Toshiba Accounting Scandal: A Corporate Culture Problem

We have all read about the Toshiba accounting scandal in which the company overstated earnings by more than $1.2 billion over seven years. (My colleague Matt Waldron’s posts on the issue generated the most buzz on our Market Integrity Insights blog, to date, this year.) The fallout from the scandal included the resignation of its CEO and a reorganization of its board in which many members stepped down. Indeed a report from the company stated that its three most recent CEOs had a part to play in inflating the company’s operating profit.

The Toshiba scandal exemplifies a massive failure in corporate culture, candor, and governance. And it came as a surprise to many, as Toshiba had been lauded not that long ago for its ethical culture and corporate governance practices. According to the Financial Times:

In 2013, the group was ranked ninth out of 120 publicly traded Japanese companies with good governance practices in a list compiled by the Japanese Corporate Governance Network, a Tokyo based non-profit organization.

As it turns out, the governance structure that looked good on paper was ineffectively monitored by the company. How could this have been avoided?

CFA Institute has long supported a strong corporate culture, good governance, and transparency. We believe they are necessary not just to avoid major accounting and business scandals, but also because they have a large impact on both company valuations, investor trust, and investment. L.J. Rittenhouse, CEO of Rittenhouse Rankings, maintains the valuation of companies is affected by perceptions of the quality of its leadership. Senior executives are viewed as the protector or destroyer of the corporate culture, and candor is essential to building strong, effective cultures.

Similarly, the CFA Institute publication, Financial Reporting Disclosures: Investor Perspectives on Transparency, Trust, and Volume, discusses the lack of transparency in corporate financial reporting and its implications for investor trust and investment. The study examines the recent financial crisis that clearly demonstrated the insufficiency of financial reporting and disclosures, particularly within financial institutions. The report contends that without trust in financial institutions — the handmaiden to the broader economy — investment overall can lag.

Likewise a report of the Association of Chartered Certified Accountants (ACCA), Understanding Investors: Directions for Corporate Reporting, illustrates the critical relationship between transparency in financial reporting and investor trust — and the potential ramifications for investment activity. It states:

Clarity and transparency matter. More than two out of three investors said they would apply a bigger discount to a company if its corporate reporting lacked clarity. Good reporting can also help to strengthen financial markets and ensure that capital flows to where it can be most usefully invested.

Simply put, good culture, governance, and candor are necessary elements for a company to thrive.

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