METRICAL: Why Are Scandals Repeated In the Same Company?

The topic of this year’s annual shareholders’ meeting was Toshiba again. As many of you may have heard, an external report revealed that “Toshiba and the Ministry of Economy, Trade and Industry worked together to exert undue pressure on some of its shareholders over a personnel proposal by its largest shareholder, Effissimo Capital Management, which was rejected at the annual shareholders’ meeting last June. This led to the replacement of the proposal for the election of directors (proposed by the company) at the annual shareholders’ meeting, and the reappointment of the director who chairs the board of directors was rejected at the shareholders’ meeting. In the wake of the accounting scandal that broke in 2015, it was thought that Toshiba had revamped its governance structure, with 10 of its 11 directors now independent outside directors and the transition to a company with a nominating committee, but the scandal has struck again. In January this year, Toshiba IT Services, a subsidiary of Toshiba Corporation, was found to have window-dressed its accounts with fictitious transactions. In addition to Toshiba, Nissan Motor, Mitsubishi Motors, and other companies have been repeatedly involved in scandals in the past, hiding recalls and cheating on inspection data. Why are the scandals repeated?

Companies that have been involved in scandals often set up independent or internal investigation committees to investigate the scandal, and then report the findings to the relevant authorities so that they can be used to improve the situation in the future. Why are scandals repeated without being applied to future improvements? There is not much research on this subject (perhaps because there are few companies outside of Japan that cause repeated scandals?) I found the concept of “Groupthink” by Janis, Irving, Groupthink: Psychological Studies of Policy Decisions and Fiascoes, 2nd edition (Boston: Houghton Mifflin Company, 1982) helpful. Groupthink is the tendency to act in a way that maintains group cohesion and comfort rather than making calm and objective judgments, resulting in poor quality solutions and objectively strange decisions. Groupthink is more likely to occur under the following circumstances: (1) the group is highly cohesive and isolated from the outside world, (2) there is no checking of opinions or provision of information in the process of considering a case, (3) there is a strong leader or influential person, and (4) there is excessive control, lack of time, and few clues. In Japanese society, where group cohesion is often prioritized over individual opinions and where peer pressure is strong, people tend to fall into the “Groupthink” described above, and as a result, I assume that it is not uncommon for objectively strange judgments and decisions to be made.

However, as mentioned above, Toshiba has reformed its governance system and now all but one member of the Board of Directors is an independent outside director. 10 independent outside directors include a total of 4 women and foreign-born directors, and the composition of the Board of Directors seems to take diversity into consideration. Incidentally, these 4 independent outside directors have expressed their opposition to the proposal to appoint directors who were allegedly involved in the scandal related to last year’s shareholders meeting. Did the board of directors have an open discussion on the personnel proposal of the largest shareholder prior to last year’s shareholders meeting? Have all independent outside directors been provided with the same fair and sufficient information as the executive side? Are the directors and executive officers sufficiently aware of governance and compliance? These are just a few of the questions that come to mind. The repetition of such scandals is an example of a governance system that is ostensibly in place, but in reality is not fully functional.

One of the characteristics of the scandal-ridden companies mentioned above is that they are large companies with a long history. The presidents (and executive officers) of large companies tend to serve as “salaryman presidents (and executive officers),” as they are called in Japanese, for a certain period of time on a rotating basis. These presidents (and executive officers) tend to be less conscious of managing the company from the shareholders’ point of view because they do not own much of the company’s stock. In this respect, their mindset is very different from that of the managers of companies run by the founding families. On the other hand, in the case of a not-so-large company, one scandal can put the company at risk of survival, so it can be said that only a large company can cause multiple scandals. As the saying goes, “too big to fail,” one might think that since they can’t fail, they can get away with doing something even if they are aware of the problem, or that the government and regulators will protect them in the end (in fact, in the case of Toshiba, it was reported that the government moved to prevent some shareholders from voting, and in the case of Nissan, the Ministry of Economy, Trade and Industry (METI) may have moved to remove Carlos Ghosn from management because it was concerned about the proposed merger with Renault. In light of the current repeated scandals, we cannot deny the risk at this point that companies that have been scandalized once are likely to be scandalized again. Even if the company has improved its governance system, we need to be very careful to determine that it is really getting better. In light of the current repeated scandals, we cannot deny the risk at this point that companies that have been scandalized once are likely to be scandalized again. Even if you have improved your governance system, you need to be very careful to determine that it is really getting better. It takes careful judgment to determine whether practices an action are actually improving, because it is not possible to immediately determine whether a change in the governance structure will lead to a substantial improvement in the quality of management. The conclusion is that such companies are not suitable for long-term investment at this time.

Aki Matsumoto, CFA

Please see detail research the following links.
http://www.metrical.co.jp/
Please feel free to contact the below email address if any interest or query.

Aki Matsumoto, CFA
Executive Director
Metrical Inc.
akimatsumoto@metrical.co.jp
http://www.metrical.co.jp/jp-home/

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