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A massive accounting fraud by Toshiba has raised fresh questions about Japan’s corporate governance practices
Four years after the Olympus scandal in which the Japanese camera maker was accused of concealing nearly $1.7bn in losses, Toshiba – a leading industrial conglomerate - has become the new bad boy of corporate misgovernance in Japan. An independent investigation has confirmed that Toshiba inflated profits by $1.2bn over a period of seven years, using accounting malpractices. The probe was launched by Japan’s Securities and Exchange Surveillance Commission after the agency was tipped off by an unidentified whistleblower. A more perverse aspect of the saga is that Toshiba was recognised as a leader in corporate governance before the fraud came to light.
Nine Toshiba executives, including half of the 16-member board, among them three former chief executives and incumbent chief executive Hisao Tanaka, have resigned in shame, leaving a large hole in the top management. There was the usual guilt-laden Japanese bow ritual at the press conference where they announced their departures. The board chairman has been appointed as interim chief executive with a 90% cut in remuneration. By mid-July, Toshiba shares had dived 30% in value.
So what went wrong? Everything, it seems. The fraud was systematic and several top executives were complicit. Profit figures were inflated under pressure from top management to meet ambitious targets. The scam spanned three successive chief executives. Out of these, two joined the board after stepping down. The auditors Ernst & Young ShinNihon failed to notice anything amiss.
The timing of the Toshiba scandal could not have been worse. Barely two months before the scandal, Japan had introduced a new corporate governance code championed by prime minister Shinzo Abe, who sees corporate governance reforms as necessary to restart the sluggish economy.
The scandal has cast doubts about the effectiveness of the new code, which is not legally binding. A key measure in the new code requires nearly 2,400 companies listed on stock exchange to appoint at least two independent directors. Toshiba pioneered the practice of appointing independent directors a decade ago and had four independent directors on its board when the fraud came to light.
The new corporate governance code does include a whistleblower policy but as the code is voluntary, companies are not required to follow it. Other principles of the code include gender diversity, stakeholder engagement and social and environmental responsibility.
Japan's problem is not limited to Toshiba. The country has had a dismal record in corporate governance. It ranked 36th in corporate governance quality out of 39 developed and emerging economies in a survey by the research firm GMI Ratings in 2010.
Japan’s poor corporate governance is rooted in the way Japanese companies are run. It’s common knowledge that most companies have clubby boards. Boards generally have a significant number of senior company executives and former executives who have worked together for years and are bound by cultural norms of loyalty to seniors. Then there is a widespread practice of appointing former bureaucrats to the board who once regulated the industry or the company. Former diplomats are also a popular board choice among the companies. Toshiba had two diplomats on its board who were also on the audit committee without having a relevant qualification or experience. Add to this the popular practice of cross-holdings in which companies hold each other’s shares and protect mutual interests.
Chummy boards face little challenge. In Japanese culture, it’s unthinkable for employees to question their bosses or express any disagreement, let alone protest. Lifelong employment in exchange for complete loyalty is the social contract Japanese society has respected in the post-war era. So whistle blowing does not figure in the scheme of things. In the case of the 2011 Olympus scandal, the whistle blower was the company’s British chief executive Michael Woodford, the first westerner to head a Japanese conglomerate. He was later fired by the board for seeking answers to $2 billion of dubious payments.
The Toshiba scandal has also brought attention to the quality of accountants and auditors in Japan. Auditors in Japan are among the worst paid, by international standards. Companies in Japan pay their auditors an average of 0.032% of turnover, compared with 0.053% in the UK and 0.118% in the US, while the international average is 0.056%, according to a study by Hong Kong-based GMT Research. Toshiba paid Ernst & Young ShinNihon 0.015% of turnover for the year ending March 2014. The quality and rigour of low paid and overworked auditors in Japan is being debated.
Japan needs to act tough to win international investors’ confidence. Tougher disclosure requirements should be imposed on companies. These should include disclosing the number and names of ex-government officials as board members and in company employment. An increased external oversight into company affairs as well as effective internal controls should be required. A board membership should carry stringent qualification criteria. Comprehensive director training should be introduced. Independence of independent directors should be subjected to rigorous tests.
Employees should be trained in the benefits of whistle blowing including the larger interests of the company. Japan should also think of introducing rewards and real protection for whistleblowers. The biggest change however, and the most difficult one, is to create an environment of openness and transparency and a establishing a culture in which diversity of ideas, including feedback from underlings, is encouraged.
The latest corporate crisis could be a potential opportunity to start an open debate in the country to find effective ways to fix corporate misbehaviour by the boardroom boys.fraud Japan Toshiba Asia column technology Tech industry