Impact of Toshiba’s Fraudulent Accounting

In a report published on July 20, an independent committee of experts examining Toshiba’s fraudulent accounting determined that inappropriate accounting had been carried out based on management decisions. This revelation led to the resignations of the current and preceding two chief executives, creating the biggest crisis faced by Toshiba since its founding. The overstatement of earnings by one of Japan’s leading corporations is having an enormous impact both domestically and abroad.

Current and Former Chief Executives Step Down

With the publication of the report by the committee, which was chaired by Ueda Kōichi, former superintending prosecutor of the Tokyo High Public Prosecutors Office, Toshiba’s current and preceding two chief executives resigned on July 21. The three--President Tanaka Hisao, Vice-Chairman Sasaki Norio, and Senior Advisor Nishida Atsutoshi--have led Toshiba over the last 10 years. Moreover, along with Tanaka and Sasaki, six other directors thought to have taken part in improper accounting stepped down from Toshiba’s board of 16 directors.

Chairman Muromachi Masashi will provisionally serve as president and work to overhaul Toshiba’s management structure. A new management team will be announced by mid-August and referred to an extraordinary general meeting of shareholders in September. Much uncertainty remains, however. Vice-Chairman Sasaki also resigned from such positions as vice-chairman of Keidanren (Japan Business Federation) and private-sector member of the government’s Industrial Competitiveness Council on July 21.

At a press conference, President Tanaka apologized for the scandal and fielded questions. He stated that he solemnly accepted the investigative report and offered his apology to Toshiba’s shareholders and other stakeholders. He also remarked that he would promote the reform of Toshiba’s business structure by accelerating the consolidation and selection of business undertakings and would ensure the adequacy of funding plans by selling marketable securities and real estate holdings.

Earnings Inflated by ¥156.2 billion

Toshiba is Japan’s second largest electrical machinery conglomerate with consolidated sales of ¥6.5 trillion. What has happened at this illustrious company whose senior executives have served as Keidanren chairmen?

Toshiba’s inappropriate accounting was discovered early in 2015. The Securities and Exchange Surveillance Commission began to investigate the accounting of Toshiba’s infrastructure-related business, and the company admitted in early April that it had found inappropriate accounting. As the discovery of improper bookkeeping spread to the television, semiconductor, and personal computer divisions, Toshiba’s shares plunged in value. In mid-May President Tanaka apologized at a media event and announced the establishment of the independent committee of experts.

The report published by the investigative committee indicated that Toshiba’s inappropriate accounting lasted for nearly seven years from fiscal 2008 to the third quarter of fiscal 2014 and that earnings had been inflated by ¥156.2 billion. The report revealed the demands and systemic involvement of senior management during this period, which included nearly all major divisions from infrastructure to televisions and personal computers. It also noted that elaborate measures had been taken, including concealing the situation from the auditing company.

Preoccupation with Profit

The inappropriate accounting centered on the period when Sasaki was president. Sasaki was pressed to restore earnings that had fallen off in the economic downturn following the collapse of Lehman Brothers in 2008. Divisions that were unable to meet profit targets were strongly urged to achieve absolute goals as a “challenge.” When achievement of these goals proved difficult, they turned to inappropriate accounting, such as the advance recording of future profits and deferral of losses to future years.

Toshiba also put off the recording of costs for its Westinghouse nuclear business. When Tanaka replaced Sasaki as president in June 2013, he recognized the problem of overstated profit. While there were business units that had resolved the problem by March 2015, inappropriate accounting continued in many divisions. Once improper accounting had been adopted, the process was repeated in subsequent fiscal years so as to maintain consistency.

Absence of Effective Corporate Governance

What explains this continued malfeasance? The report cited an obsessive preoccupation with profit within Toshiba and pressure from superiors to achieve goals in the context of a corporate culture where going against the wishes of superiors was all but impossible.

Another reason cited was the lack of outside directors well versed in finance and management on the corporate audit committee who would have been able to put a stop to the situation. While there were outside directors monitoring management on the audit committee who were aware of such improprieties as the advance recording of future profits, no evidence was found that this had become an issue for the committee. In other words, corporate governance through outside directors had been reduced to an ineffective formality.

The Tokyo Stock Exchange established a corporate governance code in 2015 that specifies how listed companies should be governed, including the responsibilities of the board of directors. The code aims to increase management transparency, thereby contributing to higher corporate value and to the greater confidence of domestic and foreign investors. The discovery of Toshiba’s accounting scandal at a moment being heralded as the “first year of corporate governance” shows that it is not easy for outside directors whose role is to monitor management from an independent perspective to function as they should.

Toshiba May Face Class Action Suits

The cost to Toshiba of its accounting scandal is immeasurable. With the publication of the investigative report, the Securities and Exchange Surveillance Commission will begin a full-fledged review, and Toshiba may be fined as an administrative disposition. The TSE is also considering designating Toshiba stock as a “security on alert.”

Repercussions of the accounting scandal have engulfed not only shareholders and the stock market but society and the international community as well. The scandal risks damaging confidence in Japanese companies and markets. The decline of market confidence in the United States caused Toshiba stock to plummet in value there. Individual investors, claiming they had suffered losses, had already taken Toshiba to court by July 21. These investors claim that Toshiba violated the Federal Securities Act and are demanding compensation for losses incurred from the decline of Toshiba shares. In coming months, class action suits may be brought against Toshiba by foreign and domestic investors.

A Lesson for All Japanese Companies

There is talk that a criminal penalty will be imposed on Tanaka and the preceding two chief executives. In the past the president of Livedoor was found guilty of accounting fraud and fined ¥5.3 billion. Toshiba’s accounting irregularities are 30 times larger than Livedoor’s. Although Toshiba’s overstatement of earnings is enormous compared to Livedoor, however, the degree of its malicious intent is seen as small. Therefore, some expert observers maintain that criminal liability is unlikely to be sought against Toshiba.

The cost and time needed to restore lost market and consumer confidence and to rehabilitate the company will be enormous for Toshiba. The company must address many issues, such as the implementation of measures to prevent the recurrence of scandals, the rebuilding of operations to overcome the blow to earnings, and the sale of assets to strengthen its financial position. Toshiba’s wrongdoing and its aftermath should be seen as a valuable lesson by all Japanese companies with a global presence.

(Originally written in Japanese by the Nippon.com editorial department and published on July 22, 2015. Banner photo: (From left) Chairman Muromachi Masashi, President Tanaka Hisao, and others apologize for the accounting scandal at Toshiba’s head office in Minato-ku, Tokyo, on July 21, 2015. © Jiji.)