Shareholders’ Equity and Dividend Regulation in Japan: How Can Financial Reporting and Capital Maintenance Be Reconciled?

Abstract

The concept of shareholders’ equity is fundamental in both company law and financial reporting standards. In continental European countries and Japan, these legislations have traditionally shared common principles by limiting the source of distribution to shareholders to the accumulated profits a company has earned. As the purposes of financial accounting have progressed towards decision usefulness for investors, however, the link between accounting and statutory distribution restriction has been undermined. Our research addresses the treatment of shareholders’ equity in Japan based on legal primary sources and related literature. Its purpose is to explain the divergence between financial reporting and dividend restrictions in light of their contrasting objectives. Our findings provide two main implications. First, reconciling financial reporting and dividend restriction requires a complex recalculation of distributable profits. The regulation has become too complex to ensure all the companies easily comply with dividend distribution restrictions. Second, the underlying definitions of equity items and their presentation in financial statements have remained consistent between the Companies Act provisions and the accounting standards even after converging with the IFRS. This has been achieved by splitting the concept of shareholders’ equity from net assets in financial accounting.