What Japan Inc can learn from Kobe crisis

Hiroya Kawasaki, Kobe’s president, said trust in his company had fallen to zero. To what degree the groups his steelmaker supplies will be affected is yet to be seen

The most unsettling aspect of Kobe Steel’s data falsification scandal is not the scale of wrongdoing — more than 500 customers globally have so far been affected and the risk of litigation could crush the company’s finances — but the problem of familiarity, according to legal and academic experts.

Kobe’s self-discovered and self-declared crisis arises from selling materials used in planes, cars, rockets, trains and nuclear reactors with falsified quality certificates. The practice may date back more than a decade. No safety consequences have yet been brought to light, though investigations have begun across Kobe’s domestic and international client base.

Four days after the scandal became public last week, Hiroya Kawasaki, Kobe’s president, described himself as “astounded” by the revelations and acknowledged that trust in his company had “fallen to zero”. Investors also appeared stunned. By Friday evening, when Mr Kawasaki admitted that the problem had reached multiple divisions of the company and the list of affected customers was more than twice as long as previously stated, the shares had lost more than 40 per cent of their value over the week.

After a concentrated two-year outbreak of Japanese corporate scandals — ranging from unqualified quality testers (Nissan) and accounting fraud (Toshiba) to safety cover-ups (Takata) and working staff to death (Dentsu) — common elements of crisis across Japan Inc have become more obvious. But while the specifics of each scandal may be unique, the corporate governance shortcomings and risk management systems are not.

“Did we not learn anything from Toshiba?” says Shin Ushijima, a lawyer and corporate governance expert, referring to the series of calamities that brought one of Japan’s most famous corporate names to the brink of collapse this year. “It showed how important the board is. What was [Kobe Steel’s] board doing?”

It is a question that will resonate further as more details emerge — particularly now that Mr Kawasaki is under pressure to explain how this continued to happen despite revelations of precisely the same data manipulation problem at one of Kobe’s group companies more than a year ago. That pressure will be all the more powerful than in the past, say analysts, because the 2015 corporate governance code has provided Japan with a better toolkit for parsing its crises.

Nicholas Benes, one of the authors of Japan’s governance code, says: “So far, this scandal seems to reflect aspects that are common to the governance-related mis-steps made by many other Japanese companies: something very embarrassing was done, and even if discovered, it was not reported widely enough internally, so it happened again. And at some level of the company it became a cover-up — making things much, much worse.”

One of the giveaways of corporate governance failure, says Thanh Ha Pham, an analyst at Jefferies, is that the problem has emerged across the Kobe group, rather than being restricted to a single division. Management does not see what is going on in each business unit, he says, adding that one eventual upside of the scandal could be to jolt the rest of Japan Inc into recognising that failure. 

Koji Morioka, an economist at Kansai University, says the Kobe crisis could be ascribed to companies across corporate Japan and is damaging to the country’s attempts to present itself as a pre-eminent purveyor of quality. 

Global competition has forced companies to cut costs, flout labour laws and over-stretch staff, often to the point of destruction, says Professor Morioka. They have increased the ratio of non-permanent workers, with less training and commitment than their full-time peers. “Each company has its own culture but generally in Japan all companies share the same very stale air, where they hide mistakes. Whistleblowing does not really work — somehow it is squashed,” he says.

Even now, with the scandal still in its confused early stages, it can be linked with many others. Tadashi Kunihiro, a lawyer with experience unravelling Japanese corporate scandals, says the root causes of Kobe’s crisis were shared with data falsification scandals at Takata, Mitsubishi Motors and Toyo Rubber.

There is a common mindset that data falsification cannot be found out easily and so can be repeated, he says, adding that the checks on technical data in many parts of corporate Japan were surprisingly loose. Others specifically link that with the more general reluctance of Japanese companies to embrace IT as quickly as their peers elsewhere in the world — particularly IT-based systems that reduce the scope for human error or fraud. 

“The question you ask with a lot of these older, diversified Japanese companies is whether they have absorbed real risk control into financial management, or whether they still allow human weaknesses to compound,” says Peter Eadon-Clarke, a Japan strategist at Macquarie. “Outside Japan, it is common for boards to include a number of outsiders who ask difficult questions; a board filled with insiders does not do that and nor, in Japan’s case, are they incentivised to probe.”

There may even be grounds for optimism in this scandal, says Nobuo Gohara, a lawyer and corporate compliance specialist who sees the increase in scandals as a signal of a rise in the number of employees uncomfortable with data tampering and fraud.

Nobuo Tomoda, a director at the think-tank Tokyo Shoko Research, sees an even brighter silver lining. “The Kobe case arose because of an internal inspection. In the past, this sort of thing would have been rubbed out even if it had been discovered. Whoever found it would have needed a tremendous amount of courage,” he says.

This post originally appeared on Financial Times

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