REAL (KOBE) STEEL,

FAKE RESULTS

Case overviewI
In the latest of Japan’s string of corporate scandals, Kobe Steel, Ltd. (Kobe
Steel) admitted to falsifying data for its products to meet customer requirements.
This had gone on for almost five decades. Kobe Steel’s overemphasis on
profitability, coupled with its lack of regard for corporate governance and its
insular organisational structure, were seen to have contributed to the repeated
occurrences of data falsification. Not only did the scandal adversely affect Kobe
Steel’s business and financial performance, it also caused problems for customers
across various industries as they scrambled to check for compromises in the safety
and performance of products manufactured with Kobe Steel’s materials. Although
no major lapses were reported, the episode prompted companies to evaluate their
approaches towards supply chain risk management. The objective of this case is
to facilitate a discussion of issues such as corporate culture; crisis management;
supply chain risk management and the role of the board of directors.

This is the abridged version of a case prepared by Chen Shenghui, Shane, Lydia Lim Tien Li, Shaun Tan
Wei Wen and Teo Fu Jie under the supervision of Professor Mak Yuen Teen. The case was developed
from published sources solely for class discussion and is not intended to serve as illustrations of effective
or ineffective management or governance. The interpretations and perspectives in this case are not
necessarily those of the organisations named in the case, or any of their directors or employees. This
abridged version was edited by Isabella Ow under the supervision of Professor Mak Yuen Teen.

Copyright © 2018 Mak Yuen Teen and CPA Australia.

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Time to go
Hiroya Kawasaki bowed long and low as he offered his resignation in light of
the Kobe Steel scandal, which occurred when he was Chief Executive Officer
(CEO) and Chairman of the company.1 “I feel heavy responsibility,” he told the
news conference. “I’ve offered my resignation … as I think preventive measures
should be done under a new management”.2 Kawasaki left the Japanese steel
manufacturer on 1 April 2018,3 exactly five years after his appointment as
President on 1 April 2013.4 Bogged down by compliance issues, malfeasance,
and a battered reputation, perhaps – as the number five suggests in Japanese – it
was time for Kawasaki to go.

Forged from steel

Kobe Steel is Japan’s third-largest steelmaker, supplying steel and other metals
to numerous airline and automobile manufacturers worldwide.5 The company
engages in several business activities, including iron and steel, machinery, welding,
and aluminium.6 The steel manufacturer had its beginnings in the early 1900s,
and steadily grew after World War II to establish itself as a leading manufacturer
of steel, nonferrous metals and machinery.7 However, the 2000s brought new
challenges for Kobe Steel, ranging from project bid-rigging to data falsification.8

Constructing the organisation

Kobe Steel had in place its own “Basic Policy and Initiatives on Corporate
Governance”.9 The document detailed the execution of policies and functions of
various players, as well as the philosophy behind such measures and structures.

The company had a silo-like organisational structure, which facilitated specialisation

within each unit, with minimal data exchange and personnel interaction between
them.10 Such a system allowed divisions to function outside management
oversight. As such, management personnel were not aware of happenings in
other divisions apart from those they oversee.11

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The board of directors consisted of the Chairman, President, various executive
directors who were in charge of the various divisions, and outside directors. CEOs
and Presidents were often picked from long-serving executives in its mainstay
steel business or general affairs division – Kawasaki was no exception.12,13

The Audit and Supervisory Committee (ASC) was responsible for the company’s
internal control system, group compliance and risk management. It had
“investigation authority without complete separation between supervision and
execution”, with those in charge of audits granted voting rights on the board.
Meanwhile, the Compliance Committee (CC), with the majority of the committee
coming from outside the company, dealt with compliance and ethical issues and
advised the board.14

All employees were required to report material risks occurring in business activities
and the response status to the ASC. An “outside attorney without a retainer
fee arrangement” manned the internal reporting system. Anonymous reporting
was permitted, and search and retaliation against internal whistleblowers was
prohibited.15

The core values of Kobe Steel

Kobe Steel’s core values16 clarified its corporate philosophy of providing
satisfactory products and supporting employees,17 with the Six Pledges of
KOBELCO Men and Women valuing ethics, professionalism and quality products
among others.18 Quality of products was guided by the Quality Charter.19 Kobe
Steel also established a Corporate Code of Ethics that required employees to
“operate business fairly and honestly”, with the Standards of Corporate Conduct
reiterating the need for quality products and compliance with laws. 20

With its insistence on company-wide compliance and harsh actions taken against
non-compliance, Kobe Steel’s data fabrication scandal came as a surprise.
However, according to a retired employee, Kobe Steel’s corporate culture was “to
look the other way even while you saw what was going on.”21

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Digging through the steel pile

The Kobe Steel saga began in August 2017, when the Aluminium and Copper
Business’ (ACB) self-inspection of past records first revealed quality inspection
misconduct. The President was informed and shipping of non-conforming products
ceased. On 12 September 2017, the company conducted an emergency audit on
its businesses, and informed customers of data inaccuracies.22

On 8 October 2017, Kobe Steel publicly admitted to falsifying strength and durability
data to meet customer specifications – of the 20,000 tonnes of metals shipped
in the year leading up to August 2017,23 four percent had false certifications of
certain properties such as tensile strength levels.24 Upon hearing the news, the
Japanese authorities acted fast. Within the same month, the Ministry of Economy,
Trade and Industry had ordered the company to deliver a report on the data
fabrication and detail the steps it would take to prevent such misconduct from
occurring in the future.25 After the submission of the report, Kawasaki attempted
to regain investor confidence at a press briefing by stating that “improving (Kobe
Steel’s) management and corporate governance and instilling a culture where
employees can say anything are imperative” and asserting that he would make
such improvements his utmost priority.26

On 26 October 2017, Kobe Steel set up an Independent Investigation Committee

(IIC) consisting purely of outside members to investigate self-inspections and
misconduct.27 This was due to a tip-off by a whistleblower, who had suggested
that workers were obstructing internal inspections by concealing data.28,29 On
6 March 2018, the company released the “Report on the Kobe Steel Group’s
Misconduct”, revealing its long history of data falsification.

The first fallen domino

The scandal’s eruption almost burned Kobe Steel’s reputation to ashes and trust
in the steel manufacturing giant had effectively “fallen to zero” when its corrosive
business practices came to light.30 The company had Japanese government-
sanctioned seals of quality revoked on many products, faced lawsuits, and was
subject to a U.S. Justice Department inquiry.31 Furthermore, it estimated that 525
firms – including aeroplane and car manufacturers – had been affected by the
instances of data fabrication.32

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Investors who were concerned about the potential financial impact from product
recalls or replacements and possible litigation, began dumping Kobe Steel stock.33
Within a week of the breaking of the data fabrication news, Kobe Steel’s share
price plummeted over 42%, reaching a five-year low on 16 October, 2017.34

The domino effect

In the grand scheme of things, Kobe Steel was embedded in a highly intricate
global supply chain system. The scandal sparked concern across supply chains
in various industries such as aviation, automobiles, railways and nuclear power.35
Customers scrambled to check for any compromised safety and performance
aspects in their products.36 While no major safety risks were raised,37 the incident
clashed with Japan’s Corporate Governance Code (Principle 2), which expects
Japan-listed companies like Kobe Steel to duly regard the wider group of
stakeholders’ interests.38

Elements of the steel-faking process

Nearly five months later, on 6 March 2018, Kobe Steel released a report following
the IIC’s investigation. With the admission of data falsification since the 1970s,
misconduct occurring in various departments, and at least two directors being
aware, there is no doubt the problems were deeply rooted in the organisation.39
The report suggested causes of the misconduct, as well as proposed measures
to prevent possible recurrences.40

Overemphasis on profitability
The head office’s overemphasis on profitability pressured individual business
divisions to adopt a ‘production over quality’ attitude, causing them to accept
orders beyond their capabilities. Employees had limited understanding of plant
process capabilities and were unable to carry out adequate feasibility evaluations
on orders. It became common for employees to falsify test data for products that
failed to meet the unattainably strict internal standards, which were usually higher
than customer specifications. The lack of appropriate quality-related training and
disciplinary actions created the false assumption that data falsification had no
consequences.41

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Working in silos
The operational, manufacturing and development functions were self-contained at
spread out locations. This resulted in an ‘insular organisational culture’, creating
opportunity for misconduct to manifest.42 Since substantial management authority
was transferred to each individual business division, the head office failed to
maintain centralised control over the Group and run a compliance program
effectively, so plants could only rely on their own existing controls. Various major
business departments within the plants lacked proper audit functions and did not
have adequate internal inspection processes to detect data falsification incidents.43

Little emphasis on corporate governance

In general, insufficient emphasis was placed on corporate governance by
the company’s upper management; as long as divisions were profitable,
higher management did little to get involved.44 Questions were raised over the
effectiveness of the company’s internal controls and whether the board fulfilled
its supervisory role.45 As such, extended periods of silence, combined with the
Group’s segmented structure, made the detection of any data falsification very
difficult.

De-rusting the governance system

In response to the uncovering of the widespread data falsification incidents, Kobe
Steel has implemented continual remedial actions to prevent future occurrences
of such misconduct. The company aimed to restore trust by promoting the Next
100 Project, aimed at spreading the company’s core values and Six Pledges of
KOBELCO Men and Women throughout the Group. Activities under the project
include direct communication between management and employees. Additionally,
the month of October had been selected to be ‘Core Values of KOBELCO Month’
to constantly remind employees about the lessons learned from past compliance
incidents. The Six Pledges of KOBELCO will also be revised to include expressions
emphasising customer satisfaction and contribution to the society.46,47

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To better comply with Japan’s Corporate Governance Code (Principle 4) highlighting
“effective oversight of directors and management from an independent and
objective standpoint”, Kobe Steel vowed to ensure that at least a third of the board
members are independent outside directors. The Chairman would be elected from
the aforementioned pool of independent outside directors. The company also said
that it would abolish the Office of Executive Chairman and establish a Nominating
and Compensation Committee to act as an advisory body to the board.48

Another revision made by the company to its existing structure is that division
heads would not necessarily be elected as directors now. Instead, the materials,
machinery and electric power businesses, as well as compliance and quality
management would each be assigned and overseen by a director. Additionally, an
independent Quality Supervision Committee consisting of external experts would
be set up.49

Further, Kobe Steel promised to regularly conduct compliance awareness surveys

to improve risk management based on internal standards, formulate the ‘KOBELCO
Quality Guidelines’, and set up a Compliance Management Department under
the counsel of a dedicated executive officer. Issues with the existing silo system
would be addressed through personnel rotation amongst divisions, and problems
at worksites would be resolved through procedures such as employee awareness
surveys.50

Strengthening quality management

Kobe Steel introduced the ‘Quality Charter’ to restore trust in the Group. Kobe
Steel also established a Quality Management Department (QMD); led by an outside
officer, its role includes the planning of personnel development, division quality
education and training, as well as rotation plans of quality assurance personnel.
The company also implemented a quality assurance section directly controlled
by each division to reinforce the quality assurance system at plants, factories,
divisions, and the head office.51

Kobe Steel also stated that it would automate test and inspection data records
and eradicate one-man data entry processes. It would eliminate the presence
of double shipment standards – customer specifications and internally set

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 Real (Kobe) Steel, Fake Results

standards – which was believed to have caused the misconduct and will instead
maintain a single shipment standard. Moreover, the company would also revise its
authorisation process for new orders and for switching manufacturing processes
affecting product quality, and ensure that employees compare the company’s
process capabilities with the customer specifications when obtaining orders.52

The aftermath
In December 2017, Kobe Steel demoted three executives from the aluminium and
copper business divisions, who were aware of the widespread data fabrication.53

In March 2018, Chairman Kawasaki and Vice President Akira Kaneko resigned,
two managing executive officers were dismissed, and another executive officer
faced a four-month long remuneration reduction of 80%. All other directors and
executive officers – apart from outside directors and directors on the ASC – faced a
10% to 50% remuneration reduction for a period between one and four months.54

Kobe Steel and the Japan corporate

environment
Although Japan’s Corporate Governance Code was only established recently in
2015, Japan’s earnest push to improve corporate governance has seen fruitful
changes in the country’s business landscape. Kobe Steel is only one of the
many examples of Japanese companies enveloped by corporate scandal while
going through corporate governance reforms due to pressures from various
stakeholders.55

Indeed, the comprehensive remedial action plan and numerous departures of

key personnel reflect the gravity of the situation and the embattled steelmaker’s
seriousness in addressing the scandal. Although some critics remain sceptical
about the sufficiency of Kobe Steel’s resolutions in addressing the root causes
and the larger Japanese corporate culture, others remain optimistic, viewing the
string of Japanese scandals as attempts at greater transparency and progressive
change.

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Discussion questions
1. In light of the numerous corporate scandals occurring in Japanese companies,
Japan’s corporate culture has come under great scrutiny. Given that the Kobe
Steel had core values which placed emphasis on ethics, professionalism, and
reliability in providing quality products to customers, identify and discuss the
various factors within Kobe Steel’s corporate culture that might have led to
the data fraud.

2. Do you think Kobe Steel’s board of directors had fulfilled its supervisory
role? As a result of its actions (or lack thereof), to what extent did the board
contribute to the widespread data fabrication in the company?

3. The effects of Kobe Steel’s data falsification were felt far and wide by hundreds
of companies globally, both directly and indirectly. In what ways could these
companies have better protected themselves from the supply chain risks
involved?

4. Comment on the adequacy of Kobe Steel’s response to the scandal. To what

extent would the measures outlined in Kobe Steel’s remedial action plan
prevent similar incidents in the future? What additional measures could Kobe
Steel have implemented in response to the scandal?

5. With reference to Japan’s Corporate Governance Code, in what respects did

Kobe Steel fail to observe the stipulated guidelines? Taking its remedial action
plan into consideration, how does Kobe Steel aim to achieve compliance with
the Code?

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