Olympus is a Japanese company that specializes in medical imaging tools and photo/video cameras. Back in the 1980s, when the operating income of the company decreased due to the “sharp appreciation of the yen”, the Olympus executives started an “aggressive financial assets management” in order to shift losses off the company’s balance sheet (Elam, Madrigal, & Jackson, 2014, p. 325). As a result, Olympus has managed to hide $1.7 billion of investment losses for more than a decade.
The case of Olympus is the example of the financial statement fraud in which an employee “intentionally causes a misstatement or omission of material information in the organization’s financial reports” that eventually results in “median loss of $1 million” (Morgan & Burnside, 2014, p. 175). To conceal the losses, the company has developed a tobashi scheme in which they booked the company’s assets at historical cost instead of fair market value. In 1997, the Japanese legislation was reformed, and since then all the assets should have been booked at fair value.
In response to these changes in accounting regulations, the Head of Olympus Accounting Department Hideo Yamada and his subordinate in investment dealings Hisashi Mori developed a “loss separation scheme” that used newly created off-balance sheet entities to hide the investment losses (Elam et al., 2014, p. 326). With the help of this scheme, Olympus expended $1 billion on three companies that never existed, but had been registered as “a mail order face cream company, a company that made plastic plates for microwaves, and a recycling company” (Lorsch, Srinivasan, & Durante, 2012, p. 3).
Besides that, $700 million were allocated for the so-called financial advisory services that Olympus needed for the acquisition of the UK health care company Gyrus (Lorsch et al., 2012). When KPMG AZSA LLC, the independent auditor of the company, questioned the overvalued price of three small companies and excessive advisory fees, Olympus broke the contract with its longstanding partner and started to work with Ernst & Young ShinNihon LLC.
In 2011, when Michael Woodford was appointed to the position of a Chief Executive Officer, he also noticed the improbably large sums of deposits into the shell companies and attempted to investigate the accounting activities of Olympus. Two weeks later after his appointment, the Board of Directors initiated Woodford’s dismissal. Then he hired a forensic accounting company PricewaterhouseCoopers to conduct an independent investigation. When the Olympus fraud was exposed and made public after the publication of the Investigation report, the company faced severe consequences.
The Tokyo Stock Exchange imposed $130,000 fine on Olympus “for damaging investor confidence” but made a decision to allow the company to keep its shares listed (Lorsch et al., 2012, p. 8). Such relatively low financial price of the Olympus fraud was supplemented by the criminal prosecution of its initiators. Thus, in 2012, the former chairperson Tsuyoshi Kikukawa, former executive vice president Hisashi Mori, former company auditor Hideo Yamada as well as the external auditors Akio Nakagawa, Nobumasa Yokoo, and Taku Nada were filed by the Securities and Exchange Surveillance Commission for the violation of Japan’s Financial Instruments and Exchange Act (Lorsch et al., 2012).
These men were sentenced to imprisonment or $125,000 fine (Elam et al., 2014, p. 327). The Olympus Corporation faced $1.2 million fine for false accounting (Elam et al., 2014, p. 327). The financial statement fraud of Olympus has led to international scandal and heavy penalties both for the company and for its managers.
The key players of the Olympus financial statement fraud knew about the fraudulent scheming of the Accounting Department. Toshiro Shimoyama had been the president and CEO of the Olympus Corporation since 1980. He was aware of the shell companies that Olympus used for deposits. Hideo Yamada and Hisashi Mori were the authors of the loss separation scheme, which allowed them to become the members of the company’s Board of Directors. Tsuyoshi Kikukawa was the management director and the chairperson of the Board of Directors.
Michael Woodford that was appointed to the position of Olympus CEO in 2011 did not know about their fraudulent scheming and attempted to find out the sources of the excessive deposits and advisory fees. However, there are parties whose awareness of the Olympus fraud is a controversial issue. While the investigative panel that was formed to examine the case of Olympus stated in their report that the internal auditors had allowed Olympus “to misstate its finances” (Tabuchi & Bradsher, 2012, para. 8), Woodford claimed that he had had no reason to question the professional competence of the Olympus auditors (Audit and Risk, 2014).
At any rate, Japanese corporate culture highly relies on the personal loyalty in business affairs (Lorsch et al., 2012). The internal auditors could conceal the fraudulent scheming of the company’s top management in order to express their loyalty and respect. During the investigation, the shareholders requested to examine the activity of the Olympus independent auditors: Ernst & Young ShinNihon LLC and KPMG AZSA LLC.
The shareholders believed that these external auditors might participate in the Olympus fraud. KPMG AZSA LLC remained the unchanging Olympus auditor for a long time, but when they started to doubt the financial advisory fees paid for acquisition of Gyrus, the Board of Directors replaced them with Ernst & Young ShinNihon LLC. Unlike KPMG AZSA LLC, the new auditors had approved the difference between the book value and the purchase price. The Investigation Report states that the audit of Ernst & Young ShinNihon LLC was “inappropriate” but explains it by the lack of professionalism rather than intentionality (Lorsch et al., 2012, p. 8).
The reason why the Olympus fraud remained hidden for over ten years consists in the high-quality scheming of the Olympus top management and professional incompetence of the auditors. The Investigation Report states that the Olympus executives had “so cleverly buried the losses that external auditors could not have uncovered them” (Tabuchi & Bradsher, 2012, para. 7).
However, there may be one more factor that contributed to the success of the Olympus executives in concealing the company’s losses. Japanese national culture that values loyalty and propriety over criticality has profoundly influenced the corporate culture as well. As Morgan and Burnside (2014) put it, Japanese employees might “be reluctant to disclose improper behavior of others in positions of authority” (p. 117). It makes possible to conclude that the Olympus auditors were only fulfilling their duties that consisted in misstating the information in financial reports.
Moreover, in a detailed description of the fraud background, Lorsch et al. (2012) reveal the group thinking of the Olympus Board members. The group thinking in which the goals of the group are more valuable than individual goals and responsibilities is another feature of Japanese corporate culture. Thus, the Olympus fraud remained hidden for more than a decade because of the top management inventiveness, bad external auditing, and national features of Japanese business.
References
Audit and Risk. (2014). Billion dollar questions.
Elam, D., Madrigal, M., & Jackson, M. (2014). Olympus imaging fraud scandal: A case study. American Journal of Business Education, 7(4), 325-332.
Lorsch, J. W., Srinivasan, S., & Durante, K. (2012). Olympus (A). Harvard Business School Case, 413-040, 1-24.
Morgan, A. R., & Burnside, C. (2014). Olympus Corporation financial statement fraud case study: The role that national culture plays on detecting and deterring fraud. Journal of Business Case Studies, 10(2), 175-184.
Tabuchi, H., & Bradsher. K. (2012). Olympus clears auditors in an accounting cover-up.