The operator of Japan's main international airport is to manage and upgrade Palau's airport.
Japan Airport Terminal, which operates Haneda airport in Tokyo, has entered into a joint venture with Palau International Airport Corporation.
Palau's airport has a two-kilometre runway and receives mid-range jets.
However the Japan Times reported Palau's government-run terminal was prone to over crowding and is short of seats.
A Japan Airport Terminal spokesman said these shortfalls were damaging the passenger experience in Palau.
He said the expansion of the terminal and other infrastructure at a cost of $US31 million would benefit Palau's tourism.
In 2015, more than 160,000 people visited Palau of whom around 30,000 were Japanese.