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I. INTRODUCTION 318 II. BASIC DIFFERENCES BETWEEN THE UNITED STATES AND JAPAN 319 A. The Position of Executives 319 B. Components of Executive Compensation 321 III. THE PROCEDURE FOR SETTING EXECUTE COMPENSATION 322 A. United States 322 1. The Law and Practice of Compensation-Setting 322 2. The Current Movement: "Say on Pay" 323 B. Japan 325 1. The Law and practice of Compensation-Setting 325 2. Realities: Shareholders' Passivism in Exercising 329 Their Rights IV. DISCLOSURE RULES 330 A. United States 330 1. The 1992 Rules 330 2. The Sarbanes-Oxly Act of 2002 332 3. The 2006 Rules 332 B. Japan 334 1. Disclosure Rules under the Corporate Law 334 2. Disclosure Rules under Securities Law 336 3. Recent Movement: Shareholders' Activism to Seek More 336 Detailed Disclosure V. PROPOSALS FOR THE BETTER COMPENSATION-SETTING 339 A. The United States 340 1. The Prescriptions for soaring Executive Compensation 340 2. Shareholder Participation 340 3. Disclosure Rules 343 B. Japan 344 1. Not Expensive, But Problematic 344 2. Shareholder Participation 344 3. Disclosure Rules 346 VI. CONCLUSION 349
Executive compensation is a highly controversial issue both in the United Slates and in Japan. In the United States, skyrocketing executive compensation hay been criticized for more than two decades, especially alter a series of corporate accounting scandals that started in 2001. (1) Despite the criticisms and new regulations, executive pay is still increasing. (2) The United States has been seeking a way to stop the rapid rise but has not yet succeeded.
By contrast, executives of Japanese companies earn far less than their American peers. Recent studies show that the executive compensation of Japanese companies is about one-third that of similarly-sized American companies. (3) These large disparities may be explained by the differences in shareholder powers over executive pay--Japanese shareholders have much greater influence over pay than their American counterparts. In comparing these two countries, the first question is whether the United States should increase shareholder participation if it wants to stop the sharp rise of executive compensation. This Article concludes that increasing shareholder participation in the United States is desirable but that America should choose the method cautiously because increasing shareholder participation could infringe on hoards' discretion to hire talented executives.
While the United States has struggled with the problem of excessive executive compensation, (4) Japan's main problem has been inadequate disclosure rules for executive compensation. Many Japanese scholars have criticized Japanese disclosure rules as lacking transparency, but the rules have not changed yet due to the strong opposition from the business community. By contrast, in the United States, highly detailed disclosures are required under securities laws. However, the disclosure rules in the United States appear to be an inadequate check on the rise of excessive compensation. Rather, critics have claimed that detailed disclosure rules have helped to promote the sharp rise of executive compensation. (5) According to these critics, executives, through detailed disclosure, learn how much their peers receive. If they discover that their compensation is lower than the average of their peers, they request that their boards pay them more. Every executive wants his compensation to be more than the average, so this leads to the rapid rise of executive compensation. From Japan's perspective then, the second question is whether Japan should introduce more detailed disclosure rules. This Article concludes that more detailed disclosure rules are necessary for Japan but that Japan should create its own rules to fit its circumstances and concerns, not just adopt American rules.
In this Article, Part II outlines the basic differences between the United States and Japan: who are the executives, how are they hired, and what are the components of executive compensation. Part III then explains how the process of setting executive compensation works in both countries, focusing especially on shareholders' participation. Part IV examines the disclosure rules about executive compensation and the continuing discussion about them. Based on these analyses, Part V proposes how both countries should improve their compensation-setting procedures and disclosure rules. Part VI is the conclusion of this Article.
II "BASIC DIFFERENCES BETWEEN THE UNITED STATES AND JAPAN
The United States and Japan are among the world's leading economic powers. They are also important business partners and have a close political and economic relationship. However, the basic legal system and social structure surrounding executive compensation in each country is quite different- As a basis for later discussion, this Section examines two basic differences between these two countries: who corporate executives are, and what constitutes executive compensation.
A. The Position of Executives
In the United States, an executive is defined as "a corporate officer at the upper levels of management." (6) Top American executives have titles such Chief Executive Officer (CEO), and Chief Operating Officer (COO). Some have positions as board members, but the number of such "inside" directors is not large in American companies. Japanese executives also have management powers, but in contrast to the United States, most Japanese executives have positions as board members. (7) Under Japanese corporate law, which was borrowed in the 1890s from the German legal system, corporate auditors (kansayaku), and not corporate boards of directors, have the primary monitoring function. (8) Although boards of directors have authority and responsibility for monitoring, their role is focused primarily on the day-to-day operational management. In other words, in most Japanese companies, directors have two sets of responsibilities: they act as board members, and more importantly, they operate as executives. (9) Of course, there are outside directors who do not have managerial roles, but the number of such directors is not large. Executives are almost equal to directors in most Japanese companies. (10)
Another Significant difference between the two countries is the recruitment of the new executives. In the United States, many executives are hired from outside of the company. One of the important roles of boards of directors is to hire excellent executives from the outside. The talent war among companies to hire the best person is so serve that boards try to catch a "big one" by using lucrative compensation packages as "bait." (11) On the other hand, Japanese companies tend to hire inside employees who have been working for that company for a long time. (12) In Japan, becoming an executive is a part of the career ladder within the company. When Japanese companies hire executives from outside, the executives from outside, the executives often have some significant relationship with management (for example, companies sometimes hire a person at the request of large creditors), or such companies are in special situations (for example, facing a financial crisis). (13) Therefore, unlike the United States, there is almost no market for hiring outside executives.
B. Components of Executive Compensation
Executives of American companies usually receive three types of compensation: non-equity based compensation (salary and bonus), equity based compensation (stock options and restricted stocks), and a retirement allowance. (14) In contrast, until recently, Japanese pay arrangements consisted only of non-equity based compensation (salary and bonus) and retirement allowance. Japan introduced stock options in 1997 so that today, the basic components of executive compensation in Japan have become similar to those in the United States.
The proportion of equity-based compensation to total compensation is however, quite different in the two countries. In the United States, companies frequently use stock options as apart of the compensation by exercising stock options in 2004. (15) This figure shows that the American pay arrangement is highly incentivized because of the heavy use of stock options. In addition, there is a tendency that highly paid executives earn most of their incomes by exercising stock options. For example, Ray R. Irani, the CEO of Occidental Petroleum, Corp., gained $270.2 million (which was approximately 69 percent of his $394.3 million earnings in the fiscal year 2006) by exercising stock options. (16)
In contrast, only one-third of public companies use stock options as a part of executive compensation arrangements in Japan. (17) Many Japanese companies have seniority systems such that age traditionally has been the most important element in determining the size of employees' salaries. Although they have gradually shifted toward performance-based pay systems, which consider individual ability, productivity, and accomplishment, age is still a more important element than individual performance is not considered an from among their employees, individual performance is not considered an important element in determining executive pay. The number of companies which have introduced stock options is increasing steadily, especially among new companies that do not enough cash to offer sufficient compensation. Stock options, however, still do not constitute a substantial portion of executive income.
III. THE PROCEDURE FOR SETTING EXECUTIVE COMPENSATION
The processes for setting executive compensation are quite different in the United States and Japan. The most significant difference is how shareholders participate in the process. Generally speaking, shareholders of American companies have weak powers to influence executive pay arrangements, while shareholders of Japanese companies have relatively strong powers to rescind compensation plans. This Section explains how the process works in each country, focusing especially on shareholder participation.
A. United States
1. The Law and Practice of Compensation-Setting
Since boards have the authority and responsibility to hire executives, they have wide discretion to make decisions on executive compensation plans. In addition, the business judgment rule protects their decisions unless they engage in self-dealing or waste corporate assets. (18) Therefore, it is very difficult for shareholders to challenge excessive compensation by litigation. (19)
To avoid accusations of self-dealing, many corporate boards delegate decision-making authority on executive pay to the compensation committee, which consists of disinterested directors. (20) Because the committee members may not have enough information and expertise, and because they may seek the safe harbor of the business judgment rule, the compensation committee often hires outside compensation consultants. (21) Compensation consultants then create compensation surveys and other necessary information for the committee. When making recommendations, consultants often use a "quartile method of comparison," meaning that the executives should strong receive top quartile compensation compared to their peers. (22) Despite strong criticism, companies and consultants continue using this method because almost all the companies want their executive compensation to be in the top quartile, as a kind of proof that their executives are the most qualified people. (23)
Some state laws (such as New York) and stock exchange rules (NYSE and NASDAQ) require shareholder approval to grant equity-based compensation. (24) In addition, even if companies do not have to obtain shareholder approval, they sometimes choose to do so because the Internal Revenue Code requires shareholder approval to make equity-based compensation tax-deductible. (25) However, in such a case, shareholders cannot reject or approve a particular executive's pay package since the option plans proposed to shareholders usually do not specify who receives how much. (26) Therefore, shareholder participation in the compensation-setting process is limited.
2. The Current Movement: "Say on Pay"
Excessive executive compensation is a serious problem for shareholders. Salary, bonus, and retirement allowance may directly affect the value of shares because they decrease corporate assets. Stock options also may affect shareholders' interest because exercising the options would dilute the stock value if executives exercise the options at a price lower than the market price.
Under the current law, the most effective method for shareholders to put pressure on boards is to use shareholder proposals under Rule 14a-8 of the Securities Exchange Act Rules. (27) Although shareholder proposals are precatory (non-binding) and rarely receive majority support from shareholders, they have some indirect impact on future decisions. For example, Thomas and Martin show that target companies do not increase average total CEO compensation levels as rapidly in the year after receiving a shareholder proposal as companies not receiving such proposals. (28)
Until recently, institutional shareholders did not voice frequently their opinions on executive pay. (29) However, in the last few years, the situation seems to have changed. Institutional investors have started making proposals to introduce mandatory advisory votes by shareholders on executive compensation. (30) In 2007, such proposals won majority support at seven companies (Verizon, Motorola, Blockbuster, Inc., Ingersoll-Rand Co., Clear Channel Communications, and Valero Energy Group). (31) Since the United Kingdom introduced mandatory advisory votes in 2002 that seem to have succeeded in curbing the rapid rise of executive pay, institutional investors have advocated for the United States to follow the United Kingdom. (32)
Facing institutional investors' proposals, some companies have already announced that they will introduce a new advisory vote system on …