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Stocks

Market Scramble: Cracks in governance undermine case for buy Japan

Toshiba case shows how hasty overseas M&A growth can blur oversight

TOKYO -- Recent blows to investor confidence in the accuracy of corporate Japan's earnings statements are making it harder for the stock market to pull out of a slump.

"Though their earnings may be good, stocks in companies known for lax governance tend to suffer," said Mitsushige Akino, an executive at Ichiyoshi Asset Management.

Take Japan's leading advertising agency, Dentsu, which reported last Friday that it had erred in its assessment of the liabilities of a U.S. marketing company it bought last year. This should have been flagged in its internal controls report but was not, the company said.

Fixing the mistake led to a downward revision of its group net profit for the nine months ended last September. Shares in Dentsu fell more than 2% in the session after the announcement and still seem shaky, slipping 0.7% Thursday.

Consumer electronics maker Funai Electric recently submitted a remedial report to the Tokyo Stock Exchange after improper accounting surfaced at a U.S. subsidiary. Its shares also sold off Thursday, as did those of industrial materials distributor Shoko, which has delayed the release of its 2016 financial statements owing to a review. 

"Foreign investors are taking a harsher view" of such reporting missteps, said Masatoshi Kikuchi, pan-Asian chief equity strategist at Mizuho Securities. Fiscal 2017 is shaping up to be a good year for listed Japanese companies, but doubts about reporting accuracy impose an unwelcome weight on their shares.

A particular worry for investors are flaws in the internal controls that are supposed to alert the market to potential problems in the organizations behind earnings reports. Weakness in this area of governance has kept beleaguered Toshiba from reporting April-December results.

Twenty-two companies disclosed problems with internal controls reports in the fiscal year ended March 2016 -- the most in five years, reported Zeimu Kenkyukai, a Tokyo tax accounting research firm. In the last six months, such disclosures have come from Suminoe Textile, online auction site operator Aucfan and others, nearly all of which have seen their shares fall the following session. Typical reasons for the reports include improper accounting.

More generally, cases of improper accounting are on the rise. According to Tokyo Shoko Research, a record-high 57 listed companies disclosed them last year. Part of the problem is that, as a shrinking domestic market pushes Japanese companies to venture abroad, sometimes through rushed, poorly vetted acquisitions, oversight can fail to keep pace with group expansion. In broad terms, this describes the plight that Toshiba finds itself in, faced with staggering losses in its U.S. nuclear power business.

Toshiba already was rocked by revelations of dodgy accounting, and its auditor, Ernst & Young ShinNihon, was subject to administrative action by Japan's Financial Services Agency. Auditing has become stricter, which also explains the rise in disclosures of improper accounting.

Corporate Japan has made strides toward better governance, embracing outside directors, targeting return on equity and unwinding cross-shareholding ties. But this progress means little if investors cannot trust their earnings numbers. Toshiba's crisis should serve as an object lesson to other listed companies.

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