Business Ethics TOSHIBACORP.
ACCOUNTING SCANDAL Toshiba Corporation expresses sincere apologies to ourshareholders, customers, business partners and all the other stakeholders forany concern or inconvenience caused by issues relating to the appropriatenessof its accounting treatments. With the new management team and governancestructure, Toshiba as a whole will unite to make every effort to regain thetrust of shareholders, investors, and all others stakeholders and members ofthe public, and asks for your understanding and ongoing support.-ToshibaCorporation IntroductionOnJuly 21st 2015, CEO Hisao Tanaka announced his resignation along with thepublic statement of the ongoing accounting scandal. The company overstated itsearnings by US$ 1.2 billion over the previous 7 years. It was termed as themost damaging event for the brand in the company’s history of 140 years.
8other officials including two previous CEOs also resigned. Following thisincident, the company’s share fell to its lowest point in two and a half years.They had to suffer a quarterly loss of US$ 102 million and this episode wipedabout US$ 8 billion of Toshiba’s market value. A report from the company statedthat 3 most recent CEOs had part in inflating the operating profit. Theinvestigative report revealed that the CEOs did not directly instruct anyone tocook the books but rather placed immense pressure on subordinates and waitedfor the corporate culture to turn out the results they wanted.
This is aperfect example of failure in corporate culture and governance. Toshiba had acorporate culture in which decisions by senior management could not bechallenged. Investigators also found that employees were pressured to movecosts into next years or postponing loss reports.
Investigators describe how Toshiba’s corporate leadershiphanded down strict profit targets, known as Challenges, to business unitpresidents, often with the implication that failure would not be accepted. Insome cases, quarterly Challenges were handed down near the end of the quarterwhen there was no time left to materially affect unit performance. It soonbecame clear within individual business units that the only way to achievethese Challenges was to do so through the use of irregular accountingtechniques. This could also be a result of the corporate culture of Japanesecompanies, where they usually have a difficult relationship with shareholdersand outsiders not related by blood are excluded. In Japan, where it’s disrespectfulto disobey orders, a poor tone at the top can be detrimental to a company. Overthe last two decades, for instance, Japan has experienced its share of largefinancial reporting scandals that have occurred despite laws designed toprotect investors and the public.
When the company is doing well, everythinggoes smoothly but once the things go downhill, the first reaction is cover up.How did Toshiba’s accounting scandal cometo light?Suspectingaccounting irregularities at Toshiba, the Securities and Exchange SurveillanceCommission under the financial watchdog Financial Service Agency launched aprobe in February. Realizing the seriousness of the issue, Toshiba decided toset up an in-house investigative committee in April, when the firm publiclyannounced its accounting troubles. The irregularities apparently went deeperthan the firm initially believed; thus it handed the investigation over to anindependent outside committee in May and said that it would postpone reportingits fiscal 2014 earnings. The committee compiled a nearly 300-page report andsubmitted it to Toshiba on July 20. When, in September 2015, the full andaccurate financial results were finally released for the fiscal year endingMarch 31, 2015, it emerged that the firm had suffered a cumulative net loss ofmore than US$ 2.
14 billion over the past seven years. All dividend paymentswere immediately suspended, and shareholders were left reeling.Theaudit also revealed that, in addition to overstating profits, the firm had alsoconducted various write-downs.
The actions of those involved were attributed tothe fact that the group’s executives had been placed under significant pressurefollowing the 2011 Fukushima disaster, which seriously impacted Toshiba’snuclear unit. In a bid to compensate for losses in this division, management hadset aggressive targets in many other divisions, including smart meters andelectronic toll booths, and this had led to executives inflating figures tocreate the impression that these difficult targets were being met.Toshiba’s responseMasashiMuromachi, Representative Executive Officer, President and CEO of Toshiba, onSeptember 17, 2015 issued a public apology and sincerely apologized for theinconvenience and losses caused by Toshiba and acknowledged that it would taketime to regain the public trust and respect. A prompt restructuring was alsopromised with emphasis on treatment of human life, safety and compliance. AManagement Revitalization Committee consisting of outside directors and expertswas also promised, with tasks such as facilitating the reforms of corporateculture.Muromochialso promised to reinforce the audit function, implement new controls toenhance the corporate governance structure, and establish an Internal AuditDivision that would report to an Audit Committee of independent outsidedirectors.
A new evaluation system for President and Chief Executive Officer,increase in the number of outside directors in the Board to majority was alsovowed. A Culture of DeceptionToshiba’saccounting practises could be rooted into the development of extreme pressuresituations in which people were told to meet targets in a challengingenvironment. Along with the organizations top down culture, which generated theexpectation that employees should pledge blind loyalty to senior personnel,resulted in illegal accounting practices going unreported. Senior executivesdenied that had delayed any loss booking process purposely but theirsubordinates told that this was done on their managers’ instructions.
Duringmonthly meetings, top management issued “challenges” and other targets to theirteams and told the employees to “get creative” to ensure such targets are met.The resulting pressure engendered a culture of deceit. Every manager throughoutthe organisation, from middle management up to the president, had his or hereye firmly on the profit. Manipulating figures and inflating earnings hadbecome so systematic throughout the organization that it was practicallyimpossible for any one employee to overturn this illegal practices.
Toshiba’s failingswere a direct result of the actions of a wayward corporate management team. Toprevent any future accounting scandals, it was critical that Toshiba’s newmanagement team take positive action to eradicate the dishonest andprofit-driven corporate culture that had emerged. Failure of Corporate GovernanceAtone point of time Toshiba was considered to be a pioneer in corporategovernance. In 1998, a corporate officer system was created which brought themanagement closer to a US-type management model, with a committee governanceframework.
It increased the authority of the external board members who formedthe majority of the three separate management committees responsible forappointing board members and overseeing management.In2008, Toshiba, led by the president and other senior executives, began a driveto achieve profits setting aside everything else. This led to the company 150billion yen in overstated profits. While internal board members knew somecritical information about the actual performance of the firm, these losseswere unnoticed by external board members.Thisalso exposed the failure of the governance model when appointing external boardmembers. Two out of four external board members were former diplomats who hadlittle experience of management and accounting practices, and also wereinexperienced in the fields of finance and law.
It looks like they wereappointed just to reach the specific numbers, not providing serious managementoversight. Hence, Toshiba’s corporate governance system was subsequentlyexposed as being nothing more than an illusion. Cultural differences between US andJapanese companies US Japan Board Members Less than 15 and elected representatives Promoted internally and can go higher than 30 Company Objective Maximize shareholder wealth Maximize stakeholder wealth Agency Problem Managers pursue own objectives and behaviour is influenced by incentives to maximize shareholder wealth Objectives of the stakeholders are varied and dynamic. Problem is more complicated Employment Transient Lifetime and seniority-based Speed vs.
Consistency Rapid and efficient decision-making Decisions made in stages in accordance with hierarchy Heterogeneous vs. Homogeneous Heterogeneous, multicultural and flexible Homogeneous, people from same background Collaboration Meetings are few and less time consuming Daily lengthy meetings Remote vs. Face-to-face Communications More remote like email and phone Meetings are typically face-to-face Personal Life vs. Professional Life. Work life balance is valued Work take priority over personal life Self-Sponsored vs.
Company-sponsored Retirement Rewards People pursue own objectives and are not tied to one company People stay in one firm and are provided with rewards and promotions Hofstede Cultural Analysis Power/Distance Evenly distributed power. Anyone can challenge any decision Top-down. Lower-level personnel are expected to only follow orders Individualism/Collectivism Typically individualistic approach but the goal should be aligned with company Group takes precedence over individual Masculinity/Femininity Men and women work together Men and women have segregated roles. Uncertainty Avoidance Uncertainties are handled when they arise Uncertainties are not at all preferred Long-term vs. Short-term Orientation Short-term Long-term Improving Japan’s Corporate GovernanceImprovingcorporate governance was one of the main initiatives by the Japanese governmentunder Prime Minister Shinzo Abe to reinvigorate the economy through what becameknown as Abenomics.
Twolevels of analysis: the internal concerns of corporate agency and the emergenteffects on social welfare, are required while understanding ethical behaviourin the context of corporate governance: Corporate agency’s premise is thatemployees, managers, and directors (i.e., agents) should behave in the bestinterests of owners or shareholders (i.e.
, principals). Social welfare is basedon the premise that companies should engage in fair dealing with all of theirstakeholders—including customers, employees, suppliers, and communities, aswell as shareholders—in accordance with the expectations of the larger societyin which they operate.”Shareholder value” is an economic imperative. The business judgment rule allows boards and managers to easily get away with pet projects, the avoidance of difficult decisions, or the excuse that “as long as the music is playing (for our industry), we have to dance.” But every time a corporation gives up ground in the capital markets through value-compromising behavior, it comes one step closer to losing its viability as a stand-alone entity, and its ability to afford the maintenance of its stakeholder ecosystem.
(It will be interesting to see if “B-corps” will be able to survive in the current capital markets, or if they will have to derive capital exclusively from endowments, as non-profits are supported, or if some hybrid capital/endowment market will evolve to accommodate them.)The single most important job of the board is getting the right CEO. A close corollary is its willingness to get rid of the wrong CEO. Boards have to force themselves to do this work conscientiously because it can be personally uncomfortable, especially if the CEO does not want to spend time on it. Boards are also reluctant to force changes, since CEO transitions generally create a dip in the stock price; but if done it right, the company will quickly end up further ahead than where it would otherwise be.
External shareholders are inherently, significantly constrained regarding what they can know. These constraints make it easier for management and the board, and in fact make it compelling, to practice “short-termism,” e.g., via earning management. But companies have considerable leeway in choosing whether or not to play that game.
When it comes to executive compensation, “How” is much more important than “How much.” Incessant criticism of CEO pay has driven most boards to focus on compensation cost to the point of ignoring incentive effects. Overpaying the CEO could result in the waste of millions of dollars to a large company, and should be avoided. However, for a similarly sized company, the difference between mediocre incentives and good incentives can easily be worth hundreds of millions of dollars.Good boards provide a balance of advisory support as well as monitoring oversight. Much of the corporate governance discussion for the last two decades has (appropriately) focused on the need for better monitoring, but research indicates the pendulum may have swung too far, with the advisory roles of boards getting short shrift.
When these two roles come into conflict, as they invariably must, the board’s job is to resolve that conflict as best as possible in favor of shareholder interests.Overconfidence and hindsight bias are enemies of effective governance. Companies benefit from constantly questioning what they are doing right and what they can do better, rather than assume that everything is fine when times are good, or that sweeping changes are necessary when times get rough. (It’s tough for a public company to avoid these reactions since these biases are at least as strong among the investor community.)New Corporate Governance Code of JapanOnJune1, 2015, new corporate government code was introduced. It was a seriouseffort to reform the current scenario which was highly criticised forinhibiting growth and shielding of thee directors.
§ Principle-based approach: Companies were required toquestion whether its activities were matching with the purpose of fivestandards o Securing the Rights and Equal Treatment of Shareholders:Cross-shareholdings have to be disclosed and adequate consideration has to beprovided to minority and foreign shareholders o Appropriate Cooperation with Stakeholders Other thanshareholders: Sustainable growth in the mid and long term arises not only fromshareholders but others as well such as employees and customerso Ensuring Appropriate Information Disclosure andTransparency: Companies are expected to actively provide information thatexceeds the requisite standards o Responsibilities of the Board: Give direction to thestrategy, risk taking environment has to be established, effective oversight ofdirectors and management. Minimum 2 independent directors have to be appointed o Dialogue with Shareholders: Open and constructive dialoguewith the shareholders has to be encouraged § Comply-or-Explain Approach: Companies were expected tocomply with the norms. If they are not able to comply then they have to explainin complete detail and transparency to all stakeholders and shareholders