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Japan Inc must back independent boards as a check on hostile takeovers

Yahoo Japan's victorious fight with Askul is ominous precedent

| Japan
The Yahoo Japan-Askul precedent demonstrates that, without independent directors, companies are more vulnerable to hostile takeovers.

Two recent events -- Yahoo Japan's ousting of Askul's CEO and three independent directors, and H.I.S.'s unfolding hostile tender offer for Unizo Holdings -- should prompt corporate Japan to question its failure to adopt a hard legal requirement that listed companies maintain majority independent boards.

The conventional argument in favor of independent boards, the norm in other advanced economies, is that they protect general shareholders from potential abuse at the hands of self-interested management and controlling shareholders.

But these recent cases demonstrate that independent boards, formally required by hard law as opposed to the unenforceable "soft law" principles of the Japanese corporate governance framework, may in fact be management's best friend when, as is occurring more frequently, a controlling shareholder turns hostile.

Take Yahoo Japan's battle with Askul. Yahoo Japan acquired its controlling stake in the office supplies distributor in 2012 as part of a "strategic alliance" in which Yahoo Japan helped Askul develop a B2C e-commerce platform called Lohaco, which has evolved into one of Askul's growth engines.

Earlier this year, Yahoo Japan, under pressure in its own e-commerce operations, asked Askul to sell it Lohaco. Askul's management, backed by its three independent directors, declined.

Yahoo Japan "came to question CEO Iwata's ability to plan and execute businesses," the internet company said in a statement.

Shortly before Askul's August 2 annual general meeting, Yahoo Japan announced that it would vote against Askul's chief executive, Shoichiro Iwata, and its three independent directors, including Atsushi Saito, former head of the Tokyo Stock Exchange and a leading proponent of corporate governance reform.

Yahoo Japan cited dissatisfaction with Askul's overall performance, but one can infer that the vote was intended to eliminate obstacles to the acquisition of Lohaco on terms deemed acceptable to Yahoo Japan.

Yahoo Japan later said its vote against Iwata had "no relationship with the transfer of the Lohaco business" and was based on Askul's "sluggish performance."

Yahoo Japan's use of its controlling vote to oust Askul's CEO and independent directors drew immediate protest from the Japan Corporate Governance Network and Japan Association of Corporate Directors. Yahoo Japan's response that it would consider at some time in the future replacing the three independent directors with others acceptable to Yahoo Japan offered little comfort.

Yahoo Japan's vote laid bare for all to see that, despite principle 4.8 of Japan's corporate governance code recommending that listed companies have at least two independent directors, the code lacks the force of law and can be ignored without sanction.

The Yahoo Japan-Askul precedent should be troubling to policymakers and CEOs alike because it suggests that the current corporate governance framework leaves management as well as general shareholders legally defenseless against a controlling shareholder intent on bending the company to its will.

Travel agency H.I.S.'s recent unsolicited tender offer for budget hotel operator Unizo Holdings, which may be shaping up to be Japan's first successful hostile tender offer, illustrates the implications of the Yahoo Japan-Askul precedent.

H.I.S. has offered to buy 40% of Unizo at a 50% premium, providing plenty of incentive for Unizo's shareholders to sell out. If H.I.S. succeeds against the wishes of Unizo management -- and a "white knight" offer from an investment arm of SoftBank -- the Yahoo Japan-Askul precedent would clear the way for H.I.S. to sack incumbents, including outside directors, and operate Unizo in the service of H.I.S.'s own priorities.

Japanese CEOs have so far discounted the virtues of legally required independent boards in protecting them -- and general shareholders -- against controlling shareholders, probably because the vast majority of controlling shareholders have historically been friendly and unthreatening.

We can no longer confidently assume that controlling shareholders will be forever friendly. Trading company Itochu's dispute earlier this year with sporting goods maker Descente is an example that closely parallels Yahoo Japan-Askul.

Itochu, like Yahoo Japan, initially acquired a substantial 30% stake in Descente as part of a "strategic alliance" in which Itochu helped Descente distribute its products in Asia. Subsequently, disagreements arose between Itochu and Descente management over Asian business strategy.

Itochu's solution was to launch a hostile tender offer to raise its share ownership to 40%, which it then leveraged to remove the CEO and incumbent independent directors.

Unlike Yahoo Japan, Itochu did replace the incumbent independent directors with its own candidates, but doubts linger whether independent directors hand-picked by a controlling shareholder can be truly independent.

Behind the corporate establishment's pushback against Yahoo Japan-Askul was very likely alarm at the implications for another high-profile case of a dispute involving a controlling shareholder -- Renault-Nissan.

With the French and Japanese governments lurking in the shadows, Renault has so far refrained from using its 43% shareholding in Nissan Motor to sweep out current Japanese management and replace them with candidates nominated by Renault -- a result that would send shock waves through Japan Inc.

Yahoo Japan-Askul is a reminder that, legally speaking, there is nothing to prevent Renault from exercising the thermonuclear option.

Not surprisingly, domestic and international private equity funds and hedge funds are paying close attention. The common wisdom used to be that a hostile takeover was close to impossible in Japan.

Recent precedents, though, suggest that a 30%-40% initial stake in a target company can be leveraged to secure effective control, dismiss management and independent directors who stand in the way, and ultimately squeeze out general shareholders at a bargain price.

These precedents and their logical implications should make Japanese CEOs consider whether legally required independent boards might not be a good idea after all.

Stephen Givens is a corporate lawyer based in Tokyo.

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