CASE 1.
Five years ago, George Woof was appointed CEO of Tomato Bank, one the largest global banks. Mr
Woof has a successful track record in senior management in America and his appointment was
considered very fortunate for the company. Analysts rated him as one of the world’s best bankers
and the other directors of Tomato Bank looked forward to his appointment and a significant
strengthening of the business.
One of the factors needed to secure Mr. Woof’s services was his reward package. Prior to his
acceptance of the position, Tomato Bank’s remuneration committee (comprised entirely on nonexecutives) received a letter from Mr. Woof saying that because his track record was so strong, they
could be assured of many years of sustained growth under his leadership. In discussion concerning
his pension, however, he asked for a generous non-performance related pension settlement to be
written into his contract so that it would be payable whenever he decided to leave the company
(subject to a minimum term of 2 years) and regardless of his performance as CEO. Such was the
euphoria about his appointment that his request was approved. Furthermore in the hasty manner in
which Mr. Woof’s reward package was agreed, the split of his package between basic and
performance- related components was not carefully scrutinized. Everybody on the remuneration
committee was so certain that he would bring success to Tomato Bank that the individual details of
his reward package were not considered important.
In addition, the remuneration committee received several letters from Tomato Bank’s finance
director, John Temba, saying, in direct terms, that they should offer Mr. Woof “whatever he wants”
to ensure that he joins the company and that the balance of benefits was not important as long as he
joined. Two of the non-executive directors on the remuneration committee were former colleagues
of Mr. Woof and told the finance director they would take his advice and make sure they put a
package together that would ensure Mr. Woof joined the company.
Once in post, Mr. Woof led an excessive aggressive strategy that involved high growth in the loan
and mortgage books financed from a range of sources, some of which proved unreliable. In the fifth
year of his appointment, the failure of some of the sources of funds upon which the growth of the
bank was based led to severe financing difficulties at Tomato Bank. Shareholders voted to replace
George Woof as CEO. They said he had been reckless in exposing the company to so much risk in
growing the loan book without adequately covering it with reliable sources of funds.
When he left, the press reported that despite his failure in the job, he would be leaving with what the
newspapers referred to as an “obscenely large” pension. Some shareholders were angry and said
that Mr. Woof was being rewarded “for failure”. When Mr. Woof was asked if he might voluntarily
forego some of his pension in recognition of his failure in the job, he refused, saying that he was
contractually entitled to it and so would be keeping it all.
a/ Criticize the performance of Tomato bank’s remuneration committee in agreeing Mr. Woof’s
reward package.
b/ Describe the components of an appropriately designed executive reward package and explain
why a more balanced package of benefits should have been used to reward Mr. Woof.
CASE 2
On July 22, 2015, Masashi Muromachi was appointed president of Toshiba Corporation (Toshiba)
after the resignation of the former chief executive officer (CEO), Hisao Tanaka. Tanaka had resigned
over the revelation of a JP¥151.8 billion (US$1.2 billion) accounting scandal that shocked the world. At
a press conference, Muromachi commented on his new role: “I am strongly feeling the social
responsibility of alarming and causing trouble to our 400,000 shareholders, including domestic and
international investors, as well as our clients and the authorities concerned. We will devote ourselves
wholeheartedly to regain your trust, and revive Toshiba under the new management.” Toshiba, a
Japanese multinational conglomerate with net sales of ¥6.5 trillion and total assets of ¥6.2 trillion,
had been widely criticized in the news for the multi-billion-dollar accounting fraud. The company’s
stock prices had declined by 38 per cent since it announced the accounting probe, and the company
had withdrawn the dividend that had been declared earlier.
The impact of the decreased share prices and the withdrawal of the declared dividend due to the
accounting scandal had been challenging for investors in the company, who had always regarded
Toshiba as a reputable company. On September 30, 2015, shareholders protested at an investor
meeting, questioning the company officials as to what went wrong. As the Hürriyet Daily News
noted, “Nearly 2,000 shareholders turned up to an investor meeting outside Tokyo, peppering a
new management team with questions about the affair which led to the resignation of Toshiba’s
president and seven other top executives in July.”
The investors were wondering the same as everyone else watching the scandal unfold: How could a
company with a 140-year history do this, and why? “There was no explanation of what we [wanted]
to know most: why it happened and who is to blame,” said one investor. Understanding investors’
concerns and the damage done by the accounting fraud to Toshiba’s investors worldwide,
Muromachi, the newly appointed CEO, apologized to investors: “Toshiba Corporation expresses [its]
sincere apologies to our shareholders, customers, business partners, and all other stakeholders for
any concern or inconvenience caused by issues relating to the appropriateness of its accounting.”
However, investors were still haunted by the unsolved puzzle of the accounting scandal.
What would the company do in response to this crisis?
ABOUT THE COMPANY
Toshiba was founded in 1938 with the merger of two firms, Shibaura Seisaku-sho (established in
1875) and Tokyo Denki (established in 1890). The Toshiba Group expanded and was driven by a
combination of acquisitions and organic growth in the 1940s and 1950s. The company name was
officially changed to Toshiba Corporation in 1978.
Since then, Toshiba, headquartered in Tokyo, Japan, had dealt in various products and services,
including information technology equipment and systems, industrial and social infrastructure
systems, electronic components and materials, consumer electronics, office equipment, household
appliances, lighting, and logistics. As of March 31, 2015, the company’s financial and stock data
included common stock valued at ¥439 billion and net sales of ¥6.7 trillion (US$55 billion), with 4
billion shares issued. The company employed approximately 200,000 people. Toshiba marketed itself
as committed to improving the quality of life for all people and ensuring progress in the world
community.
Domestically, Toshiba was listed on the Tokyo Stock Exchange (TSE), Nagoya Stock Exchange, and
Osaka Securities Exchange. As of March 2015, Toshiba had diversified into energy and infrastructure,
community solutions, healthcare systems and services, electronic devices and components, lifestyle
products and services, and others.
Financial Performance before 2008
Toshiba had enjoyed good overall sales and performance until 2008, with the net sales of the
company growing from ¥5.2 trillion to ¥7.2 trillion by the end of March 2008. At the beginning of
2008, Toshiba was in fourth position in the global portable personal computer market.
Financial Performance, 2009–2014
During 2009, Toshiba recorded disappointing results. The company implemented action programs to
improve its profitability by bringing in a ¥319.2 billion public offering to increase its capital
expenditure (mainly for strategic investments). From 2009 to 2013, Toshiba’s total sales decreased
from ¥6.5 trillion to ¥5.8 trillion, a fall of approximately 11 per cent. In June 2013, Hisao Tanaka was
named the president and CEO of Toshiba Group, while Asotosh Nishida held the position of chairman
of the board of directors. The economic growth the firm had experienced was better than the
previous year, but in terms of global economic growth, issues with the external business
environment persisted.
For the fiscal year ending in March 2014, all business segments showed better sales and growth; as a
result, the overall net sales of the company increased to ¥6.5 trillion, up from ¥5.8 trillion in the year
ending March 2013. The operating income rose to ¥290 million, an increase of 47 per cent, for the
same period (see Exhibits 1, 2, and 3 below).
Financial Performance, Q1 2015
For the first quarter of the financial year ending March 31, 2015, the net sales of the company stood
at ¥1,349 billion. In terms of operating income, the company incurred an operating loss of ¥11 billion,
leading to a net income (loss) attributable to shareholders amounting to ¥12.3 billion.
THE FACTS OF THE ACCOUNTING FRAUD
On February 12, 2015, Toshiba received an order from the Securities and Exchange Surveillance
Commission (SESC) to allow a disclosure inspection with respect to some projects in which a
percentage of completion method of accounting, among other methods, was used (see Exhibit 4).
The Japanese market regulator investigated Toshiba’s accounting methods under the authority
granted by Article 177 of the Financial Instruments and Exchange Act.
The SESC’s investigation was launched in response to a whistleblowing tip, the details of which were
never disclosed. It was then unclear whether the irregularities were due to errors or were deliberate.
Technology experts helped to recover deleted and old email messages that connected Toshiba with
accounting fraud. The recovered emails contained messages suggesting the use of misleading
practices, confirming that the irregularities were not simply errors: they were intentional
manipulations.
An internal investigation committee was set up by Toshiba to investigate the company’s book of
accounts from financial year (FY) 2009 through the third quarter of FY2014. FY2008 was also
included, but as a comparison year for the FY2009 securities report. When the committee revealed
the various fraudulent distortions across various Toshiba companies, Toshiba had no other choice
but to establish an independent investigation committee, which first met on May 8, 2015. The
independent investigation committee consisted of members from outside the company, as opposed
to the company -appointed members of the internal committee.
The problem was identified as accounting fraud when investigators found evidence of overstated
profits in various Toshiba business units, including the visual products unit, the personal computer
unit, and the semiconductor unit. It was found that the total amount of contract costs was
underestimated, and contract losses were not recorded in a timely manner.
The fraud had begun under CEO Atsutoshi Nishida in 2008, in the middle of the global financial crisis,
which had drastically reduced Toshiba’s profitability. The fraud had evidently continued with the
same intensity under the next CEO, Norio Sasaki.
In June 2013, Hisao Tanaka, a long-time manager of procurement and manufacturing in Toshiba’s
consumer electronics division, was promoted the position of president and CEO. As part of his
management strategy, Tanaka pushed his employees to meet their budget targets. The fraud
continued under Tanaka in this budget-conscious environment, and eventually ended in scandal.
Toshiba had a policy of personnel rotation after every few years. Due to this policy, by the time a
project was finished, the person who initiated it was gone and his or her successor was held
responsible for the losses of the project, if any. This system led to making immediate goals a priority,
even if it meant taking orders at a loss.
In one of Toshiba’s manufacturing contracts, the cost of the ordered work was expected to exceed
the negotiated price; however, the company did not record a provision on the balance sheet for any
loss-making contracts. In another project, Toshiba exaggerated its cost reductions. A review of the
contract work concluded that ¥1.7 billion could be shed in costs; however, in reality, the costs were
only reduced by ¥100 million.
To meet its profit targets, Toshiba implemented a plan to carry over and overstate profits by
adjusting profits and losses—a practice that had been going on since 2008. It was determined that
Toshiba used a cash-based method for its accounting instead of using the accrual method. The
company had also requested that its vendors issue postdate invoices in order to show those
expenses in the next quarter, even though the expenses had already been incurred. The company
has also failed to record some items, such as valuation losses, loan loss allowances, and so on. Eight
of the 16 members of the board resigned after the fraud become known.
TOSHIBA’S CORPORATE CULTURE
According to a summary of the investigator’s report, “Toshiba had a corporate culture in which
management decisions could not be challenged.” The investigation report further stated that
“employees were pressured into inappropriate accounting by postponing loss reports or moving
certain costs into later years.” Toshiba’s accounting fraud occurred less than four years after the
Olympus Corporation scandal with accounting fraud. In light of these instances of fraud in Japan,
Japan’s finance minister, Taro Aso, called the accounting fraud at Toshiba “very regrettable” and “a
blow to the country’s efforts to regain the confidence of global investors”. He also added, “If Japan
fails to implement appropriate corporate governance, it could lose the market’s trust.”
THE SITUATION BY SEPTEMBER 2015
The fraud was detected on July 21, 2015, and showed overstated earnings of ¥152 billion. On August 3,
2015, Toshiba was removed from the Dow Jones Sustainability World Index. Toshiba planned to
decide in late September how to punish its non-executives who were caught in the fraud. To prevent
the reoccurrence of such a situation, Toshiba said that it would scrap its monthly resident’s
meetings, where employees were told by top management to achieve unrealistic targets. The
company also decided to sell some of its assets to recover part of the funds lost to the fraud. By
September 29, 2015, Toshiba’s shares were at ¥292.8, a significant decrease from the peak stock price
of ¥539.9, attained in December 2014.
Mark Newman, an analyst at Sanford Bernstein, said that the financial impact was likely to be
manageable because of Toshiba’s flash-memory business. That business supplied smartphone
makers such as Apple Inc., and was expected to provide a majority of the company’s operating profit
in the current year. Yoshihiro Nakatani, a senior fund manager at Asahi Life Asset Management, had
recommendations for Toshiba: “They need to change into a more transparent organization, which
could mean the executives stepping down and bringing more outside directors… There is an
increasing chance of a downgrade…Concerns are mounting that this will begin to affect the
company’s relationship with financial institutions”
On September 14, 2015, the TSE, under its Securities Listing Regulations, designated the shares of the
company as “security on alert”, effective September 15, 2015. The TSE required payment from the
company in the amount of ¥91.2 million as a listing agreement violation penalty. The fears of
Toshiba’s shareholders intensified.
EXHIBIT 1: CONSOLIDATED STATEMENTS OF INCOME, TOSHIBA GROUP (¥ BILLIONS)
2009
2010
2011
2012
2013
2014
Net sales
6,364,800
6,129,900
6,270,700
5,994,300
5,727,000
6,502,500
Cost of sales
Selling, general, and administrative
5,103,905
4,710,778
4,781,880
4,538,563
4,313,956
4,854,349
1,357,430
1,493,754
1,301,472
1,250,128
1,253,156
1,215,289
expenses
Operating income (loss)
−232,859
117,600
238,700
202,600
197,700
290,800
Income (loss) from continuing operations
−259,677
27,200
194,700
145,400
159,600
180,900
Income taxes
Net income (loss) attributable
61,562
−343,559
33,534
−19,700
407,200
137,800
64,200
70,100
59,315
77,400
96,299
50,800
EXHIBIT 2: CONSOLIDATED BALANCE SHEETS, TOSHIBA GROUP (¥ MILLIONS)
Assets
2009
2010
2011
2012
2013
2014
Current assets
2,720,631
Long-term
receivables and
534,853
investments
Property, plant, and
1,089,579
equipment
2,761,606
2,799,668
3,009,513
3,160,440
3,209,224
622,854
660,380
701,225
706,188
664,646
978,726
900,205
851,365
884,680
960,035
Other assets
1,087,987
1,019,066
1,190,634
1,348,694
1,407,718
1,108,162
Total assets
5,453,225
5,451,173
5,379,319
5,752,737
6,100,002
6,241,623
Liabilities and equity
2009
2010
2011
2012
2013
2014
1,033,884
257,364
311,762
326,141
433,128
203,523
Short- term debt
Other current
liabilities
2,033,889
Total current liabilities
3,067,773
Long-term debt
Other long-term
2,231,081
2,488,445
2,186,547
2,343,421
2,498,309
2,304,311
2,669,562
2,388,523
2,737,439
2,592,046
776,768
960,938
769,544
909,620
1,038,448
1,184,864
849,403
874,168
931,850
943,344
908,038
812,386
liabilities
Total long-term liabilities
Equity attributable to
shareholders
1,626,171
1,835,106
1,701,394
1,852,964
1,946,486
1,997,250
447,346
797,455
868,119
863,481
1,034,268
1,229,066
311,935
330,167
311,497
366,730
381,809
423,261
5,453,225
5,451,173
5,379,319
5,752,737
6,100,002
6,241,623
Equity attributable to noncontrolling interests
Total L & E
EXHIBIT 3: CONSOLIDATED STATEMENT OF CASH FLOWS, TOSHIBA GROUP (¥ MILLIONS)
Cash flows
2009
2010
2011
2012
2013
2014
Net cash provided by (used in) operating activities
−16,011
451,445
374,084
334,997
132,316
286,586
Net cash used in investing activities
−335,308
−252,922 −214,700
Free cash flows
Net cash provided by (used in) financing activities
Effect of exchange rate changes on cash and cash
−351,319
478,452
198,523
−277,861
159,384
−154,716
−42,230
−240
−64,031
41,772
40,031
−89,309
−31,989
equivalents
Net increase (decrease) in cash and cash equivalents 95,144
2,994
−13,277
−2,065
17,123
11,449
−76,344
−8,609
−44,535
−5,136
−37,829
Cash and cash equivalents at beginning of year
248,649
343,793
267,449
258,840
214,305
209,169
Cash and cash equivalents at end of year
343,793
267,449
258,840
214,305
209,169
171,340
−377,22 −196,347
EXHIBIT 4: PERCENTAGE OF COMPLETION METHOD OF ACCOUNTING
This method of accounting recognizes a portion of revenue associated with a long-term contract in each accounting period
of construction or production under the contract. The percentage of completion is typically estimated by dividing the total
construction costs incurred to date by the total estimated costs of the contract or job.
% complete = (Total construction or production costs to date) / (Total estimated costs of contract)
Total estimated revenue, or gross profit, is then multiplied by this percentage of completion to derive the total revenue or
gross profit that has been earned to date.
Gross Profit to date = % complete x Total Estimated Gross Profit
Percentage of completion follows the accrual principle of accounting and matches expenses with related revenue.
−246,555
Questions
1.
What factors motivated
Toshiba to commit
accounting fraud?
(What pressure?)
1.
2.
3.
4.
2. List of factors that
increased the likelihood
of manipulation?
1.
2.
3.
4.
3. What are the
justifications for
committing fraud?
(rationalizations for the
fraudulent actions)
1.
2.
3.
4.
4. What options are
available for the
1.
company moving
forward? How can it
prevent such fraud in
the future?
2.
3.
4.
CASE 3.
The executive compensation committee of Blue Cross Blue Shield Board has come up with the
following reward package for the CEO, Redmayne for the coming year:



Base salary: $1 million. This salary is the standard for the CEO of a large public corporation.
The Blue Cross Blue Shield Corporation does not want to cross this $ 1 million since the
amount exceeding $1 million would not be tax-deductible.
Short term incentive: For every 1% over a threshold of 7% ROE, Redmayne received a
$1,500,000 bonus. He also received an additional $250,000 for every 0.5% improvement over
the prior year.
Long-term incentive: Redmayne had received stock options for 500,000 shares at $15 dollars
a share 5 years earlier. Since then, Redmayne had received annual grants of 100,000 shares
(see the following table for details)
Year
ROE (%)
Actual year
2012
12.04%
2013
11.5%
2014
6.5%
2015
7.8%
Number of shares issued
Exercise price ($)
upon exercise of
outstanding options
2011
500,000
15
2012
100,000
20
2013
100,000
25
2014
100,000
30
2015
100,000
27
a/ Calculate the cash compensation of Redmayne for the three years 2013, 2014, 2015
b/ In what year should Redmayne exercise his stock options to maximize the proceeds? (Assuming
that he has to exercise all his outstanding stock options up to that year)