Nissan and Mitsubishi shares have fallen by more than 5% in Tokyo trade, after the arrest of chairman Carlos Ghosn.
He is accused of under-reporting his income by 5bn yen ($44.4m; £34.5m) over five years, prosecutors said, and using company assets for personal purposes.
Japanese broadcaster NHK also reported Nissan had spent millions to purchase luxury homes for Mr Ghosn.
Mr Ghosn heads up the Japanese-French car alliance Renault-Nissan-Mitsubishi.
Both Nissan and Mitsubishi have said they are preparing to remove him from his posts, and the board of Renault is also due to meet to decide Mr Ghosn’s future.
Shares in Nissan sank 5.5% and Mitsubishi Motors tumbled 6.9%.
What has happened so far?
In a late night press conference on Monday, Nissan said an internal investigation prompted by a whistleblower had revealed “significant acts of misconduct”.
The announcement sent shockwaves through the automotive industry where Mr Ghosn, 64, is seen as titan, responsible for a dramatic turnaround at Nissan in the early 2000s.
Nissan chief executive Hiroto Saikawa said “too much authority was given to one person in terms of governance”, speaking at the Yokohama headquarters of the firm.
“I have to say that this is a dark side of the Ghosn era which lasted for a long time,” Mr Hiroto said, adding that he was still thinking through whether Mr Ghosn was “a charismatic figure or a tyrant”.
What are the accusations?
Prosecutors later said in a statement that Mr Ghosn and senior executive Greg Kelly had conspired to understate Mr Ghosn’s compensation, starting in 2010.
Mr Ghosn is accused of filing annual securities reports containing fake statements, which could mean up to 10 years in prison, or a fine of 10m yen, or both.
From 2010, Japanese firms have been required to disclose the salaries of executives who earn more than 100m yen.
Japanese prosecutors also said they had already raided Nissan’s Yokohama headquarters, near Tokyo, as part of their investigation.
BBC Tokyo correspondent Rupert Wingfield-Hayes said the charges against Mr Ghosn had come to light because of a new law that had come into effect in Japan in June, aimed at improving corporate governance and uncovering corporate misdeeds.
He said under Japanese law, Mr Ghosn can be kept in custody for up to 23 days without charge.
No further details of his alleged misconduct have been given. But some specifics were being reported by Japanese media.
Broadcaster NHK reported, citing unnamed sources, that Nissan provided Mr Ghosn with houses in four countries without legitimate business justifications.
Millions of dollars had been spent to purchase and renovate the homes in Brazil, Lebanon, France and the Netherlands, NHK said.
There has been no comment from Mr Ghosn or Mr Kelly.
How will this impact the Alliance?
As misconduct revelations emerged, the future of the car alliance led by Mr Ghosn remained unclear.
He has been credited with turning around both Nissan and Renault before becoming the linchpin of the alliance the companies later formed.
The Renault-Nissan-Mitsubishi Alliance sold 10.61 million passenger cars and light commercial vehicles in 2017, making it the number-one automotive group worldwide.
Nissan chief executive Mr Saikawa insisted the partnership “will not be affected by this event”.
Janet Lewis, Macquarie’s head of industrials research in Asia, said it is “in the interests of all three companies to get through this as there aren’t a lot of alternatives for them, especially in light of the investments they have made together so far”.
Five notable Japan Inc scandals
- The Olympus affair: Michael Woodford blew the whistle on a vast accounting fraud at the camera firm
- Toshiba’s irregular accounting: the industrial group revealed it had overstated operating profit by nearly $1.2bn
- Takata’s deadly airbags: faulty airbags produced by the firm led to injuries and deaths around the world
- Kobe Steel data scandal: the country’s third-largest steelmaker falsified data on quality of some of its goods
- Nissan emissions failure: the carmaker admitted some emissions and tests “deviated from the prescribed testing environment”.