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Satyam Episode: Failure of Corporate Governance

1. Praveen Kumar
Professor-Department of Management Studies
Sobhasaria Engineering College, Sikar-332001. E-mail: pk61delhi@gmail.com
2. Ms. DurgaPuja
Sr. Lecturer-Department of Computer Science
BSA College of Engineering & Technology, Mathura-281001.
Email:naintara10@gmail.com

Abstract

Satyam is clearly an unusual corporate failure because it was the owner himself who was
involved. Almost a year has passed since Satyam founder Ramalinga Raju flung Satyam into
chaos after confessing to his role in a major financial fraud. Since then, various government
agencies have scrutinized the affairs in the company and much debate has been waged on the
role of independent directors and internal control, and even the role of auditors in corporate at
large. Irony is that just an year back, Satyam was awarded for Corporate Governance . Once a
poster boy for the IT world, Satyam chairman Mr. Ramlinga Raju resigned after confessing to
having forged and inflated the company's accounts for years. Mr. Raju admitted that Satyam's
balance sheet was inflated and forged to the extent of Rs 7,136 crore and that he'd been cooking
books for several years. He said none of the board members were aware of this. This is the worst
kind of scam for Indian economy which otherwise could have escaped the financial meltdown
with minimum pain. World media is likely to paint the whole of Indian economy with Satyam
kind of scandals unless the government takes steps to stop such an attack. Satyam’s fraud is
expected to lead a severe blow to the entire industry with investors being more cautious going
ahead. This paper attempts to discuss issues which must be addressed by government and
regulating bodies to restore confidence of investors & stakeholders.

Introduction:

Liberalisation of Indian economy since 1991 has seen rise in economic scandals and crimes
involving huge sums of money invested by Public. Harshad Mehta Case, Satyam, Ketan Parikh
and UTI on national level and Lehman Brothers on international level are some of the examples
resulting in topics on corporate Governance and Business Ethics being included by many
universities and autonomous institutions in their curriculum post liberalization.

January 7, 2009 will be etched in the annals of India's corporate history as it brought to light one
of the biggest scams in India. It was on this day that chairman B Ramalinga Raju of Satyam
Computer Services considered to be one of the torchbearers of India's new economy, confessed
to a corporate fraud amounting to Rs 7,800 crore (Rs 78 billion).In a letter to the board,
confessing his misdeed, Raju said: "Every attempt to eliminate the (balance sheet) gap failed. As
the promoters held a small percentage of equity, the concern was that poor performance would
result in a takeover, thereby exposing the gap. It amounted to riding a tiger without knowing
how to get off and not yet eaten by the tiger. While the existing board was subsequently
dissolved, and Raju and his brother Rama Raju, and the company's chief financial officer
Srinivas Vadlamani were remanded to judicial custody, the future of 53,000 employees looked
uncertain. Then government formed a new board with HDFC chairman Deepak Parekh, former
president of Nasscom Kiran Karnik and former Sebi member C Achuthan as the members untill
it was taken over by Tech Mahindra (owned by the $6.3 billion Mahindra Group) in an open
auction in April. Two months after taking over scam-tainted Satyam Computer Services, Tech
Mahindra Sunday renamed the IT major as Mahindra Satyam. The logo was adopted from the
Mahindra Group. Ever since the Tech Mahindra group took over the company and brought the
cash inflow, Mahindra Satyam has come up with flying colors. It is soaring high on profits and
as the share market results show, Mahindra Satyam is among the most active share in the
exchanges. As has been revealed by company sources, much of the cash which Tech Mahindra
brought is still unused.

The company sources also revealed that Mahindra Satyam has been able to pay back the loans
it had incurred from HDFC bank (69 Crore), Citibank(100 crore), IDBI bank (150 crore) and
Bank Of Baroda (150 crore). These debts were incurred when the government selected
committee was running the company. These loans were taken to pay the employees and the
vendors. Part of the BNP Paribas loans of 225 Crores, which was taken for the Satyam BPO has
been repaid and this unit too is registering profits.

It is true that Satyam has been infused with new life by Mahindra group but entire episode has
left many lesions for regulators to avoid any such incidents in future. Before we analyse the
fallout of this episode, let us understand the concept of corporate governance.

Corporate Governance:

Corporate Governance is defined by Wikipedia as set of processes, customs, policies, laws, and
institutions affecting the way a corporation or company is directed, administered or controlled.
Corporate governance also includes the relationships among the many stakeholders involved and
the goals for which the corporation is governed. The principal stakeholders are the shareholders,
management, and the board of directors. Other stakeholders include employees, customers,
creditors, suppliers, regulators, and the community at large.

Greater disclosure, better accountability of independent directors, separation of internal audit


from statutory audit, third parties check, screening of customers and vendors and clearly defined
policies for whistle blowing and gender difference are some of the important principles of
Corporate Governance.

India’s report card on corporate Governance is dismal with survey in 2008 indicating that 54 %
of companies have non executive chairman as compared to 39% is US. Women Directors
represented 3.9% of total nos. of directors in India as compared to 10.7 % in UK and 29.7% in
US.
Another survey shows that 7 out of 10 directors on board of listed companies are home members,
relatives and friends.

Independent directors who fulfil the criteria of independent directors are not directors of
independent mind as we have seen in case of major petrochemical giant where national assets
became part of family MOU.

The success of Satyam (and many of its competitors) represent the fruits of the Indian economic
boom, a relatively new and evolving phenomenon no more than 15 years of age. Consequently,
the Government of India has had the onerous task of updating its former corporate governance
principles and laws (unchanged since independence) to 21st century standards within 15 years.
Given the complexity of the task and the time period, the Government of India has successfully
overhauled the governance framework; the proof lies in the stellar reputation of firms like
Infosys which have taken the trouble of implementing it. The fact that hundreds of western firms
investing in India have complained about infrastructure and bribery, but not about governance,
clearly illustrates that Indian governance practice is on par with internationally accepted practice

One finds increasing concern about improving the performance of the Board. This is doubtless
an important issue, but a close analysis of the ground reality in India would force one to conclude
that the Board is not really central to the corporate governance malaise in India. Central issue is
conflict between major shareholders and minority shareholders. Many of abuse under corporate
governance in India have been defended on the principle of “shareholder democracy” since they
have been sanctioned by resolutions of the general body of shareholders. The Board becomes
powerless to prevent such abuses. It is indeed self evident that the remedies against these abuses
can lie only outside the company itself. Company law provides for regular accounting
information to be supplied to the shareholders along with a report by the auditors. It also requires
that when shareholder approval is sought for various decisions, the company must provide all
material facts relating to these resolutions including the interest of directors and their relatives in
the matter. Disclosure does not by itself provide the means to block the dominant shareholders,
but it is a prerequisite for the minority shareholders to be able to exercise any of the other means
available to them.

Satyam Case

Satyam landed itself in the soup by successfully circumventing every governance principle; it
thrived on internal non-compliance. The proof of this confronts us in the form of doctored
financial results being shown to the Board of Directors on more than one occasion with the latter
suspecting nothing! Satyam’s Board of Directors passed a motion to acquire Maytas in
December without a serious discussion about obvious conflicts of interest. This suggests that
rubber-stamping of management proposals was the norm. The CFO signing financial results
produced by his assistant and company auditors without objections (or even cognizance) from
the audit committee proves that governance in Satyam had degenerated into the blind leading the
blind. The sad fact is that Satyam’s management ruled the board, as opposed to the standard
practice of the latter governing the former.
We all know that “one man can take a horse to water, but a hundred can’t make it drink.” There
is the need to tighten up governance, but there is the bigger need for companies to embrace good
governance. Blaming governance without discussing the company’s adherence is a perfect
example of sophistry. As Mr. Raju himself had admitted to Board in his letter which is
reproduced below:

"It is with deep regret and tremendous burden that I am carrying on my conscience, that I would
like to bring the following facts to your notice:

1. The Balance Sheet carries as of September 30, 2008,

a) Inflated (non-existent) cash and bank balances of Rs 5,040 crore (as against Rs 5,361 crore
reflected in the books);

b) An accrued interest of Rs 376 crore, which is non-existent

c) An understated liability of Rs 1,230 crore on account of funds arranged by me;

d) An overstated debtors' position of Rs 490 crore (as against Rs 2,651 reflected in the books);

2. For the September quarter(Q2) we reported a revenue of Rs 2,700 crore and an operating
margin of Rs 649 crore(24 per cent of revenue) as against the actual revenues of Rs 2,112 crore
and an actual operating margin of Rs 61 crore (3 per cent of revenues). This has resulted in
artificial cash and bank balances going up by Rs 588 crore in Q2 alone.

The gap in the balance sheet has arisen purely on account of inflated profits over several years
(limited only to Satyam standalone, books of subsidiaries reflecting true performance).

What started as a marginal gap between actual operating profit and the one reflected in the books
of accounts continued to grow over the years.

It has attained unmanageable proportions as the size of the company operations grew
significantly (annualised revenue run rate of Rs 11,276 crore in the September quarter, 2008, and
official reserves of Rs 8,392 crore).

The differential in the real profits and the one reflected in the books was further accentuated by
the fact that the company had to carry additional resources and assets to justify a higher level of
operations thereby significantly increasing the costs.

Every attempt made to eliminate the gap failed. As the promoters held a small percentage of
equity, the concern was that poor performance would result in the takeover, thereby exposing the
gap. It was like riding a tiger, not knowing how to get off without being eaten.
The aborted Maytas acquisition deal was the last attempt to fill the fictitious assets with real
ones. Maytas' investors were convinced that this is a good divestment opportunity and a strategic
fit.

One Satyam's problem was solved, it was hoped that Maytas' payments can be delayed. But that
was not to be.

Mr. Raju has claimed that no one else in the company was privy to the fudging of accounts but
BSE figures show a number of senior people in the company, including Mr. Raju and CFO
Vadlamani were reportedly selling Satyam's shares over the last 22 quarters. In June 2001, Raju
had nearly 23 per cent shares. By December that year, his share was down to 22.4 per cent. In
September 2002, it fell to 21.6 per cent which fell a year later to just over 19 per cent. In 2004,
Raju's holding was 16 per cent which fell to 14 per cent in 2005, 11 per cent in 2006. In 2007 it
was in single digit. By September 2008 Raju's share was just 8.27 per cent.

BSE figure also show Vadlamani sold 92,538 shares while the then CEO Ram Mynampati sold
700,000 shares plus 2,50,000 ADRs.Apart from these, other senior officials also reportedly sold
large number of shares. Sources say they include one Kiran Cavale who reportedly sold 400,000
shares and 10,000 ADRs and one Rajan Nagarajan who reportedly sold 430,000 shares and
70,000 ADRs. None of the independent directors tried to find out reasons for the sale which
could have prevented fraud of such magnitude.
Lessons:

• Satyam episode has led to statement by Mr. Salman Khurshid, Union Minister for
Corporate Affairs to gauge the efficacy of an early warning system to detect corporate
fraud.He is pinning his hope on company bill which makes independent directors and
statutory auditors more responsible. The new bill would provide higher penalties and
better system of accountability and adjudication

• Clause 49, of the Indian listing agreement deals with the role of independent directors
and assumes, that not being related to a promoter or having a direct economic benefit
from a company, makes a director independent. This definition ignores the reality,
namely those even eminent persons, find their prestige enhanced by association with
board membership and some having been CEOs earlier, are empathetic to management.
The current regulatory dispensation focuses strongly, on what goes into making an
independent director, but makes little effort to assess whether that person continues to
remain independent, once he is on the board.

• Post-Satyam, certainly a lot of Indian corporates have taken the role of internal auditing
very seriously and especially the independent directors are now absolutely focused on the
internal audit of the company. There has also been a clear shift in terms of the amount of
time they spend on audit committee meetings compared with previous years. Also, there
are a lot of questions being asked in terms of how they respond to audit queries and
issues related to internal audit function.

• The State has to ultimately bear the responsibility of the public space and ensure its due
governance for public good. Today, when the corporate sector is a dominant occupant
here,enjoying huge public funds -- including large tranches from the bourses and more
recently, state bailouts -- it's necessary that Indian corporations are subject to rigorous
public oversight processes and systems. The government should immediately consider
forming an Oversight Committee to inquire into the systemic lapses that may led to the
Satyam fiasco.

• In India, there is a labyrinth of external and internal auditors -- with a Price Waterhouse
Coopers endorsing an internal auditor in the Satyam case -- with no guarantee that
relationships of collusion won't develop. It doesn't seem that peer supervision of auditors
with monitoring by professional bodies like the Institute of Chartered Accountants of
India (ICAI) can ensure due prudence. What we need is a public accounting body akin to
the CAG's office with a mandate to oversee private audit firms and monitor organisations
like ICAI

• There should be well defined policy backed by legislation to protect whistle blower who
can expose such deeds.

There is no doubt that Satyam had certain inherent strength which helped Mahindra Tech
to bring it back on track. If we compare the fate of companies that have gone through
similar gut wrenching circumstances, the direction for Satyam is enequivocally positive,
as said by Mr. Alok Shende, Principal Analyst-Ascentius Consulting. We hope that
Government, regulating bodies, board and all stakeholders will ensure that such fraud do
not take place again.

References:

1. Economic Times dated 14th Dec., 2009

1. Financial Express: Jan07, 2009

2. Press releases of: Satyam on prdomain.com

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