Japan Shame Index Dumps Toshiba After Scandal, Adds Olympus

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Toshiba Corp. was kicked off a stock index showcasing Japan’s best companies after a $1.2 billion accounting scandal, while Olympus Corp. made the cut.

The government-backed JPX-Nikkei Index 400 added 42 other firms, including Daio Paper Corp. and Shimizu Corp., the gauge’s compilers said in a statement Friday. Lixil Group Corp., McDonald’s Holdings Co. (Japan) and Konami Corp. are among those being removed when the changes take effect on Aug. 31.

This marks the second reshuffle of the index, which picks companies with the best operating income, return on equity and market value to shame executives of those it excludes into boosting profit and shareholder returns. Inclusion matters because investors including the world’s largest pension fund use the stock gauge as a benchmark.

The decision to remove Toshiba “was clearly made on the back of concerns about corporate governance with the scandal. It has got to be kicked off,” said Nicholas Smith, a strategist at CLSA Ltd. in Tokyo. Olympus, which used fraudulent accounting to cover losses over 13 years, is “back from sitting on the naughty step. It’s a sort of rehabilitation of offenders.”

Toshiba was tossed out after an internal probe revealed managers overstated profits. A report showed that top executives set unrealistic targets that systematically led to the flawed accounting. The company must correct earnings stretching back six years.

“Toshiba’s financial data are wrong, so they’re not even at the starting line” for selection, Japan Exchange Group Inc. Chief Executive Officer Akira Kiyota told reporters on July 28 in Tokyo.

Daio Paper

Daio Paper is also joining the index after having its own scandal. The company’s former chairman was sentenced to prison in 2012 after spending the company’s money in casinos.

“Even if you had a problem in the past, if there isn’t a problem in the selection period, you become eligible,” said Kazunari Tomita, head of information services at the Tokyo exchange.

Tokyo Electric Power Co., the utility behind the worst nuclear disaster since Chernobyl, wasn’t chosen. Its addition had been predicted by analysts at Nomura Holdings Inc., Daiwa Securities Group Inc. and Mizuho Financial Group Inc, after surges in earnings and share price.

The constituents of the index, compiled by Japan Exchange Group Inc. and Nikkei Inc., are picked based on three-year average return on equity, which measures how efficiently capital is used, and cumulative operating profit, each accounting for 40 percent of the selection criteria. Market value makes up the remaining 20 percent.

About 10 firms can also be replaced based on corporate governance standards, such as providing English-language results and appointing two independent outside directors.

Lixil, McDonalds Japan

Some 42 companies are being removed. Lixil is losing its place after the housing-materials maker reported accounting irregularities at its German unit. McDonald’s Japan is being thrown out after food scandals prompted restaurant closures and led to losses.

In the first reassessment of the gauge’s constituents last year, Panasonic Corp. was among 31 companies added, while fellow consumer-electronics manufacturer Sony Corp. was dumped.

The JPX-Nikkei 400 rose 0.3 percent on Friday in Tokyo before the announcement, as did the broader Topix index. Both measures are up about 19 percent this year.

“We think we chose companies with high investment appeal,” Tomita of the Tokyo bourse said.

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