A tale of two scandals: Toshiba and Samsung
Can the two troubled giants reinvent themselves?
Corporate scandals occur in many places and in many shapes and forms. Usually the misdeeds are particular to the company concerned, but sometimes they tell a bigger story, of time-honored corporate cultures struggling to cope with new economic and social realities. Such is the case with the recent troubles of two iconic Asian companies, Toshiba and Samsung Electronics.
The case of Toshiba is Japan's first, though probably not last, example of an American-style, bull-market corporate scandal. In previous decades, investors had become inured to backward-looking corporate cover-ups, such as the Olympus scandal of 2011. That came to light when British CEO Michael Woodward blew the whistle on his own company, which had been concealing huge investment losses since the early 1990s. In bear-market scandals of this sort, nobody gets rich and the disclosure corrects no great injustice.
In contrast, the Toshiba scandal was forward-looking and had obvious beneficiaries. In line with corporate Japan's new emphasis on RoE (return on equity), top management set ambitious internal profit targets for the main divisions. The word went out that these goals were to be achieved by all means possible. The targets were met soon enough but with the help of channel-stuffing, backloading of costs on projects, unrealistic valuation of acquisitions and other accounting flim-flam.
When the accounts were revised in 2015 and the ugly truth was revealed, the result was a torrent of red ink. A scheme intended to boost shareholder value and reflect glory on top executives ended up sinking the stock price to 35-year lows and imperilling the company's stock exchange listing.
As corporate accounting fiddles go, it was hardly in the Enron class; but given the company's illustrious tradition, the shock-waves were palpable.
Karakuri dolls and sutras
The two companies that came together to form Toshiba were founded by two remarkable inventors. Hisashige Tanaka, born in 1799, was a self-taught genius who created long-burning lamps served by fuel pumps, clocks that ran for a year and "karakuri" mechanical dolls that could walk, shoot arrows accurately and pick up ink-brushes and write Chinese characters. Ichisuke Fujioka visited Thomas Edison in the U.S. and pledged to the great man that he would build an electric power industry in Japan. And he did.
The company's austere integrity was symbolized by ex-engineer Toshio Doko who became CEO of Toshiba in the 1960s and an advisor to Japanese prime ministers in the 1980s. Doko, a devotee of Nichiren Buddhism, lived in a small wooden house and woke every morning at 4 a.m. to chant sutras. He used the same hairbrush for 50 years and went to work by bus, even as head of the Keidanren association of large corporations. He once said "I don't trust people who live in luxury residences."
Toshiba grew into a sprawling industrial empire, with a vast portfolio of products ranging from rice-cookers to guided missiles, from light-bulbs to locomotives. Amongst its many innovations were the world's first laptop computer (1985), flash memory (1991) and DVD player (1997).
For much of its history Toshiba epitomized the technological prowess and dynamism of Japanese conglomerates. By the 1980s its logo and advertising slogans had become familiar sights in Western capitals. From the 1990s onward, though, the going grew a lot tougher. Lower cost competitors, one of which was Samsung, proved as adept at copying Japanese products as the Japanese had once been at copying American and European products.
Doko had counselled Japanese companies to exit businesses that other Asian countries were entering and move up the value chain, but Toshiba and its Japanese peers plowed yet more capital into TVs, memory chips and other commoditized products. The result was chronic financial deterioration. Even the inflated profit margins the company was posting before the deceit was uncovered were poor by international blue chip standards.
The 'Republic of Samsung'
Samsung Electronics, like most of South Korea's industry, went through a savage restructuring during the Asian crisis of the mid-1990s. It emerged in ferociously competitive shape, with the structurally weak currency, the won, adding a welcome boost. The company's strategic focus on three key products - LCD panels, flash memories and smart phones - proved to be a masterstroke, giving it a powerful position in rapidly growing markets. Profits boomed as an army of talented engineers and designers kept it ahead of the ever-changing technology game.
Investors now are certainly not complaining. The stock has risen 580% since 2000, and accounts for about 20% of South Korea's total market capitalization. Even with the recent scandal, Samsung Electronics' stock is up 60% over the past 12 months.
The involvement of Jay Y. Lee, vice-president of Samsung Electronics and de facto leader of the Samsung group, in the scandal surrounding President Park Geung-hye is complicated and murky. But the eruption of street protests involving ordinary middle-class citizens speaks of deep dissatisfaction with the status quo.
Clearly, there is little problem with the operational side of the company -- the excellence of its track record speaks for itself. Rather, the issue is governance. Specifically, the merger of two Samsung groups in 2015 was waved through by regulators at terms that benefitted the founding family at the expense of minority shareholders. There are suspicions over questionable dealings at the highest levels.
Not for nothing is South Korea sometimes dubbed "The Republic of Samsung."
The governance vacuum
In pre-war Japan, the commanding heights of industry were dominated by the "zaibatsu," groups of companies controlled by the founding families. After Japan's World War II defeat, the American occupation authorities broke them up on the grounds that they had been complicit in militarism.
In the 1950s and the 1960s the companies came together again in looser networks known as "keiretsu," this time with no wealthy capitalists on the shareholders' register. Instead there developed a pattern of cross-holdings which bound the keiretsu members together and served as bulwarks against interfering outsiders. Toshiba joined the Mitsui zaibatsu in 1893 and remains part of the Mitsui keiretsu today.
The upside of this arrangement was that in the high-growth era of the 1970s, Japanese companies could support each other and managements were free to invest as they liked, with ample capital available from the group's main bank. The downside, increasingly apparent from the 1980s onward, was the existence of a governance vacuum. Japanese managements had little incentive to take the bold decisions necessary in rapidly changing circumstances -- and there was nobody to pressure them to do so.
South Korea, not being a defeated nation, underwent no such enforced restructuring. Wealthy families continue to control the industrial groups known as "chaebol", which is written with the same Chinese characters as "zaibatsu."
The upside is that these companies are now run by people with a vast amount of skin in the game, like the Lee family, as opposed to the cautious "salaryman CEOs" who are still abundant in Japan. The downside is the age-old political question: "Quis custodiet ipsos custodes," or :"Who guards the guardians?" In the absence of transparency and shareholder democracy, what is to stop top management abusing the rights of minority shareholders, practicing nepotism or damaging civil society by corrupting politics?
The absence of good governance is rarely an issue when everything is going well. But in the dynamic world of technology, winners do not stay winners forever. Not just Toshiba, but Nokia, Motorola, Xerox, Fujitsu and many other faded tech and electronics stars can attest to that. With Chinese challengers becoming ever more sophisticated in smart phones and other devices, even the mighty Samsung Electronics may face testing times ahead. The recall of exploding Galaxy 7 smart phones is financially trivial, but also a reminder not to take anything for granted.
Setbacks spur change
The Toshiba scandal has already had a constructive effect on the company itself and on corporate Japan as a whole. It has shown that increases in RoE must come from structural improvements, not accounting legerdemain. For over-extended behemoths like Toshiba, concentrating resources on strong businesses and exiting the weak ones is essential. In 2016 the company sold its household goods business to China's Midea and its medical instruments business to Canon. It has the depth of technology to survive, but in order to prosper it will have to make further efforts to reinvent itself.
The Samsung scandal may well be positive too. The South Korean stock market trades on the lowest price earnings ratio in the Asia-Pacific region partly because of the discount applied by investors to compensate for shabby treatment of outside shareholders. If the political reaction leads to a weakening of the hold of the chaebol oligarchs, there will be benefits for investors and the wider South Korean economy, as more space appears for entrepreneurial activity.
In the words of the great Toshio Doko, speaking 40 years ago, at a time when Japan's economic conditions were much worse than now: "Just as we needed a lost war to change from militarism to democracy, so people always need a spur to do something new."
Peter Tasker is an analyst with Tokyo-based Arcus Research