Corporate Governance in Japan

1. Corporate Governance　in Japan Board Structure and its implication to the function of the Board– Japanese Experience Policy Dialogue on Corporate Governance in China 26th February 2004 Masatoshi Toriihara, Statutory Auditor, CSK Corporation and Member, Committee of Corporate Governance, Japan Association of Corporate Directors

2. 1．Transitions of Japanese-style management 1960s ・・・1980s 1990s 2000～ High-growth period Economic bubbles Lost decade New corporate governance (Limitation of Japanese-style governance) Japanese-style management Mutual dependence among companies Crossholding of shares, main financing bank system, company groups, etc. Era of Japanese-style corporate governance Governance by management, bank and economic agencies of state Reform of the board of directors Change of capital market Indirect financing　→　Direct financing Introduction of US-style Japanese-style employment practice Lifetime employment, seniority system, company union, etc. Shift to borderless economy Global economization Trade and capital liberalization Big ban, IT revolution Independent board members System selectivity Industrial policy Administrative control, public-private cooperation framework, coordination in a industry group, etc. Enhancement of auditor's authority Corporate scandal Executive officers Shareholder value Ambiguous corporate accounting practice Limited disclosure of corporate information ・ ・ ・

3. 2．Transitions of corporate governance 1960s ・・・1980s 1990s 2000～ Points (issues) ・Stultified as an auditing organization (auditor and executor) ・No external control ・Employee board member (representative from each department) Loyalty Moral ・Large number ・Expansion of the president's (CEO's) authority ・Authority for personnel shuffle of the President's auditor Heyday of Japanese-style management Cross shareholdings Main financing bank system Lifetime employment Promotion by seniority Administrative control （Major reform / selectivity） 2002 ・Company with the boad committee established ・Independent dorectors 1998 ・Introduction of executive officers Board directors ・Internal appointment 1993 ・3 years,3 auditors ・Independent auditors ・Board of auditors 2003 ・Term: 4 years ・Independent auditors （more than half） ・Independence Reform Auditors ・Authority for operational audit ・Accounting auditor system ・Several statutory auditors ・Coordination with accounting auditors State enterprise 1985 Privatization of Nippon Telegraph and Telephone Public Corporation (NTT) 2003 Launch of Japan Post (Public company) 1987 Privatization and separation of the Japanese National Railways (JR)

4. 3．Request for establishment of corporate governance with emphasis on shareholders 70.0 Financial institutions Individual shareholders 60.0 50.0 40.0 Business corporations 30.0 20.0 Annuity trust Foreign shareholders Investment trust 10.0 0.0 1950 55 60 65 70 75 80 85 90 95 2000 02 Fund-raising of the companies has consistently depended on indirect financing centered on banks since the World War II. It is now shifted to direct financing-oriented fund-raising after experiencing financial Big Bang and collapse of bubble economy. Change of company's fund raising Main financing bank Loan Individual Corporate stock ・Financial crisis ・Big Bang ・Deregulation of stock market Crossholdings of shares Credit ＜Indirect financing＞ ＜Direct financing＞ Transition of shareholding ratio by holder ％ Increase of individual shareholders The total number of individual shareholders increased 250, 000 to 33,770,000. It has been increasing for 7 years in a row. National stock exchange 2002

5. Auditors’ meeting Shareholders’ meeting Board meeting 4．Selective system　～Commercial law revision on board reform～ Commercial law revision of 2002 focused on enhancing compliance and transparency/efficiency of the management using external human resources (independent board members), and established the new system which separates the operating organization from the supervisory organization and ensures the effectiveness of agile management and supervisory functions. It also allows major corporations to select the company form from the following models. Auditor model Company with the committee established Objectives Existing type Selective starting from April 2003 ・Evaluation of achievement of management objectives conducted by the independent directors. ・Audit by audit committee ・Operation of performance-linked reward system by the compensation committee ・Change of the president (CEO) by the nomination committee Shareholders meeting Nomination committee Company with the major asset committee established Audit committee Board meeting Auditors’ meeting Shareholders’ meeting Compensation committee Board meeting Executive officer Major asset committee 62 companies have been shifted to this type of company form from April 2003 to October 2003.

6. 5．The company with committee established 62 companies have been shifted to "Company with committee established" from April 2003 to October 2003. The reason for this shift is "to speed up the management dramatically by clearly separating the supervisory function from the operating function and to realize the fair and highly transparent management“. There are several tendencies for the companies adopting "Company with committee established" type. Most of such companies fall into pattern 1 or 3 at present. 1. Adopted for placing emphasis on the group strategy Hitachi 2. Adopted mainly expecting the increase of foreign investors Sony, Mitsubishi Electric 3. Adopted by holding company and affiliated company Nomura Holdings 4. Adopted by being affiliated by foreign company Seiyu 5. Others

7. Qualification for an independent director Independence Representative of stakeholders High sense of ethics Deep understanding of social common practice Sound judgment Who is qualified to be an independent director? ・Top management of the other company with extensive experience in business ・Experts on law, academic, and international relations ・Former employees of competent authorities ・Person related to the correspondent bank such as a main financing bank ・Representative of consumers or local community (Reference: The proposal of "Business Administration Committee" by Japan Association of Corporate Executives) 6．Independent director 【Fiscal year 2002】 Total of 112 companies Q. Companies adopting the independent director　⇒　55.4% Q. Origin of independent directors (see the table before) Rank Number Origin (personal history・attribute） 1 19 Person involved in the company having a business relation. 2 12 Person involved in the company having no business relations. ” 12 Person involved in the parent company. 4 11 Person involved in the bank such as a main financing bank 5 8 Institutional investors (life insurance) who are big shareholders. ” 8 Person involved in the same enterprise group 7 Critics, economists, management consultants 5 8 3 Scholars such as university professors ” 3 Former employees of competent authorities 10 Person involved in public entities 2 11 1 Person of legal profession such as lawyers ― 5 Others (accounting companies, person involved in the company of big shareholder) An independent director is the person who has not been involved in business and affairs of the corporation of interest or the affiliate company as a board member or employee from past to present. Current situation? At least approx. 1000 out of the total 1,500 independent directors in the listed companies are big shareholders or former employees of the main financing bank or the same enterprise group.

8. 7．Scope of responsibility Legality audit Validity audit ・Audit on legal compliance ・Audit on compliance with internal rules ・Audit on validity of management decision Auditing system Auditor (meeting) ○ 　　　　△（Note） Board meeting ○ ○ Board meeting of the company with the committee established Board meeting （Audit/ Compensation/Nomination Committee） ○ ○ Note: Auditor performs legality audit. However, laws and regulations include the duty of care and the auditor needs to check for breach of such duty regarding the matters involving business judgment by the board members. Therefore, legality audit performed by the auditor has almost the same effect as the validity audit.

9. 8．List of audit overview / structure Item Audit by auditor Audit by audit committee Systematic audit by the audit committee Audit by single auditor Number of auditor 3 or more 3 or more Number of independent auditor One or more (more than half after 2 years) Majority of the committee members One or more auditor is elected by mutual vote Not required legally Number of statutoryauditor Appointment of auditor (committee member) Board meeting Shareholder meeting Term of auditor (committee member) 4 years 1 years Subject of audit Execution of board's duty Execution of board's and executive officer's duties Investigation right on operation and propertyInvestigation right on the affiliated company Attendance at the board meeting・statement duty Investigation right on operation and property Investigation right on the affiliated company Authority of audit Scope of audit Legality audit including validity audit Legality audit including significant injustice

10. （％） （％） 4.68 7 5 6.45 5.57 6 4 4.69 5 3 4 2.26 2 3 2 1 -0.03 1 0 Low JCGIndex company Company answered all items High JCGIndex company 0 Company answered all items Low JCGIndex company High JCGIndex company -1 （％） 2 2 1.68 0.97 1.5 0 1 Low JCGIndex company High JCGIndex company Company answered all items 0.58 -2 0.5 -4 0 Low JCGIndex company High JCGIndex company Company answered all items -0.5 -6 -5.58 -1 -8 -1.5 -1.35 -8.54 -10 -2 9．Effect of governance　 　～ High-low comparison of JCGIndex～ JCGIndex is an index for the maintenance level of the company's governance system The following graphs show the result of questionnaire conducted from July to September 2003. (No. of response: 201companies) ROA (combined: average of last 3 years) ROE (combined: average of last 3 years) （％） Rate of return on stock (average of last 3 years) Increase of No. of employee (average of last 3 years)

11. 10．What is corporate governance ? (For whom? For what?) ■Corporate governance focuses on "to whom management is directed". ■A corporate is a social existence and bears various responsibilities in the society. Points for corporate governance 　・Awareness for corporate social responsibility 　・Establishment of check & balance system 　・The ultimate issue is a human mind (ethics, responsibility) Management Compensation Customer Payment Employee Salary Company Cost Supplier Globe・Environment Payment Tax Government Creditor Interest Profit Shareholder