In the modern corporation, governance belongs to the shareholders. This is because shareholders are the substantial owners and bearers of risk. We refer to this as governance by shareholders.

In order for a corporation to achieve its objectives, the CEO should set clear goals for corporate performance, and establish a management system that will achieve these goals. The CEO should take the final responsibility for achieving these goals.

In order to respond quickly and flexibly to the uncertain and rapidly changing environment faced by today's corporation, the CEO should hold the comprehensive authority within the firm. In order to assure that the CEO is managing the firm effectively in order to motivate the corporate goals, it is necessary to have a system that monitors and motivates the CEO.

In order to effectively monitor and supervise the CEO, it is necessary to clearly separate management and governance. It is desirable to have a separation of roles, whereby the board of directors is responsible for governance and the CEO is responsible for management. The board of directors must be independent, and must be able to maintain a neutral stance vis-a-vis stakeholders other than the shareholders.

Good governance must encourage and draw out a CEO's effective management. For this to happen the following are necessary in a board of directors: A nomination committee or its equivalent, with clear standards for nomination and dismissal of the CEO and directors. It is also necessary to have an incentive system that motivates the CEO to effectively lead the company achieve the corporate goals. Therefore, a board should have an auditing committee or its equivalent that checks the efficacy of the internal auditing system and assures that the CEO's leadership is fair, legal, and effective. A board should also have a compensation committee or its equivalent that checks the incentive system.

While a CEO's effective leadership is critical to achieving corporate goals, a corporation should not rely only on the individual qualities of the CEO, and the corporation must establish a sustainable management system. The CEO should establish an effective management system and an internal audit system that checks that management system, and both of these systems must be directly under his or her control.

The CEO should disaggregate corporate performance goals and allocate specific performance goals to each business unit and subsidiary, and supervise and monitor the managers of these sub-units to assure that these goals are reached. Managers of sub-units should be evaluated and provided compensation based on their achievement of these goals.

The CEO should maintain close communication through IR activities and general shareholders' meetings, to exercise accountability and maintain the trust of shareholders.

In order to maintain fair business dealings with stakeholders as well as shareholders, the CEO should obey the law and respect the market principles that are the fundamental pillar of a capitalist economy. The CEO should disclose a wide range of information to all stakeholders. A critical responsibility of the CEO is to maintain the transparency of the corporation through accountability and disclosure.

The stock company (kabushiki kaisha) is a profit-making corporation. Its objective is to make profits through its business activities and to distribute these profits to shareholders. Shareholders are the owners of the firm, and as residual claimants, bear risk from business activities. Therefore, the governance of the firm should be in the hands of the shareholders.

The Japanese stock company system is based on the separation of ownership and management. Shareholders, through the general shareholders' meeting, have the right to nominate and dismiss directors, and the board of directors nominates and dismisses the representative director who is the CEO of the firm and other executive directors. In this way, ownership and control are aligned.

Under the system of separation of ownership and management, the representative director or an executive undertakes the management of the corporation. We refer to this top management position as the CEO. The responsibility of the CEO is to realize the goal of the corporation, which is to make profits. In the Japanese capital markets, institutional investors and other investors who seek to use the stock market to increase the value of their shares are predominant. Consequently, the CEO of the modern corporation must strive to maximize long-term shareholder value, through achieving profits. We refer to this as creating shareholder value.

If the CEO is aware of his or her role, and strives to create shareholder value, there will be no problem for shareholders. However, because this cannot always be expected, a system that assures that the CEO will make his or her maximum effort for the shareholders is required. We refer to this as a governance system.

In the face of increasing global competition, continued development of information technology, and rapid technological progress, speedy and flexible decision-making is necessary. For a corporation to respond appropriately to this environment, a CEO must have maximum authority to make decisions. However, if a CEO who holds this maximum authority exercises poor or inappropriate management, not only the shareholders, but all other stakeholders will suffer. Therefore, a system must be established to assure that the CEO uses his or her authority wisely.

Business experts around the world increasingly acknowledge that in the current environment the most effective system is one in which management is left to the CEO, while the board of directors is responsible for governance from the perspective of the shareholders. We refer to this system as separation of management and governance.

In order to monitor the CEO, the board must be independent from the CEO. Also, in order to focus on profits for the shareholders, it is desirable for the board to take a neutral stance vis-a-vis other stakeholders. We refer to a director who fulfills these conditions as an "independent directors." Corporations should consider independence as a fundamental standard for the nomination of directors, and should clearly disclose the degree of independence of their directors.

Shareholders want the CEO to raise shareholder value over the long term. For this reason, the CEO should establish clear and concrete performance goals, and shareholders should constantly monitor the management system and evaluate performance. The CEO should be provided with incentives to reach the performance goals with a compensation system that is based on the achievement of these performance goals. We refer to these two functions of a governance system as monitoring and motivation.

The board, centered around independent directors, uses monitoring and motivation to assure that the CEO is making maximum efforts to create value for shareholders. Monitoring is achieved through an internal auditing system (or internal control) system while motivation is achieved through the compensation system. From the perspective of governance, the role of the board of directors is to assure the effective function of the internal audit and compensation systems.

To further assure that the CEO strives to achieve the performance goals, the board of directors should be able to appoint and dismiss the CEO.

The CEO should take the firm's performance goals and break them down by business unit and subsidiary. The CEO should assign these specific performance goals to each sub-unit manager, and supervise and monitor these managers in achieving their goals. The internal control and compensation systems should induce responsible managerial behavior among these sub-unit heads. The CEO should oversee the construction and operation of systems for planning, budget, performance evaluation and compensation that assure that sub-unit managers achieve their goals. The objective of these systems is to create shareholder value through steady profits, and we refer to these systems as executive systems (shikko system).. The system that makes sure that these systems are functioning properly is the internal control system (naibu tosei system). We refer the internal control system and the executive systems as the management systems. The fundamental task of the CEO is to manage and monitor sub-unit managers through these management systems.

A corporation has dealings with a wide range of stakeholders. Under the fundamental principles of capitalism, the state, corporation, and individual engage in fair dealings according to market principles, based on the spirit of respect for the law and liberalism. Companies that violate the law or market principles will be severely sanctioned by society, and cause losses not only among shareholders but among all stakeholders. An internal control system is critical to preventing and rectifying violation of the rules. The CEO's most important responsibility is to assure that the internal control system functions effectively, while the board of directors must also constantly monitor the system to assure that it is operating effectively.

The CEO uses the assets of shareholders to conduct business activities to earn a profit for the shareholders. In this sense, the CEO bears a fiduciary duty and has an obligation to report appropriate information to the shareholders to demonstrate that he or she is fulfilling this fiduciary duty. We refer to this as accountability. At the same time, the CEO must demonstrate to shareholders that he or she can be relied upon to create shareholder value in the future. In order to do this, the CEO must maintain good communication through the shareholders general meeting and through investor relations activities.

The role of the CEO, vis-a-vis the shareholders, is to make profits. But the CEO must also conduct business with a firm's various stakeholders in accordance with the law and with market principles. In order to assure that transactions with each stakeholder are carried out in a fair and equitable way, it is imperative to provide each stakeholder with appropriate and timely information. It is also important to demonstrate to all other stakeholders that transactions with any single stakeholder are being carried out in are fair and equitable way. In today's business environment, a firm that does not carry out its transactions in a fair and equitable way will be sanctioned by law and by society, and not only the shareholders, but also all stakeholders will suffer. Therefore, the CEO must always provide the maximum amount of information to external constituencies. We refer to this as disclosure. Because shareholders in today's corporation are very dispersed, the provision of information to shareholders is in effect disclosure. By disclosure, we mean disclosure to all stakeholders, with the objective of maintaining corporate ethics through transparency.

The most important aspect of corporate governance is that the CEO is aware of his or her responsibility to shareholders, and strives to increase performance for the sake of the shareholders. To some extent, aspects of a governance system, such as monitoring by independent boards of directors, internal control systems, and incentive systems are all formal practices, which in the worst case, can exist in appearance only. The most critical element of a governance system is the awareness of the CEO, and the way in which the CEO exercises his or her managerial duties. Good governance is not only the appearance of good governance through formal systems, but is determined by the actual content of governance practices. Therefore, good governance may be achieved in different ways.

While we believe that it is the essence of governance, not simply the formal practices, that is important, and that good governance may be achieved in different ways, we also believe that there is a governance system that is most appropriate in the environment faced by Japanese corporations today. We believe that for a corporation to contribute to society by maintaining steady performance over a long period of time as a going concern, it is crucial to adopt a governance model that fits its current environment. Based on this belief, we have developed a model that indexes the governance of Japanese corporations, based on principles which include the setting clear performance goals and a board of directors centered around independent directors that monitors the CEO. While other forms of governance may have been effective in the past, we believe that this model is most appropriate for the Japanese corporation in current business environment.