The Satyam saga will go down as the worst episode of corporate governance failure in India.
The saga of Satyam Computers will go down as the worst episode of corporate governance failure in corporate India. The fraud which is in excess of Rs 7,000 crore, is unfortunately of a truly global scale. Post the aborted merger with Maytas, many had suspected that Ramalinga Raju and family were heavily leveraged at a personal level, stuck in property and thus needed a bail-out. Nobody, however, I think suspected that Satyam itself was a fraud, with no cash and a non-existent margin structure. Raju’s letter implies that the company is basically unprofitable at a net level, and made no money over the last few years. How can Satyam, with 50,000 employees and global scale, make no money at all, when even mid-tier mediocre IT companies make atleast 10 per cent operating margins? How can this fraud be going on for years? How can the auditors not have confirmed cash balances, and that too of Rs 5,000 crore? Cash is supposed to be real, profit an accounting fiction, but here the cash itself was fraudulent. Raju goes on to state that he was going to merge Maytas Infra and his privately-held property company to bail out Satyam, and not use Satyam’s cash to bail himself out (as assumed by most who opposed the merger). Raju also writes that he pledged all his shares to raise cash to pump into Satyam, to keep the charade going.
While the truth will eventually come out, I still find it difficult to believe that Satyam actually makes no money, even though the revenues, clients and employees are real. How is it that a company with a scale of 50,000 employees, which pays employees industry standard wages and has billing rates comparable to industry standards, makes no money when TCS, Infosys and Wipro make 25-30 per cent operating margins? Even mid-tier companies with only 5,000 employees make 10-15 per cent margins. If Satyam really makes no money, what accounts for the margin leakage? Where are its costs out of line? Is money being sucked out of the company? Was Raju really willing to shortchange himself and family to bail out a company in which he had no more then an 8 per cent stake (as he claims he wanted to do by merging Maytas)? I suspect Raju’s letter may not be the last word in this saga.
While this sad episode will obviously raise doubts on India Inc and have damaged the country’s reputation, I do not believe the damage is permanent. Tragic episodes like this do happen, and this in no way dampens the IT or India growth story. Every boom/bust cycle invariably exposes weak players and Satyam will not be the last fraud we see in this country. The shock is, however, magnified both due to the scale and because it has claimed a top 5 player in the IT sector, a sector which has been the poster child of a more progressive and investor friendly corporate India.
Post Enron in the US, we saw a slew of regulations culminating in the Sarbanes-Oxley Act. In India, we have by and large adequate laws and disclosure standards, though we can improve disclosure in areas like promoters-pledged shares or detailing the bank accounts where the company’s cash is parked. Our framework of a majority of independent directors, minimum frequency of board meetings, shareholder approval needed for major decisions etc is of global standards. We also force our CEO and CFO to certify the accuracy of the published accounts. We can tinker with new disclosures but it is unlikely to make much difference. Satyam after all reported its results in Indian GAAP, IFRS and US GAAP, and even gave audited half-yearly statements. With a US listing it was also under the jurisdiction of the SEC, but none of this made any difference.
We now need to ensure that the guilty are brought to book and we see a swift and coordinated regulatory response. In the case of Enron in the US, the guilty were tried within three years — we cannot allow a 20-year litigation cycle (like the 1992 scam) in this case. We must quickly investigate, find out the truth, and then move against all the actors in this fraud. The company and Raju cannot have single-handedly pulled off a fraud of this magnitude and duration. Bankers, auditors and the finance function in Satyam will all be involved in some form or fashion. At the least they can be accused of incompetence. Investigation and action must be directed at all these service providers. It is especially critical that the sanctity of the independent audit process be maintained. The CA institute has to tighten standards and move against proven incompetence.
The only way to win back investor confidence is for justice to be done quickly and the punishment be severe enough to instil fear and disincentivise corporate fraud. In the case of Enron both the company and its auditors (Arthur Anderson)went out of business.
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The ultimate defence against poor governance is the market itself. It was well-known that Satyam had a suspiciously high and growing current account balance, as well as nearly Rs 400 crore interest accrued but not received on deposits. Why will a company keep Rs 2,000 crore in a current account? Why will the bank not credit interest to a deposit for multiple quarters? While investors can legitimitely claim that they were relying on a Price Waterhouse-signed balance sheet, one of the lessons of the sub-prime debacle is that investors cannot rely blindly on external service providers.
Investors should exercise proper due diligence, and not allocate capital to companies with poor disclosure or governance practices. Investors cannot allow large companies to have unknown auditors, or rubber-stamp boards and must force them to split the CEO/chairman role in substance. If investors refuse to back poor managements, you will see large valuation gaps for companies in the same industries. If poor governance attracts poor valuations, it will incentivise shareholder-friendly behaviour and marginalize companies with weak corporate governance. Investor memory also cannot be short, poor governance has to attract a permanent de-rating.
This episode should further galvanise shareholder activism in India, with the HIRCO and GACL episodes being the first signs of greater shareholder organization and participation. We must see a greater market for corporate control in India. Investors must be willing to throw out poorly performing managements and boards, especially in companies where institutional investors have a higher stake than the erstwhile promoter group. Only when poor governance practices lead to poor valuations and hence vulnerability to takeover, will the economic incentives be aligned to prevent a recurrence of Satyam.