference in remuneration levels reflects differences in the way the US and Japan look at the purpose and function of a company. In the British and American tradition, the company is owned by its shareholders and managed for their benefit. In the 1980s, however, the failure of the US model to compete against Japan led to the accusation that companies were managed for the short term only. As a result, US companies tried to learn how to introduce a broader stakeholder model.

The gulf, however, is far too profound for the pendulum to swing very far between the two models. The Japanese system, based on the German Commercial Code, allows stakeholders (notably employees) first claim on the firm's resources. In this model, the ultimate purpose of the firm tends to be self-perpetuation. The keiretsu system is designed with this in mind. It has succeeded, too, bearing in mind how few major companies have disappeared entirely over the years, unlike in the US or the UK. In this way, a kind of aristocracy of companies has been preserved, with a flotsam and jetsam of much less stable companies below. Although the form of the keiretsu system is changing, the new structures that are evolving, such as the merger of the Sumitomo and Mitsui groups, suggest that stability remains the ultimate goal. These mergers are designed to achieve self-perpetuation, or survival of the species.

The question at stake is really the concept of what management is supposed to do--manage the company for the next generation, or manage it for shareholders who may decide to sell it, merge it, change its direction or totally re-invent it. Japan is probably not ready for this.

Morioka is not especially optimistic about how much KO can achieve. The problems of disclosure in Japan are culturally based and systemic, he says, and are not fixed even by changes in the law. KO has helped to open up a window into the corporate world, but the danger is that the dealmakers will retreat into darker places in pursuit of self-perpetuation. Real, deep change of the kind KO desires demands a more profound change in the psyche of the nation, not just the statute books. Recalling the Meiji era, Japan needs another revolutionary movement from the wings, like the Kochi or Satsuma clans, who emerged from the remote seashores of the Japanese archipelago and overturned the conservative order in Edo. Does Osaka have its own revolutionaries-in-waiting? Perhaps this is what Japan needs.

K'Os Method of Operation

1. Monitor corporate activities and criticize anti-social acts

2. Exercise the legal rights of common shareholders, using lawsuits when necessary to force disclosure

3. Introduce a shareholder proposal to a company and/or its board of directors requesting a particular action from the standpoint of such things as corporate transparency, equity, social justice and the environment

4. Praise and publicize companies that improve working conditions, practice philanthropy, protect the environment, employ handicapped people, promote gender equality and engage in full disclosure of their activities

RELATED ARTICLE: growing investor activism.

The laissez faire era of corporate governance may be drawing to a close.

By Darrel White

AN IMPORTANT DEBATE ABOUT corporate governance is raging in Japan. Amid a historic destruction of shareholder value, there is continued resistance by large Japanese companies to more stringent corporate governance. But that resistance is being met by more investor activism. Recent steps taken by investors in Japan show that at least some of them will no longer go along quietly with the status quo:

Money-management firms are now being required by public pension-fund sponsors to vote their shares according to a predetermined set of voting guidelines, and to report back on how they voted. For example, the Public Pension Fund Association, which handles pensions for workers who have pulled out of their employers' pension funds as well as assets from dissolved pension funds, is pressing its asset-management firms to exercise their voting rights. It voted against 15 out of 150 management proposals at shareholders' meetings last year and aims over the next couple of years to build a structure enabling it to screen out troubled firms with two yardsticks: earnings and corporate-governance standards. It may also use the shareholder activism tactics of CalPERS (the California Public Employees' Retirement System) as a model for its own activities.

CalPERS itself has teamed up with Sparx Asset Management in Japan and Relational Investors LLC in California to set up a pilot Japan Corporate Governance Fund. Worth $200 million, the fund is established to make significant investments in a small number of Japanese companies and "collaborate with management to increase the value of the companies for the benefit of shareowners, employees and other stakeholders." The Pension Fund Association has expressed an interest in teaming up with CalPERS. Such an alliance could have a dramatic impact on how Japanese companies view corporate governance.

M&A Consulting, headed by former bureaucrat Yoshiaki Murakami, has been making hostile bids for Japanese companies since 1999. Murakami sees shareholder value becoming the new Japanese standard, given new accounting regulations and enhanced visibility, the unwinding of cross-shareholdings, growing foreign ownership and an aging society combined with massive under-funding in the pension system. He pushes companies to focus on cash flow and profit, core businesses, capital efficiency, board monitoring, executive compensation aligned with the interests of shareholders, higher dividend payouts and share buybacks.

Individual shareholders with high net worth are also becoming more activist-oriented. Chozo Nakagawa, who invested in 3,000 shares of financial services company Nippon Shimpan, has initiated a [yen] 46 billion class-action suit against its directors. Nakagawa quit his job last July to prepare for the lawsuit. He studied commercial law on his own and plans to act without hiring a lawyer. Kanehide Yoneyama is a major shareholder in Sekiwa Real Estate, Yuraku Real Estate and the retailer Konaka. Yoneyama started investing in stocks seriously in 1998, using funds he earned while running his own business. As a major shareholder of auto-parts maker Kiriu, Yoneyama pressured management to raise production efficiency and ultimately encouraged the eventual sale of Kiriu to Unison Capital. Yoneyama is now making waves at Konaka, where he is the fifth largest shareholder, with 1.02 million shares.

More organizations are closely watching corporate governance activities at individual companies, rating companies for their corporate governance standards and corporate responsibility regarding environmental and other social issues. Goldman Sachs has prepared a corporate governance ranking system of Japanese corporations based on criteria such as the identity of shareholders, return on equity and employee stock-option plans. The brokerage found a direct correlation between high rankings and high stock prices. Morningstar, in conjunction with the non-profit Public Resource Center, is developing a stock index of 100 Japanese companies noted for both profitability and social responsibility. Akiyama of IntegreX specializes in assessing the level of social responsibility in the nation's 3,530 listed companies through questionnaire-based surveys. The surveys are meant to assess a company's awareness of its civic duties and to find out what systems the company uses to assure responsible operations. Several trust banks that manage pension funds are negotiating with IntegreX to use the survey results in building their investment portfolios. The Japan Corporate Governance Index Research Group has created the JCG Index (www.jcgr.org) from a survey of 1,504 listed Japanese companies, of which only 159 responded. The index measures how closely each firm adheres to the Revised Corporate Governance Principles of the Japan Corporate Governance Forum (www.jcgf.org/en/). Of a possible 100, the average of the companies that responded was 36.3, with most firms scoring lowest on the functioning of their board of directors.

Finally, employees themselves are learning that they need to monitor their company's performance. Matsushita Electric maintains an internal electronic message board as part of an initiative to improve disclosure to employees. Employees can view quarterly earnings figures on the board alongside competitors' numbers. Major entertainment producer, Horipro, has said that its employees are becoming more active. The company reports that it is not uncommon for employees to press management with hard questions like: "Why is our stock price below Yoshimoto Kogyo's?" Nissan's Carlos Ghosn has made a particular effort to keep employees informed and involved in the company's fortunes, installing TVs where the production line stops in the factories--so employees can watch key presentations by top management figures.

This is excerpted from the weekly MoneyWatch newsletter, available for free at the J@pan Inc Web site.