Corporate Governance: Can Japanese Business Adapt to a New Era?

Toshiba Accounting Scandal Highlights Issues in Corporate Governance


Though Toshiba had actively adopted corporate governance practices, an independent investigation found that the company’s top executives were complicit in fraudulent accounting. As Japan continues to bolster its governance rules, the incident serves as a lesson for other firms.

Shady Accounting by a Leading Corporation

Following the discovery that electronics conglomerate Toshiba carried out inappropriate accounting, the company announced a reduction of ¥224.8 billion in its pretax income for the period from April 2008 through December 2014. Toshiba was seen as a leader in introducing formal corporate governance, and the incident raises questions as to how such a scandal could occur at one of Japan’s leading corporations.

To probe into the issue of fraudulent accounting, Toshiba established a third-party committee of lawyers and certified public accountants chaired by Ueda Kōichi, former head of the Tokyo High Public Prosecutors Office. The committee’s July 20 investigation report verified that inappropriate accounting was carried out simultaneously at numerous business units (called “companies”) in an institutional manner with the involvement of corporate-level management.

The report, however, only goes as far as to say that top management was involved and does not state whether or not the company’s chief executives ordered fraudulent accounting to be carried out. At a July 21 press conference, during which he announced his resignation, Toshiba’s President Tanaka Hisao denied instructing employees to inflate profits, defer losses, or otherwise falsify accounts.

Corporate Governance in Name Alone

There is no indication so far that Toshiba’s top executives, senior officers, or employees pocketed funds or received kickbacks from client companies. So it seems unlikely that those involved in the scandal were motivated by personal greed. All we can suppose is that executives were driven by a desire to make the company look good to outsiders, while those lower down were looking to safeguard their own positions within the company.

At the July 21 press conference, Tanaka admitted that Toshiba had suffered “what could be the biggest erosion of our brand image in our 140-year history.” The motivation for the improprieties and the chain of command involved in their implementation remain unclear, but a major contributing factor cited in the investigation committee’s report was a “corporate culture where employees cannot act contrary to the intent of superiors.” At Toshiba, executives put top priority on the financial results for the current accounting period, placing severe pressure on subordinates to improve the figures for their business units. Faced with no alternative but to bend to executive demands, those lower down in the company turned to cooking the books.

Unlike scandals perpetrated by a single actor or specific group, which might be treated as isolated incidents, dubious accounting carried out on a broad and systematic scale by employees responding to the wishes of top management points to a deeply rooted problem. Corporate culture was implicit in the scandal at Toshiba, which thus has implications for other Japanese firms sharing a similar organizational character.

So what is at the heart of the issue? Toshiba had been actively moving to improve its corporate governance system, but the measures it adopted lacked teeth and were more for show than effect. Governance in any shape or form is ultimately ineffective if top management is not committed to implementing it. And if directors and employees are subservient to those above them, nothing can check corporate malfeasance.

At a September 7 press conference, Chairman Muromachi Masashi, who stepped in as president following Tanaka’s resignation, admitted that formal rules are meaningless if they are not brought to life, and he expressed his determination to avoid such an outcome in implementing measures to prevent recurrence of the improper accounting.

Bending Accounting Rules to Fit Executive Will

The investigation committee’s report provides a clear overview of how the fraudulent accounting was conducted. What is most apparent is the existence of a set of de facto rules placing the will of corporate management ahead of regular accounting standards. Under the normal standards, for example, if a long-term power generation project comes to face future red ink due to increased costs and other factors, it is established practice under the accrual-based accounting method to record a charge for the estimated shortfall in the results for the current fiscal period. The affected business unit is supposed to book the estimated red ink as a reserve against future losses. But one of the de facto rules at Toshiba requires advance approval for such write-offs from corporate management as well as from the head of the business unit. And since booking the losses means a reduction in net income for the current fiscal year, in cases like this executives would issue “challenges” to business units—applying heavy pressure on them to come up with additional profits to make up for the amounts written off. Faced with the difficult task of meeting such challenges, employees bent rules by postponing losses to subsequent accounting periods.

CEO Calls for Desperate Efforts

Toshiba’s television manufacturing unit put off booking losses by using “carryovers,” requesting vendors, for example, to postpone issuing invoices for advertisement, distribution, or other services until the next quarter, while moving up projected discounts on parts to the current accounting period. In addition, it inflated profits by boosting prices of products sold to overseas affiliates.

In its personal computer business, the company inflated revenues through transactions with manufacturers producing Toshiba-brand computers under contract. Toshiba sells the manufacturers key parts for the computers and then buys the finished products from them. To avoid revealing the actual prices of its parts to competitors, the company sells them at an inflated “masking price” to the manufacturers and it buys the finished computers from them at a price that adds production and other costs to this inflated amount.

Since the high masking price for the parts is offset by a correspondingly inflated price for the finished product, the gains on these sales of parts cannot properly be booked as profits. But that is what Toshiba did. Over the years the company raised its masking prices until they were almost five times the actual cost of the parts. And by forcing manufacturers to buy more parts than they needed, Toshiba was able to make its profits for the current accounting period look bigger.

In January 2009, President Nishida Atsutoshi ordered the PC unit to “work desperately” to improve its results, threatening to pull Toshiba out of the business entirely if it failed to do so. This led to the unit’s padding of its revenues through forced sales of parts to manufacturers.

Fraudulent Accounting Repeated to Keep the Books Balanced

Nishida’s successor, Sasaki Norio, is quoted in the investigation report as saying that he wished to cut back on the padding of revenue figures. But in September 2012 he pushed the business unit handling PC and visual display operations to meet a ¥12 billion revenue enhancement goal in the last three days of the fiscal period. Presenting such a stiff challenge was tantamount to forcing employees to cook the books.

Subsequently, in a September 2013 meeting with Toshiba’s chief financial officer Tanaka presented the idea of using PC parts transactions as a means of improving the unit’s performance—billing this as a “top-secret discussion.”

The company also padded accounts by adjusting the inventory records of its semiconductor business. However, stopgap measures implemented for the sake of temporarily boosting profits had to be accounted for in subsequent accounting periods. And as a result, Toshiba found itself in the position of needing to continue padding its books.

Focusing on the Role of Top Executives

Toshiba was quick to adopt the “company with committees” structure introduced when revisions to Japan’s commercial code took effect in April 2003. Under the system firms establish nominating, audit, and compensation committees with majorities made up of outside directors. Toshiba made this move at a time when many Japanese top executives were critical of the US-style governance system, with its heavy use of outside directors, in the wake of a string of massive accounting scandals at companies like Enron.

In an interview that appeared in the business daily Nikkei on April 6, 2013, Toshiba President Okamura Tadashi declared that no matter what sort of system a company may create, it will not work if a sense of ethics is lacking. Ironically, it was such a lack that led to Toshiba’s current woes. Okamura also observed that authority at Japanese companies is over-centralized, saying that the excessive authority wielded by company presidents has resulted in poor transparency and widespread structural ossification among major corporations.

Toadying to bosses is certainly not limited to the Japanese business world. But  at Japan’s traditional major corporations, where the norm is lifetime employment—with employees recruited straight out of school and serving until they reach retirement age—there is undeniably a strong structural tendency toward top-down thinking. After enduring a long race for promotion, an employee reaching the position of company president, the pinnacle of the corporate pyramid, has in reality won the right to wield full managerial authority, including the right to choose other executive officers.

In June of this year the Tokyo Stock Exchange put into force a new corporate governance code requiring listed companies to have at least two independent outside directors. The provisions of Japan’s corporate code have also been revised, with formal rules successively added to bolster corporate oversight and control.

However, Deputy Secretary General Tamaki Rintarō of the Organization for Economic Cooperation and Development points out that even the best corporate governance code cannot prevent abuses carried out deliberately by a company’s chief executive officer. Toshiba plans to introduce measures to prevent recurrence of the improprieties, including an increase in the number of outside directors, but the real focus of attention is on the stance taken by the company’s CEO.

Former Asahi Group Holdings President Ikeda Kōichi, who recently joined Toshiba’s board as an outside director, declares that it is up to the company’s management team to implement measures for a corporate revival. The role of outside directors is to monitor these efforts, he says, adding that the company’s officers and employees must take a personal stake in the success of the drive. Though it is no easy matter to achieve this sort of commitment at every level of the company, Toshiba’s accounting scandal illustrates the impossibility of establishing proper corporate governance without it.

(Originally written in Japanese and published on September 24, 2015. Banner photo: Muromachi Masashi, president and chairman of Toshiba, right, and Watanabe Yukikazu, general manager of Finance and Accounting Division, bow at the end of a press conference on September 7, 2015 in Tokyo explaining the company's inappropriate accounting. ©Jiji)

electronics Toshiba corporate governance accounting scandal