* PM to call on companies to appoint more independent directors
* Change to come slowly, most boards still filled with insiders
* Investors seeking higher ROE, dialogue
By Ritsuko Ando
TOKYO, May 15 (Reuters) - Prime Minister Shinzo Abe is set to outline plans to improve corporate governance as part of an updated economic strategy next month, aiming to overturn Japan's reputation for neglecting shareholders and salvage his reform credentials.
The draft plans, which face resistance from Japan's largest business lobby, would push companies to appoint more outside directors as part of a package aimed in part at winning back overseas investors who have turned sceptical of Abe's ability to push through politically sensitive reforms on labour and trade.
Currently, Japanese firms are not required to have independent directors.
"There is a lot of interest in this, especially from outside Japan," said Liberal Democratic Party (LDP) member Masahiko Shibayama, who heads a group preparing such reforms, adding that he hoped the June announcement would deliver "powerful pitches" on corporate governance as well as reforms of Japan's public pension fund.
Tokyo stocks have fallen around 12 percent so far this year, for the first time since Abe took power in late 2012. In addition to the drag from slowing growth, many foreign investors remain unconvinced that Japanese boards dominated by insiders are receptive to the views of shareholders.
Nicholas Benes, representative director of the Board Director Training Institute of Japan, said a new corporate governance code was crucial for Abe's "third arrow," the last of a three-part growth strategy of monetary easing, fiscal spending and reforms aimed at revitalising the long-moribund economy.
"This is the reform that Prime Minister Abe most needs to announce in the coming month," he said.
"If the industry were to control the corporate governance code drafting process... the global investment community would conclude that Abenomics lacks both substance and spine."
Anticipation of new governance rules and pressure from proxy advisory firms have persuaded companies such as Canon Inc to recently nominate independent directors after years of refusing to do so.
Yet with around 40 percent of companies listed on Tokyo's main bourse still filling their boards with insiders last year and under 3 percent appointing independent directors to a majority of seats, analysts say it will take years to see the sweeping change in governance which activist investors have long urged.
"There has been progress in the sense that it's now harder for companies to say they have no intention of appointing even a single outside board member. But the next step is for companies to voluntarily appoint more," said Kengo Nishiyama, a strategist at Nomura Securities.
"That will take more time."
Most developed economies require listed firms to select a majority of their board members from outside the company, and corporate governance experts say one or two directors on a board of more than 10 are not enough.
The three outside directors on Olympus Corp's former board, for example, failed to detect a scheme to hide investment losses relating to a $1.7 billion accounting scandal in 2011. Damages from the scandal continue to weigh on the company.
Cerberus Capital management struggled in its push for a management shakeup at Seibu Holdings while Sony Corp rejected a proposal from activist shareholder Daniel Loeb to spin off its entertainment business.
Shuhei Abe, CEO of hedge fund SPARX Group, said executives often forget that shareholders should hold ultimate power over the company.
"In many companies in Japan, management simply assumes that absolute power is given to them," he said. "They are honest and hard-working, but they don't know who they are working for."
Japan's large institutional investors rarely challenge management, a practice analysts say has contributed to chronically low return on equity (ROE), which measures efficient use of shareholders' capital. The average ROE among Japan's listed companies is around 5 percent compared with over 15 percent in the United States.
"There is a heightened awareness now, but Japan really lags the rest of the world in terms of corporate governance," said Melissa Otto, a director at asset manager TIAA-CREF.
To address such concerns, the government has recently introduced a new stewardship code for institutional investors and promoted a new stock index, the JPX400, which takes ROE into account.
Lawmakers last year, however, scrapped plans to include a requirement for independent directors in a revision to company law, following pressure from the politically powerful Keidanren business lobby, which is now drawing up its own proposals in a bid to stave off pressure for change.
It remains unclear how much detail the June announcement will include, but sources say LDP lawmakers are hoping to at least provide a outline of a new governance code that would bring Japan in line with international standards. While not legally binding, it would require companies to "comply or explain" - an approach common in Britain and other parts of Europe.
Analysts, however, say real change will come slowly. Some said forcing strict regulations may compel some companies to go through the motions of compliance without embracing the spirit of the reform.
A case in point could be Nintendo. After racking up losses for three straight years as sales of its flagship game consoles sagged, the company announced last week that it would nominate one external director to its board for the first time.
But Chief Executive Satoru Iwata made clear the move was neither a reversal of policy nor an acknowledgement of long-running criticism that it had turned a deaf ear to suggestions such as making its games available on smartphones.
He told Reuters that he believed Japan's governance system still worked, but that nominating an external director was a concession to the international consensus.
"The reality is that the world's attention is the way it is, and it was time for us to reconsider our governance," he said. (Additional reporting by Noriyuki Hirata and Sophie Knight; Editing by Kim Coghill)