The $110 billion Pension Fund Association (PFA), a leading quasi-government pension fund in Japan, is reviewing guidelines for proxy voting in light of a recent move by hundreds of Japanese companies to install poison pills against takeovers.

The PFA has been at the forefront of corporate-governance initiatives in Japan. It introduced an innovative equity fund investing in companies with good governance, managed by Nomura Asset Management, which has so far beat indices such as the Nikkei 225.

And last year it introduced standards to guide proxy votes, including a rule to vote against the re-election of board members of companies whose return on equity falls under 8% for three consecutive years. By Japanese standards this is bracing stuff: in many cases, as the PFA extends its communication with managers of Japanese listed companies, they are the first domestic institution to ask such questions.

But events of last year showed the inadequacy of this approach, as shareholders of some 400 companies bought the line of panicking managers about destructive activist managers such as Steel Partners, which not only failed to acquire the under-performing small cap, Bull Dog Sauce, but was then deemed an ôabusive acquirerö by a Tokyo court.

The PFA is a major shareholder in many of these companies. So how did it vote? Daisuke Hamaguchi, its director of investments, says the PFA was surprised by the wave of poison pills. Initially it lobbied management to put the resolution to a shareholder vote, which it assumed might be enough to squash the more ludicrous measures.

This was considered a success. For most companies it was the first time they had bothered to put such measures before a fair vote, or to include independent directors and accountants in it. But then one after another, shareholders approved the poison pills.

Hamaguchi says the PFAÆs response was to approve these measures provided the company expanded the number of independent directors who would be allowed to review them. In some cases, it voted against the anti-shareholder rules.

But its campaign for better corporate governance was largely a failure with a few modest successes. ôIt was not encouraging,ö Hamaguchi says. ôWe are fundamentally against these anti-merger measures.ö

The PFA has since decided to take a stronger line and is lobbying the Tokyo Stock Exchange to set appropriate rules regarding takeovers. ôWe are discussing how to improve the environment,ö Hamaguchi says. The PFA has also hired an experienced fund executive from Nomura Asset Management whose sole job is to head a unit dedicated to corporate governance, who is now outlining a three-year agenda.

But the PFA and other progressive investors face an uphill battle given the composition of JapanÆs shareholders. The episode of the poison pills demonstrated the dominance of cross-shareholdings based on corporate relationships û and this is a characteristic of the market that is increasing, not decreasing. The true free float is shrinking. The PFA is coming round to the necessity of a harder line on corporate governance, but too late to prevent one of AsiaÆs biggest setbacks to shareholder rights.