Japanese Regulations against Foreign Corporations
and Global Competition in Corporate Law
A. Introduction III. Arguments against Cary and the
B. The Debate on the Japanese Regulations Theory of the “Race to the Top”
against Foreign Corporations IV. Recent Circumstances
C. State Competition in Corporate Law in the D. Global Competition in Corporate Law
United States I. Premise
I. Premise and Delaware’s Dominance II. Possible Consequences of the
II. Cary’s Criticism and the Theory of Abolishment of Article 482
“Race to the Bottom” E. Conclusion
In Japan the 1980s are commonly referred to as the “Bubble Era”. At the end of the
1980s the bubble economy burst. Since then, Japanese corporations have been
struggling with a protracted recession. As a result, Japanese corporations have had to
restructure their businesses and governance system.
In order to accelerate restructuring and make Japanese corporations competitive
again, the Ministry of Justice (the MOJ) started a project to drastically revise the
provisions applicable to corporations in the Japanese Commercial Code. In January
2001, the MOJ requested the Legislative Council of the MOJ (Council) to review the
corporate law and to propose amendment plans. In response, the Council undertook a
review of the corporate law and prepared a series of amendment plans.1 At the same
time, a number of members of the Diet proposed their own amendment plans for the
corporate law. As a result, the Japanese corporate law was revised six times from 2001
to 2004. In addition, the Council started to prepare an even more drastic amendment
plan for the corporate law which was called the project for the “Modernisation of the
Article 482 of the Commercial Code is one of the issues that was examined in the
series of discussions related to the project for the Modernisation of the Corporate Law.
1 For more details, see <http://www.moj.go.jp/ENGLISH/CIAB/jc101-1.html>.
Article 482 is a provision to regulate foreign corporations doing business primarily in
Japan. Several questions arose during the discussions about this provision, namely:
1) Should we maintain or abolish the provision?
2) If the provision is not abolished, should it be amended?
3) If so, how should we amend it?
Surprisingly, while debating these issues the problem of State competition in
corporate law was focused on in Japan.
B. The Debate on the Japanese Regulations against Foreign Corporations
Article 482 of the present Commercial Code provides as follows:
A corporation that establishes its head office in Japan or the primary purpose of which is to carry
on business in Japan shall, even in cases where it is incorporated in a foreign State, be governed
by the same provisions as those applicable to a corporation to be incorporated in Japan.
This provision is based on the assumption that the governing law of a corporation shall
be the law of the place where the corporation was incorporated. In the Japanese Code
of Private International Law (Horei)2, we have no clear provision on the governing law
of a corporation. Nowadays, however, it is commonly interpreted that the law
applicable to a corporation shall be the law of the place where it was incorporated.3
According to the choice-of-law rules mentioned above, a corporation which was
incorporated in a foreign state is to be governed only by the law of the foreign state.
Article 482 requires, however, that a foreign corporation shall additionally be governed
by the Japanese corporate law if the foreign corporation establishes its head office in
Japan or its primary purpose is to carry on business in Japan. The regulations were
established based on the idea that a corporation which has its head office in Japan or
the primary purpose of which is to carry on business in Japan (a
pseudo-foreign-corporation) should be incorporated in Japan. The underlying
rationale for this rule is that incorporation in a foreign state for the purpose of doing
business primarily in Japan is tantamount to evasion of the law.
This regulation has been criticised, however, by a number of scholars and
2 Law No.10 of 1898.
3 Yoshio Tamaike, Kokusaishiho Kogi [Private International Law] (2005) 296-97;
Yoshiaki Sakurada, Kokusaishiho [Private International Law] (2005) 169-71; Ryoichi
Yamada, Kokusaishiho [Private International Law] (2004) 226-28.
practitioners. One of the reasons for this criticism is that the provision is too vague.
It is argued that it is difficult for a foreign corporation doing business in two or more
states to know whether or not the “purpose” of the corporation will be characterised as
the one the provision regulates. Also, it has been posited that such a concern creates a
chilling effect for foreign investors who desire to carry on business activities in Japan. 4
On the other hand, the regulations have been criticised because historically they
have not been applied in practice. In spite of the existence of the regulations a number
of multinational financial conglomerates incorporated corporations outside of Japan
(e.g. in the Cayman Islands) for the purpose of doing business primarily in Japan and
those foreign corporations actually operate their business primarily in Japan.
However, to date, those corporations have never been sanctioned or punished.
In the context described above, the project for the Modernisation of the Corporate
Law focused on reforming Article 482 of the Commercial Code. In the Council‘s
preliminary draft, issued in October 2003, two optional plans were presented for public
comment, as follows:
Option (a): the Article 482 shall be maintained.
Option (b): the Article 482 shall be abolished.
Option (a) is a plan that would maintain the regulation. This would mean that a
pseudo-foreign-corporation would be prima facie illegal and the status of a foreign
corporation as a legal entity would actually be nullified. On the other hand, option (b)
is a plan that would abolish the regulation. Of course, even if the regulation was
abolished, foreign corporations would still be subject to other regulations in Japan (e.g.
antimonopoly regulations). Under option (b) pseudo-foreign-corporations would not be
prima facie illegal.
In the pubic comment to the preliminary draft of the Council, option (b) received
widespread support. Comments on this specific issue, however, were actually offered
mainly by foreign investors or entities having relationships with them. Using
examples from the comments, the Council began to reexamine the possible
consequences of option (b) and addressed the following questions:
1) If the incorporation of a company in a foreign State is allowed – even when the
primary purpose of the corporation is doing business in Japan – will any serious
4 About this type of criticism, see Yoshihisa Hayakawa, Giji Gaikoku Gaisha
[Pseudo-Foreign-Corporation]: Jurist 114 (2004) 1267.
problems occur or conversely benefit result?
2) How will this issue effect public welfare?
The debate reminds us of the famous debate in the United States about competition
among states in the development of corporate law.
C. State Competition in Corporate Law in the United States
I. Premise and Delaware’s Dominance5
In the United States, basically, the Federal Government or the Congress does not have
control over corporate issues. In principle, corporate issues are governed by State law
– not federal law. Each state has its own corporate law and a business entity in the
United States is incorporated or reincorporated under the corporate law of one specific
state. Since only a few states have regulations that oblige a business entity, doing
business primarily in the state, to be incorporated under that state’s law, in almost
every case, a business entity can select under which State’s corporate law it wants to be
Under this system, Delaware’s corporate law has attracted the vast majority of
business entities in the United States. In other words, in recent history, Delaware has
been the winner in the State competition for corporate law.
It is pointed out that Delaware has many advantages for this race6:
a Revenues from the corporate franchise tax constitute a large portion of the budget
of this relatively small state. Therefore, it is (and has been) more important for
Delaware compared to other larger states to attract business entities in this race.
b Delaware has few local industries and a small industrial population. Pressures
from labor unions or local companies on corporate law are weaker than they are in
other larger states.
c The general public has an interest not in the corporate law itself but on the
revenues from the corporate franchise tax. Corporate lawyers can wield a
stronger influence over the legislature and the judiciary than they can in other
d Delaware has accumulated a highly-regarded specialized judiciary and
5 The state competition issue in corporate law in the United States is also examined by
Tomoyo Matsui, in this volume p. 207et seq.
6 See Mark J. Roe, Delaware’s Competition: Harv. L. Rev. 117 (2003) 588, 594.
jurisprudence in the area of corporate law. It has also always striven for the
most attractive and cutting-edge corporate law.
In these circumstances, a debate occurred with respect to Delaware’s dominance in the
competition in corporate law.
II. Cary’s Criticism and the Theory of “Race to the Bottom”
Even in 1933, Justice Brandeis criticised the circumstances and regarded them as
“Lesser states, eager for the revenue derived from the traffic in charters, had removed
safeguards from their own incorporation laws…The race was one not of diligence but of
laxity … great industrial States yielded in order not to lose wholly the prospect of the
revenue and the control incident to domestic incorporation.”7. A more detailed analysis,
from a critical perspective, was given by William Cary the chairman of the US
Securities and Exchange Commission (SEC), in 19748.
Cary’s analysis has been elaborated on by a number of critics and his theory has
come to be known as the theory of the “race to the bottom”9. It implies that state
competition in corporate law necessarily results in the minimisation of public welfare
through the following steps10:
a If a state would like to attract business entities to incorporate under its corporate
law, the State has to provide a corporate law that is attractive to business entities.
b In respect of reincorporation, a business entity’s decision is usually conducted not
by shareholders but by managers. Shareholders usually just rubber-stamp
c The state has to attract not shareholders but managers. The State has no other
choice but to provide pro-manager rules, which strengthen the power of managers
and deprive shareholders of safeguards.
d If another state would like to provide a greater incentive than other states to
attract business entities, the state has to provide more pro-manager rules, which
strengthen the power of managers and deprive shareholders of safeguards.
e The natural consequence of the competition among states in corporate law (as
7 Louis K. Liggett Co. v. Lee, 288 US 517, 557-60 (1933).
8 William Cary, Federalism and Corporate Law: Reflections upon Delaware: Yale L.J.
83 (1974) 663.
9 As the most influential criticism from the viewpoint of “race to the bottom” in
1980-90s, see Lucian Arye Bebchuk, Federalism and the Corporation: The desirable
Limits on State Competition in Corporate Law: Harv. L. Rev. 105 (1992) 1435.
10 See Roe (supra note 6) 595.
described above) is that in the end the corporate law of each state will lack
safeguards for shareholders.
This is a general overview of the logic that comprises the theory of the race to the
bottom. Based on this logic, ultimately, it seems that corporate issues should be
regulated by Federal law or that a state should require a business entity doing business
primarily in the specific state to be incorporated under its respective state’s law.
III. Arguments against Cary and the Theory of the “Race to the Top”
The theory of the race to the bottom has been, on the other hand, seriously criticised by
another group of academics11. This group’s argument is called the theory of the “race to
the top”12. They argue that state competition in corporate law results in maximization
of public welfare and in doing so challenge certain parts of logic that underlies the
theory of the race to the bottom.
First, in some instances, shareholders might simply rubber-stamp managers’
recommendation to select an anti-shareholder corporate law13. However, a corporation
that reincorporates under an anti-shareholder corporate law will not attract investors
in the equity market. Over the long run, a corporation which incorporates in a state
with an anti-shareholder corporate law will become weak because it will lose its ability
to raise capital. Thus, managers will quickly realize that reincorporating in a state
with an anti-shareholder corporate law is a strategy doomed to fail.
Second, reincorporation under an anti-shareholders law weakens a corporation in
other ways, besides simply hindering it from raising capital. The corporation will
eventually become uncompetitive if it remains governed by an anti-shareholder
corporate law. This will ultimately lead to the demise of the corporation because it will
either have to file for bankruptcy or be the subject of a takeover.
Third, a state that would like to attract business entities to incorporate does not
have to adopt pro-manager policy only. In the “free market” for corporate law, the
11 As a direct argument against Cary in the 1970s, see Ralph K. Winter, State Law,
Shareholder Protection, and the Theory of the Corporation: J. Leg. Stud. 6 (1977) 251.
12 As the most influential argument from the viewpoint of “race to the top” in the
1980-90s, see Roberta Romano,: Law as a Product Some Pieces of the Incorporation
Puzzle: J. L. Econ. & Org. 1 (1985)225; Roberta Romano, The Genius of American
Corporate Law (1993).
13 In the contemporary corporate scene of the United States, institutional investors
have strong influences on the decisions as shareholders and they always make them
strategically. It is criticised that the image of “rubber-stamp” shareholders has become
far from the real feature of contemporary shareholders. See Roberta Romano, The
Advantage of Competitive Federalism for Securities Regulation (2003) 65.
winner will be a state which provides well-balanced rules that balance the power of
managers to make prompt decisions and safeguards for shareholder rights.
Fourth, based on the three points made above, the corporate law of each State will
become well-balanced. Ultimately, the competition in corporate law will contribute to
and maximize public welfare.
The above provides a general overview of the logic of the theory of the race to the top.
Based on the logic, they have argued against what Cary and his followers assert.
IV. Recent Circumstances
It is without a doubt that Delaware has dominated in the competition for corporate law
– whether from the standpoint of the race to the bottom or the race to the top theories.
However, there are other explanations for the “Delaware phenomenon” besides the two
aforementioned theories. For instance, this phenomenon can be regarded as a
consequence of Economies of Scale or External Economy 14 . Alternatively (or
additionally) the phenomenon can be regarded as a consequence caused by corporate
lawyers’ moral hazard. A corporate lawyer specializing in Delaware law usually
suggests that Delaware law should be used when his client tries to incorporate or
reincorporate another one. This is because the corporation will be able to utilise the
lawyer’s expertise if it incorporates under Delaware law.
There are debates in the literature not only about the competition in corporate law
itself but also about the reason for Delaware’s dominance. The debates are still
unsettled. This has prompted recent scholarship to employ empirical studies to
attempt to unravel the Delaware conundrum15.
In the modern era of corporate law, we would be remiss if we were to ignore the
Enron debacle and the establishment of the Sarbanes-Oxley Act of 200216. These
events, to some extent, have actually encouraged the supporters of the race to the
bottom theory. However, there are strong arguments about the evaluation of the
Enron debacle and the Sarbanes-Oxley Act that have also been made by the supporters
14 Ehud Kamar, A Regulatory Competition Theory of Indeterminacy in Corporate Law:
Colum. L. Rev. 98 (1998) 190, 1923-24 and 1928-33.
15 From this viewpoint, many scholars have examined stock price reaction to changes in
a firm's state of incorporation. About the results of this type of event studies, see
Lucian A. Bebchuk/Alma Cohen/Allen Ferrell, Does the Evidence Favor State
Competition in Corporate Law?: Cal. L. Rev. 90 (2002) 1775, 1792. On the other hand,
some scholars have examined whether States actually compete for incorporation or not.
See Marcel Kahan/Ehud Kamar, The Myth of State Competition in Corporate Law:
Stan. L. Rev. 55 (2002)67.
16 Sarbanes-Oxley (SOX) Act of 2002, Pub. L. No. 108-204, 116 Stat. 745 (codified in
scattered Sections of 15 and 18 USC.).
of the Race to the Top theory17.
D. Global Competition in Corporate Law
The discussion above leads to the following questions:
1) If the incorporation of a company in a foreign state is allowed – even when the
primary purpose of the corporation is doing business in Japan – will any serious
problems occur or conversely benefits result?
2) How will this issue effect public welfare?
In order to answer these questions, we have examined the debate of the competition
in corporate law in the United States. At the outset we must be cognizant of the
differences between state competition in the United States and state competition on a
First, there is no integrated controller when competition occurs on a global scale. It
is logically possible to transfer the authority of the corporate issues, as a number of race
to the bottom supporters assert, from the state level to the federal level. On the other
hand, on a global scale it is impossible to give the authority to an integrated controller.
A supporter of the theory of the global race to the bottom theory, if any, can do nothing
but propose the regulations of a state like the Article 482 in Japan.
Second, there are several differences in the details of corporate laws among US
states. In principle, however, the corporate law of each state is not dramatically
different. Conversely, on a global scale, there are significant differences among the
corporate laws of different nations – which are much greater than those among US
states. The corporate law of certain nations might lack important rules for the
protection of shareholders from creditors. Also, some nations might provide rules for
the protection of shareholders or creditors in the manner which would be unimaginable
to another nation. In other words, the corporate law under which a business was
incorporated might have rules that the opposing party in a business transaction could
Third, it is relatively easy for a business entity in the United States to research the
17Roberta Romano, The Sarbanes-Oxley Act and the Making of Quack Corporate
Governance: Yale L. J. 114 (2005)1521.
corporate law of another US state. On the other hand, there are sometimes significant
hurdles to overcome when researching the corporate law of a foreign state on a global
scale. The research costs for examining the foreign corporate law of another nation are
significantly higher than doing similar research on US States.
II. Possible Consequences of the Abolishment of Article 482
It is supposed that there are two different possible scenarios if Article 482 of the
Japanese Commercial Code was to be abolished. One possible scenario is influenced by
the race to the bottom theory and the other by the race to the top theory.
a A corporation can be freely incorporated by a foreign law even if the corporation
which has its head office in Japan or the primary purpose of which is to carry on
business in Japan.
b The opposing party in a transaction has to consider the risk that the corporate
law by which the corporation was incorporated may lack rules for the protection of
creditors. It is important for the opposing party to know what the governing law
of the corporation is and how the law provides for the protection of creditors.
c There is a heavy burden on the opposing party to do so and it is sometimes
practically impossible to know the details of a foreign law.
d Instead of doing the research, a business entity tends to include the risk into the
risk of non-performing loans. The cost of businesses will increase – even in
domestic transactions in Japan.
e Business practice adds an incentive for a business entity to be incorporated by the
corporate law of a state which does not impose an avoidable burden or cost, e.g.
rules for the protection of creditors.
Points a-c are the same as described in Scenario 1.
d In a business transaction, instead of doing the research into the law that governs
corporations, a company tends to have a prejudice to do business with a
corporation incorporated in a jurisdiction with a highly reputed corporate law (i.e.
enough safeguards for the protection of creditors and for which the details of the
corporate law are well known). Japanese law will be regarded as the safest
option in terms of domestic transactions in Japan.
e Business practice adds an incentive for a business entity to be incorporated under
the corporate law of a state which fits the above conditions. Of course, Japanese
law will become the one used in the domestic transactions in Japan.
The question thus becomes: Which scenario is the most realistic if the regulations in
Article 482 are abolished?
After the debate in the project for the Modernisation of the Corporate Law the Council
ultimately decided that the regulation should not be abolished. The Council decided
that Article 482 should be modified in form but maintained in substance. In response a
brand-new Japanese Corporate Law was established in June 200518.
Article 821 (1) of the new Japanese Corporate Law will provide as follows:
A foreign corporation that establishes its head office in Japan or the primary purpose of which is
doing business in Japan shall not regularly carry on business transactions in Japan.
If a person carries on business transactions in violation of Paragraph 1, Paragraph 2 of
the Article makes the person liable, jointly with the foreign corporation, for any loss
caused by such transactions. In addition, Article 979 provides that the person shall be
sanctioned by civil penalty.
The new Japanese Corporate Law raises the following questions:
1) How should we evaluate the Council’s decision?
2) Why did the Council decide to act contrary to the public comments?
3) Did the members of the Council believe Scenario 1 (as described above) was more
Unfortunately, the minutes of the Council’s meetings do not shed any light on these
At present, however, as described above, there are a lot of foreign corporations
incorporated only for the purpose of doing business in Japan and actually operate their
business primarily in Japan. After the new law becomes effective, will these foreign
corporations, many of which are subsidiaries of major financial conglomerates, be
18Law No.86 of 2005. The new Corporate Law will be effective from May 2006.
19See the minutes of the 20th meeting and 25th meeting of the Council, available at
considered to be in violation of the law? In the last stage of the law-making process,
these financial conglomerates and the related enterprises lobbied the Diet with respect
to these provisions. In the end, the Upper House of the Japanese Diet declared that
the provision should not have any negative effect on the foreign corporations already
incorporated and being operated in Japan and/or against overseas investors using such
foreign corporations20. In addition, the explanatory note of the New Corporation Law,
written by the MOJ, emphasises that it is necessary to adequately consider this
declaratory decision by the Upper House when the relevant provision is interpreted21.
In other words, the Japanese regulations against pseudo-foreign-corporation will have
The law still has some ambiguity, namely: Which corporations will be considered a
foreign corporation regulated under the new Article 821 and which foreign corporations
will be treated as exceptions to the new law? The ambiguity means that there remains
considerable discretion in interpreting the details of the provision
We are also still left wondering whether we should allow incorporation in a foreign
state to be an exception even when the main purpose of the corporation is to conduct
business in Japan? Moreover, it is still an open question whether Scenario 1 or
Scenario 2 is more realistic. An economic analysis of the global competition in corporate
law is still needed to resolve these questions – even with the new Japanese Corporate
20 See the minutes of the meeting on June 28, 2005 of the Judicial Committee of the
Upper House, available at
21 Tetsu Aizawa (ed), Ichimon Itto Shin Kaishaho [Q&A New Corporate Law] (2005)