Introduction

In recent years, in order to attract and retain talented personnel there has been a growing demand to grant stock compensation to employees, as is already the case for directors, as a form of incentive compensation. However, while Article 202-2 of the Companies Act currently permits the gratuitous issuance of shares where listed companies grant shares as remuneration, etc. to their directors, the gratuitous issuance of shares to employees is not permitted. Accordingly, in practice, stock compensation for employees has been implemented through a technical arrangement whereby a monetary claim is first granted to the employee, who then contributes such monetary claim to the company as an in-kind contribution in exchange for the issuance of shares.

Against this background, the Legislative Council has been discussing amendments to Article 202-2 of the Companies Act that would permit the gratuitous issuance of stock compensation to employees under certain conditions. The Interim Draft Proposal for the Review of the Companies Act (Matters Relating to Shares, Shareholders' Meetings, etc.) (the "Interim Draft Proposal"), compiled at the 12th meeting of the Company Law Subcommittee (Matters Relating to Shares, Shareholders' Meetings, etc.) of the Legislative Council held on March 18, 2026, presents a specific framework for expanding the scope of persons eligible to receive gratuitously issued stock compensation. However, the Interim Draft Proposal also states that, "before reaching a conclusion, it is necessary to organize the issues concerning whether shares gratuitously issued to employees, etc. constitute 'wages' under the Labour Standards Act (Act No. 49 of 1947)." This indicates that, as a prerequisite to permitting the gratuitous issuance of stock compensation to employees, determining whether such stock compensation constitutes "wages" under the Labour Standards Act is a significant issue.

This article explains the current understanding of whether stock compensation, including stock options, constitutes "wages" under the Labour Standards Act.

Criteria for Determining Whether Stock Compensation Constitutes "Wages"

Where a payment is determined to constitute "wages" under the Labour Standards Act, compliance is required with the principles set forth in Article 24 thereof, namely, the principles of payment in currency, direct payment, payment in full, and payment at least once a month. If stock compensation were regarded as "wages" under the Labour Standards Act, it would conflict with the principle of payment in currency. Accordingly, unless the exception under the proviso to Article 24, paragraph (1) of the Labour Standards Act applies by virtue of provisions contained in a collective bargaining agreement, the grant of shares to employees would violate Article 24 of the Labour Standards Act and therefore would not be permissible. Consequently, whether stock compensation can be characterized as falling outside the definition of "wages" constitutes an important issue in implementing stock compensation plans.

The term "wages" is defined in Article 11 of the Labour Standards Act as follows: "The term 'wages' as used in this Act means wages, salaries, allowances, bonuses, and every other payment to the employee from the employer as remuneration for labour, regardless of the name by which such payment may be called."

The phrase "remuneration for labour" is understood to mean payments made by an employer to an employee as compensation for labour performed under a relationship of subordination to the employer. Although this is an abstract concept, it is generally understood that, except where a payment constitutes (i) a voluntary or gratuitous benefit, (ii) a welfare facility or benefit, or (iii) part of the employer's business facilities, it ordinarily constitutes "remuneration for labor" and therefore falls within the definition of "wages." However, even where a payment is voluntary or gratuitous in nature, it is regarded as "wages" if the conditions for payment have been clearly established in advance under a collective bargaining agreement, work rules, employment agreement, or similar instrument (Ministry of Labour Circular No. Hakki-17 dated September 13, 1947).

In addition, with respect to stock compensation in the form of stock options, Ministry of Health, Labour and Welfare Circular No. Kihatsu-412 dated June 1, 1997 (the "Stock Option Circular") addresses whether stock options constitute "wages" as follows, and may be read as taking the position that stock options uniformly do not constitute "wages":

Because the employee who has been granted the right may decide whether or not to exercise the right and, if the right is exercised, when to exercise the right and when to sell the shares, both the timing and the amount of any benefit obtained under the scheme are left to the employee's own discretion. Accordingly, such benefit does not constitute remuneration for labour and therefore does not fall within the definition of "wages" under Article 11 of the Labour Standards Act.

Furthermore, Q80 of the Guidebook to Introducing Incentive Plans for Directors' Compensation to Promote Proactive Management for Sustainable Corporate Growth (the "Guidebook"), published by the Ministry of Economy, Trade and Industry (and not the Ministry of Health, Labour and Welfare), states that stock compensation does not constitute "wages" where the following conditions (a) through (c) are satisfied:

a. The stock compensation is granted in addition to, and without reducing, monetary wages, etc. (including retirement benefits and other monetary wages that employees are expected to receive; the same shall apply hereinafter). b. The stock compensation is not treated as wages, etc. under the employment agreement or work rules. c. When the aggregate amount of monetary wages, etc. is compared with the share price at the time the stock compensation scheme is introduced, the former constitutes the principal benefit received by the employee as consideration for labour.

However, these requirements are based on the Report on New Company Share Ownership Schemes (the "Report"), which assumes a scheme under which a company grants its own shares to employees upon retirement. Accordingly, it remains unclear to what extent consideration has been given to whether conditions (a) through (c) are equally applicable to schemes under which shares are granted during employment. 

Classification of Various Forms of Stock Compensation

(1) Categories

The extent to which the above criteria for determining whether stock compensation constitutes "wages" apply should be examined separately for each type of stock compensation.
In practice, stock compensation schemes are broadly classified into upfront grant-type and deferred grant-type schemes. An upfront grant-type scheme refers to a scheme under which shares subject to transfer restrictions are granted shortly after the commencement of the employee's service. This category includes Restricted Stock (RS), under which restrictions are imposed based on continued employment conditions, and Performance Shares (PS), under which restrictions are imposed based on performance conditions.

In contrast, a deferred grant-type scheme refers to a scheme under which shares are granted after the completion of the service period. Deferred grant-type schemes include Restricted Stock Units (RSUs) and Performance Share Units (PSUs), under which rights to receive shares, referred to as "units," are granted in advance and shares corresponding to the number of units are delivered upon satisfaction of the applicable conditions.

The Guidebook also classifies so-called JPY 1 Stock Options as a form of deferred grant-type stock compensation under which employees acquire shares upon exercise of the options. However, because the Stock Option Circular specifically addresses stock options, stock options should be analyzed separately.

With respect to other forms of stock compensation, although upfront grant-type and deferred grant-type schemes differ in the timing of share delivery, both ultimately result in the delivery of shares to employees. Accordingly, it is appropriate to analyze both types under the same legal framework.

On the other hand, the Guidebook also refers to arrangements such as Phantom Stock, under which shares are not actually granted but cash equivalent to the value of the shares is paid after a specified period; Performance Cash, under which cash is paid based on the degree of achievement of medium- to long-term performance targets; and Stock Appreciation Rights (SARs), under which cash equal to the appreciation in the market price of designated shares above a predetermined price after a specified period is paid. Although these arrangements resemble stock compensation schemes, they require separate consideration because what is actually paid is cash rather than shares.

Accordingly, the following sections briefly examine (i) stock options, (ii) stock compensation other than stock options, and (iii) cash-based arrangements similar to stock compensation.

(2) Whether Stock Options Constitute "Wages"

As discussed above, the Stock Option Circular uniformly states that stock options do not constitute "wages." Nevertheless, it remains questionable whether the same conclusion should necessarily apply to arrangements such as JPY 1 Stock Options, in which the exercise price is set at a nominal amount.

The Stock Option Circular explains that stock options do not constitute "wages" because "the timing and amount of the benefit derived from the scheme are left to the employee's own judgment." However, the "benefit" referred to therein appears to mean the investment gain generated after the employee becomes able to exercise the option. It is not necessarily clear whether the Circular also intended to include within that concept the economic benefit arising merely from the acquisition of the stock option itself (this point also appears not to have been examined in the illustrative diagram accompanying the Stock Option Circular).
Specifically, where the exercise price is set at a nominal amount and the market price of the shares at the time the option is granted exceeds the exercise price, the employee acquires an economic benefit equal to the difference between those amounts immediately upon receiving the stock option. Whether that portion constitutes "wages" therefore requires separate consideration.

In addition, the Stock Option Circular was issued before the introduction of the current stock option system based on share acquisition rights, during the era of the former Commercial Code. Accordingly, it may be said that the premises underlying the Circular differ from those applicable to the current stock option system under Articles 236 et seq. of the Companies Act.
Nevertheless, even if an economic benefit may be recognized at the time stock options are granted, the acquisition of an economic benefit through stock options is institutionally similar to the acquisition of an economic benefit through stock compensation involving the delivery of shares. Accordingly, at least where the three requirements set forth in the Guidebook are satisfied, there remains room to conclude that stock options do not constitute "wages." This interpretation is also consistent with the Guidebook's treatment of so-called JPY 1 Stock Options as a form of deferred grant-type stock compensation.

(3) Whether Stock Compensation Constitutes "Wages"

At present, the Ministry of Health, Labour and Welfare has not issued any circular specifically addressing whether stock compensation other than stock options constitutes "wages." However, considering currently available published materials, it appears appropriate, as a general matter, to conclude that such stock compensation does not constitute "wages" where the three requirements set forth in the Guidebook are satisfied.

That said, because the Guidebook merely quotes the requirements presented in the Report and, as noted above, the Report was prepared on the premise that companies grant their own shares upon employees' retirement rather than under other types of stock compensation arrangements, more detailed examination will be necessary.

a.    The stock compensation must be granted in addition to, and without reducing, monetary wages, etc. (including retirement benefits and other monetary wages expected to be paid; the same shall apply hereinafter).

The key consideration under this requirement is whether the stock compensation substitutes for wages that have previously been paid. Accordingly, where part of the wages previously paid to existing employees is reduced and replaced with shares, requirement (a) would not be satisfied.

Similarly, where wages are frozen and, in lieu of a conventional salary increase, only the amount corresponding to the salary increase is provided in the form of stock compensation, such arrangement may in substance be regarded as replacing monetary wages and therefore requires careful consideration in relation to requirement (a).

b.    The stock compensation must not be treated as wages, etc. under the employment agreement or work rules.

Ministry of Labour Circular No. Hakki-17 dated September 13, 1947 suggests that payments whose conditions are clearly prescribed in work rules or similar regulations are generally regarded as "wages." On the other hand, it is difficult to envisage a stock compensation scheme whose payment conditions are not clearly specified in internal regulations or similar documents.

Accordingly, in relation to this requirement, the issue is not whether the payment conditions are clearly prescribed in internal rules as such, but rather whether the relevant stock compensation scheme is treated as part of an employee’s wages. Therefore, even where the payment criteria for stock compensation are clearly prescribed in internal regulations, it is reasonable to conclude that such stock compensation does not constitute "wages," provided that the three requirements set forth in the Guidebook are satisfied.

For this reason, companies should expressly state in their stock compensation regulations that stock compensation does not constitute wages. In addition, even where references to stock compensation are included in work rules, notices of employment conditions, or similar documents, it is desirable to use wording that clearly indicates that the scheme constitutes a separate incentive program rather than wages.

c.    When comparing the aggregate amount of monetary wages, etc. with the market value of the shares at the time the scheme is introduced, the former must constitute the principal benefit received by the employee as consideration for labour.

With respect to this requirement, it remains unclear how to determine what constitutes the "principal benefit" and over what period wages should be compared with stock compensation.
This uncertainty appears to reflect the fact that, when the requirements were originally considered in the Report, the widespread use of stock compensation schemes was not contemplated. Accordingly, further clarification will be necessary going forward.

Moreover, because the Interim Draft Proposal also states that the issue of whether stock compensation constitutes "wages" requires further examination, it is hoped that the Ministry of Health, Labour and Welfare will in due course publish guidance clarifying the treatment of stock compensation under the Labour Standards Act.

(4) Whether Cash-Based Arrangements Similar to Stock Compensation Constitute "Wages"

With respect to arrangements such as Phantom Stock described in the Guidebook, although no shares are delivered, the amount of cash paid is determined by reference to the share price. Accordingly, it might be argued that such arrangements likewise do not constitute "wages" if the three requirements set forth in the Guidebook are satisfied. However, because the Guidebook's three requirements are derived from the Report, and the starting point of the Report's analysis was the Ministry of Labour Circular concerning in-kind remuneration (Circular No. Kihatsu-452 dated December 9, 1947), those requirements are not appropriately applied to arrangements involving the payment of cash.

As discussed above, the issue of whether a payment constitutes "wages" principally arises because of the principle of payment in currency. Since cash-based arrangements do not conflict with that principle, there is no need to conclude that they fall outside the definition of "wages."

Although such arrangements possess the characteristic that the amount of cash paid fluctuates according to the share price, payments of money from employers to employees are generally regarded as "remuneration for labour." Accordingly, it is appropriate to conclude that such cash-based arrangements constitute "wages."

Conclusion

As indicated in the Interim Draft Proposal, clarification of whether stock compensation constitutes "wages" is expected because it is a prerequisite for the formulation of the proposed amendments. Accordingly, further clarification of the applicable standards is anticipated.

From the perspective of labour law, numerous issues remain to be addressed in addition to the question of whether stock compensation constitutes "wages," including the validity of malus provisions and clawback provisions, which in practice are frequently included in stock compensation plans. Given the absence of sufficient judicial precedents on these issues, it will be necessary to continue monitoring future developments closely to ensure the appropriate operation of stock compensation schemes.