The toshiba accounting scandal how corporate governance failed pdf

Prof. Mitsuru Misawa prepared this case for class discussion. Dr. Misawa is a professor of finance and director of the Center for Japanese Global Investment and Finance at the University of Hawaii at Manoa. This case is not intended to show effective or ineffective handling of decision or business processes. © 2016 by The Asia Case Research Centre, The University of Hong Kong. No part of this publication may be reproduced or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise (including the internet)— without the permission of The University of Hong Kong. Ref. 16/579C

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MITSURU MISAWA

THE TOSHIBA ACCOUNTING SCANDAL: HOW CORPORATE GOVERNANCE FAILED

Toshiba Corporation expresses sincere apologies to our shareholders, customers, business partners and all other stakeholders for any concern or inconvenience caused by issues relating to the appropriateness of its accounting treatments. With the new management team and governance structure, Toshiba as a whole will unite to make every effort to regain the trust of shareholders, investors, all other stakeholders and members of the public, and asks for your understanding and ongoing support.

- Toshiba Corporation1

Toshiba CEO Resigns Amid Major Accounting Scandal

Toshiba Corporation (Toshiba) hit the headlines in 2015 for all the wrong reasons. Following an internal audit, it emerged that the accounts of the Japanese conglomerate, which manufactured everything from consumer electronics to nuclear energy technology, contained major irregularities, and that profits had been significantly inflated [see Exhibit 1 Toshiba’s Corporate Profile]. The scandal, which first came to light when Toshiba itself investigated the accounting practices of the group’s energy division in April 2015,2 led to the resignation of then-chief executive and president, Hisao Tanaka, in September of that year, along with eight additional board members, including Vice Chairman Norio Sasaki.3 Stepping into the breach, Toshiba's new president and CEO, Masashi Muromachi,4 immediately instructed a third-party committee to conduct a detailed audit of the group’s accounting practices. The findings of this review revealed that Toshiba had overstated profits by 151.8 billion yen (US$1.2 billion) over a seven-year period.5 When, in September 2015, the full and accurate financial results were

1 Toshiba IR News (n.d.) Home Page, http://www.toshiba.co.jp/about/ir/index.htm, (accessed August 1, 2016). 2 Ibid. 3 Nikkei (June 21, 2015) "Toshiba's Accounting Scandal,"

http://www.nikkei.com/article/DGXZZO89536830R20C15A7000000/, (accessed August 1,2016). 4 Toshiba IR News (September 7, 2015) “Notice of New Representative Executive Officers,”

http://www.toshiba.co.jp/about/ir/en/news/20150907_3.pdf, (accessed August 1, 2016). 5 Toshiba IR News (May 8, 2015) “Notice Regarding Establishment of Independent Investigation Committee,”

http://www.toshiba.co.jp/worldwide/index.html (accessed August 1, 2016).

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finally released for the fiscal year ending March 31, 2015,6 it emerged that the firm had suffered a cumulative net loss of more than 255.5 billion yen (US$2.14 billion) over the previous seven years. 7 All dividend payments were immediately suspended, and shareholders were left reeling.8 But where had these losses come from? An analysis of the now-accurate accounts traced a major portion of the loss back to the group’s personal-computer and white-goods product lines, which accounted for 230 billion yen (US$1.81 billion) of the total losses.9 This was attributed to Toshiba’s strategic decision to shift the lion’s share of the group’s white-goods production overseas in the late 2000s, on the back of a strong yen. Unfortunately, the strategy backfired when the yen lost ground against other world currencies. In addition, competition from Toshiba’s Asian rivals in the personal computer market contributed to operating losses of 109.7 billion yen (US$0.87 billion) in the fiscal year ending March 31, 2015. This represented a 54.6 billion yen (US$0.43 billion) decline from the year before. 10 Fortunately, the firm’s semiconductor business was thriving, due to high sales of smartphone flash memories, and this segment was propping up the rest of the firm. The audit that followed Toshiba’s accounting scandal revealed that, in addition to overstating profits, the firm had also conducted various write-downs. The actions of those involved were attributed to the fact that the group’s executives had been placed under significant pressure following the 2011 Fukushima disaster, which seriously impacted Toshiba’s nuclear unit.11 In a bid to compensate for losses in this division, management had set aggressive targets in many other divisions, including smart meters and electronic toll booths, and this had led to executives inflating figures to create the impression that these difficult targets were being met. Corporate checking and auditing systems that had come under scrutiny, following a 2011 accounting fraud scandal involving camera and medical device manufacturer Olympus Corp.,12 were once again being brought into question as a result of the Toshiba case.13 A major focus of the investigation into the accounting scandal centered on the roles that Toshiba’s top officials played in the process, and the extent to which these highly respected professionals had been aware of the truth behind the figures. A fundamental requirement of the Corporate Governance Code of Japan implemented in June 2015 [see Exhibit 2 New Corporate Governance Code of Japan] is that companies listed within the first and second sections of the Tokyo Stock Exchange must have at least two independent directors on their boards.14 Toshiba had been fully compliant with this requirement. In fact, Toshiba had a model system in place, which was the envy of many similar firms, and the group had been one of the first organizations in Japan to offer places on its board to outsiders, with four of its 16 board members being independent 6 Toshiba IR News (September 7, 2015) “Notice on Restatement of Past Financial Results, Outline of FY2014 Consolidated

Business Results, Submission of 176th Annual Securities Report and Outline of Recurrence Prevention Measures, etc.” http://www.toshiba.co.jp/about/ir/en/news/20150907_1.pdf (accessed August 1, 2016).

7 Nikkei (September 7, 2015) “Toshiba Reveals 230bn Yen in Losses in PCs, Appliances,” http://asia.nikkei.com/Markets/Tokyo-Market/Toshiba-reveals-230bn-yen-in-losses-in-PCs-appliances (accessed August 1, 2016).

8 Toshiba IR News (August 18, 2015) “Notice Regarding Dividend of Surplus,” http://www.toshiba.co.jp/about/ir/en/news/20150818_1.pdf (accessed August 1, 2016).

9 Ibid. 10 Nikkei (September 7, 2015) “Toshiba Reveals 230bn Yen in Losses in PCs, Appliances,”

http://asia.nikkei.com/Markets/Tokyo-Market/Toshiba-reveals-230bn-yen-in-losses-in-PCs-appliances (accessed August 1, 2016).

11 Mainchi (August 31, 2016) “What Happened for Toshiba?” http://mainichi.jp/premier/business/entry/index.html?id=20150831biz00m010032000c (accessed August 1, 2016).

12 Greenfield, K. T. (February 16, 2012) "The Story behind the Olympus Scandal," Bloomberg Businessweek, http://www.businessweek.com/articles/2012-02-16/the-story-behind-the-olympusscandal (accessed August 1, 2016).

13 For the details of the Olympus case, see: Elam, D., Madrigal, M., and Jackson, M. "Olympus Imaging Fraud Scandal: A Case Study, "AJBE American Journal of Business Education (AJBE) 7, no. 4 (2014), doi:10.19030/ajbe.v7i4.8812.

14 Tokyo Stock Exchange (June 1, 2015) “Corporate Governance Code,” http://www.jpx.co.jp/equities/listing/cg/tvdivq0000008jdy-att/code.pdf (accessed August 1, 2016).

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representatives. However, it was later speculated that these members, two of whom were former diplomats, may have lacked the skills and experience required to identify shortfalls in accounting practices.

Toshiba’s Response to the Scandal The accounting scandal rocked Toshiba to the core, and it was clear the organization faced a long and difficult road if it was to recover. On September 17, 2015, Masashi Muromachi, Representative Executive Officer, President and CEO of Toshiba, issued a public apology to the organization’s shareholders and stakeholders 15 He sincerely apologized for the inconvenience and losses that Toshiba’s actions had caused, and acknowledged that it would take time for the stakeholders and the public to regain their trust in, and respect for, Toshiba.16 He vowed that Toshiba would return to the principles on which the organization had originally been formed, and that the Board would treat human life, safety and compliance as the highest priorities in the forthcoming restructuring.17 He promised he would personally endeavor to ensure that a new corporate culture was established that would prevent similar issues from ever happening again.18 Muromachi also disclosed plans to establish a Management Revitalization Committee consisting of outside experts and directors.19 This committee would be tasked with facilitating the reform of corporate culture and identifying measures by which accounting irregularities could be prevented in the future.20 While Muromachi expressed his deep regret that the organization had taken so long to post the FY2014 financial results, he gave shareholders and customers his word that Toshiba would immediately begin the difficult task of restating the financial results for recent fiscal years, and that all accounting data would be submitted to the relevant authorities via the 176th Annual Securities Report.21 Muromachi also promised to reinforce the audit function, implement new internal controls to enhance the corporate governance structure, and establish a new Internal Audit Division that would report to an Audit Committee consisting of independent outside directors.22 To ensure top management was closely supervised and held accountable for their actions, he also vowed to increase the number of outside directors sitting on the Board of Directors to a majority, and to introduce a new evaluation system for the President and Chief Executive Officer [see Exhibit 3 Toshiba’s Actions Taken in Response to Inappropriate Accounting].23

Who Was Responsible for the Development of a Culture of Deception? Toshiba’s accounting practices could be traced back to the development of a high-pressure situation in which executives were expected to meet difficult targets in a challenging environment. This, in combination with the organization’s top-down culture, which generated the expectation that employees should demonstrate blind loyalty to senior personnel, resulted

15 Toshiba (September 17, 2017) “Toshiba’s New Management Team is Dedicated to Regaining Your Trust,”

http://www.toshiba.co.jp/worldwide/about/message.html (accessed August 1, 2016). 16 Ibid. 17 Ibid. 18 Ibid. 19 Toshiba (July 29, 2015) “Notice on Action to be Taken by Toshiba in Response to the Results of the Investigation Report by

the Independent Investigation Committee,” http://www.toshiba.co.jp/about/ir/en/news/20150729_1.pdf (accessed August 1, 2016).

20 Ibid. 21 Toshiba IR News (September 7, 2015) “Notice on Restatement of Past Financial Results, Outline of FY2014 Consolidated

Business Results, Submission of 176th Annual Securities Report and Outline of Recurrence Prevention Measures, etc.” http://www.toshiba.co.jp/about/ir/en/news/20150907_1.pdf (accessed August 1, 2016).

22 Ibid. 23 Ibid.

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in undesirable and illegal accounting practices’ going unreported.24 While senior executives were quick to deny that they had purposely delayed the process through which losses were booked, their subordinates were solidly of the opinion that delayed booking of losses had been conducted at their managers’ instructions.25 At the monthly meetings that were attended by the heads of in-house companies and subsidiaries, top management issued “challenges” and earnings improvement targets to their teams and urged employees to “get creative” to ensure such targets were met.26 These targets were particularly aggressive in the 2011 and 2012 fiscal years.27 The resulting pressure engendered a culture of deceit. Essentially, Toshiba’s failings were not due solely to a lack of corporate governance or poor internal controls; they were the direct result of the actions of a wayward corporate management team.28 To prevent any future accounting scandals, it was critical that Toshiba’s new management team take positive action to eradicate the dishonest and profit-driven corporate culture that had emerged. Accounting figures represent the most important measurement by which shareholders can determine how a company is performing. The people who invested money in Toshiba did so on the basis of the figures in the firm’s annual report, and the assumption was that these figures were honest and accurate. Once the full extent of the deception was unveiled, it became apparent that Toshiba had a serious problem. Irregular accounting practices were not limited to just one or two rogue divisions within the organization, but had become a standard part of the group’s operating practices, and were conducted systematically across the firm.29 As opposed to being limited to the infrastructure division, where the problems were first unearthed, inaccurate accounting methods were found in the majority of Toshiba’s principal business divisions, including the semiconductor, computer, and television businesses. The propensity for staff to massage the figures could be traced back to Toshiba’s strong top- down culture, which discouraged staff from questioning the authority of senior management. The extent to which the culture was corrupt and employees were programed to do as they were told was evidenced by the fact that, in some cases, the illegal deception had been going on for as long as eight years, without a single employee blowing the whistle. 30 Every manager throughout the organization, from middle management up to the president, had his or her eye firmly on profit. Manipulating figures and inflating earnings had become so systematic throughout the organization that it was practically impossible for any one employee to overturn this illegal practice.31 The only way forward was to change the firm’s top-down culture by completely restructuring the management team32 [see Exhibit 4 Cultural Contrasts between US and Japanese Companies]. It was clear that the numerous controls and systems that were in place were insufficient in themselves. They also depended on the development of a culture that fostered and supported honest reporting.

24 Toshiba (July 21, 2015) “Notice on Publication of the Full Version of the Investigation Report by the Independent

Investigation Committee, Action to be Taken by Toshiba, and Clarification of Managerial Responsibility,” http://www.toshiba.co.jp/about/ir/en/news/20151208_2.pdf (accessed August 1, 2016).

25 Ibid. 26 Ibid. 27 Ibid. 28 Ibid. 29 According to the third-party panel report. See: Japan Times (May 16, 2015) “Third-party Panel to probe Toshiba

Bookkeeping,” http://www.japantimes.co.jp/news/2015/05/16/business/corporate-business/third-party-panel-to-probe-toshiba- bookkeeping/#.V2ZAd7grJ2Q (accessed July 1, 2016).

30 Ibid. 31 Ibid. 32 Ibid.

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Was Corporate Governance an Illusion? I myself tried hard to make significant changes to Toshiba's image. Clearly, I didn't try hard enough.

-Taizo Nishimuro, president of Japan Post Holdings Co., Toshiba president during the late 1990s33

Toshiba had once been considered to be a pioneer in corporate governance. The company began a process of reform in the late 1990s, which continued into the new millennium. In 1998, it created a corporate officer system that transformed the company management into something that more closely resembled a US-type management model, with a committee governance framework. The creation of a committee governance structure increased the authority of the external board members who formed the majority of the three separate management committees responsible for appointing board members and overseeing management. Toshiba’s strong external scrutiny should have been an example of an advanced, robust system of corporate governance. Unfortunately, in 2008, Toshiba, led by the president and other senior company executives, began a drive to achieve profit targets above all other considerations. This behavior was unimpeded by corporate governance controls and led to the company booking 150 billion yen in overstated profits. While internal board members were certainly privy to some critical information about the true performance of the firm, the delayed losses went unnoticed by external board members.34 The issues with fraudulent accounting practices exposed the weaknesses in Toshiba’s corporate governance model, especially with respect to the appointment of external board members.35 Two of the four external board members were former diplomats who had little experience of management and accounting practices, and a poor grasp of finance and law.36 It appeared they were appointed only to reach target numbers, as opposed to providing serious management oversight. Toshiba’s much acclaimed corporate governance system was subsequently exposed as being nothing more than illusory [see Exhibit 5 The Difference Between Corporate Governance Practices in Japan and the US]

Goodwill Impairment Related to Westinghouse Electric I will take the lead and disclose information more actively to gain trust from stakeholders. We feel deeply responsible for our failure to publicize the huge write-downs, considering that investors have strong interest in Westinghouse's business.

-Masashi Muromachi, Toshiba president37 On October 17, 2006, Toshiba, which was Japan’s largest manufacturer of nuclear power-plant equipment at the time, purchased Westinghouse Electric Co., allowing it to acquire BNFL USA Group Inc. and Westinghouse UK Limited (collectively: Westinghouse) for a purchase price of US$5.4 billion.38

33 Mainichi (July 25, 2015) “Toshiba Scandal Shows Company had Illusion of Corporate Governance,”

http://mainichi.jp/english/english/features/news/20150723p2a00m0na012000c.html (accessed August 1, 2016). 34 Ibid. 35 Ibid. 36 Ibid. 37 Muromachi held a press conference on November 17, 2015 only after the Tokyo Stock Exchange urged him to do so. For the

details, see: Nikkei (November 17, 2015) “Toshiba President Vows Greater Transparency in Wake of Serial Scandal,” http://asia.nikkei.com/Business/Companies/Toshiba-president-vows-greater-transparency-in-wake-of-serial-scandal (accessed August 1, 2016).

38 Toshiba (October 17, 2006) “Toshiba Completes Westinghouse Acquisition,” Toshiba, October 17, 2006, http://www.toshiba.co.jp/about/ir/en/news/20061017_2.htm, accessed August 1, 2016..

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Through integrating Westinghouse and its extensive expertise in nuclear power into Toshiba, the organization was able to develop a global energy-systems perspective, and position itself as the world’s leading nuclear power organization. At that time, the nuclear power industry was very attractive due to renewed interest throughout the world in nuclear energy and environmentally friendly technologies. China and many other developing economies had already invested heavily in plant construction, and the need for additional nuclear energy capacity was emerging in the United States and Europe. At the time, there were 439 nuclear power plants operating around the world, and demand for additional nuclear energy was poised to grow as part of the more environmentally conscious society of the 21st century. At the time of the merger, Toshiba was a leader in BWR39 technology in the Japanese market, while Westinghouse enjoyed a leading position in the world market with its PWR40 nuclear systems. Through combining the competing offerings of Toshiba and Westinghouse, the organization was able to leverage its manufacturing, sales and marketing, engineering, and R&D capabilities. It was anticipated that the merger would enable Toshiba to develop a major strategic advantage in the nuclear sector and technological synergies allowing the firm to enter new business areas. In addition, the merger was expected to boost sales by up to 700 billion yen by 2015 and 900 billion yen by 2020, a 700 billion yen increase over current sales.41 However, despite initial high hopes, by 2015 it became clear that Toyota’s merger with Westinghouse had not delivered on its anticipated advantages. Following the 2011 nuclear disaster in Fukushima, interest in nuclear technology had waned significantly, and Westinghouse had been forced to book impairment losses. In 2012 alone, Westinghouse booked losses of US$900 million, followed by a further US$400 million in 2013.42 These results were devastating for Toshiba in light of the fact that the firm had invested US$5.4 billion in the acquisition of an 87% stake in Westinghouse.43 It is standard accounting practice that, when an acquired company becomes less profitable than it was at the time of acquisition, the parent firm should reduce the goodwill value in their own books to ensure that the true value of the investment is represented. In short, Toshiba was legally obliged to report Westinghouse’s US$1.3 billion write-downs to the public and investors.44 However, it failed to do so, in violation of the rules of the Tokyo Stock Exchange.45 Toshiba explained its actions as follows: “Impairment testing is conducted for the overall business results of Westinghouse and the division of Toshiba responsible for Westinghouse. Because the division as a whole was profitable, no goodwill impairment was necessary.”46 However, these events had already started to throw Toshiba’s accounting practices into doubt. On November 27, 2015, Toshiba executives promised investors that the organization would adopt greater transparency in their accounting practices and that they would actively disclose information to the public in a more timely and accurate manner.47 Toshiba also notified the

39 BWR: Boiling Water Reactor, a reactor developed and commercialized by General Electric in the US 40 PWR: Pressurized Water Reactor, a reactor developed and commercialized by Westinghouse in the US. 41Toshiba (November 17, 2015) “Regarding Goodwill Impairment Related to Toshiba's Consolidated Subsidiary, Westinghouse

Electric Company L.L.C,” http://www.toshiba.co.jp/about/ir/index.htm (accessed August 1, 2016). 42 Ibid. 43 Ibid. 44 Ibid. 45 Ibid. 46 Muromachi held a press conference on November 17, 2015 only after the Tokyo Stock Exchange urged him to do so. For the

details, see: Nikkei (November 17, 2015) “Toshiba President Vows Greater Transparency in Wake of Serial Scandal,” http://asia.nikkei.com/Business/Companies/Toshiba-president-vows-greater-transparency-in-wake-of-serial-scandal (accessed August 1, 2016).

47 Ibid.

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Tokyo Stock Exchange of Westinghouse's fiscal 2012 and 2013 write-downs of 115.6 billion yen (US$0.925 billion).48

Legal and Administrative Implications for Toshiba The first disclosure of accounting issues at Toshiba came on April 3, 2015, when the company issued a press release announcing that an independent committee was to be established to carry out a special investigation into accounting practices on certain infrastructure projects.49 Investor confidence in Toshiba was severely damaged by these revelations and the stock price collapsed by 26% following the news, prompting shareholders to seek damages for the losses incurred (see Exhibit 1 Toshiba’s stock prices for 2011-2015 ).50 (1) Shareholders’ class action against the company Class action legal proceedings were brought against the company by those who had purchased shares of Toshiba between May 8, 2012 and May 7, 2015 (known as the “Class Period”), with the Court serving as the lead plaintiff.51 According to the complaint, during the Class Period, the defendants had made false and/or misleading statements. They also argued: 1. The total amounts of contract costs for certain infrastructure projects were underestimated; 2. The timing with which such contract losses were recorded was improper; and 3. Toshiba’s public statements were materially false and misleading.52 (2) Administrative actions against Toshiba Once the independent investigation had concluded, Toshiba faced hefty financial penalties from regulators. The Securities and Exchange Surveillance Commission (SESC) and the Financial Services Agency of Japan deliberated administrative disciplinary action against Toshiba.53 As a consequence of the investigation, the Tokyo Stock Exchange placed Toshiba on a watch list of companies with poor or inadequate internal controls.54 Based on the commission's decision, the FSA's Certified Public Accountants and Auditing Oversight Board also investigated Ernst & Young Shin Nihon, the auditing company that had signed off on Toshiba's earnings.55 (3) Toshiba’s legal action against former executives In September 2015, Toshiba set up an external panel of three lawyers to examine whether former executives had fulfilled their basic duties when the accounting malpractices were in full swing. On October 25, 2015, after an independent panel's report on the company's book- padding scandal was released, Toshiba initiated legal action against former executives, including presidents Hisao Tanaka, Atsutoshi Nishida and Norio Sasaki.56 Japanese corporate

48 Toshiba (November 17, 2015) “Regarding Goodwill Impairment Related to Toshiba's Consolidated Subsidiary, Westinghouse

Electric Company L.L.C,” http://www.toshiba.co.jp/about/ir/index.htm (accessed August 1, 2016). 49 Ibid. 50 Ibid. 51 Mainichi (September 5, 2015) “Class Action for Toshiba?” http://mainichi.jp/select/news/20150906k0000m040045000c.html

(accessed August 1, 2016). 52 Ibid. 53 Toshiba (July 12, 2015) “Notice on Recommendation for Administrative Monetary Penalty Payment Order by the Securities and

Exchange Surveillance Commission,” https://www.toshiba.co.jp/about/ir/en/news/20151207_2.pdf (accessed August 1, 2016). 54 Toshiba IR News (September 14, 2015) “Notice on Designation of Toshiba Shares as ‘Securities on Alert’ and Imposition of

Listing Agreement Violation Penalty,” http://www.toshiba.co.jp/about/ir/en/news/20150914_1.pdf (accessed August 1, 2016). 55 Ibid. 56 Mainichi (October 25, 2015) “Toshiba Preparing to Sue Former Executives,” 2016,

http://www.nikkei.com/article/DGXLASDZ24H5Q_U5A021C1MM8000/?dg=1 (accessed August 1, 2016). And also see,

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law stipulated that company executives were liable for any damages their companies suffer as a result of their failings.57 Toshiba filed a civil case against 28 current and former executives for damaging the company's reputation, and sued for a total of 1 billion yen (US$8.2 million) in compensatory damages.58 Toshiba’s decision to sue the former executives was driven by shareholder demands that former executives be held accountable for the book-padding that had taken place. (4) Could Clawback Provisions Come into Play? Although there is no “clawback” (or recovery) law in Japan itself, some Japanese corporations listed in the United States are subject to statutory clawback provisions for certain employees, and this was the case for Toshiba. Clawback could take several forms, such as applying to vested as well as unvested awards, annual bonuses, long-term equity incentives and even non- equity compensation. They may be triggered by misconduct or poor financial performance. Following the US financial crisis of 2007-08, Wall Street regulators and politicians forced banks to adopt so-called clawback provisions in order to recover the compensation paid to banking executives whose longer-term deals incurred losses. A key feature of the crisis was the lack of accountability of traders whose deals had been profitable in the short-term, and who had subsequently been paid generous performance-related compensation, despite the fact that the trades incurred significant losses at later dates. Following its implementation on Wall Street, the Dodd-Frank law passed by the US Congress obliged all listed companies to implement clawback provisions on executives for up to three years following payment of compensation.59 In theory, the rule was designed to ensure executives were held accountable. If a company had made less than its stated earnings and an executive had been paid on those earnings, it would make perfect sense for the firm to clawback the compensation. As such, it was envisaged that the rule would go a long way toward preventing executives from being inappropriately rewarded. However, the reality was very different from the theory. The fundamental issue with the Dodd-Frank law was that the legal requirements were frequently misinterpreted. In addition, instead of controlling how much executives were paid, the law served to increase base salaries, because executives demanded compensation for the risk of potential clawback. This reduced the incentive for executives to maximize profits and, therefore, they were not necessarily acting in the shareholders’ best interests. Furthermore, the new rule was unique because it specified that recoveries were to be made regardless of whether fault could be attributed to an individual executive. In addition, it applied to a broad group of people that included not only senior officers, but also to any other employee who had responsibility for policy-making exercises. The Dodd-Frank law strictly prohibited US companies from indemnifying or reimbursing any executives subject to clawbacks. However, the law did allow a firm the option of not pursuing a clawback if it anticipated that the costs associated with doing so would outweigh the amount that could be recovered. But could Toshiba sue their executive managers to make them accountable for their financial reporting practices on this basis?

Toshiba (December 7, 2015) “Notice on Action for Compensatory Damages against Former Company Executives”

http://www.toshiba.co.jp/about/ir/en/news/20151207_3.pdf (accessed August 1, 2016). 57 Japanese Corporation Law Article 423. http://www.japaneselawtranslation.go.jp/law/detail/?id=2035&vm=04&re=02

(accessed August 1,2016) 58 Toshiba (January 27, 2016) “Notice on Petition for Increase in Amount Sought in Action for Compensatory Damages against

Former Company Executives on the Grounds of Toshiba's Payment of Administrative Monetary Penalty, Etc.” http://www.toshiba.co.jp/about/ir/en/news/20160127_2.pdf (accessed August 1, 2016).

59 The White House (n.d.) “Wall Street Reform: The Dodd-Frank Act,” https://www.whitehouse.gov/economy/middle- class/dodd-frank-wall-street-reform (accessed August 1, 2016).

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Decision for the New CEO I want to step aside within three years once things settle down somewhat so that younger hands can devote themselves to a strategy for growth.

-Masashi Muromachi, Toshiba CEO60

On July 21, 2015, Masashi Muromachi was appointed Toshiba's new president and CEO. The organization was at a crossroads in its history, and it was imperative that the new CEO have the strong strategic, corporate and social qualities needed to drive real organizational change.61 Toshiba set sail on rough seas with a new board of executives. At a special shareholders’ meeting that was held in Tokyo on September 30, 2015, Toshiba added seven outsiders, including Shiseido senior adviser Shinzo Maeda and Mitsubishi Chemical Holdings chairman Yoshimitsu Kobayashi, to its board. However, the future still looked uncertain.62 Unprofitable businesses that had been propped up by accounting maneuvers remained intact. President Muromachi told shareholders that the company would not hesitate to streamline the personal computer, television, white-goods, and semiconductor businesses, with memory chips being the exception.63 Fine words, indeed. But was Toshiba following through on these promises? Many managers had stepped down as a result of the scandal, and Toshiba faced many challenges if it was to ever get back on its feet.64 President Muromachi approached the momentous task by investigating how the situation had been allowed to arise in the first place:65 (1) Why had the corporate governance structures that were in place at Toshiba failed to work? Were there inherent problems in the attitude and approach taken by the company's top management? Why hadn’t the corporate governance structures and reforms that Toshiba had implemented been more closely aligned with those that had been proven to work in the US and Europe? Were there considerable differences between corporate governance practices in Japan and the US? (2) Toshiba had a corporate governance system in place to keep a close eye on management. Why had internal and external audit functions failed at Toshiba (see Exhibit 6 Differences Between Internal and External Auditors). (3) Had Toshiba failed in its objectives to create a transparency forum? How effective was Toshiba’s fraud-resistant corporate ecology or culture? (4) Through the implementation of aggressive targets that were disguised as “challenges,” and calls for employees to “get creative,” had Toshiba actively fostered a top-down corporate process of deceit?

60 Mainichi (September 5, 2015) “Class Action for Toshiba?” http://mainichi.jp/select/news/20150906k0000m040045000c.html

(accessed August 1, 2016). 61 Toshiba (December 21, 2015) “Toshiba to Execute ‘Toshiba Revitalization Action Plan,”

http://www.toshiba.co.jp/about/ir/en/news/20151221_4.pdf , (accessed August 1, 2016). 62 Toshiba (September 20, 2015) “Notice of Resolutions, The Extraordinary General Meeting of Shareholders (Sep. 30, 2015),”

http://www.toshiba.co.jp/about/ir/en/stock/pdf/tsm2015e_resol.pdf (accessed August 1, 2016). 63 Ibid. 64 Ibid. 65 Toshiba (2015) “Annual Report,”http://www.toshiba.co.jp/about/ir/en/finance/ar/ar2015/tar2015e_or.pdf (accessed August 1,

2016). And also see, Muromachi held a press conference on November 17, 2015 only after the Tokyo Stock Exchange urged him to do so. For the details, see: Nikkei (November 17, 2015) “Toshiba President Vows Greater Transparency in Wake of Serial Scandal,” http://asia.nikkei.com/Business/Companies/Toshiba-president-vows-greater-transparency-in-wake-of-serial- scandal (accessed August 1, 2016).

65 Ibid.

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(5) To what extent were Toshiba’s failings the result of the lifetime employment and seniority systems that were common in Japan? The huge responsibility of getting the company back on track and restoring the brand’s reputation rested heavily on the shoulders of Masashi Muromachi.66 Muromachi had a long way to go to restore the trust that had been lost as a result of the accounting scandal. He was also well aware that the brand’s reputation had been significantly damaged and that this would, in itself, entail further sales losses. Ensuring that the organization benefited from diverse and varied revenue sources had been an area of weakness for Toshiba for quite some time and, following the scandal, it was imperative that Toshiba immediately restructure its entire household appliances division. The former president, Hisao Tanaka, had previously claimed that the organization was taking active steps to reduce its reliance on the electronic devices and components market.67 However, in reality, the firm’s dependence on this market was much higher than disclosed. This failing was compounded by the failure of its overseas manufacturing strategy. Although Toshiba’s executives had attempted to counter the impact of the falling yen by placing a strategic focus on more advanced, value-added products, this strategy had also failed. In the fiscal year ending March 2015, the firm sustained a 39 billion yen impairment loss. A further issue was that the firm’s rivals were reporting strong results. In the 2015 fiscal year, Hitachi was expected to announce an operating profit for the third successive year.68 Mitsubishi had also reported the strong performance of its factory-automation equipment.69 Mitsubishi had strategically enhanced revenue from its consumer appliances division by focusing on high- performing products such as air conditioners, rice cookers, and refrigerators.70 In addition to unloading ineffective assets, it would be crucial that Toshiba streamline its operations in the future. Now was the time for Toshiba to transform the less competitive business segments that had directly contributed to the process by which earnings manipulation had permeated the organization. There was an inherent need for Toshiba to completely reassess its Southeast Asian white-goods operations and to re-examine its semiconductor business in terms of both its system and discrete chip segments.71 Furthermore, there was a fundamental need for a shift in focus from corporate offerings to consumer products in the personal-computer division.72 Muromachi identified a number of key responsibilities that would be of major importance for the new CEO of Toshiba:73 (1) Developing, sharing, and implementing Toshiba’s vision, mission and strategy. Formalizing a strategic direction through which the plan’s main deliverables could be achieved. Prior to the accounting scandal, managers and executives throughout Toshiba had been operating under significant pressure from top management to achieve target profits. Unable to meet such stringent “challenges,” many of the managers had resorted to massaging the figures and delaying losses. The culture of the organization was fundamentally to blame, and it was now imperative that this culture undergo significant reform. The accounting scandal had 66 Ibid. 67 Nikkei (June 21, 2015) "Toshiba's Accounting Scandal,"

http://www.nikkei.com/article/DGXZZO89536830R20C15A7000000/ (accessed August 1, 2016). 68 Ibid. 69 Ibid. 70 Ibid. 71 Ibid. 72 Ibid. 73 “Toshiba IR News (April 3, 2015) Notice regarding establishment of Special Investigation Committee,”

http://www.toshiba.co.jp/worldwide/index.html (accessed August 1, 2016).

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exposed Toshiba's structure of corporate governance as something that lacked credibility and substance. But how could Muromachi change something that had evolved over many, many years?74 (2) Managing the organization and value chain according to the requirements specified in strategic plans. Ensuring the work and behavior of executive leaders, both internal and external, were aligned with corporate objectives. Toshiba faced numerous accusations that the executive management committee had not followed effective processes when selecting external board members. 75 The future external board members needed to possess advanced knowledge of law, finance and accounting. However, Muromachi was undecided as to whether Toshiba should rely on the four external board members to ensure adequate corporate governance was exercised, or insist that this task was the responsibility of internal board members, who had advanced, internal knowledge of Toshiba. (3) Devising, communicating, and implementing a strategic business plan that guided the development and direction of the organization. Ensuring management strategies and standards that took the competitive landscape, opportunities, and threats in the external market, and developments in the market and industry, into account. Muromachi pursued a no-holds-barred approach to structural reform, and nothing was off limits. Toshiba could shut down any white-goods manufacturing plants that were located abroad and reorganize the overseas network of factories that were producing large appliances.76 Some 90% of Toshiba's large appliances were made in China, Indonesia and Thailand, yet importing refrigerators, washing machines and other items to sell in Japan had become far less profitable than it once was. However, this was not the sole reason for Toshiba’s demise.77 The firm’s poor performance was also rooted in the competitiveness of its products.78 Muromachi knew that Toshiba had fallen behind other companies in terms of the speed at which it brought new offerings to market.79 In light of the fact that Toshiba could pull out of some markets altogether, he believed that an unbiased decision should be made about what to do with the domestic white- goods, television and personal-computer businesses. Although Toshiba had once been a dominant player in the PC market, having launched the world's first mass-market laptop computer, its market share had declined in recent years as a result of the increase in competition from lower-cost Chinese and Taiwanese manufacturers.80 He very much saw his responsibility as planting the seeds of growth. It was then up to his successors to make these seeds prosper and grow. But where exactly should he plant these seeds?

74 Ibid. 75 Ibid. 76 Ibid. 77 Ibid. 78 Ibid. 79 Ibid. 80 Ibid.

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EXHIBIT 1: TOSHIBA’S CORPORATE PROFILE

Business Summary Toshiba Corp. was founded in July 1875, and is headquartered in Tokyo, Japan. It employs around 200,000 employees. The company manufactures and sells electronic and electrical products in five principal domains, as follows: Energy & Infrastructure, which offers hydro, solar, geothermal and wind power generation

facilities in the renewable energy space, as well as thermal, hydroelectric and nuclear power generation systems. The Energy & Infrastructure division also supplies power transmission and distribution systems that deliver electricity to homes, commercial facilities and other users. It is also a source of social infrastructure solutions in fields ranging from transportation and security to automation and telecommunications.

Community Solutions, which covers city infrastructure support management of energy, water and other essentials across building, home, commerce and retail solutions.

Healthcare Systems & Services, which provides healthcare system and service solutions in four areas: Diagnostics & Treatment for early detection and stress-free, patient-friendly therapy; Prevention to reduce the risk of disease onset or ameliorate its impact; Prognosis & Nursing Care to support patients and their caregivers; and Health Promotion to contribute to mental and physical health and to the safety of food, water and air.

Electronic Devices & Components, which handles the development of NAND Flash memories, the semiconductor business, and the system LSI business.

Lifestyle Products & Services, which includes digital products like LCD TV and Blu-ray Disc players, Notebook PCs and tablets, and home appliances.

Financial Highlights (Currency in JPY) (Units, B= billion, M=million) Mar 2011 Mar 2012 Mar 2013 Mar 2014 Mar 2015

Revenue 6,398.50B 6,100.26B 5,800.28B 6,489.70B 6,655.89B

Gross profit 1,500.95B 1,465.06B 1,415.86B 1,623.91B 1,669.14B

Operating income 240,273M 202,663M 194,316M 257,126M 262,721M

Income before tax 195,549M 145,579M 155,553M 182,336M 136,644M

Net income 146,028M 71,349M 77,533M 68,942M -37,825M

EBITDA 499,877M 452,309M 412,068M 428,922M 452,659M

Diluted EPS 31.25 16.32 18.31 14.23 -8.93

Dividends per share 5 8 8 8 4

Total assets 5,379.31B 5,752.73B 6,106.73B 6,172.51B 6,334.77B

Total liabilities 4,199.70B 4,522.52B 4,690.21B 4,726.52B 4,769.42B

Total equity 868,119M 863,481M 1,034.45B 1,027.18B 1,083.99B

Operating cash flow 374,084M 334,997M 132,316M 284,132M 330,442M

Source: Toshiba’s home page, “Investor Relations”, http://www.toshiba.co.jp/about/ir/index.htm (accessed August 1, 2016)

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Toshiba’s Stock Prices for 2011-2015

Source: Yahoo Finance (n.d.) http://stocks.finance.yahoo.co.jp/stocks/chart/?code=6502.T (accessed August 1, 2016)

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EXHIBIT 2: NEW CORPORATE GOVERNANCE CODE OF JAPANi On June 1, 2015, a new corporate governance code (Code) was introduced on the Tokyo Stock Exchange (TSE) under the patronage of the Financial Services Agency of the Japanese government. The Code represented a serious effort to reform the corporate governance systems systemic throughout Japan, which were frequently criticized for inhibiting growth and preventing boards of directors from being accountable to shareholders. While the new code was only applicable within publicly listed companies, the broad expectation was that the governance reforms that it promoted would ultimately shift to private companies. The code outlined two basic approaches to corporate governance: (1.) A Principle-based Approach This approach required companies to consider each of five relevant principles, and to question whether its activities were in line with the spirit and purpose of these standards. In situations in which a discrepancy between the principle and the firm’s operations were identified, the organization was required to take concrete actions to close this gap. The five principles were as follows: 1. Securing the Rights and Equal Treatment of Shareholders

In addition to securing shareholder rights and providing equal treatment for shareholders, companies should also give adequate consideration to the issues and concerns of minority and foreign shareholders. The Code also required companies listed on the first and second sections of the TSE to disclose any cross-shareholding positions they held in other companies, and the reasons why such cross-shareholding had been established.

2. Appropriate Cooperation with Stakeholders Other than Shareholders

The Code emphasized the need for companies to recognize that their sustainable growth and mid-term or long-term corporate value were derived not only from the resources and contributions bestowed by shareholders, but also those provided by other stakeholders, such as employees and customers. It was essential that firms cooperate fully with all stakeholders.

3. Ensuring Appropriate Information Disclosure and Transparency

As opposed to simply disclosing the bare minimum of information required by law and other regulations, under the Code, companies were expected to strive to actively provide information that went above and beyond that required, if this was deemed to be important to the establishment of a constructive dialogue with shareholders.

4. Responsibilities of the Board The Code highlighted three main roles and responsibilities of the board of directors of a company: (1) setting the broad direction of corporate strategy; (2) establishing an environment in which appropriate risk-taking was supported; and (3) carrying out effective oversight of directors and management. The Code recommended that companies appoint a minimum of two independent directors to their boards.

5. Dialogue with Shareholders

The Code recommended that companies enter into open, constructive dialogue with their shareholders, and that directors pay attention to shareholders’ concerns and clearly explain the company’s business policies to them.

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(2.) Comply-or-Explain Approach This approach specified that, in the event a company did not comply with a principle, there was a requirement to explain the reasons for non-compliance in full and to be transparent with stakeholders and shareholders about any such non-compliance. This dialogue would ensure companies were held accountable for their actions and for failing to meet the required standards.

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EXHIBIT 3: TOSHIBA’S ACTIONS TAKEN IN RESPONSE TO INAPPROPRIATE ACCOUNTING

Oct. 8, 2015 Partial Restatement of Earnings Release for the Period Subject to

Restatement of Past Financial Results: Restated Version Posted

Sep. 17, 2015 Notice on Establishment of Executive-Liability Investigation Committee

Sep. 14, 2015 Notice on Designation of Toshiba Shares as “Securities on Alert” and Imposition of Listing-Agreement Violation Penalty

Sep. 9, 2015 Convocation Notice of the Extraordinary General Meeting of Shareholders

Sep. 7, 2015 Notice on Restatement of Past Financial Results, FY2014 Consolidated Business Results, Submission of 176th Annual Securities Report and Outline of Recurrence Prevention Measures

Sep. 7, 2015 Notice of Nominees for Directors, Committee Members and Executive Officers

Sep. 7, 2015 Notice of New Representative Executive Officers

Sep. 7, 2015 Notice Regarding Holding of and Other Information on the Extraordinary General Meeting of Shareholders

Aug. 31, 2015 Notice on Approval of Postponement (Re-extension) of the Deadline for Submission of the 176th Annual Securities Report April 1, 2014 to March 31, 2015)

Aug. 18, 2015 Notices on Toshiba’s New Management Team and Measures to Reform Governance Structure, and Outline of Correction of Past Financial Statements and Financial Forecast

Jul. 29, 2015 Notice on Action to be taken by Toshiba in Response to the Results of the Investigation Report by the Independent Investigation Committee

Jul. 21, 2015 Notice on Publication of the Full Version of the Investigation Report by the Independent Investigation Committee, Action to Be Taken by Toshiba, and Clarification of Managerial Responsibility

Jul. 21, 2015 Notice on Appointment of Representative Executive Officers

Jul. 20, 2015 Notice on Receiving Report from Independent Investigation Committee, and Action to be taken by Toshiba for Corrections Identified for Past Financial Results

Jun. 25, 2015 Notice on Content of Matters to be reported at the Ordinary General Meeting of Shareholders for the 176th Fiscal Year

Jun. 12, 2015 Notice on the Result of Self-Check by Consolidated Subsidiaries, Outline of Investigation by Special Investigation Committee and Relationship to Items Delegated to Independent Investigation Committee

May 29, 2015 Notice on Approval of Postponement of the Deadlines for Submission of the 176th Annual Securities Report (April 1, 2014 to March 31, 2015) and the 177th First Quarterly Securities Report (April 1, 2015 to June 30, 2015)

May 29, 2015 Notice on Holding the Ordinary General Meeting of Shareholders

May 29, 2015 Notice on Submission of Applications for Approval of Postponement of the Deadlines for Submission of the 176th Annual Securities Report (April

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1, 2014 to March 31, 2015) And the 177th First Quarterly Securities Report (April 1, 2015 to June 30, 2015)

May 22, 2015 Notice on Scope of Investigation by Independent Investigation Committee

May 15, 2015 Notice on Selection of Members of Independent Investigation Committee

May 13, 2015 Currently Expected Amount of Correction of Past Financial Results and Supplementary Explanation Regarding Independent Investigation Committee

May 8, 2015 Notice Regarding Establishment of Independent Investigation Committee

May 8, 2015 Notice Regarding Revision of Business Results Forecast

Apr. 3, 2015 Notice Regarding Establishment of Special Investigation Committee

Source: Toshiba (August 1, 2016) “Actions Taken in Response to Inappropriate Accounting,” http://www.toshiba.co.jp/about/info-accounting/index.htm (accessed August 1, 2016).

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EXHIBIT 4: CULTURAL DIFFERENCES BETWEEN US AND JAPANESE COMPANIES

US Japan Board Members Elected representatives.

Less than 15 people per board.

Representatives who have been promoted internally. Can be more than 30 people per board.

Company Objective To maximize shareholder wealth.

To maximize stakeholder wealth. Shareholders are considered to be as important as management, employees, suppliers and customers.

Agency Problem Managers typically pursue their own objectives and act in their own interests. Performance and behavior are typically influenced by incentives to maximize shareholder wealth.

The objectives of the stakeholders can be varied and dynamic. As such, the agency problem is more complicated.

Employment Transient. Lifetime and seniority-based. Employees typically progress according to seniority.

Speed vs. Consistency Rapid and efficient decision-making approaches are favored.

Company makes decisions in stages in accordance with the wider corporate hierarchy. Management is typically conservative in their decision- making processes and takes a significant amount of time to make a decision.

Heterogeneous vs. Homogeneous

Heterogeneous. The US is multicultural; as such, people think in very different ways. Flexibility and openness to new ideas are encouraged.

Homogeneous. The majority of people come from the same background and have worked for the same firm for a long period of time.

Collaboration Efficiency is highly valued. The fewer and less time-consuming meetings are, the better.

Meetings are a standard part of daily work life and can be lengthy.

Remote vs. Face-to-Face Communications

Communications are typically more remote, and email and phone calls are preferred over meeting face-to-face.

Meetings are generally conducted on a face-to-face basis.

Personal Life vs. Professional Life

Family and personal time are treated as a priority. Work-life balance is highly valued.

Work takes priority over family and personal life.

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Self-Sponsored vs. Company-Sponsored Retirement Rewards

People pursue their own objectives, and this means they will readily leave a firm if a better career opportunity is presented elsewhere. As such, turnover tends to be relatively high.

People tend to stay in one company and are encouraged to do so through monetary rewards and seniority-based promotion mechanisms.

Hofstede Cultural Analysis1

Power/Distance Power is typically evenly distributed among managers at each hierarchical level. Lower- level managers may challenge the decisions of their superiors.

Top-down: Power is unequally distributed. Top management personnel make all the decisions and pass them down to lower-level personnel, who are expected to carry out all orders.

Individualism/Collectivism

Individuals should make a positive contribution that is aligned with the company goals. However, members are typically self-centered and competitive, as opposed to cooperative. Employees are not typically loyal to the organizations they work for, and will pursue their own goals. They do not depend on others and can be calculating and strategic in their behavior.

The group takes precedence over the individual. Members of the group must act for the greater good of the whole, as opposed to in their own interests. As such, employees strongly subscribe to the perspective that joint efforts reap group rewards.

Masculinity/Femininity Women and men work together. Small is considered to be beautiful, and high value is placed on caring for the environment and having a good quality of life.

The culture is masculine. Women and men have segregated roles. Big is considered to be good. Money is highly valued, and people like to show off power and wealth.

Uncertainty Avoidance Uncertainties are managed as they arise and without undue anxiety. People may agree to do something even if they are not 100% confident that it is possible.

Members do not like uncertainty. It is only in situations in which they are 100% confident that they can achieve something that they will say “yes.”

Long-term vs. Short-term Orientation

Short-term Long-term

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EXHIBIT 5: THE DIFFERENCE BETWEEN CORPORATE GOVERNANCE PRACTICES IN JAPAN AND THE US

Although they share some basic similarities, the board structures and governance practices of US and Japanese businesses differ significantly. These differences have become particularly more noticeable in the process of SEC-mandated reforms such as independent audit and compensation committees.

US Corporate Governance Practices Required of NYSE-Listed Companies

Japanese Governance Practices as Mandated by the Japanese Company Act1

Section 303A of the NYSE Listed Company Manual outlines the independence requirements for all NYSE-listed U.S. companies. According to this directive, all firms must have a majority of directors who meet independence requirements.

Under the Companies Act of Japan, there is no requirement for a company that adopts the structure of the three committees to have a majority of outside directors on the board; however, all firms are required to have a majority of external directors on every audit, nomination and compensation committee.1

All NYSE-listed US companies must ensure that an audit committee is in place which consists of at least three members. This committee must meet the requirements of Section 303A of the NYSE Listed Company Manual, including those imposed by Rule 10A-3 under the US Securities Exchange Act of 1934. Every member of the audit committee should be an independent director.

If a Japanese company has an audit committee that consists of three directors, two of these need to be outside directors in order to ensure that the firm complies with the requirements of the Companies Act of Japan.

According to Section 303A of the NYSE Listed Company Manual, all NYSE-listed US companies must have a nominating/corporate governance committee in place that consists of independent directors. The full responsibilities of this committee should be outlined in full.

To comply with the Companies Act of Japan, Japanese firms need to have a nomination committee in place that consists of three directors, two of whom should be external directors.

According to Section 303 A.02(a)(ii) of the NYSE Listed Company Manual, NYSE-listed organizations are required to have a compensation committee in place which consists entirely of independent directors. These committee members are permitted to access advice from other advisors, providing the process they follow to gain such advice is in compliance with prescribed independence criteria.

The Companies Act of Japan requires Japanese companies to have an established compensation committee that consists of three directors, two of whom are outside directors.

Generally speaking, all NYSE-listed US companies must obtain the approval of shareholders prior to issuing any equity compensation plan.

According to the Companies Act of Japan, stock options represent compensation for the services that company directors and executives have performed. As such, they are not subject to shareholder approval.

All external directors of a NYSE-listed US organization must meet at regularly scheduled executive sessions, in the absence of management.

Under the Companies Act of Japan, there is no requirement for outside directors to meet without the presence of inside directors.

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EXHIBIT 6: DIFFERENCES BETWEEN INTERNAL AND EXTERNAL AUDITORS

Internal Auditors External Auditors Appointment Employees of the company. External resource that is

appointed on behalf of the board of directors.

Objectives Set by management. May be limited to certain areas of the organization.

Defined by statute and regulations. Have free rein to examine all systems and processes throughout the organization.

Responsibility Responsible to senior managers.

Responsible to the company’s owners, the shareholders, the government and the general public.

i “Financial Services Agency, Japan, (March 5, 2015) “Corporate Governance Code” http://www.fsa.go.jp/singi/corporategovernance/ (accessed July 1, 2016),

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