In November 2006, a contingent of Japanese businessmen from NEC Electronics visited the offices of Perry Capital, an investment fund based on Fifth Avenue in New York.

Led by Toshio Nakajima, chief executive, and Junshi Yamaguchi, executive managing director, they were making one of their regular investor relations visits. This time, however, they were bringing some particularly unwelcome news.

Since late 2005, Perry had inv­ested as much as $150m for a 4 per cent stake in NECEL, one of Japan's leading semiconductor makers, in the belief that the management team would deliver on crucial restructuring and re-engineering measures that the US fund had discussed in detail with top NECEL management.

But as Mr Nakajima (pictured) and colleagues spoke about performance and strategy, one piece of information stunned the Perry team. It became horribly clear that NECEL had not found a big overseas customer for its wireless baseband chips, used in mobile phones.

For Perry, that had been a priority as it believed such a move would improve NECEL's performance and justify its investment in the company. Worse, although top NECEL executives had promised to close the loss-making business if no outside customer emerged, they were now saying they had no intention of doing so.

"It was not a pleasant meeting," recalls one person present.

Almost two years later, NECEL's share price issubstantially below the Y3,000 to Y3,500 at which Perry acquired its stake, which it later raised to 6 per cent.

Perry's experience with NECEL illustrates a pitfall met by many foreign investors in Japan. While Japanese companies with state-of-the-art technologies or oth­er competitive advantages look like good investments, management is often not focused on maximising profits, using capital efficiently or improving shareholder returns. Some want to act but are prevented by historical circumstances or cultural and social constraints.

"Japanese companies have been fantastically successful, we have immense admiration for what has been achieved. It is really about what happens with the fruits of that success," says Chris Hitchen, chief executive of Railpen Investments - which manages retirement money for Britain's rail industry - and head of the UK's National Association of Pension Funds.

Foreign investors, who now own about a third of all Japanese listed shares, are at the head of a growing campaign to encourage Japanese companies to improve corporate governance through active dialogue with management.

That campaign is being fought mostly behind the scenes, but also in public forums including the popular media and through lobbying of policymakers and regulators.

Given that many Japanese companies are experiencing shareholder engagement for the first time and foreign investors are often unfamiliar with Japanese corporate culture and business practices, some observers say progress is promising. "The relationship with investors has changed a lot," says Kunio Kojima, president of Keizai Doyukai, the Japan Association of Corporate Executives. More Japanese companies are ready to discuss corporate governance issues with investors.

Meanwhile, although it disappointed Perry over its chipmaking arm, NECEL is shrinking its loss-making businesses, optimising R&D and capital spending and focusing resources on areas where it has competitiveness - all recommendations the fund had made. As Alp Ercil, Perry managing partner responsible for Asian investments, said after the company's annual general meeting in June: "This is a whole change in philosophy and approach. For the first time I feel like the management team is 100 per cent on board executing our business plan."

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In a different sector, NipponKoa Insurance is also implementing changes under pressure from a foreign investor - in this case, Southeastern Asset Management, a US fund that has invested in the non-life insurance company for 11 years and is its largest shareholder with a 20 per cent stake.

The US fund voted against the reappointment of Makoto Hyodo, chief executive, at this year's AGM, citing "rapid destruction of value" under his leadership. Mr Hyodo stayed, but Southeastern won a big concession in getting a representative on the board - Junichiro Sano, Japan head of Dalton, a US hedge fund. Also, NipponKoa has hired consultants, including AT Kearney, the US firm, to advise on strategy.

However, while Japanese companies may be heeding shareholders more, social and historical ties that bind companies to customers, suppliers and others mean progress in achieving global standards of corporate governance is slow.

In Perry's case, it had underestimated the influence of NECEL's parent company, NEC. Although listed on the Tokyo Stock Exch­ange, NECEL is 70 per cent controlled by NEC and makes its wireless baseband chips mainly for the parent company, which investorssay presents a conflict of interest. While acknowledging that "investing in order to raise revenue isn't going to work" in the current business environment, Mr Nakajima has held on to the wireless baseband business. He denies the decision owes anything to the relationship with NEC, but argues that if NECEL restructured as fast as Perry wanted, its business would disappear, because Japanese customers dislike that kind of instability. "If all these funds are involved and they cut and paste and every year things change, many customers would be afraid to do business with us," Mr Nakajima says.

Meanwhile, NipponKoa argues that Southeastern's suggestion that it separate its investment and underwriting businesses would not work in Japan. NipponKoa, like other Japanese insurers, holds stakes in companies from which it receives underwriting business. "Holding stocks acts as a kind of licence to participate in a tender for business," Mr Hyodo explains.

Japanese companies argue that there is a Japanese approach, which is better suited to the business culture. "What is positive for us, we will accept," Mr Hyodo says. "But the American way is not always right." For most investors that would be acceptable, as long as they received good returns.

But regardless of how they do it, until Japanese companies achieve global standards of shareholder returns, foreign investors and, increasingly, domestic ones too will continue to apply pressure, if not pull out. Japanese companies "are going to have to change their behaviour. We are going to keep talking about it," Mr Hitchen says.

Meanwhile, the current global crisis, which is sending Tokyo stocks plummeting, means many foreign investors no longer have the luxury of patiently encouraging change and are being forced to exit their investments.