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Toshiba Scandal Presents First Big Test Of Abenomics New Governance Reform

This article is more than 8 years old.

The Toshiba accounting scandal will indeed go down as one of the most significant events in the history of Japanese corporate governance. Established back in 1875 and  recently ranked No. 2 in terms of revenues among the electronic companies in Japan, Toshiba had seemed to be the very embodiment of the best this country's corporations had to offer. That is, until the scale and scope of the recent scandal was finally revealed.

Toshiba had been inflating its profits by at least $1.2 billion from 2008 to the present across all divisions of the conglomerate. A number of top managers were found to be involved in the accounting manipulation. On Jul. 21, President Hisao Tanaka along with two of his predecessors, Atsutoshi Nishida and Norio Sasaki, stepped down from their current positions.

The resignations followed the release of a report by an independent investigative committee set up by Toshiba. Their findings deemed Toshiba’s accounting malpractice as merely “inappropriate,” while it seems the more appropriate word to describe the deception would have been “fraudulent.” In a subsequent interview, Hideaki Kurbori, a well-known corporate lawyer in Japan, said that he would give the report a grade of F. He argues that the committee should have asked for more than two months to investigate such a convoluted case, and they also should have clarified whether the “inappropriate” accounting was intentional or not.

Some would argue that this is a major blow to Abenomics, which purports to set 2015 as the first year of corporate governance reform in Japan, but this need not be the case. The government and other authorities should set an example and take the appropriate course of action by conducting a thorough investigation into whether Toshiba's "inappropriate" accounting violated the law.

For example, Toshiba’s manipulation of inflating corporate profits might have pushed up its stock price, which could be interpreted as a violation of the Financial Instruments and Exchange Act. In any case, the authorities should examine the Toshiba case with the utmost attention. It is their duty to enforce the laws and safeguard the integrity of the market.

When the government implemented the “corporate governance code” in June this year, one of it major initiatives was for each company to appoint at least two outside directors. But for those skeptical of the new measure, Toshiba's misdeeds will undoubtedly serve as evidence to support their view, after all Toshiba already had several outside directors on its board. Isao Iijima, the former secretary of the then-Prime Minister Junichiro Koizumi and, interestingly enough, one of the special advisers to current Prime Minster Abe, argues that outside directors do not help to improve corporate performance (here, in Japanese).

Iijima’s reflection is largely anecdotal, though. Although more academic research is needed on this topic, there are several interesting articles available (herehere and here in English) from Takuji Saito, an associate professor of management at Keio Business School. According to his research, two things stand out.

First, examining 500 large publicly held corporations from 1997 to 2008, it was shown that "board of directors is structured in ways consistent with the managers’ preferences, which are not aligned with shareholders' interest, when managers can control director selection."

Second, comparing those companies with outside directors to those without, he concludes that “the introduction of outside directors significantly improves operating performance and firm value. In addition, when the firm has at least one outside director on the board, president turnover is more sensitive to firm performance and management earnings forecasts are more realistic and accurate.” And this finding is consistent with other studies on other countries. The upshot is that the introduction of outside directors can improve corporate performance.

The Toshiba scandal certainly reveals the weakness of Japanese corporate governance. The authorities now need to step up and show their commitment to the recent reforms in terms of how they handle the electronics and engineering giant.