Case 22: Olympus: A Corporate Governance Picture That Was Out of Focus

Case Summary

Background

On October 14, 2011, British-born Michael Woodford, CEO of Olympus, was fired 6 months after becoming CEO.The firm's board of directors unanimously voted for his dismissal.

Olympus is a Japanese company that is well known for cameras, but the company also produces products such as medical imaging equipment. Woodford had worked at Olympus for 30 years, starting as a junior salesman selling surgical instruments. Woodford's vision was to not keep the status quo at Olympus but to shake up the organization. It appeared that Woodford's rebel-like nature was his ultimate downfall because he wanted to make quantum adjustments in the corporate culture at Olympus. In response to the firing, Tsuyoshi Kikukawa, the Chairman of Olympus, stated that Woodford was not able to understand the way business had been done at Olympus for 92 years. Woodford was told that even though he would no longer be CEO, he would still be a board member at Olympus. Woodford claimed that he was not fired because of a disagreement over his management style or because of his vision to change to the firm's corporate culture.

The Acquisitions

Woodford stated that he was fired for challenging Olympus officials to explain a story, published in July 2011, that claimed that Olympus paid exorbitant premiums on four acquisitions that occurred from 2006-2008. When asked by Woodford to explain the story, the Olympus executives told him not to worry about it. For the medical equipment company Gyrus acquisition, Woodford discovered that Olympus paid $687 million in advisory fees to a Cayman Islands based company, Axam Investments, that did not have any ties to Olympus. The fees were approximately 1/3 of the total acquisition price of $2.2 billion. Olympus also bought a plastic medical-waste disposal company, a company that makes microwave cookware and a mail-order cosmetics business. The acquisitions were not related to its core business of developing products that use lens and/or camera-like devices. On October 18, 2011, Kikukawa admitted to paying a high advisory fee for the Gyrus acquisition but refuted Woodford's estimates of $687 million in fees. The following day, Olympus reversed its course and agreed with Woodford's figure of $687 million being paid to advisors for the Gyrus acquisition.

The Ramifications of the Firing

Less than a week after Woodford's firing, Nippon Life and Harris Associated demanded an explanation from Olympus for the advisory fees paid for the Gyrus acquisition. As two of the largest shareholders of Olympus, both companies demanded accountability from the executives. Also, the Tokyo Stock Exchange ordered the company to explain the fees, since the average advisory fee is 1% of the price. A very firm ''friendly'' board of directors had 12 of the 15 members being Olympus executives who were loyal to Kikukawa. Within a week, the Olympus stock price was down 41%. On October 20, 2001, Olympus agreed to set up a third-party committee to investigate the acquisition. On October 24, Kikukawa lashed out at Woodford in a memo posted on the firm's internal website, where Kikukawa called Woodford's questioning aberrant and unforgivable. Kikukawa accused Woodford of using the controversy to try to consolidate his power base and try and force Kikukawa to resign. The same day the FBI announced it was going to start an investigation on the transactions that took place at Olympus. On October 26, 2011, Kikukawa announced his resignation as president and chairman of Olympus. He was replaced by Shuichi Takayama who had been at Olympus for 41 years.

The Cultural Treatment of Due Diligence

The Japanese culture is steep in traditions and customs. Along with harmony and consensus is the belief that that trust is enough for due diligence. Japanese managers believe that trust will ''guarantee'' that the correct actions are taken. In addition, a quirk in the Japanese corporate governance system occurred during the 1990s when aggressive deal making took place by Japanese firms. Small Japanese shareholders would threaten to challenge and dispute the annual stockholder meetings unless they were given money to keep quiet. The threatened use of extortion resulted in a culture that developed in which managers were never challenged, even by stockholders, at their annual meeting.

The Truth Starts Coming Out

On November 8, 2011, Olympus finally admitted that the payments were not for advisory fees. Takayama admitted that Olympus had carried out accounting practices that were not appropriate. On November 8, 2011, Olympus finally admitted that the payments were not for advisory fees.

Olympus had incurred decades of investment losses and used a number of acquisitions to "write off" the losses by writing down the acquisition's goodwill after the purchases had taken place.

The Use of Tobashi

The Tobashi procedure to write down trading losses is not a new one. Tobashi means ''fly away'' in Japanese and was used to ''clean up'' the financial statements of Japanese corporations.By transferring the money-losing assets, the losses "fly away". Approximately $2.6 billion in losses were hidden by making money ''transfers'' between Olympus and various clients.

How the Fraud Occurred

Olympus had numerous securities that had lost significant value. By the late 1990s, the loss on the securities was more than $1 billion, and there was going to be a change in the accounting procedure that would require the disclosure and writing off of the losses. Olympus officials decided to close down the transfer of funds through two major initiatives. The first was acquiring the three small Japanese companies. The other initiative was to write off the remaining losses by using the $687 million in fees from the Gyrus acquisition. The firm Axes America, which received the fees, was owned by Hajime Sagawa who was a ''partner'' with Olympus in setting up the fraud from the beginning. The reason why these payments were so large is because Olympus was running out of time. Japanese accounting standards had changed because of Enron.

In the past, Olympus could have used off-balance sheet subsidiaries to ''dump'' liabilities and make the financial statements more "attractive". In 2008, Japanese firms were required to consolidate any shell and off-balance sheet subsidiaries into their corporate financial statements.

Olympus had to dump the remaining losses as quickly as possible to have a clean financial slate by 2008 or else Olympus officials would have to disclose all of the previous transfers used to cover up the losses.

Rotten to the Core

On December 6, 2011, the outside panel appointed by Olympus to understand the cause and scope of the scandal released its report, which summarized Olympus's top executives as ''rotten to the core.'' The report stated that Olympus had told the banks to refuse KPMG's request to verify the collateral for the loans given to Olympus. The corporate culture at Olympus was opaque and lacking any corporate governance. The panel's report described top-level managers as a one-man system in which no one could challenge or object to the president. Only this type of laissez faire attitude toward checks and balances could have allowed this type of fraud to occur over decades. The panel concluded that it appeared that the top-level executives at Olympus did not care and were not concerned with the fraud that was taking place. The belief system of the executives was based on avoiding trouble and minding their own business. In a fine twist of irony, the two masterminds of the fraud, Yamada and Mori, were also responsible for overseeing Olympus's internal whistle-blowing hotline. To further reduce the effectiveness of the hotline, the whistle-blower system would not accept anonymous tips.

Where Were the Auditors?

KPMG Azsa signed off on the financial statements in March 2009 even though KPMG disagreed with Olympus about the treatment of the Gyrus acquisition. After being challenged by KPMG, Olympus hired Ernst & Young ShinNihon as the new auditor. When a new auditor is hired, the auditor must ask the previous one thirteen clearly defined questions that include whether the former auditor had a dispute with the firm over the handling of any account. During its tenure, KPMG appeared to have battled with Olympus on many occasions related to the fraudulent transactions.

The Aftermath After the Report

On December 21, 2011, Japanese authorities raided the corporate headquarters of Olympus in Tokyo. Former CEO Woodford tried to gather support from executives within and external to Olympus so he could return as CEO with a new management team. On January 10, 2012, Olympus filed a lawsuit against 19 current and former Olympus executives and board members for approximately $47 million for their role in the fraud. On February 16, 2012, seven people were arrested in connection with the fraud. On March 7, 2012, Japanese prosecutors filed charges against Olympus and six people, including three former Olympus executives, with violating Japanese law by creating and submitting falsified financial statements from 2006 to 2008. On September 25, 2012, all three former Olympus executives pleaded guilty to the charges. On July 3, 2013, Kikukawa, Yamada, and Mori were all convicted of falsifying financial statements and received a three-year suspended sentence. Olympus was also fined $7 million by the Tokyo District Court.

Answer the Questions (Write 150-word minimum for each question. Research outside of the case may be required to provide additional points)

1.If Olympus is found guilty, will the fine of $17.3 million be enough? Why or why not?

2.Ethics hotlines can be an effective resource for identifying unethical actions in a company. Why, in your opinion, did Olympus allow the hotline to be run internally?

3.Japanese culture seems to play a large role in this case. Explain the concept of due diligence and how it differs in American culture.

4.What stakeholders are affected in this case, other than the shareholders?