Olympus: you really couldn't make it up

Readers may feel I go on too much about the scandal at Japanese camera and medical equipment firm Olympus but, although everything about it seems so extreme that it has become a parody of a corporate scandal, still it holds important lessons for corporate governance everywhere.

This story illustrates how good corporate governance demands that three key groups of stakeholders must act to preserve it; directors must live up to their responsibilities; investors must apply proper stewardship and regulators must act to protect the public interest. If directors fail in their duties then external directors must act, if they fail then investors or regulators must act. In contrast, the case of Olympus seems seems to illustrate  more of a national conspiracy amongst all parties to preserve the corrupt status quo.

The two latest acts in the comedy are; firstly that sacked CEO, Michael Woodford, has given up his attempt to be reinstated because the major Japanese investor groups refuse to act swiftly against the disgraced management; and secondly - you really couldn't make this up - that the firm is suing most of its own directors, who had a hand either in falsifying the company's accounts or in protecting colleagues who did, yet they remain in office until March and seem to have a hand in choosing their successors. Meanwhile the police, stock exchange and government regulators are 'investigating'. This has been going on for months - since October 2010. All of which clearly suggests that it is unsafe for foreigners, who are outside the coterie of Japanese conspiracists, to invest in Japanese companies. Who knows what else is going on elsewhere? Regulation and the rule of law patently mean nothing in Japan.

There are also other stakeholders who should have acted and could have influenced events. The auditors are clearly culpable. How on earth is it possible for successive auditors to miss a hole in the accounts that was over $1bn? And what are the Japanese authorities, whether accountancy bodies or police, doing about this and why is it taking so long? The other guilty party comprises the company's banks, who have extended credit in this situation. You can argue that it is not the role of banks to change management, their role is to lend at profit. That, however, is a simplification. In Japan the banks seem to be part of the conspiracy of the business elite. They have continued to lend, without apparent conditions, to a company that has been teetering on the verge of collapse. They have provided critical support that has enabled a corrupt management to stay in place: in a western context, banks would have demanded both good security and immediate management changes to protect their investment.

Governance on Olympus

Sorry for the dreadful pun of a title. Its poor quality gives some indication of the struggle I have had, and continue to have, with this important case study in appalling governance. The big question I have been thinking about is what lessons there are for corporate governance outside Japan where this company is based. Is it just too specific to the curious business environment of that one country to have wider significance?

I must start with a brief summary of the salient facts. In April 2011 an Englishman, Michael Woodford, was elevated to the position of president and chief operating officer of Olympus Corporation where he had worked for 30 years. The man he replaced, Kikukawa, was elevated to chairman. Woodford was appointed CEO in October but then removed after just two weeks. He claims this was because he queried transactions that had been brought to his attention by an article in Japanese financial magazine Facta in July.

This reported that Olympus had bought a series of small businesses that were peripheral to its main activities but apparently for very high prices. One of these, Welsh medical equipment maker Gyrus was acquired for $2.2bn, which included a $687m success fee to a middleman through a Cayman Islands registered company. A 31% fee is extraordinarily high and totally out of proportion to the size of the company acquired. Further acquisitions were queried in the days that followed and Woodford fled Japan, claiming his life was threatened. Japanese newspaper reports alleged that huge payments had been made to criminal underworld figures. After repeated denials of any wrongdoing by the company, a halving of its share price, and the opening of investigations by police forces and regulators around the world, it eventually admitted that these payments were actually an attempt to hide investment losses from the 1990's. Three board members resigned but the rest, who had all voted for the sacking of Woodford, remain. They have indicated there will be further resignations but not until after they have appointed new directors.

One of the many curious facts about this most curious scandal is that Japanese investors have been relatively subdued. Calls for resignations of all the board have mainly come from overseas investors which has led to a polarisation. Indeed the board of Olympus has spoken of issuing new shares, presumably to a 'friendly' party, which would have the effect of diluting the overseas shareholders who are vociferous in their criticism.

It would take too long to rehearse further facts of the case (for latest developments see here), I must turn to the issues;

• How have internal and external auditors missed such huge losses (around $1.5bn) over so many years and what sanctions do they face?
• Were they in collusion with management?
• What are the Japanese regulators and police doing, since such a huge falsification of accounts is surely criminal?
• Why are Japanese investors still so quiescent when they have lost over half their investment and they too have been seriously misled?
• The board of Olympus comprised almost exclusively company 'insiders'. Will this be an impetus to corporate Japan to start appointing genuinely independent directors who will challenge management?
• How on earth can the board that presided over this debacle still be in office and in charge of appointing their own successors?

The biggest question of all is why there seems a (possibly unspoken) conspiracy of collusion and closing of ranks between company executives, shareholders, regulators, police and government. Clearly Japan is a curious place where identity and loyalty are more important than cleaning the stables and punishing wrongdoers. The disgrace in this case does not just lie with Olympus but with corporate and government Japan.

Although a case like this occurring in the UK or USA would have resulted in arrests by now and a removal of the entire board I think there are still lessons on corporate governance for all of us outside Japan. The most important is that good corporate governance is not just about publishing codes of conduct: people may flout them. It demands that all stakeholders in the company live up to their responsibilities;

• Auditors must do their job properly
• Shareholders must not collude with the people who betray them
• Lenders must not support disgraced management
• Regulators must act swiftly and decisively to maintain trust
• Directors must be willing to challenge their colleagues

And let us not be too compacent because we are not Japanese. I will write separately about the results of the investigation into the collapse of Royal Bank of Scotland, one of the biggest banks in the world. Despite having a board packed with big names from the world of business, we are told that nobody really ever effectively challenged a domineering chief executive in Fred Goodwin, neither fellow directors nor the regulator.

The Boardroom Conversation

Unless key figures in an organisation live company values and are prepared to speak up, corporate governance policies are pretty much meaningless.....see my piece on the Boardroom Conversation in Financial Director

Update for "women in the boardroom"

Politicians love easy wins: they love good news; so UK government ministers are positively ecstatic that their calls for greater representation of women in corporate boardrooms has borne fruit after just a few months. Figures published by Cranfield Business School show that FTSE 100 companies have moved from 12.5% representation to 14.2%. Whoopee!

But look more closely. Out of 21 female appointments to FTSE 100 companies in the past six months, 18 are non-executives. So there is no evidence that promotion of women within companies is improving. Also the number appointed to a wider spread of FTSE 250 companies was only 28 - so just 7 for companies ranked 100 to 250.

Now it is movement and it may be a good thing but it still misses a large part of the point - diversity in the boardroom is good but equality of opportunity is better and demands changes to recruitment, development and promotion practices below board level. How many of those 28 had kids?

Psychopaths in the boardroom

A recent Horizon television programme for the BBC discussed the physical differences of psychopaths, whether noticeably different brain functions or differences in key genes. One of the principal researchers in this field, who appeared on the programme, reported that he found no less than sixteen murders committed by members of one branch of his family, over several generations. He also found that he himself had the gene that predisposes its carrier to this condition, attributing his lack of symptoms to a happy childhood and proposing that the gene on its own does not cause the condition but needs to be triggered by stressful influences such as childhood abuse.

Towards the end of the programme a New York psychologist, Paul Babiak, recounted his research that shows psychopathic characteristics are found disproportionately amongst top executives. Why should this be found amongst the most successful? Because the characteristics of the psychopath revolve around a lack of empathy for others and a need to take big risk. So the psychopath can be ambitious, manipulative and ruthless, without qualms and they will be attracted to jobs that give high adrenaline surges. Of particular note is another aspect of Babiak's research that shows these people may get to the top but that , once there, they perform noticeably less well than their peers. This should not be surprising - business is a collective activity that calls for social skills far beyond a mere ability to manipulate others.

Perhaps none of this should be too much a of a surprise. Many of us will have come across such people; manipulative, bullying charmers who, you feel, would sacrifice anyone to their ambition, whether friend or foe. And yes, I have felt they talked the talk but actually lacked the substance to perform in that top job.

What implications for corporate governance? I think this raises serious questions for those people who believe that rules and codes, or even laws, will control corporate governance on their own. If one or more senior people in a corporation is driven to take risks and seek thrills whilst having no moral scruples about harming others then will they not simply ignore those rules if they can? And the more precise you make the rules, to strengthen them, the more chinks appear, through which the determined can wriggle. You have to have the rules, but more important, you have to have the collective ethos that, like a net, holds the errant individual tightly in its strands. To continue the analogy, if the individual can cut one of the strands of the net then the net is weakened but it will still hold him unless he can cut many strands. So the real constraint comes from shared values across the organisation, where people will not be bullied into doing things that are patently contrary to those well-communicated values and the constraint comes from individual ethical behaviour - which is shared values at a society level.

Financial Times Briefings: Corporate Governance

My book on UK corporate governance is finally published.
ISBN-10: 0273745972

"Corporate governance describes the systems, procedures and behaviours by which an organisation is directed and controlled."

The book is designed as a quick, practical and accessible guide to what you need to know about UK corporate governance. It describes the basis of law and how voluntary codes, backed by a "comply or explain regime", were encouraged as government took fright over the effect of corporate scandals on capital markets. Inevitable accretions of bureaucracy have led to the voluntary approach being partly subsumed into law and describes how this trend is likely to continue under the influence of EU pressures to unify national practices.

The book covers the responsibilities of directors and boards and how the latter should be organised and managed. It also addresses the practicalities of how to measure, manage, discuss and justify corporate governance.

However, rules are not enough – both corporate scandals and anecdotal evidence suggest that behaviours are critical to good governance. Indeed too much legislation is counterproductive, turning into a box ticking exercise rather than something people really engage with. For the ill intentioned those laws and regulations merely provide neat targets for side-stepping and proving that their behaviour did not quite fit the definitions givem. Rules and codes, together with the prevailing climate of opinion can encourage appropriate behaviours and ensure the quality of the ‘Boardroom Conversation.’ But  if people think they can get away with sliding around the definitions while ticking the boxes then many of them will.do so; that climate of opinion is critical because it can discourage behaviour that falls just outside the definitions but that business partners believe is beyond the pale.

Furthermore, governance extends beyond the boardroom door. The blowout at BP’s Deepwater oil rig and GSK’s product quality failings at its Costa Rica drug manufacturing plant occurred despite compliance processes and safety officers and reams of risk assessments and governance procedures in annual reports. The behaviour of subordinates is also the responsibility of the board and an integral part of their governance duties – how do they make their policies stick?

The book emphasises that corporate governance applies as much to private as to listed companies as well as to a range of public bodies and not-for profit organisations. Good corporate governance contributes to business success, to successful fundraising and to dealing with business partners. It balances the needs and rights of different interest groups. It constrains the overmighty chief executive, chairman or shareholder to consider other stakeholders, appropriate levels of risk and to follow fair and transparent processes. It should reduce the incidence of corporate disaster as much as corporate fraud – better board structures and approach would surely have increased the chances of GEC avoiding policies that led inexorably to the company’s implosion? 

Key chapter headings include;

PART 1 – In Brief   

1          The executive précis:

2          What is it? What do I need to know?  Key terms/ concepts

The Background, Corporate Culture, Creative Accounting, Individual Behaviour, The legal structure, Current UK developments, Voluntary Codes or Legislation? The International Picture – EU, The Sarbanes Oxley Act etc

2.1            What is it for?  

2.2            Who is it for?  

2.3             Objectives

3.         Why do it? Risks/ Rewards

Compliance, Stakeholder demands, Corporate effectiveness, Public and Employee Relations, The costs, risks and rewards of good governance, Roes it work? Reasons for Corporate Social Responsibility

4.         Who’s doing it? Who has done it?   

What do success and failure look like?

  

PART 2     In Practice          

5.         How to do it

Role and Duties of Directors, The role of the Board, Integrity and Values, Shareholder rights, The Role of Markets      

6.                  How to manage it

           

7.                  How to measure it

           

8.                  The business case for corporate governance

9.                  How to talk about corporate governance      

PART 3 - Intervention

Executive intervention, Internal communication, Delegated Authority, Risk Management, Whistleblowing, When is my intervention needed? What questions should I ask, and who should I ask?   What are the decisions I need to make? What levers should I pull?            How do we know when we’ve succeeded or failed? 

PART 4 – Other Resources

websites, books, courses, consultants

Do directors of private companies have a duty to declare insider knowledge when puchasing shares?

Yesterday The Times reported on the settlement of a court case involving former shareholders in Uswitch who alleged that the Marquess of Milford Haven induced them to sell their shares, at an undervalue, to a company that they did not know was connected to him. Shortly afterwards the business was sold in its entirety for over £200m to a US company at a price per share some ten times what they had received.

The outline of the allegations points to an anomally in UK company law. For a company whose shares are publicly traded on an exchange, the directors are obliged by the Financial Services and Markets Act to disclose information about their share dealing and to make full disclosure of relevant information to shareholders through the regulatory news services. But this legislation does not apply to private companies. Shareholders in these businesses can only sue for deception or misrepresentation if they feel they have been wronged.

In another example, a friend of mine is a shareholder in a private company. After some years the shareholders as a whole appointed an outsider as chairman who, over a period, bought shares from individuals and became the largest individual shareholder. During this period there were expressions of interest from a foreign company in buying the business, though this has not yet come to anything. My friend thinks the chairman is very capable and has done a good job. There is no implication that he has done anything morally wrong. But UK company law offers very little protection if he had used inside information to buy shares at an undervalue. In this case, at least, the sellers would have known they were selling to an insider but would they have imagined that protections against insider dealing applied to them? Insider dealing is an offence defined in relation only to quoted companies not to private ones.

It seems to me that larger private companies which allow their shares to be traded should produce, at least, a code of behaviour for directors and other executive shareholders. If it were possible to put something stronger in place through a binding shareholder agreement that would be better. If a satisfactory way could be found to extend the law to private companies then that would be better still.