Financial Fiasco in Satyam Computer Services Limited - Essay Example

? Report on Financial Fiasco of Satyam Computer Services Limited Executive Summary The report will try to throw some light on financial fiasco in Satyam Computer Services Limited. Key purpose of the report is to identify reasons behind financial scam in Satyam Computer Services Limited in the light of key issues of corporate governance. In the first part, the report will try to identify flaws in corporate governance structure of the company prior to the financial scam. In the second part, the study will recommend corrective actions to board of directors in context to international good practices for corporate governance. In the last part, the study will evaluate the recommended management control systems and cultural orientation in context to the pertinent issues of Satyam case. The study will try to analyze the financial fiasco of Satyam with the help of both corporate governance codes across different countries and academic research works of various research scholars on the topic of corporate governance. Table of Contents Table of Contents 3 Introduction 4 Corporate Governance Flaws in Satyam Computer Services Limited- Analysis of the Situation 5 Unethical Conduct 6 Insider Trading 6 Lax Board Structure 8 Questionable Role of Audit Committee 9 International Good Practice 10 Recommendation for Restructuring the Management Control Systems 13 Conclusion 14 Reference 15 Introduction It is unfortunate that the report cannot start in assertive manner because purpose of the study is to analyze financial fraud committed by renowned company hence throughout the report negative words like scandal, fraud, scam etc will be discussed in the regular interval. According to Industry analysts, committing financial fraud has become global phenomenon for corporate and business world. Corporate world has seen number of financial scandals such as Enron, WorldCom, Nortel, Lehman Brothers, Vivendi etc. In such context, the study will analyze financial fiasco of Satyam Computer Services Limited which was an Indian computer major in order to prepare report for the directors of the company which will help them to identify the reasons behind financial fiasco in the company in the light of corporate governance policies and formulate control mechanism to prevent such kind of fraud in future course of time. However, to start this discussion the study will define the meaning of fraud in context to general assumptions. O’Connell (2004) and Graham et al (2005) have defined financial fraud as the misrepresentation of financial performance or future earnings in order to gain some unauthorized benefits. According to research scholars, companies can decrease the scope of financial fraud by implementing strict corporate governance codes. According to Brigham and Ehrardt (2008), corporate governance is basically set of laws, rules or codes which help companies to conduct business in ethical manner; diminish the scope for committing financial frauds and satisfy interest of shareholders. Generally, standard of corporate governance measures are low for companies belonging to emerging countries such as India, Brazil due to inefficient institutional arrangement which tolerate poor corporate reporting standard, time taking law enforcement procedures for those who are responsible for committing financial frauds, gap in the laws which helps the culprits to escape after committing financial frauds etc (Dossani, 2012). Satyam Computer Services Limited was an Indian company hence this report can neglect the fact that, the analysis of the financial fiasco has to be in line with the corporate governance practices in India. Hence the study will briefly discuss about the existing corporate governance norm in India in order to understand macro environmental situation prevailing in January 2009, during this month, Byrraju Ramalinga Raju who was the chairman of the company, has announced that Satyam has committed financial frauds in order to produce an inflated financial statement for its shareholders for successive quarters. Corporate Governance Flaws in Satyam Computer Services Limited- Analysis of the Situation Careful investigation of Satyam case shows that, financial scandal of the company was not only a financial scam but also a shot in the arm of ethical conduct mentioned in corporate governance codes. Promoters of the company such as Ramalinga Raju, CFO Srinivas Vadlamani and Rama Raju were completely aware of financial volatility of the company and in such circumstances they desperately attempted to acquire Maytas Properties (MPL) and Maytas Infrastructure (MIL) in order to make up the non existing asset shown in the financial statement and counterbalance the pressure from external shareholders. Let’s look at the fake financial statement of Satyam in order to understand how promoters of the company had fudged the accounts. (Source: Sharma, 2009) As of September 30, 2008, Satyam had carried an inflated (non-existent) bank balance of Rs 5040 crore, understated liability of Rs 1230 crore and non-existent interest of Rs 376 crore (Sharma, 2009). It is hard to believe that such level of financial scam was committed by promoters of the company without tweaking or better to say ignoring corporate governance codes, hence the study will investigate what were the corporate governance flaws in the company that have given scope for committing financial scam of that magnitude. Unethical Conduct In Sanskrit language, ‘Satyam’ is synonymous to truth. However, for Ramalinga Raju, who was the founder of the company, earning profit by cooking financial result, avoiding taxes, pay offs etc was more important than following the path of truth or ethical conduct. Raju’s admission along with his resignation has revealed that Satyam had been feeding ‘Asatyam’ or untrue financial result to its investors for consecutive quarters. Ramalinga Raju and his brother B. Rama Raju (managing director of the company) had disguised the fake financial results and a fraud of Rs 7800 crore ($1.47 billion) from the eye of board of directors, auditors and senior managers for more than 5 years. Detailed investigation of business operation and corporate culture of Satyam Computer Services Limited shows that, it was devoid of any ethical codes (both explicit and implicit), rather derogatory conducts like corruption, bribery, and nepotism had been exercised by different verticals of the company in frequent manner. In 2008, World Bank imposed charges on Satyam for data theft and providing “improper benefits” to bank staff (Sharma, 2009). CEO and CFO of Satyam had sold their respective shares in the company and they were also accused of using asset of the company for personal interest. Hence, from the ethical perspective, Satyam performed pretty poorly which was one of the most notable corporate governance failures for the company. Insider Trading While investigating on Satyam scandal, Crime Investigation Department (CID) has found that, promoters of the company had indulged heavily in insider trading of Satyam’s shares in order to build land bank. Funds collected by B. Ramalinga Raju and his family members were used for purchasing lands in the name of more than 300 companies and 25 individuals. Almost 99% of companies and individuals were related family of Ramalinga Raju. According to Sharma (2009), family members and promoters of Satyam had sold more than 3.5 crore shares in order to collect more than Rs 3000 crore. Promoters had frequently offloaded their shares in order to create an illusion that the company is performing very well in front of investors. Hence promoters of the company have cheated shareholders in order to make personal gains. For example, Ramalinga Raju and his brother sold almost 2 crore shares in order to collect more than Rs 1600 crore in the period of 2004 to 2009. Extent of insider trading in Satyam can be briefed in the following manner. (Source: Sharma, 2009) Bogus Accounting Analyzing the financial statement of Satyam, it is evident that the company has committed accounting fraud in order to show the inflated figures to shareholders. Accrued interest was shown in the balance sheet in order to prevent auditors to detect non-existent fixed deposits. Satyam had paid taxes of 186.91 crore as part of accrued interest on non-existent earning of Rs 376 crore. Satyam had created false fixed deposits of more than Rs. 3000 crore in order to present false impression in front of shareholders. Extent of falsification in accounting practice of the company can be briefed in the following manner. (Source: Sharma, 2009) Lax Board Structure Board structure of Satyam was lenient in nature which was composed of ‘chairman-friendly’ members who did not have the spine to raise questions over the decisions of chairman regarding critical business strategies. Although board members had the knowledge about financial distress of the company but they did not take prompt action against chairman. Each of the board member was dysfunctional due to their over reliance on Ramalinga Raju. Board members failed to identify the financial wrongdoings of the company. When the company announced that they are bidding for Maytas Infra and Maytas Properties, shareholders raised concerns over the corporate governance practices in the company. Important thing is that, these two companies were owned by son of Ramalinga Raju, however the acquisition decision was wrong, because as per Indian Companies Act 1956, it is illegal to acquire directly or indirectly any other company without taking approval of shareholders. It is evident from the above discussion that, board directors supported or remained silent about scandalous activities of Ramalinga Raju and his peer group. Role of Independent Directors 6 of the 9 independent directors were academicians from pioneer institutes like Harvard Business School, IIT Delhi, and Indian School of Business (ISB) etc. Only 7 of the 9 independent directors were present during discussion of Satyam’s plan to acquire Maytas Infra and Maytas Properties. According to Companies Act, it is a mandate for companies to make sure that all of its independent directors are present during crucial board meeting. It is hard to believe that, such eminent academicians could not identify the cash pileup in the fraudulent balance sheet or manipulation in other aspects of financial statement. The fact is that, these independent directors knew the whole story of financial scam of the company but did not raise their voice and kept watching the wrong doings for consecutive years. Questionable Role of Audit Committee Audit committee in Satyam Computer Services Limited, failed miserably to detect the fraud that has been committed by promoters of the company. According to the research conducted by Professor J. P. Sharma (2009), who is one of the eminent faculty in Delhi School of Economics, whistleblowers such as Jose Abraham had send warning about financial fiasco of the company to auditors but it was the auditors who preferred to remain silent about the scandalous activities of Ramalinga Raju and his peer group. Indian government had imposed fine in accordance with the provisions mentioned in Securities Contracts (Regulation) Act, 1956 over the faulty auditors who performed questionable role in their part. It is clear from the above discussion; faulty corporate governance structure of Satyam Computer Services Limited had given the courage to promoters of the company to commit financial fraud. In the next section the study will discuss international good practice which will help the report to develop a rational silhouette for the proposed recommendations which are related to management control systems and culture of the Satyam Computer Services Limited. International Good Practice There are different corporate governance theories are available such as Stewardship theory, Agency theory, Myopic market mode, Stakeholder theory etc to the researchers to analyze the Satyam Scam. However, agency model and myopic market model are most suitable for analyzing the corporate governance failure in Satyam Computer Services Limited. Jensen and Mechling (1976) was the promoter of agency theory, according to the simplified version of the theories, promoters of Satyam were the agents on behalf of the shareholders hence it was the responsibility of Ramalinga Raju and his peer group to maximize the return for shareholders. In such context, Satyam followed the myopic market model, which states that, stock market performance of the company is most important indicator of performance of the companies. According to supporters of myopic market mode such as Keasey et al (1997), La Porta et al. (1997) and Shleifer and Vishny (1997), following myopic market model helps companies engage shareholders and measure performance of agents in an effective manner. Promoters of Satyam Computer Services Limited had tried to raise its stock market performance by showing fake financial results to shareholders. Hence, it can be inferred that, following unethical myopic market model played vital role in financial scam in the company. Zingales (2000) has warned companies to make a balance between transparent corporate governance model while relying on market based performance but financial scam of Satyam has proved that the company has ignored the warning. It will not be right to blame Satyam Computer Services Limited alone for not following corporate governance practices because the company belonged to a country which is plagued by lack of awareness regarding various principles of corporate governance codes. In the next section the study will compare corporate governance policies in India in context to other developed countries such as USA, UK for understanding macro environmental loopholes which have encouraged Satyam Computer Services Limited to commit financial fraud. According to Klapper and Love (2004) and Jensen (1997), corporate governance practices in emerging countries is still at the nascent stage, which allows companies commit financial scams in periodic manner without getting caught in the arm of law enforcement. Research scholars have defined India as ‘‘backwater of corporate governance practices’’ (Khanna and Palepu, 2004, p. 484). Corporate government structure of Indian companies can be compared with corporate government policies in companies belong to developed countries such as UK, USA, Germany and others. Corporate Governance Practices Indian Companies International Best Practices Independent directors At least 50% Majority in percentage Remuneration of independent directors Company’s equity linked securities and fees of the director Almost Same Importance of executive directors in the meeting between independent and non-executive (I/N-E) directors Low High Audit committee All the members are I/N-E, these members take care of corporate governance codes and whistleblower protection for shareholders Not necessarily include all I/N-E Compensation committee Full board members decide compensation Independent directors decide compensation of executive directors Corporate strategy Non-inclusion of all the board members, only management decide the strategy Inclusion of all the board members Shareholder rights Low because majority of companies do not disclose financial information to shareholders in transparent manner Although dual class stock is an issue but shareholder’s rights are comparatively high (Source: Dossani, 2012) It is evident from the above discussion that, lenient corporate governance policies in Indian companies has played a large part in allowing Satyam Computer Services Limited to show inflated financial performance to shareholders in successive quarters. In such context, the study will analyse the situation prevailing in January 2009 in relation to corporate governance structures existing Satyam Computer Services Limited in order to understand what actually went wrong. Internationally, companies follow various corporate governance codes such as Sarbanes Oxley (SOX) legislation in USA, Combined code in UK, Cadbury report, Greenbury recommendation, Hampel recommendation, and Walker committee recommendation etc. In USA, following SOX legislation helps companies to improve shareholder engagement, control of independent directors, increase risk taking ability etc. However, problems of Satyam Computer Services Limited is more related to SOX and modified combined code as mentioned in recommendation of Walker committee. Hence the study will examine best practices mentioned by Sir David Walker (2009) in his report. Walker report is the modified version of combined report which was published after the Enron scam and banking crisis. According to Oyvind and Odegaard (2011) and Grandmont et al. (2004), companies need to restructure their ownership structure, composition of the board, audit committee structure etc in order to decrease the scope for financial frauds. According to Weimer and Pape (1999) and Mintz (2005), corporate firms should treat corporate governance as a holistic affaire which includes responsibility of promoters of business, responsibility of audit committee, responsibility of nomination committee, responsibility of independent directors etc. In such context, existing international best practices can be briefed in the following manner; Responsibility of promoters of the company should be separated from responsibility of CEO. In simple words, CEO cannot perform dual responsibility in order to keep self interest away from the interest of the organization. Majority of the board members should be non-executive directors who do not perform any operational duty in the organization. Remuneration committee should decide the pay structure of promoters and directors of the company and directors are responsible for disclosing all their company related financial transactions to audit committee. It is obligation for the organization to disclose internal and external control mechanism to shareholders. Audit committee should be comprised of majority of non-executive directors who have sufficient expertise, knowledge and skill level to track financial irregularities in transactions. Recommendation for Restructuring the Management Control Systems There is no doubt that the predicament that has been faced by Satyam Computer Services Limited would not be desirable for any corporate. Some steps are needed to be taken by the directors of the company in order to strengthen corporate governance norms in the company and eradicate the chances of future financial scams. There should be a code of ethics in the company and separate monitoring committee which would be comprised of majority of non-executive directors would monitor whether the company is deviating from code of ethics or not. In USA, independent monitoring body or regulatory body in the company works in line with Public Company Accounting Oversight Board (PCAOB) in order to create a fair corporate governance structure. Board of directors of the Satyam Computer Services Limited should follow the same concept while developing a monitory body. Careful observation of ownership model of Satyam prior to its financial scam shows that the model has created the environment for delusion and abuse. For example, Satyam was forced to keep its equities and bond in high esteem in order to attract capital from public whereas Ramalinga Raju held very little ownership stock (merely 4%), which gave him the scope to inflate financial performance in order to keep its equities and bond in high esteem because overstatement of profits would not hurt him personally. Hence board directors should increase the ownership holding of promoters in the company in order to make them personally responsible for any financial misappropriations. Board of directors should rotate the external auditors for the company in periodic manner because prior to the financial scam, non rotation of PriceWaterhouseCoopers (PWC) as external auditors had given the scope to Ramalinga Raju to create a nexus with the external auditor to commit financial scam. Independent directors of the company should be freed from all other vicarious involvement and liability in order to make sure they only concentrate on improving standard of corporate governance practices in the company. Board of directors of the company should review the legislative norms for insider trading and implement stringent actions for such kind of activities. Conclusion According to Xie et al (2003) and Coelho et al (2003), management control systems mentioned by any corporate governance codes has close relation with the culture of the company. Hence, board directors of the company need to ensure that, they would infuse the culture of ethics and honesty in the organizational environment of the company apart from implementing recommended management control system. Board of directors of the company should implement the recommended code of business ethics in order to discourage its employees from participating in any unethical conducts such as bribery, deception, misrepresentation etc. Conjoint impact of recommended management control system and ethical organizational culture can help the company to eradicate the scope of committing financial fraud in future course of time. Reference Brigham, E. and Ehrardt, M., 2008. Financial Management. Mason, OH: Southwestern Cengage Learning. Coelho, P. R. P., McClure, J. E. and Spry, J. A., 2003. The social responsibility of corporate management: A classical critique. Mid-American Journal of Business, 18, pp. 15-24. Dossani, R., 2012. Private equity and corporate governance in India. Journal of Asia Business Studies, 6(2), pp. 223-238. Graham, J. R., Harvey, C. R. and Rajgopal, S., 2005. The economic implications of corporate financial reporting. Journal of Accounting and Economics, 40(1/3), pp. 3-73. Grandmont, R., Gavin, G. and Flavia, S., 2004. Beyond the Numbers: Corporate Governance – Implications for Investors. Frankfurt: Deutsche Bank. Jensen, M. C. and Mechling, W., 1976. Theory of the firm: Managerial behaviour, agency costs and capital structure. Journal of Financial Economics, 3, pp. 305-60. Jensen, M. C., 1997. Eclipse of the public corporation. Harvard Business Review, September/October. Keasey, K., Thompson, S. and Wright, M., 1997. Corporate Governance: Economic and Financial Issues. Oxford: Oxford University Press. Khanna, T. and Palepu, K., 2004. Globalization and convergence in corporate governance: Evidence from Infosys and the Indian software industry. Journal of International Business, 35, pp. 484-507. Klapper, L. and Love, I., 2004. Corporate governance, investor protection and performance in emerging markets. Journal of Corporate Finance, 10(5), pp. 703-28. La Porta, R., Lopez de Silanes, F., Shleifer, A. and Vishny, R. W., 1997. Legal determinants of external finance. Journal of Finance, 3, pp. 1131-50. Mintz, S. M., 2005. Corporate governance in an international context: Legal systems, financing patterns and cultural variables. Corporate Governance: An International Review, 13(5), pp. 582-97. O’Connell, B., 2004. Enron Inc: He that filches from me my good name . . . makes me poor Indeed. Critical Perspectives on Accounting, 15(6/7), pp. 733-49. Oyvind, B. and Odegaard, B. A., 2001. Corporate governance and economic performance in Norwegian listed firms. Oslo: The Norwegian School of Management. Sharma, J. P., 2009. What Went Wrong With Satyam? [pdf] Available at: [Accessed 26 April 2013]. Shleifer, A. and Vishny, R. W., 1997. A survey of corporate governance. Journal of Finance, 52, pp. 737-83. Walker, D., 2009. A review of corporate governance in UK banks and other financial industry entities. [pdf] Available at: [Accessed 29 April 2013]. Weimer, J. and Pape, J., 1999. A taxonomy of systems of corporate governance. Corporate Governance: An International Review, 7(2), pp. 152-66. Xie, B., Davidson, W. N. and DaDalt, P. J., 2003. Earnings management and corporate governance: The role of the board and the audit committee. Journal of Corporate Finance, 9, pp. 295-316. Zingales, L., 2000. In search of new foundations. The Journal of Finance, 1, pp. 1623-53. Read More