Satyam penetrate such a colossal and a

Satyam Scandal

Background

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4 months after receiving the ‘Golden Peacock Award’ for global
excellence in corporate governance, Satyam CEO Ramalinga Raju revealed that he was
involved in an unprecedented multibillion dollar accounting scam. Raju
confessed that he had been falsifying accounts for years, overstating revenues
and inflating profits. Specifically, Raju acknowledged that Satyam’s balance
sheet included Rs. 7,136 crore (nearly $1.5 billion) in non-existent cash and
bank balances, accrued interest and misstatements. It had also inflated its
2008 second quarter revenues by Rs. 588 crore ($122 million) to Rs. 2,700 crore
($563 million), and actual operating margins were less than a tenth of the
stated Rs. 649 crore ($135 million). This admission caused the regulators and
the investors everywhere to re-examine the corporate governance standards. The fact
that company which was audited by one of the most prestigious audit firms and
adopted most advanced accounting and transparent IFRS accounting system much
ahead of time can penetrate such a colossal and a global fraud is clearly eye
opening for corporate counsel worldwide.

The startling revelation was
triggered with Satyam’s bid to acquire Matyas companies for US$ 1.6 billion. Raju
was compelled to admit to the fraud following an aborted attempt to have Satyam
invest $1.6 billion in Maytas Properties and Maytas Infrastructure (“Maytas” is
Satyam spelled backwards) — two firms promoted and controlled by his family
members. On December 16, Satyam’s board cleared the investment, sparking a negative
reaction by investors, who pummeled its stock on the New York Stock Exchange
and Nasdaq. The board hurriedly reconvened the same day and called off the
proposed investment.

Role of Board of Directors

Though there are adequate checks
and balances in the system to prevent fraud, it is the slack attitude of each
institution responsible for upholding corporate governance that made such a fraud.
One of such regulatory institution is of Board of Directors.

1.       Imperfect Information available to
Directors: SEBI requires Indian publicly held companies to ensure that
independent directors make up at least half their board strength. However, the
knowledge available to independent directors and even audit committee members
is inherently limited to prevent willful withholding of crucial information. At
the end of the day the Director has to rely on whatever the management presents
to him or her. It is the auditors responsibility to ensure that the numbers are
accurate. PricewaterhouseCoopers, the external auditors of the company were
supposed to have checked, verified cash balances, bank statements, assets with
relevant confirmations. However, they did not perform the proper due diligence.

 

2.       Directors did not ask the right questions: Even
if the independent directors were unaware of the true state of Satyam’s
finances, some red flags should have been obvious. At that time, Satyam was one
of the world’s largest implementers of SAP systems. To compete against Satyam,
HCL had acquired Axon, an SAP consulting firm, for $800 million. Satyam’s
independent directors should have been puzzled that the company was proposing
to invest $1.6 billion in real estate at a time when a competitor as formidable
as HCL was aiming for one of its most lucrative markets. IT industry is a
highly capital-intensive business. Why would Satyam invest $1.6 billion in
real estate at a time when its competition with HCL was about to become more
intense?  That is what the directors
should have asked. However, The Satyam board including its five independent
directors, approved the acquisition of Maytas Infra and Maytas Properties,
owned by the Raju family. Without taking shareholders into confidence, the
directors went along with the management’s decision.

 

3.       Partisan selection of Independent Directors:
Independent directors in India are quite often friends or associates of the
management or controlling shareholders, This has become one of the major
weaknesses of corporate governance in India.

 

How effective
independent directors can be is mainly a factor of the “internal dynamics of
board room behind closed doors. The attitude in some Indian companies that the
board members actually work for the people who have brought them onto the board
is a completely misguided attitude. It appears as if this may have been a
problem at Satyam. The real strength of a healthy board is when a consensus is
challenged by dissenting views of independent directors.

 

Even if the
proposed investment in the two Maytas companies appeared to be ethical on first
sight, the independent directors should have been extra careful given the fact
that there is a family connection involved. These independent board members should
have looked very hard at whether this was the right decision for the company. Also,
even looking at it from a non-corporate governance angle, what we know about
unrelated diversification from management literature is that, as a thumb rule, it
is not a good idea; they did not make any strategic sense.

 

4.       Resignation of Independent Directors: Within
48 hours of Ramalinga Raju’s confession, resignations streamed in from Satyam’s
Board.

a.      
Krishna Palepu, non-executive director and
Harvard professor of business administration and three other independent
directors

b.      
Mangalam Srinivasan, a management consultant and
advisor to Harvard’s Kennedy School of Government

c.      
Vinod Dham, known as the “father of the Pentium
chip” and founding managing director of NEA Indo-US Ventures in Santa Clara,
California

d.      
M. Rammohan Rao, the dean of the Indian School
of Business in Hyderabad (ISB). Rao had chaired both December 16 board
meetings. On January 8, he resigned his position as the ISB dean citing the
shocking revelations of which he had no knowledge

 

The former
independent directors stated that they have resigned as they:

·        
accept the moral responsibility of failing to
cast the dissenting votes

·        
had difficulties in attending frequent board
meetings

·        
it can be challenging for independent directors
to go through voluminous documents and attend frequent board meetings
distressed companies tend to have

 

Final Word

 

A governance disaster of the Satyam kind was quite
predictable given the lag in governance best

practice in India. For example, clause 49 of the Listing
agreement gives details of corporate

governance issues to be followed by companies. But the
reality is that the clause is adhered to

more in theory the in practice, and nobody – least of all the
capital market regulator – has done

anything about this. Reporting on corporate governance by
listed companies, which runs into

innumerable pages in annual reports, is more often than not a
meaningless ritual.            

 

Boardrooms in the US now use an improved process for
selecting new board members that is normally led by the nominations committees.
These sessions allow independent directors to discuss the effectiveness of the management,
the quality of board and other issues or concerns. In spite of initial
resistance, boards have found the practice so useful that many hold an
executive session after every board meeting rather than the suggested once or
twice a year.

 

In India the board reviews have faced similar resistance. The
evaluation criteria include the

independent directors’ ability to contribute to, and monitor,
the company’s corporate governance practices, active participation in long-term
strategic planning, and commitment to the fulfillment of a director’s
obligations and fiduciary responsibilities. It is argued that the information available
to independent directors is inherently limited and they can in no way prevent
willful withholding of crucial information. But even if outside directors were
unaware of the true state of Satyam’s finances, some red flags should have been
noticed. Though board members were not responsible for re-auditing financial
statements, they had access to the auditors and the right and responsibility to
question the audit. So, for example, on seeing an accumulated $1 billion on the
books, the audit committee should have questioned the company’s plan for the
cash, or how much it was earning on the money, which nobody bothered to do.

 

It is important to
remember that people who ultimately suffer are the shareholders who lost tonnes
of money in the process.

Satyam Scandal

Background

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For You For Only $13.90/page!


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4 months after receiving the ‘Golden Peacock Award’ for global
excellence in corporate governance, Satyam CEO Ramalinga Raju revealed that he was
involved in an unprecedented multibillion dollar accounting scam. Raju
confessed that he had been falsifying accounts for years, overstating revenues
and inflating profits. Specifically, Raju acknowledged that Satyam’s balance
sheet included Rs. 7,136 crore (nearly $1.5 billion) in non-existent cash and
bank balances, accrued interest and misstatements. It had also inflated its
2008 second quarter revenues by Rs. 588 crore ($122 million) to Rs. 2,700 crore
($563 million), and actual operating margins were less than a tenth of the
stated Rs. 649 crore ($135 million). This admission caused the regulators and
the investors everywhere to re-examine the corporate governance standards. The fact
that company which was audited by one of the most prestigious audit firms and
adopted most advanced accounting and transparent IFRS accounting system much
ahead of time can penetrate such a colossal and a global fraud is clearly eye
opening for corporate counsel worldwide.

The startling revelation was
triggered with Satyam’s bid to acquire Matyas companies for US$ 1.6 billion. Raju
was compelled to admit to the fraud following an aborted attempt to have Satyam
invest $1.6 billion in Maytas Properties and Maytas Infrastructure (“Maytas” is
Satyam spelled backwards) — two firms promoted and controlled by his family
members. On December 16, Satyam’s board cleared the investment, sparking a negative
reaction by investors, who pummeled its stock on the New York Stock Exchange
and Nasdaq. The board hurriedly reconvened the same day and called off the
proposed investment.

Role of Board of Directors

Though there are adequate checks
and balances in the system to prevent fraud, it is the slack attitude of each
institution responsible for upholding corporate governance that made such a fraud.
One of such regulatory institution is of Board of Directors.

1.       Imperfect Information available to
Directors: SEBI requires Indian publicly held companies to ensure that
independent directors make up at least half their board strength. However, the
knowledge available to independent directors and even audit committee members
is inherently limited to prevent willful withholding of crucial information. At
the end of the day the Director has to rely on whatever the management presents
to him or her. It is the auditors responsibility to ensure that the numbers are
accurate. PricewaterhouseCoopers, the external auditors of the company were
supposed to have checked, verified cash balances, bank statements, assets with
relevant confirmations. However, they did not perform the proper due diligence.

 

2.       Directors did not ask the right questions: Even
if the independent directors were unaware of the true state of Satyam’s
finances, some red flags should have been obvious. At that time, Satyam was one
of the world’s largest implementers of SAP systems. To compete against Satyam,
HCL had acquired Axon, an SAP consulting firm, for $800 million. Satyam’s
independent directors should have been puzzled that the company was proposing
to invest $1.6 billion in real estate at a time when a competitor as formidable
as HCL was aiming for one of its most lucrative markets. IT industry is a
highly capital-intensive business. Why would Satyam invest $1.6 billion in
real estate at a time when its competition with HCL was about to become more
intense?  That is what the directors
should have asked. However, The Satyam board including its five independent
directors, approved the acquisition of Maytas Infra and Maytas Properties,
owned by the Raju family. Without taking shareholders into confidence, the
directors went along with the management’s decision.

 

3.       Partisan selection of Independent Directors:
Independent directors in India are quite often friends or associates of the
management or controlling shareholders, This has become one of the major
weaknesses of corporate governance in India.

 

How effective
independent directors can be is mainly a factor of the “internal dynamics of
board room behind closed doors. The attitude in some Indian companies that the
board members actually work for the people who have brought them onto the board
is a completely misguided attitude. It appears as if this may have been a
problem at Satyam. The real strength of a healthy board is when a consensus is
challenged by dissenting views of independent directors.

 

Even if the
proposed investment in the two Maytas companies appeared to be ethical on first
sight, the independent directors should have been extra careful given the fact
that there is a family connection involved. These independent board members should
have looked very hard at whether this was the right decision for the company. Also,
even looking at it from a non-corporate governance angle, what we know about
unrelated diversification from management literature is that, as a thumb rule, it
is not a good idea; they did not make any strategic sense.

 

4.       Resignation of Independent Directors: Within
48 hours of Ramalinga Raju’s confession, resignations streamed in from Satyam’s
Board.

a.      
Krishna Palepu, non-executive director and
Harvard professor of business administration and three other independent
directors

b.      
Mangalam Srinivasan, a management consultant and
advisor to Harvard’s Kennedy School of Government

c.      
Vinod Dham, known as the “father of the Pentium
chip” and founding managing director of NEA Indo-US Ventures in Santa Clara,
California

d.      
M. Rammohan Rao, the dean of the Indian School
of Business in Hyderabad (ISB). Rao had chaired both December 16 board
meetings. On January 8, he resigned his position as the ISB dean citing the
shocking revelations of which he had no knowledge

 

The former
independent directors stated that they have resigned as they:

·        
accept the moral responsibility of failing to
cast the dissenting votes

·        
had difficulties in attending frequent board
meetings

·        
it can be challenging for independent directors
to go through voluminous documents and attend frequent board meetings
distressed companies tend to have

 

Final Word

 

A governance disaster of the Satyam kind was quite
predictable given the lag in governance best

practice in India. For example, clause 49 of the Listing
agreement gives details of corporate

governance issues to be followed by companies. But the
reality is that the clause is adhered to

more in theory the in practice, and nobody – least of all the
capital market regulator – has done

anything about this. Reporting on corporate governance by
listed companies, which runs into

innumerable pages in annual reports, is more often than not a
meaningless ritual.            

 

Boardrooms in the US now use an improved process for
selecting new board members that is normally led by the nominations committees.
These sessions allow independent directors to discuss the effectiveness of the management,
the quality of board and other issues or concerns. In spite of initial
resistance, boards have found the practice so useful that many hold an
executive session after every board meeting rather than the suggested once or
twice a year.

 

In India the board reviews have faced similar resistance. The
evaluation criteria include the

independent directors’ ability to contribute to, and monitor,
the company’s corporate governance practices, active participation in long-term
strategic planning, and commitment to the fulfillment of a director’s
obligations and fiduciary responsibilities. It is argued that the information available
to independent directors is inherently limited and they can in no way prevent
willful withholding of crucial information. But even if outside directors were
unaware of the true state of Satyam’s finances, some red flags should have been
noticed. Though board members were not responsible for re-auditing financial
statements, they had access to the auditors and the right and responsibility to
question the audit. So, for example, on seeing an accumulated $1 billion on the
books, the audit committee should have questioned the company’s plan for the
cash, or how much it was earning on the money, which nobody bothered to do.

 

It is important to
remember that people who ultimately suffer are the shareholders who lost tonnes
of money in the process.

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