The Olympus scandal and corporate governance in Japan

On 22 October Sky News ‘Late Agenda’ interviewed me and Rick Wallace (Tokyo-based correspondent for ‘The Australian’) following an interview with Michael Woodford, former CEO of Olympus in Japan (click here and then here for 200-MB mp4 video-clips). Corporate governance in Japan is important for Australia, given the countries’ strong trade and investment relationship and recent pressure to finalise a bilateral Free Trade Agreement, as well as from broader regional and theoretical perspectives.

Woodford was a long-serving employee of Olympus and head of the European operations of this large and well-established camera manufacturer, who was appointed CEO of the parent company on 30 September 2011. Soon afterwards he became aware of some (third-tier) media commentary on unusual transactions in the parent’s financial statements. When adequate explanations and information were not forthcoming, Woodford called on Board members to resign, but he was promptly fired by the Board as CEO. He returned to the UK out of concern for this family’s safety, due to further media rumours that the transactions could be linked to organized crime syndicates (yakuza) in Japan. Woodford then resigned as director to lead a proxy fight to vote out the existing Board and reinstate him as CEO, but he gave up in January 2012 after the major Japanese shareholders did not commit to this course. Instead he brought a claim for unjustified dismissal before English courts, which Olympus has now settled reportedly for 10 million pounds.
Any yakuza connections have not been established, but internal and external inquiries soon proved that Woodford had been correct to question the transactions: Olympus had been covering up over a billion dollars in losses from speculative ventures dating back to the late 1980s. Key Board members were forced to resign, former directors and bankers were prosecuted, the company was fined and back taxes were sought. The share price plunged and has only partly recovered. Olympus came close to delisting and even insolvency, forcing the company to seek new business partners. Medical equipment manufacturer Terumo had been in negotiations, but it ending up lodging a claim against Olympus related to the loss cover-up. This month Olympus instead persuaded Sony to invest 50 billion yen (taking a 11 percent shareholding) and to embark on a joint venture for endoscopes. In January Olympus lodged two claims against former Board members for breach of duties (but not the former financial auditors), and a shareholder from Nara has also initiated a derivative suit. Yet the combined amount claimed represents only a small proportion of the total losses.
Woodford was in Australia to talk about this whole saga, which is certainly reminiscent of the scenario in ‘The Firm’, the fictional novel written by John Grisham (and movie starring Tom Cruise). Woodford was also promoting the forthcoming English version of his own book (‘Kainin [Terminated]’), published in Japanese in April 2012.
In the Sky News interview, I was ‘cautiously optimistic’ about the ripple-on effects from the Olympus case, thanks in part to the principled stance adopted by Woodford. The fact that the cover-up came to light and was quickly investigated, and even that Woodford had been brought in as a (semi-)outsider CEO in the first place, indicates a ‘gradual transformation’ that has been underway in Japanese corporate governance over the last two decades. As analysed in my (ARC grant related) co-edited book published in 2008, there have been some significant shifts in Japanese corporate law and practice towards giving more weight to shareholder interests.
Yet the legal reforms have also increased discretion afforded to incumbent managers in some respects, and (as in Germany, for example) the legal or de facto roles of core employees, creditors and other stakeholders do remain strong. Japanese corporations (and other organizations) also do not usually actively seek out and incorporate outsider views or promote diversity in top management – although the under-representation of women on Boards of large companies, for example, remains a serious concern in Australia too.
The Olympus scandal is indeed ‘Japan’s Enron’, although in that American corporate failure the directors were fleecing their own pockets. As in the US, this latest high-profile case in Japan is likely to prompt further reforms (either via Tokyo Stock Exchange Listing Rules or yet another round of corporate law amendments) aimed at bolstering ‘control monitoring’ (for transparency of financial accounts) or broader ‘compliance monitoring’ of incumbent managers. This should significantly benefit shareholders and indeed other stakeholders in Japanese firms. Most Japanese do tend to be cautious, usually preferring not to take high risks, so improving such monitoring mechanisms should be welcome.
However, with an ageing population putting increasing pressure on Japan’s pension schemes, as well as much greater foreign investment into Japan’s listed companies, it is no longer enough for firms to focus mainly on avoiding losses. Japanese companies are also under growing pressure to take calculated risks to generate profits. Yet the corporate governance system still does not have many strong ‘performance monitoring’ mechanisms, rewarding managers for enhancing profitability. Hostile takeovers, for example, remain rare, although they are no longer unheard of (and anyway not necessarily always effective in raising profitability).
One topic related to finding the right mix of monitoring mechanisms, and one which is generating considerable public and academic debate particularly in the wake of the Olympus scandal, is whether and how Japan should introduce more requirements for independent directors. This is the focus of ongoing comparative empirical and theoretical research that I’m presently involved in, led by Gakushuin University Professor Souichirou Kozuka with Nagoya University Professor Manabu Matsunaka (funded by the Nomura Foundation as well as the Japan Society for the Promotion of Science).
Since 2010, the TSE Listing Rules demand at least one independent director (or statutory auditor), with our research into the largest 225 companies showing on average about two ‘outside’ or 1.5 ‘independent’ non-executive directors (with board size now averaging 11.5 directors). This remains lower than proportions required or found in Australia and other major Asian markets. However, we are quite skeptical about whether such directors are always adequately equipped to carry out the monitoring roles expected of them, especially ‘performance monitoring’. The econometric evidence is mixed as to whether having more independent directors leads to significantly enhanced profitability, for example. This may be related to such directors often serving on multiple boards, as also in Australia’s ASX200 companies. And remember: it was Woodford (as an executive director and CEO) who blew the whistle on the Olympus affair, with no help from the three ‘outside’ non-executive directors (out of 15 Board members at the time).
[With thanks also to my colleague Fady Aoun, co-researcher in an LSSF-funded grant project comparing also the role of independent directors in Australia and Singapore.]

Author: Luke Nottage

Prof Luke Nottage (BCA, LLB, PhD VUW, LLM LLD Kyoto) is founding co-director of the Australian Network for Japanese Law (ANJeL), Associate Director (Japan) of the Centre for Asian and Pacific Law at the University of Sydney (CAPLUS), and Professor of Comparative and Transnational Business Law at Sydney Law School. He specialises in international dispute resolution, foreign investment law, contract and consumer (product safety) law.