Case Study: NISSAN MOTORS: CORPORATE GOVERNANCE FAILURE

On December 30, 2019, Carlos Ghosn landed in Beirut in what seemed like a Hollywood film escape from house arrest in Japan. Ghosn had been the iconic head of Nissan Motors Co., Ltd. (Nissan) for almost 18 years. A week after his escape from Japan, Ghosn held a press conference in which he claimed that he had "fled injustice and political persecution." The Japanese government and international media were busy trying to determine how someone could escape from an island nation despite being under 24-hour surveillance. However, Makoto Uchida, Nissan's newly appointed chief executive officer (CEO) and president, had no time to waste. Nearly two tumultuous years of managerial scandals involving Ghosn had dragged down the company's sales and profits and had caused stress in its alliance with French automaker Renault SA (Renault). In addition, the company's brand identity was unclear, and its luxury brand Infiniti was suffering from fierce competition by global rivals.

As Nissan tried to regain the trust of its stakeholders, Uchida and Nissan's board of directors faced some difficult challenges. How could the company strengthen leadership and governance? How would it manage its alliance with Renault? Could the company become sustainable and profitable again? A broader question was whether using a Japanese corporate governance model would help the company avoid such governance failures in the future. Should Nissan instead adopt a new governance model from among the over 20 international markets within which it operated?

NISSAN'SHISTORY

Nissan was established in 1933 in the Japanese city of Yokohama, 27 kilometres south of Tokyo. Over the next 20 years, Nissan became a leading global automaker. In 1960, it won the Deming Prize for engineering excellence, followed by numerous awards and accolades for its design, affordability, and reliability. By 2019, Nissan was operating in almost 20 countries worldwide.

After World War II, the company strived to produce reliable, low-priced, fuel-efficient cars. By the 1950s, Nissan had become a noteworthy automaker in the Japanese market. In 1958, the company began exporting its cars to North America under the brand name Datsun, outperforming Toyota Motor Corporation (Toyota) and Volkswagen AG in the number of total vehicles imported into the United States. A Kyodo News statement summarized the success of Nissan in the United States as follows: "Datsun was a big seller especially in the United States where its sporty, two-door hatchbacks became synonymous with fuel-efficiency during the 1970s oil crisis. For many teenagers in the 1970s a Datsun was their first set of wheels."

Japanese cars, with superior quality, better mileage, and greater reliability at a lower price, filled an important need in the United States during the energy crisis of the early 1970s. Nissan sales grew with the introduction of the sporty and extremely popular 240Z, which sold for only US$3,526 in 1970. Nissan's share of the Japanese automobile market expanded to 32 per cent in 1972. In 1981, the company rebranded its Datsun vehicles to Nissan, in a move that confused many customers who were not familiar with the Nissan brand. The rebranding resulted in losses of millions of dollars for Nissan.

The 1990s saw a major shift in the company's business strategy; it changed its focus on quality at the expense of customer preferences. Nissan management expected most clients to prefer fuel-efficient vehicles over playful, imaginative cars. Therefore, rather than reinvesting in research and development of new car models, as its competitors were doing, Nissan directed retained profits into different organizations and real estate, as contributions to its keiretsu (i.e., business group) partners.

A common belief among Japanese business executives was that investing in partners encouraged trustworthiness and co-operation in different parts of the value chain within the keiretsu network. Therefore, Nissan directed over $4 billion to keiretsu partners from 1990 to 1999. Moreover, starting in 1993, Nissan posted seven consecutive years of losses due to uninspired marketing, overstaffing, strict administration, exhausting vehicle designs, and conflicts with trade unions. Nissan quickly lost over 25 per cent of its market share to rivals Honda Motor Company (Honda) and Toyota, both in Japan and the United States. By fiscal year 1998-99, Nissan sales were down by $5.6 billion and the company had outstanding debts of

$22 billion in addition to the $20 billion owed by its Japanese keiretsu partners.

These issues were magnified by the Asian monetary crisis that depreciated the Japanese yen by 10 per cent against the US dollar.¹² As a result of Nissan's internal troubles and the external crisis, credit rating agencies such as Moody's and Standard and Poor warned in February 1999 that they would downgrade Nissan's stock rating to "junk" status, if it did not receive financial help from another source.

RENAULT-NISSAN-MITSUBISHIALLIANCE

Faced with an existential crisis, Nissan needed a key partner to provide both financing and new management thinking to manoeuvre a financial turnaround. Fortunately for Nissan, the global auto industry was undergoing rapid consolidation in the 1990s, with several prominent mergers and acquisitions. On March 27, 1999, Renault purchased 36.8 per cent of Nissan's shares for $5.5 billion, providing the financial support Nissan needed to rebuild and avoid bankruptcy. By purchasing Nissan's shares, Renault gained greater control and access to Nissan's top-of-the-line innovation.

In October 2001, the two merged companies announced a new alliance plan to further accelerate growth. The plan included mutual holding of shares by both companies. Renault increased its shareholding in Nissan from 36.8 to 43.4 per cent by subscribing to rights shares, while Nissan acquired 15.0 per cent of shares in Renault. In early 2002, the new Renault-Nissan alliance was registered in Amsterdam as a 50/50 strategic management company. The move provided strategic administration, created synergies, and allowed the supervision of corporate management between the two organizations. The new venture was founded on the premise that each partner would work in the pursuit of generating financial benefits for the other, while maintaining its own brand image and company values.

By September 2019, Renault owned a 43.4 per cent voting stake in Nissan, while Nissan held a 15.0 per cent non-voting stake in Renault. According to French laws, Nissan did not hold control rights in Renault because Renault held more than 40 per cent of Nissan's shares. Nissan and Renault were both listed

companies; Nissan was listed on the Tokyo Stock Exchange, and Renault was listed on the Euronext NV exchange in Paris. Both companies adopted the equity method to record their interest in each company on their financial statements.The equity method of accounting was used to value a company's investment in another company in which the investing company held significant influence and control. Several other major shareholders, including domestic and foreign financial institutions, owned stock in Nissan Global. Individual shareholding in the company was only about 20 per cent of total ownership.

In May 2016, Nissan declared its intention to obtain a controlling stake in Mitsubishi Motors Corporation (Mitsubishi). The announcement came shortly after Mitsubishi was found to have been misrepresenting the fuel mileage ratings of four small vehicle models, including two models that the manufacturer made for Nissan. A few months later, Nissan used its financial might to acquire a large stake of 34 per cent in Mitsubishi for $2.29 billion, making Nissan that company's single largest shareholder. As a result of the acquisition, Mitsubishi became the third company in the coalition, with Nissan and Renault.

The combined output from all three manufacturers exceeded 10 million units every year. The Renault- Nissan-Mitsubishi alliance employed more than 450,000 workers and controlled 10 noteworthy brands: Renault, Nissan, Mitsubishi, Infiniti, Renault Samsung, Dacia, Alpine, Datsun, Venucia, and Lada. The partnership also had vital strategic relations with other peers in the automotive industry, including Daimler AG of Germany and Dongfeng Motor Corporation of China.

In 2017, the Renault-Nissan-Mitsubishi alliance launched a six-year plan with the objective of doubling annual synergies by 10 billiona goal to be achieved through incremental revenue, cost-savings, and cost avoidance. The goal was based on working together toward zero-emission vehicles, common platforms, powertrains, and autonomous electric vehicles with connected technologies. The sales forecasts were expected to exceed 14 million cars and result in an annual turnover of $240 billion.

RISEOFNISSANUNDERLEADERSHIPOFCARLOSGHOSN

Ghosn served as Nissan's CEO from 2001 until April 2017, when he stepped down to retain his position as chair of the organization. Ghosn also served as chair and CEO of Renault starting in 2009 and chair of Mitsubishi starting in 2016. He was born in Brazil in 1954 to French and Brazilian parents, both of Lebanese descent, and he attended college in Paris. Following his graduation at the age of 24, Ghosn joined the French firm Compagnie Gnrale des Establissements Michelin (Michelin). After some time, he became chief operating officer (COO) of Michelin's Brazilian subsidiary, where he gained experience in overseeing enormous projects under unfavourable conditions. For example, he was tasked with growing sales in Brazil's highly inflationary environment.

Ghosn was later promoted to head of Michelin's North America office, where he was involved in a high-profile merger with Uniroyal Goodrich during recessionary times. Despite his triumphs during the 18 years he spent with Michelin, Ghosn understood that he could never be elevated to the position of president of the organization because Michelin was a family-run organization. With this realization, Ghosn left Michelin in 1996 and joined Renault as executive vice-president of advanced research and development, manufacturing, and purchasing. In the aftermath of a failed merger of Renault with Volvo Cars, Ghosn stepped in to turn Nissan around financially, during which time he earned the nickname "Le Cost-Killer" among Renault's big bosses and key management workforce because of his obsession with cost efficiency. After three years, during which time Renault shaped a key merger with Nissan, Ghosn was approached to take over as Nissan's COO, with the mission to revitalize Nissan. With experience in four major markets and proficiency in five languages, Ghosn seemed the right person to financially turn around a global company in trouble.

From the beginning, Ghosn was confronted with doubt from Japanese policy-makers and business leaders, who saw him as an outsider in Japana foreigner who was bringing western capitalist concepts to Japan's semi-socialist corporate culture. Many industry experts predicted a culture conflict between French and Japanese management styles. These observers felt that choosing Ghosn was one of the least favourable options for addressing Nissan's critical financial situation. The company's accounts that were incurring losses were increasing the organization's overall debt above the currently estimated $22 billion, and raising questions about Nissan's stability. Moreover, the brand's portfolio comprised models that were much older than those of competitors, projecting an image of an old, outdated organization in the minds of consumers.

In 1999, only four of Nissan's 43 models generated a profit. With little working capital available for new product development, there was no indication of increasing profit margins or a large volume of new business offers to deflect the company's misfortunes. Well aware of how critical his role was, Ghosn boldly promised to step down if Nissan failed to achieve profitability by March 2001, giving himself only two years to turn the company around. However, it took him only 18 months. By October 2000, Nissan was registering profits, to the chagrin of his critics.

Ghosn was 44 years old when he accepted the position as Nissan's COO. He immediately gained attention for being a vigorous and appealing leader who could effectively encourage and motivate individuals. Ghosn was a controlling leader who worked long hours (earning the other nickname of "Mr. 7-11"), although he eventually adapted to shorter hours to prepare for the future. Despite the predictions of sceptics, Ghosn accepted the contrast between the Japanese and his own culture. He believed that accepting and channeling those differences was a path to quick development and that accepting and expanding on the qualities of different societies would give all workers, including Ghosn himself, an opportunity to develop. Ghosn realized that if he tried to use his position to force change, as opposed to working through the Japanese culture, he would fail to turn around the company. He believed in transparency, execution, and communication, claiming that "When you get a clear strategy and communicate your priorities, it's a pleasure working in Japan. The Japanese are so organized and know how to make the best of things. They respect leadership."

Ghosn made an effort to meet each employee face to face, having long discussions with numerous employees and listening to their ideas about Nissan. Ghosn created cross-functional teams to generate proposals for change, rather than consulting outside specialists. He believed that this would increase enthusiasm and resolve communication issues that had been plaguing the entire organization. Working in groups helped team leaders find new methods and challenge existing practices. Ghosn focused on four key areas: advancement of new vehicles and markets, improvement of the Nissan brand, reinvestment in innovative work, and cost reduction.

Ghosn introduced a matrix organizational structure at the top to promote straightforward communication. Each team member was assigned two types of responsibilitiesfunctional and regionalwhich meant that each employee had two supervisors. The process would help employees gain familiarity with both functional and territorial issues. Ghosn also introduced incentive-based remuneration. The motivating forces included money and stock options linked to both top line and bottom-line targets. This strategy was a considerable departure from the customary Japanese remuneration framework, in which supervisors generally did not receive stock options. Furthermore, promotions were not restricted by age, experience, or instruction level. Some employees did not approve, but Ghosn gained support for his approach from most employees.

Ghosn's efforts were successful and led Nissan to the number-two position in Japan's auto industryafter Toyota and ahead of Honda. He sliced debt ratios, focused on cost reduction, streamlined the board of directors, rearranged accounts, and auctioned off non-performing resources. These cost-cutting measures, which seemed years overdue, were finally implemented. Ghosn shut down five local plants and laid off 21,000 employees. He sold off Nissan aviation and used the funds to pay off obligations. In the financial year 2002-03, Nissan again posted record sales and profits and paid off its debts. Nissan sold 2.77 million units worldwide, resulting in profits of approximately $7 billion, with a high margin of 10.8 per cent. Nissan saw two decades of glorious growth under Ghosn's leadership.

THEPAYSCANDALANDGHOSN'SARREST

On November 19, 2018, in the middle of the night, members of the Tokyo District Public Prosecutor's Office arrested Carlos Ghosn and Nissan representative director Greg Kelly on suspicion of misrepresenting funds in the company's annual reports. Both executives were caught unaware of the actions that led to their arrests. A special internal investigation had been carried out by Nissan under the leadership of Hiroto Saikawa, who was Nissan's CEO at the time. Saikawa had been groomed and appointed CEO by Ghosn the previous year, when Ghosn decided to step down (although he remained board chair).

The investigation was initiated in March 2018 after information was received from a Nissan foreign official who worked in the legal division. He communicated his concerns about Zi-A Capital BV (Zi-A), a subsidiary of Nissan, to the investigating group. Zi-A was set up in 2010 as a Nissan subsidiary in a suburb of Amsterdam. Ghosn was the CEO of Zi-A, and Kelly was listed as a Zi-A official. Nissan invested over $44 million into Zi-A, although the business had no representatives from Nissan.

In 2008, Kelly was promoted from his role as head of human resources and organization development in Nissan USA to become Nissan's corporate vice-president. In 2015, he became a representative director at Zi-A, with authority to represent the company. According to a whistle-blower in Nissan's legal division, Kelly ordered the confidential purchase of several real estate properties and explained that the transactions had to remain confidential for security reasons. During the financial year 2011-12, funds directed from ZiA to a dummy or shell corporation were used to buy and renovate luxury houses with a value of over $19 million in Brazil and Lebanon. Ghosn apparently occupied these properties for his personal use.

Ghosn's compensation was reported to be approximately $10 million per year since 2010, when Japanese companies were required to disclose the salary of top officials. There were concerns that Ghosn was underreporting his actual compensation each year to avoid local and overseas criticism of excessive remuneration. Overall, the company failed to disclose more than $90 million in compensation for Ghosn over a period of eight years. Ghosn's future total compensation was fixed, but not yet fully paid. Part of the amount was set aside to be paid upon retirement. The disclosures also failed to include stock options he was granted by Nissan and his salary as head of the Nissan-Renault-Mitsubishi alliance.

In 2017, Ghosn's total salary from all alliance companies was estimated at $16.9 million$8.4 million from Renault, $6.5 million from Nissan, and $2 million from Mitsubishi. Ghosn's salary as Nissan's chairperson was nearly 11 times the salary of Toyota's chairperson and higher than the total payment for the 21 highest senior executives at Sony Corporation, another Japanese company led by a foreign CEO. Ghosn instructed his human resources team to create two salary amounts for himone to report in the company's financial statements and another to report upon retirement. Nissan CEO Saikawa was aware of this plan, as were the company's internal auditors.

According to findings in the Nissan internal investigation, Ghosn and Kelly had decided that Ghosn would be paid $124 million in cash and other financial instruments as future salary for his advisory role. Ghosn entered into various secret contracts approved by Kelly and issued backdated letters authorizing himself undisclosed cash bonuses as incentives. After the investigation was completed, the resulting scandal shocked the entire automobile industry. An external panel of experts reported that the fraudulent activities were made possible both by the unchecked authority allowed to Ghosn over a long period and by weak internal controls.

THEPAYSCANDALANDSAIKAWA'SRESIGNATION

Saikawa, born in Japan and educated at the University of Tokyo, was fluent in English. He started working for Nissan in 1999, when Ghosn was first appointed COO. Saikawa supported Ghosn in his efforts to carry out radical changes at Nissan. He was initially appointed to the purchasing department to prove his ability to cut costs, which was an overriding concern for Nissan. He was later promoted to head of operations in the United States and, in 2009, to head of Nissan's Asia business, which included Nissan's China operations, a source of future growth. During the course of two decades of service at Nissan, he rarely engaged in personal conversations with his co-workers and almost never attended social gatherings. No one was sure what his ideas were, but he was a firm supporter of Ghosn's plans and orders. During meetings, he would berate underperforming executives, but he listened supportively in personal discussions. Saikawa, who would open most statements with "As Mr. Ghosn says," was considered by many as Ghosn's shadow.

Saikawa rose to Nissan's number-two position in 2013 when he became chief competitive officer. In 2017, he took over the role of CEO after Ghosn stepped down to become the company's chair. In October 2018, Saikawa learned about the secret internal investigations led by Nissan executives. He initially disagreed with the group but was eventually swayed to support the probe and formed an official team to investigate the allegations. A month later, Ghosn was arrested and Saikawa became his most vocal critic.Visibly befuddled and angry after Ghosn's arrest, he was entrusted to restore the company's reputation, mend ties with the company's major shareholder Renault, and improve declining profits. Saikawa announced immediate changes and promised improved corporate governance, setting up a special committee of independent directors to set remuneration policies for all directors.

On September 8, 2019, Nissan's board of directors met to discuss the findings of the internal audit conducted by Nissan. The audit disclosed a "share appreciation rights" function that was at the centre of the controversy surrounding Saikawa. The meeting's agenda included a succession plan for Saikawa, who expressed a desire to step down and pass the reigns of the company's management to the next generation. However, declining business performance and questions about $400,000 in stock options for Saikawa became the main topic of discussion. Saikawa claimed that the stock options were an error and agreed to return the funds, claiming that "I received remuneration in a form that does not correspond to the rules in force. I thought it was the result of proper procedures." His resignation had a ripple effect on Japan's capital markets, with investors losing confidence in Nissan's governance.

NISSAN'SCORPORATEGOVERNANCE

Nissan's board of directors comprised one female and eight male members, with five Japanese and four foreign directors. Ghosn had appointed three of the nine directors from outside the company. In 2018, Nissan's board of directors did not include sub-committees. A statutory audit committee, but no regular audit committee, was in place to oversee the appointment and functioning of the internal auditors and to review their audit procedures. The auditor was selected and appointed by the chair, subject to approval by the board of directors. Nissan's independent auditors, who were local affiliates of Ernst & Young Shin Nihon LLC, had also served as statutory auditors for Olympus Corporation and Toshiba Corporation, two companies that had experienced corporate scandals of their own.

Since 2009, all registered Japanese entities were required by Japan's Financial Services Agency to provide annual reports of an official's salary if it surpassed 100 million (approximately $800,000 at the time). By definition, executive compensation included retirement bonuses, which had to be reported after the amount was fixed. Nissan was found to have falsified documents and manipulated compensation details to circumvent disclosure of retirement bonuses and incentive compensation linked to the company's stock

price. Ghosn's compensation was underreported for eight years. Kelly, who served as Nissan's representative director for Zi-A, did not disclose his annual compensation from 2013 to 2018, when it exceeded 100 million and was therefore required to be reported. However, Japanese corporate governance did not cover the auditor's opinion on executive pay unless its impact was considered material, and underreporting an amount of 5 to 10 billion was not considered material by Nissan's auditors due to the company's 11.9 trillion in annual revenue.

Nissan's board of directors included neither a compensation committee nor a nominating committee. Starting in 2004, Ghosn was delegated the authority to determine executive and director compensation, including his own (within certain specified limits). Therefore, he had discretionary powers to set salary levels without oversight. Kelly determined the compensation for almost all staff except top management. He also looked after contracts and legal matters and had authority over all administrative matters.

In the absence of a nominating committee, Ghosn chose the company's independent directors. In April 2018, Nissan appointed two independent directors without business or management experience. One was a race-car driver, and the other was a Japanese bureaucratthe chief of international trade. Nissan's cross-shareholding plan with Renault created another issue of corporate governance. Renault owned 43 per cent of Nissan's shares, while Nissan held a 15 per cent non-voting position in Renault. Minority shareholders had no control to restrict the misconduct by Ghosn or by other Nissan officials.

Nissan paid Ghosn's sister advisory fees for no deliverables for an extended period. Ghosn also used chartered jets and Nissan's corporate jet for personal travel.Since 2009, a "CEO reserve" was established, which enabled miscellaneous expenditures beyond the budget policies of each department. The amounts were spent on "CEO matters," which remained undetectable. The transactions were considered preapproved by the CEO, which made questioning the transactions very difficult.

The average duration of meetings with the two newly appointed directors was less than 20 minutes. Ghosn avoided questions or dissenting opinions in board of director meetings. Auditors who stated opinions about Ghosn's decisionswho Ghosn referred to as "fastidious statutory auditors"were not re-elected. Directors, officers, and employees could not object or present their own views for fear of losing their jobs. The disclosure, governance, and risk-management issues at Nissan offered lessons for investors about weak internal controls and corporate governance issues in Japanese companies.

CORPORATEGOVERNANCEPRACTICESINJAPAN

The Japanese Corporate Governance Code became effective in 2015. It provided for voluntary adoption of guidelines on whistle-blowing, disclosures, shareholders' rights, and other ethical issues. Despite the fact that compliance was voluntary, the Japanese government and the Tokyo Stock Exchange provided constant support in adopting and implementing the code to bring significant improvements in corporate governance.

The focal points of the 2015 Corporate Governance Code were the composition and responsibilities of the company's board of directors. The code provided specific directions:

The board should be well balanced in knowledge, experience and skills in order to fulfil its roles and responsibilities, and it should be constituted in a manner to achieve both diversity and appropriate size. . . .

Independent directors should fulfil their roles and responsibilities with the aim of contributing to sustainable growth of companies and increasing corporate value over the mid- to long-term. Companies should, therefore, appoint at least two independent directors that sufficiently have such qualities.

In 2014, only 65 per cent of Tokyo Stock Exchange companies had at least one outside director. By the end of 2015, after the code had become effective, all Nikkei-listed Japanese companies were complying with the requirement of two independent directors. However, only an average of 1.2 of the directors had business experience.

A revised version of the code was announced in April 2019. The main purpose of the revision was to unwind cross-shareholding structures and to magnify the role of board committees in selecting and recruiting top executives, including the CEO.⁶⁹ The revised code required justification of cross-holding plans with respect to risks, cost of capital by the companies, and annual assessment of those costs by the board. The guidelines also emphasised the need to increase board diversity by including more female and foreign board members.

The corporate governance challenges highlighted at Nissan raised a general concern about the effectiveness of Japanese governance practices. It also questioned the way international alliances and joint ventures were governed and managed. Was Nissan an anomaly, or were there similar companies operating undetected across Japan and around the world?

Question: Analysis the case study.