Haven’t we learned by now? You simply should not lie about any numbers that appear on your financial statements. Even if you somehow manage to get away with it in the short run, the truth will eventually come out. And when it does, the implications will be far, far worse than whatever deficiency you were initially trying to cover.
Take for instance Toshiba, the 140-year-old Japanese tech giant, that recently came under fire for overstating revenues by approximately $1.2 billion over the course of five years. Since the news broke, stock prices have dropped by more than 30%, and eight of the company’s senior executives, including CEO Hisao Tanaka, have resigned.
So why didn’t Toshiba learn from other companies like Enron, Tyco, or Adelphia that have gone through similar scandals in the past? Why did they feel such pressure to overstate profits?
As any basic accounting class will tell you, one of the most common ways to evaluate a company is by its profitability: stakeholders use profit margin to evaluate a company’s ability to turn sales into net income, which is important for a variety of reasons. Potential stock owners want to make sure the profit margin is high in order to receive the greatest possible dividends, while lending institutions evaluate profit margin to determine their chance of being paid back on a loan.
This logic is pretty straightforward, but what else could be making senior executives want to overstate profits? There are a plethora of reasons, but it’s important to note that more often than not, executive compensation is tied to profits.
Apart from the sheer size of the cover-up, perhaps most newsworthy aspect of the Toshiba scandal is the attention being given to overall corporate governance practices (or lack thereof) in Japan. Internal controls, external auditing, and non-biased boards are not commonly found, but it seemed like Japan was making a move in the right direction when Prime Minister Shinzo Abe established a rudimentary corporate governance code a couple of months ago. Now many are wondering if this move was a "too little, too late" situation. It will be interesting to see how the governance landscape in Japan changes as the Toshiba scandal turns more and more company stakeholders into financial detectives.
Toshiba scandal sheds harsh light on Japan's corporate governance http://t.co/RreAMF72Jv
— Guardian Australia (@GuardianAus) July 21, 2015
A word of caution—enhanced corporate governance has its advantages and disadvantages, and just as Toshiba should have learned from the actions of executives in the American scandals of 2001, it should also study the effects. The introduction of Sarbanes-Oxley in 2002 greatly improved governance in America, but misstatements still occur. It seems that people will always find a loophole. Additionally, some would argue that the costs of compliance have changed the landscape of business, with more companies choosing not to ‘go public’ or changing from public to private in order to avoid the expenditures.
Will Toshiba be able to recover? How will Corporate Governance evolve in Japan?