As the financial crisis faded further into the rearview mirror, companies were getting back to business as usual and feeling some of the scrutiny on corporate governance practices recede slightly as well. That is, until the Olympus loss-hiding scandal emerged.
The 92-year-old medical photo-imaging equipment giant had allegedly been hiding losses—to the tune of $1.7 billion—since the 1990s, long before current economic pressures, slow job growth, and poor investor confidence. Now the fraud has some putting renewed focus on corporate governance practices, especially in Japan, including the lack of board independence and a corporate culture that makes it difficult for whistleblowers to come forward.
The fraud was uncovered October 2011 by then-newly appointed CEO Michael Woodford, who discovered the billion-dollar bookkeeping discrepancies only weeks into his new job. He was fired soon after and, in the days since, launched and then abandoned a campaign for reinstatement.
In the most recent development, Olympus' auditors KPMG and Ernst & Young have been cleared of any responsibility in what the Japanese call “tobashi,” a term for a financial fraud where losses are concealed by moving them off of the books.
The Tokyo Stock Exchange imposed a ¥10 million (U.S. $130,000) fine on the company for damaging investor confidence, but ultimately ruled that Olympus would be allowed to keep its shares listed. The TSE ruling claimed that the loss hiding hadn't distorted investor judgment badly enough to warrant removal from the market.
“The improper accounting practices had generally no effect on sales or operating profit,” the TSE said in a statement, adding that the incident was not directly related to Olympus' core business, nor was it significant enough to alter its earnings trend. The TSE has, however, placed Olympus on “alert” for three years, during which time it will have to prove improved corporate governance or face delisting.
According to Neil Barnwell of the University of Technology in Sydney, Australia, the colossal failure of Olympus corporate governance stems in part from the fact that, “the same process of disclosure is not as developed [in Japan] as it is in Western countries.”
Barnwell also attributes the Olympus fraud to some deep-rooted characteristics of corporate culture in Japan. “It is possible to view the Olympus scandal as an individual company acting in a deliberately misleading way, but not only the regulatory systems, but also cultural values, make this a systemic issue.” He says that values such as respect for seniority and power and unwillingness to ask awkward questions make it harder for whistleblowers to come forward in Japan.
The problem of a “yes men” culture that the independent inquiry into Olympus' management identified in its report isn't going to be easily fixed. According to GMI, a global corporate governance analyst group, “almost half (176 out of 404) of the Japanese companies GMI covers do not have a single independent director on their boards. Furthermore, fewer than one in 20 of the Japanese companies GMI covers have boards that are majority independent. In contrast, seven out of 10 of the 1,002 companies GMI covers from industrialized Europe have majority independent boards."
“The same process of disclosure is not as developed [in Japan] as it is in Western countries.”
—Neil Barnwell,
Casual Academic,University of Technology, Sydney
In a statement, new company President Shuichi Takayama said the company is considering pressing criminal charges against those involved in the wrongdoing, which may be as many as 70 individuals, including former President Tsuyoshi Kikukawa, Aauditor Hideo Yamada, and Executive Vice President Hisashi Mori, among others.
Governance Reform?
It remains to be seen if the legal action will result in criminal sentences, as it did in the United States for those accounting frauds committed by companies like Enron and WorldCom. It's also too soon to tell if the fraud could provoke a series of regulatory reforms by the Japanese government, as Enron and other frauds led to the Sarbanes-Oxley Act and the financial crisis led to the Dodd-Frank Act.
All of which begs the question: What are the standards by which a company should conduct itself through a misconduct scandal such as this? The new management team, when it is appointed, will need to focus squarely on revamping dividend policy, strategic direction, risk, and executive compensation, corporate social responsibility, and ethical culture.
Olympus 101
The following excerpt is from Michael Pesek's blog on the Olympus case:
Master of Business Administration programs the world over should add a new course: Olympus 101. For budding business magnates, it would be a timely exercise into how not to handle a crisis, run a major company or manage the third-biggest economy.
It says a lot when world-weary investors hardened by the shenanigans at Enron Corp., WorldCom Inc., Parmalat SpA and Wall Street are aghast at a corporate scandal. The Einsteins at Olympus Corp., the camera and medical-supplies maker, pulled off that feat and more in a week that can't end soon enough for Japanese politicians and executives.
This still-unfolding story has it all: a proud company founded in 1919; the firing of a foreign president brought in to shake things up in ways a local wouldn't; a very un-Japanese bout of public infighting; a whiff of possible yakuza involvement; bundles of squandered cash; clueless executives; a media frenzy; and regulators hoping the whole thing goes away.
The real intrigue has yet to come. What, if anything, will Japan do? In an ideal world, the answer is simple: The Olympus board would be fired and regulators would investigate this shameful affair with vigor, openness and sincerity to restore global confidence in Japan Inc.
The chronology began with Michael Woodford, Olympus's first non-Japanese president, being dismissed after seven months on the job for the bogus charge of cultural insensitivity. Next, Olympus denied Woodford's claim that he was axed for investigating why a fortune was spent on outside advisers without explanation. Then, Olympus suddenly recalled that, oh yeah, that's right, it paid a whopping $687 million to advisers on its $2 billion purchase of Gyrus Group Plc. Now the company says it's no big deal ...
Culture of Denial
Japan's corporate culture of denial, of ignoring problems and letting them fester, keeps running up against a globalized world that values agility, innovation and transparency. Olympus demonstrates all too painfully how much Old Japan tolerates a lack of accountability among senior executives; inadequate disclosure; a disinclination to challenge authority and absolute deference to corporate boards regardless of share performance.
The inadequacies of Japan's corporate-governance system deserve scrutiny. Boards in Japan get less heat, partly because executives aren't paid as obscenely as American ones. Shareholders assume directors are smart, devoted people working for the good of Japan Inc. Tough questions are rarely asked.
Yet what can we make of Olympus's board dismissing a PricewaterhouseCoopers report on how vast sums of cash were blown during acquisitions? The board seemed more upset about Woodford studying the books than PwC's findings. A few independent, outside directors might have led to a better result for Olympus and Woodford.
There's a punch line somewhere in here, but it's hardly a joking matter: The company may sue Woodford for leaking internal information to the press. If there's any justice, securities regulators will ask Chairman Kikukawa and the rest of his board some very uncomfortable questions. The answers might reveal whether brains even come into play at Olympus.
Source: William Pesek Blog.
Corporate governance experts Ira Milstein and Holly Gregory of law firm Weil, Gotshal & Manges say rebuilding the trust of investors and the public is a labyrinthine but possible task after a fraud like that of Olympus is uncovered. “When coupled with a clearly articulated strategy, the board's commitment to the long term should help a company withstand undue short-term pressures,” Millstein wrote on the Harvard Law School online forum on corporate governance and financial regulation. “This requires effective disclosure of board decisions and policies and concerted efforts at shareholder relations and communication.”
But perhaps Bloomberg View Columnist William Pesek sums it up best: “Japan's corporate culture of denial, of ignoring problems and letting them fester, keeps running up against a globalized world that values agility, innovation, and transparency.”
“Olympus demonstrates all too painfully how much Old Japan tolerates a lack of accountability among senior executives, inadequate disclosure, a disinclination to challenge authority, and absolute deference to corporate boards regardless of share performance.”
He also pointed out that Japanese executives are not nearly as well paid as their U.S. counterparts. “Shareholders
assume directors are smart, devoted people working for the good of Japan Inc. Tough questions are rarely asked."
Some say other norms of Japanese corporate culture make it harder for companies to move past a crisis like the one at Olympus. At the time of the Toyota safety defect and recall disaster in late 2009, Jeff Kingston of Temple University in Japan said he had rarely seen a Japanese corporation perform well in a crisis for the following reasons: Information takes too long to flow through the company since employees don't want to tell their boss what he doesn't want to hear, and Japanese companies have a tendency to try and squash bad stories before they are made public.
He added, though, that it should be remembered that communication problems are a worldwide issue in large corporations, not just endemic in traditional Japanese corporations. And it also must be noted that there has been limited improvement in Japanese corporate governance. Without the recently enacted whistleblower protection law, for instance, Michael Woodford might not have spoken up at all.
There's no doubt the scandal has put a spotlight on some bad elements of Japanese corporate governance, but there are those who are hoping that, in the long run, long overdue reform will finally come from a bad situation.
No comments yet