In Toshiba's scandal, blame samurai code

The Toshiba Corporation has struggled since at least 2008 to meet its financial targets. In 2015, the company made a shocking admission: Because of its struggles, Toshiba had committed a multi-year $1.22 billion accounting fraud that culminated in the resignation of CEO Hisao Tanaka in July of that year. What made this most surprising was that Toshiba had been perceived as “a totem of strong and virtuous Japanese corporate governance.” (See Toshiba: behind the numbers, Financier Worldwide, October 2015.)

Although Toshiba’s management and board of directors have made significant efforts to improve internal controls and corporate governance programs since its 2015 admission of fraud, new issues raised in late 2016 and early 2017 show that the organization still struggles with ethical problems and potential side effects of the 2015 scandal.

How can Toshiba, an iconic brand known around world, continue to have such serious false accounting issues? How can fraud, deceit, lying and cover-ups be the modus operandi of a respected international corporation that employs close to 200,000 employees worldwide?

In this analysis, I’ll examine the root causes of Toshiba’s corporate governance shortcomings that led to the documented accounting fraud and that threaten the survival of the organization today.

2015 accounting scandal

An independent investigation into Toshiba’s finances, which sparked the initial crisis, discovered the firm’s top executives set unrealistic profit targets, which systematically led to the falsification of figures on the company’s financial statements, according to the Financier Worldwide article.

Going back to 2005, divisional CEOs at Toshiba appear to have unreasonably pressured divisional managers, which set the managers up for unattainable financial targets. Because of this pressure, many divisions decided to adopt questionable accounting tactics and skillfully hide irregularities from the company’s auditors. However, a whistleblower complaint in early 2015 brought the issue to light, which ended a seven-year deception by the company’s senior management — described by the investigative panel as both “systematic” and “deliberate,” according to the Financier Worldwide article.

Toshiba’s staff committed multiple accounting crimes, from overstating profits to booking them too early — and everything in between, according to an investigative report cited in the Financier Worldwide article. The criminal behavior appears to have been significant, pervasive and longstanding. Much of the false accounting probably began under Atsutoshi Nishida during his reign as CEO between 2005 and 2009, according to the investigators.

The investigative panel noted that in 2008, when Nishida heard that the company was heading for a loss of around 18.4 billion yen, he declared the scale of the loss was “so embarrassing that we cannot announce it.” Accordingly, Toshiba’s staff falsified accounting records and deleted the loss from the books. The company instead reported a profit of around 500 million yen. The investigative panel wrote: “There existed a corporate culture at Toshiba where it was impossible to go against the boss’ will.”

Additionally, the panel’s report drew attention to “a systematic involvement including by top management” and “a deliberate attempt to inflate the appearance of net profit,” according to the Financier Worldwide article.

2017 crisis

Did the internal clean-up go too far? Fast forward to February 14, and Toshiba isn’t mailing Valentine’s Day cards. Instead, it has delayed announcing quarterly results, initially saying it is “not ready,” then announcing later that it needs more time to investigate a subsidiary — its Westinghouse nuclear business — after internal reports uncovered potential accounting issues, according to the Reuters article, Delays, confusion as Toshiba reports $6 billion nuclear hit and slides to loss, by Makiko Yamazaki, February 14.

These Toshiba internal reports suggested Westinghouse’s controls had been “insufficient,” and the company needed to consider if Westinghouse senior managers exerted “inappropriate pressure” during discussions over a U.S. deal to buy the company at the heart of its cost overruns, according to the Reuters article.

“We judged that it would take about a month for external lawyers ... to conduct these further probes and for the independent auditors to review the results,” Toshiba said. In total, the company announced losses of $6.5 billion in the wake of this new scandal — a write-down that wipes out its shareholder equity and will drag the group to a full-year loss.

“Finally now people are starting to recognize that internal control problems, the accounting issues and governance issues are very real and no longer abstract. They impact the viability of the company,” said Zuhair Khan, an analyst at Jefferies in Tokyo, in the Reuters article.

Fraud’s impact on long-term survival

According to a February 22 Wall Street Journal editorial, Lessons of the Toshiba Meltdown, the author believed that these losses could be attributed to Toshiba’s purge of senior-level executives after the 2015 accounting scandal came to light. Although Toshiba was lauded for taking steps to improve its corporate governance structure, a possible unwanted side effect of the purge was that less-experienced, newly promoted middle managers made several poor decisions, which led to many of Toshiba’s current troubles.

Unfortunately, the Wall Street Journal editorial argues, it seems that many of the executives — who were embedded in the organization’s DNA as it committed years of phony accounting — were also critical experts on how it handled strategically important decisions. Losing these key executives seems to have weakened the management team to a degree that current management, along with investors and other stakeholders, are now talking about survival instead of corporate governance. Indeed, what good is excellent corporate governance if an organization has a negative equity position?

Withholding bad news, fear of speaking up, the inability to address pressures in a timely manner — these are the dominant themes arising out of media reports on Toshiba’s latest woes. With these new allegations, any confidence that was restored in senior management has been lost. Investors are leaving in droves, its stock price has plummeted and Toshiba is close to being delisted from the Tokyo exchange, according to the Wall Street Journal editorial.

Understanding Bushido’s impact

One of the main challenges when applying Western standards to Japanese corporations is the vast difference in the role of national cultures in the business environments. For example, in Western cultures we have the common expression “honesty is the best policy.” In other words, “it pays to be honest.” By contrast, Inazo Nitobe, the Japanese agricultural economist, author, educator, diplomat and politician, wrote in his book, “Bushido: The Soul of Japan” (2007, IBC Publishing), “If it is followed because it brings in more cash than falsehood, I am afraid Bushido would rather indulge in lies!” Bushido, the “Way of the Warrior,” is the code of conduct of the samurai. (See the Encyclopaedia Britannica entry.)

Although many of Toshiba's current problems lie outside of specific fraud-related issues, their root causes can be traced directly to a typical Japanese corporate culture.

Engleberg writes that makoto means to “‘properly discharge all of one’s obligations so that everything will flow smoothly and harmony will be maintained’ and above everything else, even truthfulness and honesty.” (Engleberg is quoting from the academic paper, The Olympus Scandal and Corporate Governance Reform: Can Japan Find a Middle Ground between the Board Monitoring Model and Management Model? by Bruce E. Aronson.)

In other words, social harmony is best achieved through conformity and obedience to authority. Furthermore, makoto can create a leadership command chain that resembles a military hierarchy, in which top executives give the orders and all lower-level employees are expected to obediently follow them without question, according to Aronson as quoted in Engleberg’s paper.

Understanding these values reveals how corporate accounting frauds can go unchecked over the course of several months, years or even decades. Even today, subordinate employees are expected to demonstrate a deep level of commitment and loyalty to their corporate managers.

Under the principles of makoto, organizations look down upon employees who speak or act outside their positions’ scope, according to Aronson. He writes that this culture prevents individuals from questioning and/or challenging the decisions of their superiors, and discourages them from disclosing any issues that might arise.

Superiors will often reward their most loyal employees with respect, appreciation and even promotions, according to Engleberg. So, corporate managers can consolidate their power by surrounding themselves with those who are committed to following their orders, writes Engleberg.

Engleberg writes the Japanese belief in cultural harmony can facilitate corporate misconduct. Cultural harmony can be best described by going with the flow, rather than showing resistance to the group — as the Japanese proverb says, “the nail that sticks out gets hammered down.” (See Scandals Soil Japan’s Corporate Giants, by Julian Ryall, South China Morning Post, Nov. 22, 2015, as quoted in Engleberg’s paper.)

Therefore, “groupthink” is one of the prime directives of Japanese business culture, Engleberg writes. (He refers to the academic paper, Olympus Corporation Financial Statement Fraud Case Study: The Role That National Culture Plays on Detecting And Deterring Fraud, by Anita R. Morgan and Cori Burnside, The Journal of Business Case Studies, The Clute Institute, Second Quarter, 2014, volume 10, No. 2.)

Employees will use groupthink to rationalize the validity of questionable or unethical acts by concluding that other employees exhibit the same behavior, write Morgan and Burnside. Under such cultural circumstances, corporate fraud is easily committed and often goes unnoticed for long periods of time.

Furthermore, Morgan and Burnside write, the Japanese cultural values of duty, authority, honor and harmony are so highly valued that individuals are taught to avoid disrupting social tranquility. Thus, it’s preferable for an employee to turn a blind eye to corporate governance to avoid upsetting or destabilizing the social order of things.

These cultural beliefs and concepts provide insight as to how the Olympus accounting fraud, Japan’s largest known accounting scandal, persisted for almost two decades, and why it was the company’s non-Japanese CEO — Michael Woodford, who’s from England — who ultimately blew the whistle and exposed the fraud. (See The Real Cost of ‘Choosing Truth Over Self’: 2012 Cliff Robertson Sentinel Award Recipient Michael Woodford, Fraud Magazine, March/April 2012, by Dick Carozza, CFE.)

Don’t be fooled by a toothless tiger!

Toshiba has been hit on multiple fronts (financial, managerial and reputational, just to name a few), which has led to a cumulative negative impact on the value of the organization. Although many of Toshiba’s current problems lie outside of specific fraud-related issues, their root causes can be traced directly to a typical Japanese corporate culture. Toshiba placed makoto above other values, which seems to have directly affected its corporate governance programs and overall performance. For CFEs, the lesson is that we must adapt our evaluation of corporate governance programs to consider the underlying cultural differences that might turn a great program — on paper — into a toothless tiger in reality.

Steve C. Morang, CFE, CIA, CRMA, is a senior manager at a CPA firm and president of the ACFE’s San Francisco Chapter. His email address is: steve.morang@yahoo.com.