Olympus Corporation Scandal & its aftermath ?

Olympus Corporation is a Japanese manufacturer of Optical equipment and is considered one of the leaders in the industry. It flagship products include Cameras and Endoscopes in addition to all other related products. For the year ended 31 March 2011 the consolidated net sales were US$ 10589 million. The total shareholders’ equity is US $ 3281 million. The group employs close to forty thousand people around the world. Its assets were estimated at US $ 13295 million. On the remarkable aspect is the good will of Olympus Corporation which is valued at US $ 2194 million. Another significant achievement until recent is the ability of the management to sustain the profit level relatively constant at 35 billion yen for several years.

PROFIT MAKING STRATEGY OF THE CORPORATION

Being a Japanese company, Olympus used to have a clear strategy in all the areas of operation. The management has come up with a new idea called FINANCIAL ENGINEERING where they look up the financial aspects from a different angle. The objective of the exercise is to maximize profits for the company from all departments. Olympus Corporation relied on investments to boost profits. There were instances that the investment arm of the corporation was inclined towards financial derivatives and other risky investments. The aftereffect of this strategy was very evident from the books. In 1991 Olympus lost 2.1 billion yen on the value of its investments. By 1998, it suffered sizable trading losses on derivatives. Share market responded unfavorably and the value eroded to a great extent. Score card says the shares plunge by 11% at that time.

In September 2011, Olympus announced it had written off a part of 45 billion yen investment in emerging market bonds. The company also revealed that it had lost a significant amount from interest rates and currency swaps.

PRESS REPORTS

Bloomberg reported that the annual financial reports of Olympus showed a US$ 201 million prior period adjustment entry for “loss related to the purchase of preference share from a third party”.

Financial Times commented that the equity ratio of Olympus is the lowest and at below 14% when compares against the peer group. Olympus is the only Nikkei 225 constituent whose intangible assets exceed net assets. Its goodwill was valued at 168 billion yen and the net assets were only 151 billion yen. This information sent wrong signal to the investors and market alike.

On 1 April 2011 Olympus came up with a big announcement.  Michael Woodford, a Brit, was promoted as President and CEO for the group. He was an Olympus veteran and was in charge of the companies European operation. He was the MD of Olympus Medical Systems (Europe). There were rumors that he was selected to head the company because he was an easy to control guy. Company picked a bottom ranked foreign executive director for some reasons. It was obvious that the company was overlooking other capable managers for this position and there were raised eyebrows from many quarters.

Woodford himself had a bitter experience with the top management when he was heading the European operations. The company went into acquisition of Gyrus Medical Equipment Company in UK without the actual involvement of Mr. Woodford. In fact, it should have come under his purview but got ignored for obvious reasons. The then president Mr. Kikukava pacified him and promised to compensate later. He was then given the overall in charge of European operations in addition to the inclusion as Board member of the main group.

While his stint with the main group, Woodford started noticing some discrepancies in the financial side of the company. He could see that there were significant irregularities in the 2008 acquisition of Gyrus Medical Equipment Company. Upon realizing that he sent few letters to the auditing firm Earnest & Young to get clarity but failed to obtain anything. He then sent the details to another accounting firm PwC and sought some clarifications. His assumptions proved right and the accounting firm confirmed certain facts which made Woodford to think in the line of accounting fraud happened within the company.

PwC examined the earlier write down transaction of US $ 600 million. It came evident that Olympus paid US$ 687 million as an intermediary fee (success fee) to a third party. There were two beneficiary companies on this list. Two US based small firms are involved here - Axes America LLC & Axam Investments ltd (Cayman Island based). Wood ford’s suspicion founds to be right. The success fee of US$ 687 million paid is an all-time record until that time and not heard of in the industry circles.  In fact there was no need for such an exorbitant amount to be released for any consultancy job.

Woodford raised his objections and sought more clarity from the then president Mr. Kikukava but found no avail. Sensing the danger, Mr. Kikukava asked Woodford to step out from the current role he enjoyed. Unrelenting to this, Woodford was removed from the post forcefully and he was stripped of his powers. He was not allowed to speak or vote in the board meeting. Woodform himself said that an junior level executive, upon the instruction from Mr.Kikukava, taken all his belongings including laptop and mobile phones which contain important documents. Kikukava got re appointed as the president and CEO for the group and Mr. Woodford was ousted with immediate effect.

Woodford then took a flight and reached London where he called for a press meet and exposed the whole affair at the Olympus. He produced the relevant documents and other materials with was enough to incriminate the directors at that time especially Mr. Kikukava.  Market responded negatively to this happenings and the share value plunged to a great extent. It almost lost 45-50% of its value hearing the irregularities with Olympus. The share was trading at US$ 38 and was found trading at US$18 after this incident.

WHERE DID THE MONEY GO?

Due to investors demand, the government constituted a committee and its finding were relevant to note. The fees paid as part of the M&A of Gyrus, were exorbitant. The excess money was used to cover up the losses incurred from the earlier investments in derivatives and other dubious investments. This was done to improve the financials in the records.

AFTERMATH

Recent development being, Mr. Kikukava was removed from the post of the president and CEO due to the pressure from the investors especially institutional investors. He apologized before everyone and promised to look into the whole affair by appointing an independent agency. The government was quick to take control of the situation and Mr. Kikukava was arrested and remanded in custody pending enquiry.

Khaleej Times, on 21 April 2012 reported in its business section that the security exchange authorities in Japan approved of the new board to take control of the company. Some of the investors insisted to re-instate Mr. Woodford as President and CEO but did not get much support from others. Woodford himself announced from London that he is not willing to fight a proxy war to take control of the company.

HOW THIS CASE IS IMPORTANT TO US?

Financial irregularities can happen with any company especially when their fundamentals are dubious. This may occur when there are people in the top management who keep their interest before their companies. It is important for any finance student to sense the smoke and be aware of the possibility of these kinds of irregularities or else they will be caught up unaware of the actual situation.

Antony Konnoth, Dubai