The Olympus Corporation Scandal - Coursework Example

Olympus Scandal – An Analysis The Olympus Corporation, Japan was involved in a 7 billion scam in which related to its manipulationof accounts for speculative losses incurred by it over the period of lost 10 years. Critics argue that scam was the result of failure of corporate governance code of Japan as it failed to safeguard the interest of shareholders by stipulating strong governance codes like compulsory appointment of independent directors to the board , evaluation of non-independent directors’ performance by the independent directors , not following international accounting standards for accounting investments , poor play by institutional investors , non-existence of strong take-over codes and the role of statutory auditors to certify the accuracy of company accounts (Tricker & Tricker 2014:176). This research essay will examine how Olympus Corporation was organised , will discuss in-detail about the prevention of such scams in future in Japan by suggesting suitable measures by strengthening the existing corporate governance codes of Japan. Introduction The Olympus Corporation (hereinafter will be referred as OC) scandal was related to financial reporting, which offers an opportunity to throw some light how both practical and theoretical issues were the causes for the reform in the Japanese corporate governance model. Japan’s continuous reluctance to appoint independent directors- the concept which was introduced in the U.S. on the pressures from global institutional investors in the 1990s was one of the reasons for the failure of corporate governance in Japan. The main aim of the corporate governance should address risk management and conflicts of interest instead of concentrating mainly on enhancing performance of the business (Schreck 2009:57). In the absence of independent monitors to make any probable monitoring of management, it is really not practical to make corporate governance more vibrant. A good operating environment would include updated information disseminations, strong implementation, especially through private litigations and entrusting active roles to external auditors (Woodford 2012:2). A Good Corporate Governance Model (Anushma Lal 2004) OC establi shed a tobashi scheme to transform its losses off the balance sheet of Olympus. A A tobashi scheme is a financial scam where the losses incurred by a company are camouflouged by an investment firm by transfering them between other fake or genuine clients or the portfolios. Cayman based companies were acquired by paying abnormal acquisition and management fees. When Michael Woodford, a British, who was appointed CEO of the OC, revealed this scam, and later, he was asked to resign just two weeks after taking charge as CEO of the company. The latter scandal resulted in the arrests of its executive team, about 80% fall in share prices and the threat of de-listing on the Tokyo Exchange and loss of confidence in the Japanese corporate governance by the Western nations (Lessambo 2013:256). This research essay will analyse in detail about the OC scandal in 2011 in Japan, why Japan’s the present corporate governance standards did not prevent such a scam to happen , what provisions should Japan introduce in its corporate governance standards from the UK CG codes and how to avoid future scams in Japan. Olympus Scandal – An Analysis The Olympus Corporation admitted on 10 November 2011 that it had camouflaged losses in excess of Japanese Yen 135 billion (about $1.7 billion) over a period of ten years due to speculative investments’ losses it had incurred during the 1980s boom. The details about the speculative losses invited the attention of public when Michael Woodward, a British citizen and employee of the Olympus Corporation was appointed as managing director. Michael Woodford joined Olympus as a medical equipment sales representative and later promoted as head of the European and UK operations. He was selected for the position of president and chief operating officer in April 2011. The impact of the Bribery Act 2010 was significant to the Olympus case as Michael Woodward, the managing director who was a British citizen was covered under this act and hence, he had a legal accountability to report this issue as not by doing so might have resulted in serious legal penalties on him (Krantz & Johnson 2014:284). Michael Woodward questioned the large sums of money paid to ‘consultants’ or ‘advisors’ who had involved in the past acquisitions made by OC. It was revealed, after close investigation, that these huge sums were paid to cover-up the original losses. Tokyo Stock Exchange on January 2012 declared that it would be permitting OC to continue its listing but had levied a fine of Y10 million for the wrongdoings by OC. When scandal came to light, the share prices of OC dwindled to a sixth of its earlier value quoted before scandal. Tokyo stock exchange carried over its own investigation on the scandal and found that OC’s prime manufacturing facilities had not been impacted by the huge losses and due to that , there had been no impact on operating profit or sales of the company and hence , concluded the de-listing demand by the investors was not warranted (Bloomfield 2013:241). The top management of Olympus prolonged to carry on the failed investments that ended in greater losses. By booking the value of assets at historical cost instead of fair market cost, Olympus was at the beginning able to camouflage those losses. However, when accounting regulations were changed in Japan, it compelled the company to value their investments at fair -market value. Due to this, Olympus established off-balance sheet entities in Cayman Islands, mainly to camouflage those losses. In a lost resort to give a final touch up to this scheme, Olympus bought Gyrus and booked the losses on speculation as an intangible asset (Elam, Madrigal & Jackson 2014:329). A massive sum of US$2.2 billion was paid for buying Gyrus company whose yearly earnings was just one-tenth of consideration paid, and U.S. $687 million was paid as advisory fees to the consultants who were engaged for the above acquisition. Olympus paid $ 773 million for buying three companies, which had employee’s strength of just 50 each. In 2011, KPMG audit firm which was the statutory auditor of the company raised their anxieties over the financial dealings of the Olympus and had disclosed in public that major information was not offered to them in their auditing work (Layne &Reynolds 2011). “Moral Development Theory” Lawrence Kohlberg’s moral development theory is based upon ethical demeanour which has six recognisable development phases, each one is more tolerable at retorting to moral dilemmas than its antecedents. The six phases of moral development are categorised into three stages namely pre-conventional morality, conventional morality and post-conventional morality (Thomas 1997:59). Kohlberg model has three stages and two stages for each level. An individual is considered as having more knowledge on ethical awareness to each higher stage or level. At Level One Stage, two executives of Olympus showed a self-interest orientation. The executives of Olympus namely Hisashi Mori and Hideo Yamada who were at the elementary level of Kohlberg theory by prolonging to continue their belief that nothing was wrong. Their conspiracy ended in the requirement of hiding ever bigger losses. Like many other world-famous scandals, by the time when scandal became public, the loss multiplied into many folds than it was earlier reported at the inception stages of corporate fraud (Elam, Madrigal & Jackson 2014:329). Chart of Kohlbergs Theory of Moral Development Source : http://www.vtaide.com/blessing/Kohlberg.htm At stage Four and at Level Two, the executives of Olympus functioned on a social –order and authority orientation. The same values that hesitant to publish bank losses now transferred those losses to the corporate headquarters. A social norm was preserved to show as if the company was functioning without any unusual issues. At Stage Five and Level Three, there was a failure on the part of top executive of Olympus as their demeanour had to mirror the concept of a social contract. However, the top executives of Olympus preferred the lower stages of self-interest instead of higher calling to individuals well faraway from its corporate culture. Due to this, the resulting tragedy made the company almost to the bankrupt stage. It should be noted that whitewash of the losses was, in fact, a Defining Issue Test for Olympus as the top executives of Olympus failed in this test in a manner that discredited an otherwise well-functioning company .When questioned by the new CEO about the scam, the executives’ reluctance to dig out the truth about the scam, which offers an adverse picture of corporate governance that existed in Japan corporate (Elam, Madrigal & Jackson 2014:329). Failures by Key Stakeholders to prevent scandal like Olympus “Board of directors” Unfortunately, Japanese companies’ board of directors were controlled by insiders in a major way. For instance, many directors in Japanese companies are filled by erstwhile or present employees only. Due to this fact, the Board could not efficiently function and can exercise their privileges to monitor management (Shishido 2014:252).Further, the requirement of nomination of outside directors by Kansayaku Japanese companies’ is always ignored instead of honouring the same. Japanese companies justify their stand of not appointing outside directors as the governance implemented by their board of directors or outside auditors is functioning smoothly. There is no requirement for appointment of independent directors in Japanese companies, which is perusing the Kansayaku model (Mizuno & Tabner 2009:625). As the employees who were elevated as directors of the company, these directors cannot efficiently function and question the camouflaging the company’s losses through off-balance sheet entities (Mallin 2013:6). Auditors The OC scandal raised many ethical issues such as how the top management of OC was able to camouflage $1.7 billion in investment losses for nearly two decades while there was lack of due diligence on the part of external auditors who failed to unearth all the fraudulent business transactions(Elam, Madrigal & Jackson 2014:328). When KPMG questioned the Olympus management about the provision of exorbitant advisory fees paid for M&A consultants, it was replaced by Ernst & Young in 2009 who in turn permitted US$177 million as goodwill on the acquisition of Gyrus. This demonstrated that both external auditors of Olympus namely, KPMG and Ernst & Young collided with the Olympus management in manipulating the accounting figures (Elam, Madrigal & Jackson 2014:327). Institutional Investors UK places great stress on shareholder capitalism whereas Japan places higher emphasis on stakeholder capitalism. However, in both nations, institutional investors played great role on the development of corporate governance. As compared to Japanese counterparts, institutional investors in UK have more sway over the management of a company. However, it is averred that these authorities have not fully employed to their best manner in either nation. In both Japan and UK, institutional investors depicted a constructive role on the development of corporate governance. As compared to Japanese colleagues, institutional investors in UK have more influence over the management of a company. Further, institutional investors in Japan are not as aggressive as foreign investors in fighting any company proposals that likely to defraud shareholders’ interests. There have been strong recommendations from the International Institutional investors that listed companies in Japan should have independent or outside directors who will not only supervise the management but also will safeguard the interest of shareholders (Bruce 2012:95). “Corporate Citizenship in Japan” The magnitude to which businesses which are socially accountable for catering ethical, legal and economic accountabilities on them by shareholders is known as corporate citizenship. The main objective is for businesses to establish appreciable quality of life and standards of living in the societies in which they function, while still aiming profitability for stakeholders. Nowadays, there is more spotlight on ‘ethical leadership’ in Japanese companies as the Olympus scandal was the result of lack of ethical behaviour among top executives , external auditors and directors of the company. As per Martin et al (2009), the immediate need of the business leaders to think about CSR and to think of actionable structure thereby thinking beyond shareholders that makes them to function as a human being instead of self-interested executives. As per Pinney (2011), today, Japanese companies require to note not only the law and the economic forces, but also the environment and the society at large. As of today, public perceptions about a company’s environmental and social engagement have transformed radically, and Japanese businesses have no preference other than to assimilate “social value” into their business strategy. If a Japanese company wants to survive in this new background, it has to be pushed by its corporate citizenship goal, thereby not just adhering with the law (Prastacos, Wang & Soderquist: 43). Corporate Governance in Japan v Corporate Governance in UK Japan has been tilting between its customary replica of board of directors that actively administers the company which is called as “management model” and the American replica of a board that spotlights on supervising and monitoring the management which is known as “monitoring model”. As per Silver –Greenberg (2012), weak regulatory forbearance and corporate governance as two main elements in the prolonging the corporate scandals in Japan. The unwillingness or inability to acknowledge a loss and to clear the decks by companies which have ended in wide-ranging phases of economic stagnation in Japan (Davidoff , Lund & Schonlau 2014:58). The Japanese model of corporate governance has frequently been depicted as the oppositeness of the UK model. The Combined Code which is non-binding in nature is always reinforced by the slogan “adhere or explain the principle” is always raising a controversial issue in UK. In terms of safeguarding mechanisms granted to minority shareholders, corporate governance in Japan is frequently termed as relatively weak (Mizuno & Tabner 2009 :622). Listed companies in Japan have to adhere corporate governance, which is footed upon the commercial code. In 1993, Japan introduced Kansayaku system, which mandated the Japanese listed companies to have a Board with a minimum of three statutory auditors (Kansayaku) where one auditor should be from outside. Further, there were a substantial increase in the rights of shareholders as a shareholder with just 3% shareholding can ask for inspection of accounts of the company and legal fee to be spent by a shareholder for filing a class-action suit has been drastically reduced to Y 8200 ($80). The revised commercial code in 2001 stipulated that each listed company has to appoint five to seven Kansayaku and half of them should be outsiders who had no earlier transactions with the company. In Japan, Kansayaku is accountable for implementing and maintaining good corporate governance and is needed to participate in board meetings and to raise their opposition when it is essential. In each committee, half of the members should be outsiders even though the aggregate board may have a bulk of inside directors (Mizuno & Tabner 2009:623). Shareholders Proposal for Good Corporate Goverance Source : Proxy Monitor 2012 The Japan government introduced a new corporate governance in 2002, which allowed Japanese companies to choose either a new committee system or the customary Kansayaku system. Under the new committee system, audit committee, compensation committee and appointment committee have to be established. Unlike the unitary board system that exists in UK, the committee system in Japan is playing a supervisory role over the board as a whole thereby resulting dual board structure (Mizuno & Tabner 2009:624). The committee system which is based on American Model can be the best choice for Japanese companies’ corporate governance. As the committee will be comprised of independent auditors or directors , these committees can stop any frauds well in advance. In the case of Olympus ,on October 21 , 2011 , it appointed a third-party committee to examine the issue. In December 2011, the committee filed its findings, which deliberated about the Olympus scam in details and found that the Olympus management as guilty. Olympus then appointed two additional third-pary committees to report the liability issues for auditors and directors. The additional committees issued reports in January 2012 and based on the recommendations , civil law suits were filed, and criminal investigation was started (Aronson 2013:94). From the above , we can understand that American style committee system is functioning well in Japan instead of its Kansayaku model. Thus , by introducing amendments to the Commercial Code, a complete deviation from Japanese traditional corporate governance practice as it obviously alienated monitoring of the management from that of planning and business execution. The amendments to corporate governance were due to destabilisation of banks’ roles and the unwinding of cros-shareholdings with corporate scandals like Olympus .AGGA (2008) strongly recommended that the Japanese corporate governance should be based upon an Anglo-American style(ACGA 2013:6). However, critics argue that there should be piecemeal and slow approach to safeguard the potency of Japanese management setup, emphasising that CG reform is a trade-off between employees, creditors, financiers on one side and the shareholders on the other side ( Mizuno & Tabner 2009 :624). Even though, the CG of UK is being regarded as most effective, however, it is not acting as a panacea for all the issues despite continuing reform connected with the Combined Code and broader regulatory reform. Critics argue that in UK, the grey areas in corporate governance are the so-called “rewards for failure” and disproportionate rewards for assuming excessive risk among directors and top executives of the company. Critics pointed out that UK has to still plug the various loopholes like excessive leverage, buyback and immunity from pre-emption rights to avoid future scandals (Mizuno & Tabner 2009:628). However, UK Companies Act provides various mechanisms to safeguard the interest of shareholders such as right to appoint and oust individual directors, just 10% of the shareholders can summon for calling an extra-ordinary general meeting (Kraakman , Armour & Davies 2009:161). On some important resolutions, UK companies have to get the shareholders’ approval. Corporate governance of UK is mainly drawn on principles of proper supervision of company top executives and proper mechanisms to make sure that risk taking activity is carried on for the advantage of shareholders instead of for the advantage of top executives of the company. Thus, the connection between risk-taking behaviour and executive commission is the key theme of UKs CG (Freeman 2010:139). Contrasting to Japan, anti-takeover initiatives are not major issues in UKs CG as they are efficiently managed by UK’s City Code on Takeovers and Mergers (City Code), and the company law provisions. Japan is in dire need to introduce such takeover code so as to avoid future scandals like Olympus as in Olympus scandal, it established a tobashi scheme to transform its losses off the balance sheet of the Olympus. Cayman based companies were acquired by paying d Acquisition and Management Fees (Mizuno & Tabner 2009:630). UK model of corporate governance can be said to be the best model as it is having various provisions to prevent a corporate scam. Some of the UK’s corporate governance codes that help to prevent scams are appointment of independent directors , appointment of audit committees , introduction of whistle blower mechanism, appointment of remuneration committees , and barring a person to hold both chairman of the board and CEO of the company. Further, institutional investors in Japan are not as aggressive as foreign investors in fighting any company proposals that likely to defraud shareholders’ interests. Moreover, shareholder activism by both domestic and foreign investors in Japan does not seem to be as ferocious as in UK. Japan has to strengthen these areas to avoid future scandals like Olympus Mizuno & Tabner 2009:633). Conclusion To avoid a future scam like Olympus Corporation in the future, the following has to be introduced in Japan’s corporate governance codes to make it more investors’ friendly. Japan’s continuous reluctance to appoint independent directors has again introduced conflict of interests. Corporate governance code should encourage that independent directors should be appointed on compulsory basis and they should make a review of the functioning of chairman, CEO and other board members on a regular basis. Japan’s corporate governance should address the risk management and conflicts of interest instead of concentrating mainly on enhancing performance of the business. Many directors in Japanese companies are filled by erstwhile or present employees only. Due to this fact, the Board could not efficiently function and can exercise their privileges to monitor management. Hence, Japanese board should contain maximum outside directors. The external auditors should be toothed with more powers to divulge any mismanagement without any fears. Further, valuation of investments should be made as per the International Accounting Standards. Whistle Blower mechanism should be strengthened, and whistle blowers should be given statutory protection. Institutional investors in Japan are not as aggressive as foreign investors in fighting any company proposals that likely to defraud shareholders’ interests. Hence, playing an active role by institutional investors to minimise corporate frauds in Japan should be encouraged. Japan is in dire need to introduce strong takeover code so as to avoid future scandals like Olympus as in Olympus scandal, it established a tobashi scheme to transform its losses off the balance sheet of the Olympus. 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