Olympus scandal highlights need for tighter focus on corporate governance in Japan

Increased levels of accountability and transparency are needed if Japanese companies are to attract long-term shareholders.

The scandal to hit Olympus has heightened investor’s concerns over standards of corporate governance in Japan. This week (21 December), Japanese prosecutors raided the headquarters of Olympus as part of an ongoing investigation. Since Michael Woodford was ousted as the company’s chief executive in mid-October for blowing the whistle on a $1.5Bn accounting scandal, shares in the Japanese camera and medical equipment manufacturer have plummeted. Olympus’s board fired Mr Woodford after he confronted other executives about suspicious payments the company had made in acquisitions carried out under his predecessor. After being fired, Mr Woodford retained a non-executive directorship at Olympus but later resigned from the company’s board and called for an emergency shareholder meeting to replace its management. Initially, Olympus denied the allegations made by the Mr Woodford, but later admitted that it had been hiding losses for as long as two decades. In November, an independent committee which was set up to investigate the scandal, concluded that former CEOs at Olympus, including Mr Tsuyoshi Kikukawa, the former chairman and CEO, the former statutory auditor, and head of accounting were involved in the wrongdoings and recommended that the existing board members step down. The committee also reported that “a corporate atmosphere where people cannot freelyspeak up was formed, mindset of personalising the company prevailed, and the sense of duty of loyalty towards shareholders was sparse among management”. In December, Olympus was asked to refile its earnings because of deceptions and accounting irregularities. The company filed revised earnings only hours before a deadline passed which would have seen it automatically delisted from the Tokyo Stock Exchange.
The developments at Olympus raise questions for investors about Japanese corporate governance standards. Is the scandal a one-off or is it symptomatic of a wider series of corporate governance failings in Japan? And how will the affair impact the country’s image globally? Olympus had published details of a whistle-blowing policy (and relevant employee training initiatives) within its public reporting, though evidence would suggest that these were not being implemented. In 2007, in a case unrelated to the current accounting scandal, Olympus employee Masaharu Hamada took legal action against the company on the grounds that he was subjected to harassment by management after reporting a compliance breach by his supervisor. The Tokyo High Court ruled in his favour and the case is now on appeal.
The corporate governance failings at Olympus serve to highlight the lack of independent board members at many companies in Japan. EIRIS research shows that in
June 2011 only three out of 15 board members at Olympus were independent non-executives. Interestingly, this figure is above average for Japanese companies. Our research also shows that almost half of the 458 Japanese companies in the FTSE All World Developed Index do not have any independent non-executives in their boards. Furthermore, Olympus had a separate chair and chief executive at that time, while 39% of Japanese companies do not. The Japanese Financial Instrument and Exchange Act requires listed companies to annually submit an internal control report which is based on a self-assessment of their internal corporate governance control systems. The Tokyo Stock Exchange’s (TSE) listing rules require companies to appoint at least one independent director, an external board director, or an auditor who does not have conflicts of shareholders’ interests. In 2009, the TSE also released Principles of Corporate Governance for Listed Companies which focus on the relationship between executive officers and auditors. The Principles require at least one independent board director and leave it free for listed companies to choose exactly how many others independent non-executives should be appointed. The need to avoid conflicts of interests between shareholders and corporate executives is at the very centre of good corporate governance. For this reason, a higher proportion of independent non-executives on corporate boards is required in Europe and North America. It’s clear that standards of corporate governance at Olympusare far from best practice, even though the company is in compliance with the regulations in Japan and TSE listing rules. Many Japanese executives continue
to defend the existing model of corporate governance in Japan. However, increased levels of accountability and transparency are needed if Japanese companies are to attract long-term shareholders. A greater clarity on how companies in Japan incorporate fundamental corporate governance principles into their businesses strategies is also needed. Shareholders should therefore engage with Japanese companies to push for further detail on the actual corporate governance systems they are using and ask for numbers of independent non-executive board members to be increased if the current proportion is not comparable to best practice levels elsewhere. Shareholders should also work with regulators to encourage them to issue further guidelines aimed at increasing transparency amongst corporates in Japan. The developments at Olympus raise serious concerns about corporate governance in Japan. These concerns were exacerbated further by initial denials and contradictory statements by Olympus when the scandal broke out. However, the recent raid on Olympus is a signal that the Japanese authorities wish to ensure that all corporations work within the given framework of rules and regulations. However, if Japan is to improve its reputation then evidence would suggest that these rules and regulations need to be tightened.

Kazutaka Kuroda is a Research Analyst at EIRIS