Chapter 4.2 Corporate Lessons: Know Your Businesses

Join us in reading Chapter 4 of the book, The Only Way to Survive for Japan, subtitled "Corporate governance is sure to save our country." This chapter provides a case study of Toshiba Digital Solutions Corporation, known worldwide as Toshiba, from the perspective of corporate governance.

In Chapter 4.2, the author examines mergers and acquisitions (M&A) and corporate committees' duties to monitor for abnormalities. Where are the lines for parent/subsidiary supervision, and how much knowledge about a subsidiary and its local business environment is enough to catch wrongdoing? Again, Toshiba, an early adopter of corporate governance, provides the case studies.

Find all published chapters at 'The Only Way to Survive for Japan'

Read Chapter 4.2, the 25th segment of the book:

Overseas M&A: Who's to Blame if it Fails

Toshiba is facing a management crisis because of the enormous loss it incurred.

The direct cause was a loss incurred by Westinghouse Electric Corporation, an American nuclear power company, which Toshiba had acquired. This shows a failure of its overseas M&A (mergers and acquisitions) strategy. At the same time, the root cause is that Toshiba failed to build the governance of its subsidiary.

A parent company, although it acquires a subsidiary through an overseas M&A, is nothing short of a mere dominant shareholder for the management of the subsidiary. In Japan, the president of a subsidiary is regarded as an insider. However, this does not hold true in Western countries. And this difference is lost on conventional Japanese companies. The Japanese company believes that the president is not on the side of its shareholders, but the company itself. Therefore, it misconstrues the president of an acquired subsidiary as its insider.

But in Western countries, the president of a company is a management professional. He/She receives high compensation and never anticipates any position in his/her parent company in the future.

What would such professionals do when they predict that they will not be able to achieve the profit target?

They could tamper with accounting. The board of directors should monitor for this to prevent it. However, if the board of a company is only composed of directors from the parent company and its management, the top executive gets his/her own way.

The situation goes from bad to worse if the parent company lacks the capability of grasping the real circumstances at its subsidiary.

Selecting Qualified Outside Directors

A subsidiary should inevitably have independent outside directors for the sake of its governance. Those who have adequate knowledge of the subsidiary and have experience in the business of the country where the subsidiary operates are most desirable as independent outside directors.

When I helped a foreign company acquire 100% ownership of a Japanese company, the foreign company even asked me to recommend candidates for directors. They knew that the entrustment of management is one thing, and monitoring is another.

Toshiba is said to have been leading Japan's corporate governance reform. But matters related to a subsidiary should be dealt with individually ー separately from the parent company. Except for the case where the parent company is deeply involved in the management of the subsidiary, what happened to Toshiba could happen anywhere. It is not a fire on the other side of the river.

(The Asahi Shimbun dated June 2017)

Training for Outside Directors

Toshiba's recovery still remains to be seen. Strong voices are saying that its previous presidents should be held liable. However, it is the board of directors that should be responsible.

I learned that corporate governance is a basis for firing the president of a company to make way for a new president. The board of directors is capable of sending away the president at any time. Nevertheless, in the case of Toshiba, which was a banner student of corporate governance, what should be questioned is the fact that its board of directors had neglected exercising its authority for a long time. I wonder what the outside directors who were free of in-house strings and interests had been doing.

For monitoring the management of a company, its directors are required to acquire the necessary knowledge regarding the company's business, finances, and organization. On top of that, they are expected to deepen their understanding of their roles and responsibilities. The principles of the Corporate Governance Code include the provision: "Companies should provide and arrange training opportunities suitable to each director and kansayaku (company auditor), along with financial support for associated expenses."

It seems that listed companies provide inside and outside directors with training regarding management strategies and business operations. However, some strictly argue that there is a shortage of human resources who are suited as outside directors with the profound basic knowledge necessary for business operations.

Providing Meaningful Training

There is also a movement going on to provide training to outside directors.

When a certain NPO, supported by the Tokyo Stock Exchange, implemented a three-plus-month training program, mainly for outside directors, more than sixty people joined. Half of them were outside directors, while the rest were would-be candidates for outside directors. After the completion of the program, they remarked, "This program truly made us realize that being an outside director is a job with heavy responsibilities."

Establishing corporate governance, just for the sake of formality, does not do the citizenry any good. Inevitably, there must be development and an increase in such human resources to be ready to respond to shareholders' demands, being fully conscious of the magnitude of their entrustment.

(The Asahi Shimbun dated July 2017)

*Kobe Steel corporate governance homepage. (Courtesy of Kobe Steel corporate website)*

Kobe Steel, Ltd Failed to Learn from 'Toshiba'

Kobe Steel, Ltd, having tampered with its inspection data, caused a big sensation. Products, which did not conform to the qualities agreed upon in the contracts, were delivered to more than one hundred companies overseas. Therefore, also began drawing interest from abroad because investors were significantly concerned about the fluctuation of the stock price.

The falsification was said to have been caused by the pressure exerted at the job sites for the achievement of production targets. It was similar to Toshiba's case, where the top executive demanded an inordinate target, calling it a "challenge."

However, Toshiba is no longer what it used to be because the board is now properly functioning. Under emergency circumstances, unlike under normal circumstances, it is mainly the outside directors of a company that should be involved in finding what caused the misconduct to occur. Otherwise, it would be difficult to let a company's self-purification workings function to prevent any wrongdoings from occurring.

It seems that Kobe Steel has been reluctant to learn from the lessons Toshiba manifested, despite that Kobe Steel has still seen scandals continuously occur.

When Outside Directors Don't Perform

This is clearly shown in the process of making public its falsified data on its steel products. On October 12, 2017, the top executive explained to the press that "there were no illicitly manufactured steel products." Nevertheless, the media reported the news of the alleged falsification of data on its steel products. And immediately following this news, on the 13th, Kobe Steel admitted to it.

To my consternation, the fact of falsified data concerning some products had been reported to the board of directors in the past. I wonder how the board dealt with it when it was previously made known to the board?

Five out of the 16 board members of Kobe Steel are outside directors, which falls in line with corporate governance reform. It also demonstrates that the perfunctory introduction of outside directors does not necessarily make the board function well automatically.

Kobe Steel has commenced an investigation by an external investigation committee. There was, however, no explanation as to by whom and how its committee members were chosen. I am concerned that if it is left as it is, the external investigation committee is going to go the way of the third-party committee, which was established under Toshiba's previous board of directors.

The problems with Kobe Steel are no longer confined to Kobe Steel alone. They could possibly affect the credibility of the whole manufacturing industry in Japan.

(The Asahi Shimbun dated November 2017)

Follow the book from Chapter 1, as it is published.