International Conference on Human Rights, E-Commerce, Marketing, and Management (HREMM-18) Jan.

1-3, 2018 Dubai (UAE)

Toshiba Accounting Scandal

A Case Study in Corporate Governance Failure
James E. Banks


Abstract—This case study examines the 2015 Toshiba II. THE SCANDAL
accounting scandal. At first glance, the misrepresentation of In January 2015, Japan’s Securities and Exchange
Toshiba’s financial statements appears to mirror recent Surveillance Commission1 (the “SESC”) received an e-mail
accounting frauds in the U.S. and India motivated by the from a whistleblower alleging Toshiba’s use of inappropriate
avarice of self-indulgent corporate executives. Toshiba’s
accounting practices in preparing financial reports for its
accounting malfeasance, however, resulted from the
infrastructure-related business.2 The allegations prompted the
unwillingness of senior executives to disclose massive losses
SESC to meet with Toshiba executives to discuss the
suffered following the 2008 global financial crisis.
company’s use of the “percentage-of-completion" method to
Keywords— Corporate governance, accounting scandals, audit record revenues and expenses for long-term infrastructure
committee. contracts.3 During the meeting, the SESC questioned
Toshiba’s compliance with generally accepted accounting
I. INTRODUCTION principles4 in its use of the percentage-of-completion method.
In 2015, Japan’s Securities and Exchange Surveillance As a result, Toshiba launched an internal investigation which
Commission investigated a whistleblower’s allegations of uncovered evidence clearly suggesting a deliberate attempt by
Toshiba’s use of improper accounting practices in preparing its senior executives to misrepresent the company’s financial
financial reports. That investigation ultimately revealed that performance, not the mere occurrence of accounting errors.
from 2008-2015, Toshiba misrepresented its earnings by $1.2 Following this discovery, Toshiba appointed an independent
billion, nearly 40% of its previously reported income. Even panel of attorneys and accountants to conduct an impartial
more disturbing, the investigation also revealed that the investigation of the company’s accounting practices.
misrepresentation occurred with the full knowledge and After concluding its investigation, the independent panel
complicity of Toshiba’s CEO and his two predecessors. released an 82-page report which concluded that pressure
This case study examines the Toshiba scandal vis-à-vis applied to business units by Toshiba’s CEOs to meet
similar accounting scandals at Yamaichi Securities, Seibu unrealistic profit targets, coupled with a corporate culture
Railway, Kanebo Ltd., and Olympus Corporation, each of which discouraged employees from challenging directives
which occurred after the collapse of Japan’s economy in the from senior executives, influenced managers to misrepresent
1990s. The objective of this analysis is to posit three the financial performance for their units. The panel also
arguments. First, the Toshiba scandal was not an anomaly, but determined that weaknesses in Toshiba’s corporate governance
rather the continuation of a pattern and practice by Japanese program hindered the prevention and detection of the
corporations to conceal financial losses through fraudulent fraudulent accounting activities. The panel’s report led to the
accounting practices. Second, flaws in Toshiba’s corporate resignation of Toshiba’s CEO (Hisao Tanaka) and his two
governance program, coupled with weaknesses in Japan’s
1
accounting profession, resulted in the failure to detect The SESC is part of the Financial Services Agency, the financial
regulatory authority overseeing Japan’s banking, securities and exchange,
Toshiba’s fraud. Finally, attributes of Japan’s culture in
and insurance sectors to ensure the stability of the country’s financial system.
general, and Toshiba’s corporate culture in particular, thwarted
2
prevention of the fraudulent accounting practices by enabling The whistleblower’s actions were noteworthy because Japan’s cultural
senior executives to influence unethical behavior in the norms discourage individuals from reporting organizational misconduct, and
its laws offer little protection to whistleblowers against retaliatory actions
organization free from any concern about opposition from (i.e., threats, acts of physical violence, demotion, termination of employment,
junior employees or punishment if regulators discovered their etc.).
3
misdeeds. The "percentage-of-completion" method permits a business to record the
revenues and expenses of long-term construction contracts for each year as a
percentage of the construction it completes during that year.
4
Generally accepted accounting principles consist of a common set of
accounting principles, standards and procedures that companies must comply
with when preparing financial statements.
James E. Banks is with the Higher Colleges of Technology-Dubai

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predecessors,5 the resignations of other members of the board for nuclear energy plunged. 8 The precarious state of Japan’s
of directions, and restatement of Toshiba’s financial reports economy following the collapse of the bubble economy
for fiscal years 2008 through 2015. In December 2015, the provides a backdrop for the analysis of the accounting
SESC fined Toshiba Corp a record ¥7.37 billion ($66 million) scandals at Toshiba and four aforementioned Japanese
for its misdeeds, and also fined Toshiba’s external auditor ¥2.1 corporations.
billion ($17.4 million) for failing to detect the fraud when it
audited the company’s financial statements. A brief analysis IV. POST-BUBBLE ECONOMY ACCOUNTING SCANDALS
of Japan’s post-World War II economy highlights some of the At first glance the Toshiba accounting scandal appears to
factors that motivated Toshiba and other Japanese mirror recent accounting scandals at Enron (U.S.) and Satyam
corporations to falsify their financial reports. Computer Services (India) where the avarice of self-indulgent
senior executives provided the motivation for their nefarious
III. JAPAN’S ECONOMY deeds. In contrast, Toshiba’s actions emulated a pattern and
Following the conclusion of World War II, Japan practice in Japan of misrepresenting corporate earnings to
experienced rapid economic development due to the avoid public humiliation for unprofitable operations. As a
development of key industrial sectors (e.g., steel and case in point, Sanyo Special Steel (like Toshiba) inflated its
shipbuilding) which powered the country’s growth. Exports earnings for six years (1959-1965) rather than disclose its
fueled a 9% annual increase in Japan’s Gross Domestic insolvency. Following additional bankruptcies in 1965, the
Product (GDP) from 1953-1965. The period between 1985 Ministry of Finance inspected the financial statements of other
through 1990 in particular represented a time of unparalleled companies listed on the Tokyo Stock Exchange and discovered
prosperity during which Japanese companies purchased that one hundred sixty-nine companies committed similar
businesses and real estate in foreign markets, and land and transgressions.
stock prices in Japan rose dramatically (the “bubble The collapse of Japan’s bubble economy after four decades
economy”). In 1990, however, real estate and stock values of unprecedented growth created even greater pressure on
plummeted when the stock market crashed. Thereafter, senior executives at previously profitable companies like
Japan’s economy lapsed into a recession which ended four Toshiba, Yamaichi Securities, Kanebo Ltd., and Olympus
decades of unprecedented growth. Then late in 1997, the Corporation (see Table 1, “Comparison of Accounting
Asian financial crisis indirectly caused a banking crisis. As the Scandals”) to continue such practices. Japanese corporations
banking crisis continued into 1998, news surfaced of in general, overburdened with excess debt and high labor
widespread accounting fraud involving banks attempting to costs, struggled to remain profitable in an economy mired in
hide their exposure to nonperforming loans.6 deflation and economic stagnation,9 and compete globally
Japan’s economy finally began to rebound in 2001 due to against reenergized competitors that increased productivity
robust automobile exports and by 2007 economists hailed the and reduced costs in the 1990s through innovation. The
end of a 20-year period of economic stagnation eventually accounting scandals at Kanebo, Olympus and Toshiba
dubbed “the Lost Score.”7 However, the 2008 global financial illustrate this struggle because each firm misrepresented its
crisis battered Japan’s economy and crushed economists’ financial performance for multiple financial reporting periods.
optimism as exports declined by 50 percent. Making matters Some Japanese corporations, like Yamaichi Securities,
worse for Toshiba, severe damage to the Fukushima nuclear Kanebo, and Olympus, also suffered significant investment
power plant in 2013 caused by a 9.0 magnitude earthquake and losses resulting from the bubble economy’s collapse10 and
ensuing tsunami served as the death knell for the company’s used tobashi schemes to avoid public disclosure of their
ill-fated diversification into nuclear energy as global demand losses.

5 8
Atsutoshi Nishida, CEO from 2006 to 2009, resigned from his post as a In 2006, Toshiba bought Westinghouse Electric, a U.S. builder of nuclear
paid advisor to Toshiba. Norio Sasaki, CEO from 2009 to 2013, resigned plants, for $5.4 billion, but the Fukushima nuclear disaster greatly reduced
from his position as Vice-Chairman of the board of directors. demand for nuclear facilities worldwide. Consequently, Toshiba’s senior
executives set aggressive sales and profit targets to try to offset the loss of the
6
The Asian financial crisis severely affected the economies of Thailand, revenue they anticipated from the company’s investment in nuclear energy.
Indonesia and South Korea. Although the crisis did not directly affect Japan,
9
Japanese banks suffered great losses because they were saddled with $25 Deflation, a period in which prices decline, leads to economic stagnation
trillion dollars of non-performing loans. To foster greater transparency in light (i.e., a prolonged period of slow economic growth) because falling prices
of the accounting frauds, Japan’s government revised laws related to encourage customers to delay purchases for consumer and industrial goods
accounting practices and financial reporting for the financial industry in a that will cost less in the future. Consequently, businesses struggle to reduce
reform package dubbed the “Big Bang.” their debts as their revenue decreases.
7 10
The Lost Score refers to the 20-year period of economic stagnation that Investment firms like Yamaichi Securities, for example, orchestrated a
followed the collapse of the real estate bubble in late 1991. During the period tobashi scheme to conceal Client A's losses by shifting them between the
from 1995 through 2007, Japan’s GDP fell from $5.33 trillion to $4.36 portfolios of Clients B, C and D to make them disappear from Client A’s
trillion in nominal terms. financial statements.

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V. FACTORS CONTRIBUTING TO THE TOSHIBA SCANDAL participate in discussions regarding the financial issues before
Three factors hindered the prevention and detection of the committee.
Toshiba’s accounting malfeasance: (1) an ineffective corporate B. Japan’s Accounting Profession
governance program;11 (2) weaknesses in Japan’s accounting
Secondly, the failure of internal and external auditors to
profession; and (3) unique characteristics of Japanese culture
detect Toshiba’s accounting irregularities comes as no
in general, and Toshiba’s corporate culture in particular. Of
surprise. According to studies published by
the three, the flaws in Toshiba’s corporate governance
PricewaterhouseCoopers (PwC) and the Association of
program was the most critical obstacle.
Certified Fraud Examiners (ACFE), whistleblowers play a
A. Weak Corporate Governance more vital role in fraud detection than internal or external
Many considered Toshiba in the vanguard of the efforts to audits14 due to the fact that audits focus primarily on verifying
improve corporate governance in Japan. As a case in point, the accuracy of a corporation’s math and the correct
the Japanese Corporate Network in 2013 ranked Toshiba 9 th application of accounting rules, not fraud detection.
out of 120 publicly-traded companies in terms of effective Effective fraud detection requires forensic accountants
corporate governance programs. This perception stemmed and fraud examiners trained and experienced in uncovering
from the fact that Toshiba became one of the first Japanese evidence of fraud. In Japan, however, the number of qualified
corporations to adopt three of the Cadbury Committee’s accountants and auditors pales in comparison to the U.S. and
recommendations12: (1) appoint non-executive directors to the the U.K. They also rank among the worst paid internationally.
board of directors to provide objective judgement regarding a More importantly, until recently the regulatory body
corporation’s operation and conduct; (2) create a board-level overseeing Japan’s public accounting profession rarely
audit committee to ensure compliance with accounting instituted enforcement action against certified public
regulations; and (3) appoint non-executive directors to serve accountants that violated regulatory standards when
on the audit committee.13 Three major flaws in Toshiba’s performing an audit. Consequently, little incentive existed for
corporate governance program, however, militated against the accountants in Japan to perform thorough and accurate audits.
prevention and detection of its accounting fraud. First, C. Japanese Culture and Toshiba’s Corporate Culture
Toshiba executives dominated the decision-making of the
Finally, three attributes of Japan’s culture in general, and
board as executive directors held fourteen of the eighteen seats
Toshiba’s corporate culture in particular, permitted senior
on the board. Some academics argue, however, that boards
executives to influence unethical behavior free from concern
composed of a majority of non-executive directors prove more
that junior employees might raise objections. First, Japan’s
effective in promoting ethical corporate behavior than
culture places great emphasis on intra-group harmony. Group
executive-dominated boards. Second, the appointment of
members implicitly understand the importance of not revealing
Toshiba’s former chief financial officer to serve on, and worse,
unflattering information regarding the group or its members
chair the audit committee created a blatant conflict of interest
because their self-esteem is inextricably linked to the group’s
as it afforded him the opportunity to influence the approval of
success. Unfortunately, this may persuade group members to
financial statements he helped falsify. The Cadbury
remain silent regarding “questionable” conduct, especially if
Committee, however, recommended that only non-executive
they believe that the motivation for such conduct was to
directors serve on the audit committee to help prevent
protect the group’s best interests. Second, white-collar
corporations from falsifying their financial reports. Finally,
criminals in Japan rarely serve time in prison as punishment
the majority of the non-executive directors serving on the audit
for their crimes.15 Executives typically receive a suspended
committee lacked not only financial expertise, but also basic
sentence in the rare instance where a court convicts a
business experience. The Cadbury Committee, however,
defendant of committing a white collar crime. Accordingly,
suggested that boards appoint directors with financial
the lack of severe punishment for such criminal behavior
backgrounds to the audit committee who could actively
provides little incentive for senior executives to adhere to
ethical and legal standards in managing their organizations.
The accounting scandals in Table 1 clearly illustrate this point
11
Corporate governance refers to systems and controls implemented to
minimize the commission of any misdeeds that could harm a corporation’s 14
PwC in 2007 published a study of over 5,400 companies in 40 countries
reputation, brand and stakeholders.
that concluded that whistleblowers account for 43% of the fraud detection,
12 corporate controls account for 34% and law enforcement officers account for
In 1991, U.K. officials created the Cadbury Committee to improve
3%. The ACFE’s 2017 study found that whistleblowers account for more than
corporate governance standards.
34% of the detection of corporate fraud while 25% of frauds are detected by
13 accident.
The audit committee is arguably the most important committee in an
effective corporate governance program. The audit committee’s primary 15
Japan’s criminal justice system does not severely punish criminal
responsibility is to ensure both the accuracy of a company’s financial behavior, especially not for white-collar crimes. Statistics indicate that less
statements and the adequacy of internal controls designed to prevent than 5% of defendants convicted of crimes serve time in prison and the few
accounting malfeasance. who do seldom serve more than five years.

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as none of the executives at these firms served any prison time [5] History and Background: Development of CPA Profession. The
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discourages lower-level employees from questioning directives TONE AT THE TOP CAN BE DETRIMENTAL TO A COMPANY. HIGH BEAM
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[Link]
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[Link]
Accounting irregularities such as those witnessed in the [13] E. Lincoln and R. Litan. (1998). The Big Bang? An Ambivalent Japan
Toshiba scandal present a major threat to the viability of Deregulates its Financial Markets. Brookings Review. Available:
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a2bb-00144feabdc0
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[16] D. Skinner and S. Srinivasan. (2012). Audit quality and auditor
Toshiba’s internal auditors, external auditor and audit reputation: Evidence from Japan. Accounting Review, 87(5), 1737–
committee failed to detect the company’s accounting 1765. Available:
malfeasance for six years necessitates yet another clarion call [Link]
for regulators to implement strict corporate governance
standards and for courts to severely punish corporations that
fail to comply.

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[3] Anonymous. (July 2015). Murky earnings picture: Single call led to
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Available: [Link]

16
The Olympus accounting scandal provides an excellent illustration of
the potential consequences of failing to display such deference. In that case,
the board of directors fired Michael Woodford, the first non-Japanese CEO in
the company’s history, after he challenged the chairman of the board and the
company’s group president about the authenticity of advisory fees pain in
connection with suspicious business acquisitions that the board approved
before he became CEO. Woodward reported Olympus’ misdeeds to law
enforcement and regulators after his termination.

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TABLE 1: COMPARISON OF ACCOUNTING SCANDALS

YAMAICHI SEIBU KANEBO OLYMPUS TOSHIBA
SECURITIES RAILWAY
Year Founded 1897 1894 1887 1919 1939
Year Of 1997 2004 2005 2011 2015
Scandal
What Firm secretly Paid bribe to a New owners Overstated earnings by Overstated earnings
Happened reimbursed clients “sokaiya” to discovered former ¥200B yen over a 5-year by ¥136B ($1.2B)
for huge investment prevent managers period to conceal over from 2008 through
losses. Also paid disclosure that misrepresented the ¥134.8B ($1.7B) in 2015 to conceal
bribes to a shareholders company’s financial investment losses dating losses caused by the
“sokaiya”17 to owned more performance by ¥215B back to the 1990s. Paid 2008 global
prevent public than 80% of the ($1.6B) from 2000- bribes in the form of financial crisis.
disclosure. firm. 2002. advisory fees to hide the
losses.
Motivation For To conceal losses To conceal To conceal losses. To conceal investment To conceal losses
The due to reimbursing violation of losses. (e.g., losses from
Accounting clients for Tokyo Stock diversification into
Fraud investment losses. Exchange nuclear energy).
ownership rule.
How The Police found Police found Investigation initiated Whistleblower (its former Whistleblower
Fraud Was evidence of the evidence of the by new management. CEO)
Uncovered bribes. bribes.
Weakness In No non-executive No non- No non-executive Only 3 of 15 board Only 4 of 18 board
Corporate directors. Board of executive directors. Board of members were non- members were non-
Governance directors comprised directors. Board directors comprised executive directors. executive directors
Program only of senior of directors only of senior One non-executive and its former CFO
executives. comprised only executives. directors had no business chaired audit
of senior External auditor was experience and another committee.
executives. complicit in the fraud. had a conflict of interest Only 1 of 3 non-
with the company. executive committee
members had a
financial
background.
Regulatory None Seibu paid None because the ¥700M ($7.6M) ¥7.6B ($60M)
Fine ¥200M and company’s former
parent company management
paid ¥150M. committed the
accounting fraud.
Criminal Two former Former Three former Three former executives No criminal charges
Punishment executives received CEO received executives received received suspended jail filed against former
suspended jail suspended jail suspended jail sentences. executives.
sentences. sentence. sentences.

17
Sokaiya extort money from companies by threatening to disrupt their annual shareholder meetings by publicizing the sexual and financial improprieties of
their management.

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