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CASE 1.
Five years ago, George Woof was appointed CEO of Tomato Bank, one the largest global banks. Mr Woof has a successful track record in senior management in America and his appointment was considered very fortunate for the company. Analysts rated him as one of the worldâs best bankers and the other directors of Tomato Bank looked forward to his appointment and a significant strengthening of the business. One of the factors needed to secure Mr. Woofâs services was his reward package. Prior to his acceptance of the position, Tomato Bankâs remuneration committee (comprised entirely on non-executives) received a letter from Mr. Woof saying that because his track record was so strong, they could be assured of many years of sustained growth under his leadership. In discussion concerning his pension, however, he asked for a generous non-performance related pension settlement to be written into his contract so that it would be payable whenever he decided to leave the company (subject to a minimum term of 2 years) and regardless of his performance as CEO. Such was the euphoria about his appointment that his request was approved. Furthermore in the hasty manner in which Mr. Woofâs reward package was agreed, the split of his package between basic and performance- related components was not carefully scrutinized. Everybody on the remuneration committee was so certain that he would bring success to Tomato Bank that the individual details of his reward package were not considered important. In addition, the remuneration committee received several letters from Tomato Bankâs finance director, John Temba, saying, in direct terms, that they should offer Mr. Woof âwhatever he wantsâ to ensure that he joins the company and that the balance of benefits was not important as long as he joined. Two of the non- executive directors on the remuneration committee were former colleagues of Mr. Woof and told the finance director they would take his advice and make sure they put a package together that would ensure Mr. Woof joined the company. Once in post, Mr. Woof led an excessive aggressive strategy that involved high growth in the loan and mortgage books financed from a range of sources, some of which proved unreliable. In the fifth year of his appointment, the failure of some of the sources of funds upon which the growth of the bank was based led to severe financing difficulties at Tomato Bank. Shareholders voted to replace George Woof as CEO. They said he had been reckless in exposing the company to so much risk in growing the loan book without adequately covering it with reliable sources of funds. When he left, the press reported that despite his failure in the job, he would be leaving with what the newspapers referred to as an âobscenely largeâ pension. Some shareholders were angry and said that Mr. Woof was being rewarded âfor
failureâ. When Mr. Woof was asked if he might voluntarily forego some of his pension in recognition of his failure in the job, he refused, saying that he was contractually entitled to it and so would be keeping it all. a/ Criticize the performance of Tomato bankâs remuneration committee in agreeing Mr. Woofâs reward package. b/ Describe the components of an appropriately designed executive reward package and explain why a more balanced package of benefits should have been used to reward Mr. Woof. CASE 2 On July 22, 2015, Masashi Muromachi was appointed president of Toshiba Corporation (Toshiba) after the resignation of the former chief executive officer (CEO), Hisao Tanaka. Tanaka had resigned over the revelation of a JP„151.8 billion (US$1.2 billion) accounting scandal that shocked the world. At a press conference, Muromachi commented on his new role: âI am strongly feeling the social responsibility of alarming and causing trouble to our 400,000 shareholders, including domestic and international investors, as well as our clients and the authorities concerned. We will devote ourselves wholeheartedly to regain your trust, and revive Toshiba under the new management.â Toshiba, a Japanese multinational conglomerate with net sales of „6.5 trillion and total assets of „6.2 trillion, had been widely criticized in the news for the multi-billion-dollar accounting fraud. The companyâs stock prices had declined by 38 per cent since it announced the accounting probe, and the company had withdrawn the dividend that had been declared earlier. The (^) impact of the decreased share prices and the withdrawal of the declared dividend due to the accounting scandal had been challenging for investors in the company, who had always regarded Toshiba as a reputable company. On September 30, 2015, shareholders protested at an investor meeting, questioning the company officials as to what went wrong. As the HĂŒrriyet Daily News noted, âNearly 2,000 shareholders turned up to an investor meeting outside Tokyo, peppering a new management team with questions about the affair which led to the resignation of Toshibaâs president and seven other top executives in July.â The investors were wondering the same as everyone else watching the scandal unfold: How could a company with a 140-year history do this, and why? âThere was no explanation of what we [wanted] to know most: why it happened and who is to blame,â said one investor. Understanding investorsâ concerns and the damage done by the accounting fraud to Toshibaâs investors worldwide, Muromachi, the newly appointed CEO, apologized to investors: âToshiba Corporation expresses [its] sincere apologies to our shareholders, customers, business partners, and all other
of approximately 11 per cent. In June 2013, Hisao Tanaka was named the president and CEO of Toshiba Group, while Asotosh Nishida held the position of chairman of the board of directors. The economic growth the firm had experienced was better than the previous year, but in terms of global economic growth, issues with the external business environment persisted. For the fiscal year ending in March 2014, all business segments showed better sales and growth; as a result, the overall net sales of the company increased to „6. trillion, up from „5.8 trillion in the year ending March 2013. The operating income rose to „290 million, an increase of 47 per cent, for the same period (see Exhibits 1, 2, and 3 below). Financial Performance, Q1 2015 For the first quarter of the financial year ending March 31, 2015, the net sales of the company stood at „1,349 billion. In terms of operating income, the company incurred an operating loss of „11 billion, leading to a net income (loss) attributable to shareholders amounting to „12.3 billion. THE FACTS OF THE ACCOUNTING FRAUD On February 12, 2015, Toshiba received an order from the Securities and Exchange Surveillance Commission (SESC) to allow a disclosure inspection with respect to some projects in which a percentage of completion method of accounting, among other methods, was used (see Exhibit 4). The Japanese market regulator investigated Toshibaâs accounting methods under the authority granted by Article 177 of the Financial Instruments and Exchange Act. The SESCâs investigation was launched in response to a whistleblowing tip, the details of which were never disclosed. It was then unclear whether the irregularities were due to errors or were deliberate. Technology experts helped to recover deleted and old email messages that connected Toshiba with accounting fraud. The recovered emails contained messages suggesting the use of misleading practices, confirming that the irregularities were not simply errors: they were intentional manipulations. An internal investigation committee was set up by Toshiba to investigate the companyâs book of accounts from financial year (FY) 2009 through the third quarter of FY2014. FY2008 was also included, but as a comparison year for the FY securities report. When the committee revealed the various fraudulent distortions across various Toshiba companies, Toshiba had no other choice but to establish an independent investigation committee, which first met on May 8, 2015. The independent investigation committee consisted of members from outside the
company, as opposed to the company -appointed members of the internal committee. The problem was identified as accounting fraud when investigators found evidence of overstated profits in various Toshiba business units, including the visual products unit, the personal computer unit, and the semiconductor unit. It was found that the total amount of contract costs was underestimated, and contract losses were not recorded in a timely manner. The fraud had begun under CEO Atsutoshi Nishida in 2008, in the middle of the global financial crisis, which had drastically reduced Toshibaâs profitability. The fraud had evidently continued with the same intensity under the next CEO, Norio Sasaki. In June 2013, Hisao Tanaka, a long-time manager of procurement and manufacturing in Toshibaâs consumer electronics division, was promoted the position of president and CEO. As part of his management strategy, Tanaka pushed his employees to meet their budget targets. The fraud continued under Tanaka in this budget-conscious environment, and eventually ended in scandal. Toshiba had a policy of personnel rotation after every few years. Due to this policy, by the time a project was finished, the person who initiated it was gone and his or her successor was held responsible for the losses of the project, if any. This system led to making immediate goals a priority, even if it meant taking orders at a loss. In one of Toshibaâs manufacturing contracts, the cost of the ordered work was expected to exceed the negotiated price; however, the company did not record a provision on the balance sheet for any loss-making contracts. In another project, Toshiba exaggerated its cost reductions. A review of the contract work concluded that „1.7 billion could be shed in costs; however, in reality, the costs were only reduced by „100 million. To meet its profit targets, Toshiba implemented a plan to carry over and overstate profits by adjusting profits and lossesâa practice that had been going on since
- It was determined that Toshiba used a cash-based method for its accounting instead of using the accrual method. The company had also requested that its vendors issue postdate invoices in order to show those expenses in the next quarter, even though the expenses had already been incurred. The company has also failed to record some items, such as valuation losses, loan loss allowances, and so on. Eight of the 16 members of the board resigned after the fraud become known. TOSHIBAâS CORPORATE CULTURE
2009 2010 2011 2012 2013 2014 Net sales 6,364,800 6,129,900 6,270, 5,994, 0 5,727,000 6,502, Cost of sales 5,103,905 4,710,778 4,781, 4,538, 3 4,313,956 4,854, Selling, general, and administrative 1,493,754 1,301,472 1,250, 1,253, 6 1,215,289 1,357, expenses Operating income (loss) â232,859 117,600 238,700 202,600 197, 290, 0 Income (loss) from continuing operations â259,677 27,200 194,700 145,400 159, 180, 0 Income taxes 61,562 33,534 407, 64,200 59, 96, Net income (loss) attributable â343,559 â19,700 137,800 70,100 77,400 50, EXHIBIT 2: CONSOLIDATED BALANCE SHEETS, TOSHIBA GROUP („ MILLIONS) Assets 2009 2010 2011 2012 2013 2014 Current assets 2,720,631 2,761,606 2,799,668 3,009,513 3,160, 3,209, 24 Long-term receivables and 534,853 622,854 660,380 701,225 706,188 664, investment s Property, plant, and 1,089,579 978,726 900,205 851,365 884,680 960, equipment Other assets 1,108,162 1,087,987 1,019,066 1,190,634 1,348, 1,407, 18 Total assets 5,453,225 5,451,173 5,379, 5,752, 7 6,100, 2 6,241, 23 Liabilities and equity 2009 2010 2011 2012 2013 2014 Short- term debt 1,033,884 257,364 311,762 326,141 433,128 203, Other current liabilities 2,033,889 2,231,081 2,186,547 2,343,421 2,304, 2,388, 23 Total current liabilities 3,067,773 2,488,445 2,498,309 2,669,562 2,737, 2,592, 46
Long-term debt 776,768 960,938 769,544 909,620 1,038, 1,184, 64 Other long-term 849,403 874,168 931,850 943,344 908,038 812, liabilities Total long-term liabilities 1,626,171 1,835,106 1,701,394 1,852,964 1,946, 1,997, 50 Equity attributable to shareholders 447,346 797,455 868,119 863,481 1,034, 1,229, 66 Equity attributable to non- 311,935 330,167 311,497 366,730 381,809 423, controlling interests Total L & E 5,453,225 5,451,173 5,379, 5,752, 7 6,100, 2 6,241, 23 EXHIBIT 3: CONSOLIDATED STATEMENT OF CASH FLOWS, TOSHIBA GROUP („ MILLIONS) Cash flows 2009 2010 2011 2012 2013 2014 Net cash provided by (used in) operating activities â16,011 451,445 374,084 334,997 132, 286, 6 Net cash used in investing activities â335, â252,922 â214,700 â377,22 â196, â246, Free cash flows â351, 9 198,523 159, â42, 0 â64, 1 40, 1 Net cash provided by (used in) financing activities 478, â277, 1 â154, 6 â240 41, â89, 09 Effect of exchange rate changes on cash and cash â31,989 2,994 â13,277 â2,065 17,123 11, equivalents Net increase (decrease) in cash and cash equivalents 95,144 â76,344 â8,609 â44,535 â5, â37, 29 Cash and cash equivalents at beginning of year 248,649 343,793 267,449 258,840 214, 209, 9 Cash and cash equivalents at end of year 343,793 267,449 258, 214, 5 209, 9 171, 40 EXHIBIT 4: PERCENTAGE OF COMPLETION METHOD OF ACCOUNTING This method of accounting recognizes a portion of revenue associated with a long-term contract in each accounting period of construction or production under the contract. The percentage of completion is typically estimated by dividing the total construction costs incurred to date by the total estimated costs of the contract or job. % complete = (Total construction or production costs to date) / (Total estimated costs of contract)
- What options are available for the company moving forward? How can it prevent such fraud in the future?
CASE 3.
The executive compensation committee of Blue Cross Blue Shield Board has come up with the following reward package for the CEO, Redmayne for the coming year: ï· Base salary: $1 million. This salary is the standard for the CEO of a large public corporation. The Blue Cross Blue Shield Corporation does not want to cross this $ 1 million since the amount exceeding $1 million would not be tax- deductible. ï· Short term incentive: For every 1% over a threshold of 7% ROE, Redmayne received a $1,500,000 bonus. He also received an additional $250,000 for every 0.5% improvement over the prior year. ï· Long-term incentive: Redmayne had received stock options for 500, shares at $15 dollars a share 5 years earlier. Since then, Redmayne had received annual grants of 100,000 shares (see the following table for details) Year 2012 2013 2014 2015 ROE (%) 12.04% 11.5% 6.5% 7.8% Actual year Number of shares issued upon exercise of outstanding options Exercise price ($) 2011 500,000 15 2012 100,000 20 2013 100,000 25 2014 100,000 30
a/ Calculate the cash compensation of Redmayne for the three years 2013, 2014, 2015 b/ In what year should Redmayne exercise his stock options to maximize the proceeds? (Assuming that he has to exercise all his outstanding stock options up to that year)
