News that Toshiba’s leadership has been lying about its profits — inflating them by $1.22 billion over a 7-year period — rattled the global business world this week. The overstatement is approximately one third of the total pretax profits the company reported since 2008.
But the reality is, the last decade and a half has witnessed unprecedented amounts of corporate fraud and the expropriation of shareholder wealth. Accounting scandals such as Enron, WorldCom and others have sparked a public outcry for better governance and shareholder protection.
As a result, analysis and theories surrounding corporate governance has exploded in financial literature. One area that has received an increasing amount of attention is “corporate culture” and revelations of Toshiba’s behavior offer greater evidence to the importance of upholding and nurturing a sound corporate culture. At the very least, Toshiba’s downfall offers businesses large and small a lesson in paying attention to this key feature in building a strong, lasting company.
A weak corporate culture is at the heart of Toshiba’s deterioration. How could this cover up have carried on for seven years? The answer is an internal culture that promoted this type of behavior. The investigation determined that the misreporting of profits began in 2008 when senior management began imposing unattainable performance targets. The investigation report states that, “when top management presented 'challenges', division presidents, line managers and employees below them continually carried out inappropriate accounting practices to meet targets in line with the wishes of their superiors."
Furthermore, the report states that “[w]ithin Toshiba, there was a corporate culture in which one could not go against the wishes of superiors,” leaving no room for course correction or whistleblowing. Leaders hold their positions because they lead people. So, when leadership acts one way, others follow. In Toshiba’s case, its leaders led the company to destruction. A positive, ethical corporate culture is necessary for the long-run success of a business.
While Toshiba’s president, vice chairman, and half of the company’s 16 board members have resigned, the impact of events like this have detrimental effects on the company for years to come. Once investor confidence has been destroyed, it can prove impossible to recover.
In “The Agency Costs of Managerial Indiscretions: Sex, Lies, and Firm Value,” my coauthors, Professors Adam S. Yore and Ralph R. Walking, and I found that businesses whose executives where accused of bad behavior in their personal lives witness an average decline in value of 10% to 11% during the year in which the indiscretion is announced. There’s no reason to expect any different when it comes to malfeasance directly related to company management. Toshiba has already dropped about 20% since the accounting issues came to light four months ago!
At the very least, Toshiba’s downfall can service as the latest reminder to business leaders and investors that positive, ethical corporate culture is crucial to the long-run success of a business. No company culture is the same and each should strive for its own unique brand but honesty, integrity, and respect are characteristics that work for every business. And, as we’ve learn from Toshiba and countless others, these habits must start at the top!