Land of the Rising Derivative Action: Revisiting Irrationality to Understand Japan's Unreluctant Shareholder Litigant

In this chapter, Nakahigashi and Puchniak explain that from 1950 until the mid-1980s the derivative action ‘in practice’ could not have been any more different in the United States and Japan. During this period derivative litigation (for better or worse) played a significant role in American corporate governance, with almost 20 per cent of US public listed companies experiencing one or more derivative suits. In stark contrast, in Japan from 1950 until the mid-1980s there was less than one derivative action on average per year, and not a single one of them was successful. Interestingly, this divergence between American and Japanese practice did not surprise academics. Rather, it was originally viewed as natural that Japanese shareholders would forgo suing for financial gain, because of their ‘cultural obsession’ for maintaining social harmony. Based on this theory, it made perfect (but economically irrational) sense that Japanese shareholders let their US-transplanted derivative action lie moribund for over three postwar decades when at the same time it was a staple of shareholder litigation in the United States.In the late 1980s, however, the powerful law and economics movement washed over Japanese legal scholarship, leaving the ‘culturally irrational litigant’ theory in its wake. The assumption that Japanese litigants were economically rational actors (i.e., as classical economic rational choice theory predicts that they would litigate only when the financial benefit from doing so exceeded the cost) became widely accepted. In turn, the absence of derivative actions in Japan became understood largely as the direct result of the high financial costs and meagre financial benefits that derivative litigation in Japan offered.The most common features cited for making it economically irrational to pursue derivative actions in Japan were similar to those cited for the dearth of derivative actions in most other countries: the application of the Shareholder Cost and Benefit Rules; the lack of a US-style contingency fee system; a ‘loser pays costs’ rule; weak pre-trial discovery rights; an absence of DO and modest damage awards. As explained in Chapter 1, these economically unattractive features generally distinguish most other jurisdictions from the United States, and help explain the United States’ relatively high rate of derivative litigation. In this sense, the economically rational explanation for the absence of derivative actions in Japan did not make it appear exceptional. However, some scholars pointed to the Japanese rule requiring plaintiff shareholders to pay an expensive stamp fee prior to filing a derivative action as an additional idiosyncratic economic deterrent to derivative actions in Japan. In short, in the early 1990s, it appeared that the mystery of the dearth of derivative actions in Japan had been solved. Like most other jurisdictions, except for the United States, it was economically irrational for Japanese shareholders to pursue derivative actions, and so they did not. This made perfect sense – until, suddenly, it did not.As Nakahigashi and Puchniak’s research reveals, in the early 1990s the number of derivative actions in Japanese public companies skyrocketed to US levels. This left the few remaining proponents of the ‘culturally irrational Japanese litigant’ theory dumbfounded. However, the proponents of the economically motivated and rational Japanese litigant theory did not go quietly into the night. To the contrary, they posited that the dramatic rise in derivative actions was the direct result of a 1993 change in the Japanese law that effectively eliminated the requirement for plaintiff shareholders to pay the expensive stamp fee to file a derivative action. In short, this explanation (which has become the consensus in the literature) suggests that, since the elimination of the stamp fee in 1993, economically motivated and rational Japanese shareholders have utilized derivative actions because the financial benefit of doing so now exceeds the cost.In this chapter, Nakahigashi and Puchniak challenge this consensus view. Based on the largest econometric and empirical study to date, they demonstrate that the consensus view is fundamentally flawed, for three reasons: (1) the dramatic increase in derivative actions began several years prior to the 1993 stamp fee reduction; (2) even after the 1993 stamp fee reduction empirical evidence demonstrates that neither shareholders nor attorneys have financially benefited from derivative litigation; and (3) even after the 1993 stamp fee reduction the cost-benefit calculus for pursuing a derivative action in Japan has been like most other countries, which have a dearth in derivative actions. The evidence that litigants are not pursuing derivative actions for direct economic gain is clear. However, this obviously raises a conundrum: what is driving the relatively high level of derivative litigation in Japan?Nakahigashi and Puchniak demonstrate, on the basis of their empirical research and case studies, that there are two types of litigants driving derivative actions in Japan – neither of which is financially benefiting directly from derivative actions. First, there are the ‘quasi-rational’ shareholders, who bring derivative actions for non-monetary benefits. The most important of these is an activist group – the Kabunushi (shareholders’) Onbuzuman – that pursues derivative actions to advance its political agenda. Second, there are the ‘purely irrational’ litigants, who, as a result of bounded rationality (e.g., the use of inaccurate mental heuristics, self-serving bias and herding behaviour), irrationally pursue derivative litigation in Japan. Thus, through the Japan experience, Nakahigashi and Puchniak reveal that, even if the regulatory structure of a derivative action does not make it economically rational to sue, a substantial number of derivative actions may nevertheless still occur.