FOLLOWING the mass resignation of its top management in the aftermath of the revelation that Toshiba had inflated profits by ¥152bn (£785m) over the past six years, the company has promised wholesale changes to its accounting management.
On 29 July it announced a raft of corporate changes. Significantly, it intends to “establish a new corporate culture under new management and governance structures”, according to a communiqué.
After the breadth and scope of the accounting manipulations were revealed publicly on 21 July in a report by an independent committee, it became apparent that weaknesses in institutional corporate governance and negative aspects of Japan’s corporate culture had combined to produce a perfect storm of accounting wrongdoing.
Toshiba president Hisao Tanaka and his two predecessors, vice chairman Norio Sasaki and company adviser Atsutoshi Nishida, publicly apologised for the financial fiasco the same day and resigned. Four other senior managers and directors of the board also resigned, while an eighth resigned from his executive and director positions. The resignations account for half the Toshiba board of 16 members.
Unquestioned, unchecked and unaccountable
Unquestioned, unchecked and seemingly unaccountable, Toshiba’s top management had incited business unit heads to cook the books, the committee concluded. Consequently, during the past six years, subordinates used a hatful of cheap accounting tricks to inflate operating profits.
The investigation team found that Toshiba Group companies had overstated sales and profits, understated losses, delayed the recording of operating expenses, and caused related companies to hold excessive inventories of Toshiba components (“channel stuffing”).
In their summary, the investigators noted: “The inappropriate accounting treatment that was carried out or continued in a number of [Toshiba] companies simultaneously and in an institutional manner with the involvement of corporate-level top management … should be considered a management decision…”
Apparently unable to face the shame of presiding over what they regarded as an embarrassingly weak performance by Toshiba, the former presidents set impossibly high profit targets – euphemistically called “challenges” – and made sure their Toshiba company chiefs understood what had to be done.
To ensure the desired results, the committee concluded the presidents made “… the strong suggestion that those targets needed to be achieved, and sometimes implied that under-performing companies would have to withdraw from their business if they did not improve their profit”.
Such a deception could hardly have been carried out across a number of business units for such a length of time without the employees’ strong adherence to corporate values, such as obedience, loyalty to the organisation and a desire to maintain harmonious conformity – values reinforced by lifetime employment, which is still the carrot-and-stick norm in large Japanese companies like Toshiba.
“I have no doubt that employees working in Toshiba are psychologically and emotionally attached to the company,” says Masazumi Wakatabe, a professor of economics at Waseda University in Tokyo. “So Japanese corporate culture played a role in the scandal.”
However, given that major accounting frauds have occurred in most countries, Wakatabe believes the Toshiba affair has more to do with “the institutional weakness of Japanese corporate governance. Especially in situations when those at the top are not closely monitored by outside directors or government authorities like the equivalent of the [US] Securities and Exchange Commission.”
The scandal first came to light in February when Japan’s Securities and Exchange Surveillance Commission began investigating Toshiba’s accounting methods for infrastructure projects. On 3 April, the company followed up by issuing a statement saying accounting irregularities had come to its attention and so “has decided to immediately establish a special investigation committee (whose members include experts from outside the Toshiba Group) … to conduct an internal investigation into this matter”.
When the committee turned up widespread accounting distortions in various Toshiba Group companies, Toshiba had no choice but to establish an independent investigation committee on May 8. This team of outside lawyers and accountants delivered its damning ¥152bn result on 20 July.
It is no exaggeration to say the news shocked not only Japan’s corporate world but also the entire nation. Founded in 1875, Toshiba has long been regarded as a venerable blue-chip corporation, a proud Fortune 500 global company and the embodiment of Japan’s corporate strength at its best. Its multinational operations employ 200,000 people and manufacture a variety of items, including consumer electronics and household goods, semiconductor memory and components, medical equipment, and energy power systems such as nuclear plants.
Commenting separately to the press upon hearing the news, both Japan’s finance minister Taro Aso and chief cabinet secretary Yoshihide Suga described the announcement as “very regrettable”. Meanwhile, Taizo Nishimuro, a well-respected former Toshiba president (1996-2000) and a member of an advisory panel assisting prime minister Shinz? Abe, told the Japanese media the day after the resignations, that the news came as “a very great shock”.
Toshiba has responded to the crisis by appointing its current chairman of the board, Masashi Muromachi, as the interim president and CEO, and has ordered pay cuts for 16 executives, including Muromachi. To nominate a new management team and implement changes in governance structures and corporate culture, the company has established a management revitalisation committee, made up of the four current outside directors of the board, as well as an outside accountant, lawyer and a former Japan Supreme Court justice.
“Changing corporate culture is, of course, a very challenging undertaking,” said Michael Smitka, professor of economics at Washington and Lee University in Virginia, US. Smitka, who has studied and researched the Japanese economy over the past 35 years, added: “The up-or-out system that is predominant in many companies exerts very strong pressures to play the game. But nearly every organisation has these sorts of pressures to some extent.”
Among other measures, Toshiba has appointed one of its outside directors (Hiroyuki Itami) to chair its audit committee. It also intends to reform its accounting policies and improve its method of checks and balances, enhance its financial controls through supervision by the board of directors, and increase the number of external directors so they form a majority on the board.
“These reforms are in the right direction in terms of strengthening outside directors – although the details of exact measures to be taken are not yet known,” said Waseda University’s Wakatabe. “Nevertheless, a formal investigation by the authorities is necessary to hasten the whole restructuring process.”
One thing is certain. “Toshiba has got the message that the ramifications of trying to whitewash bad news can be pretty costly in terms of the number of people whose careers have ended abruptly, the financial loses to the company, and amount of time devoted to [the scandal]” said Smitka. Consequently, he is hopeful that the fallout will “generally result in a tightening-up of accounting standards and practices and getting companies to check that they haven’t being doing things they shouldn’t”.
Meanwhile, the first order of business for Toshiba will be to quickly announce its new management team and then to submit the company’s delayed annual report for the fiscal year 2014 by the end of August – having been granted a two-month extension on account of the scandal. The company will also have to deal with a class action lawsuit filed against it by a shareholder in the US over the accounting manipulations.