Corporate Governance Failure at Satyam Computer Services - Case Study Example

?Case study- Corporate Governance Failure at Satyam Computer Services Table of Contents Ethics & Fraud 3 0 Ethical Values & its Effectiveness 3 1.1 Satyam Case Scandal & its Ethical Implications 4 1.2 Code of Ethics of the Australian Accounting Profession 5 2 Earnings Management 6 2.0 Earning Management: Generic Definition & Meaning 6 Earning Management: Fraudulent, Real & Accrual Accounting 6 Earning Management at Satyam Corporation Ltd 7 3 Corporate Governance 8 3.0 Corporate Governance Mechanism 8 3.1 Corporate Governance Mechanism as Remedial Measures in Satyam Corporation Ltd 8 3.2 Corporate Governance Mechanism with Reference to OECD Principles 10 Reference List 11 1. Ethics & Fraud 1.0 Ethical Values & its Effectiveness It is observed that an organization with diverse workforce witnesses various ethical dilemmas and issues that arise out of ethical values. This happens because the interest of organizational and personal ethics is different from each other giving rise to potential conflict among employees and managers (Pollock, 2011). Ethics can be termed as a moral principles or set of standard followed by an individual. Business ethics can be termed as a set of moral values and principles that help the business managers to arrive at unified conclusion. The impact of business ethics on managerial decision making is huge and has the potentiality of changing the course of managerial decision making. It is observed that the influence of legal laws on the managerial decision making is huge and can have considerable amount of influence on the personal lives of individual as well (George, 2011). Since, business activity is also regarded as a human activity, the evaluation of business ethics would be done in a similar fashion. Apart from the importance of the business ethics, various facets of ethics and its application in the Satyam scandal would be covered. The application of ethical theories and how it’s effective result oriented approach would have changed the entire business scenario in Satyam. Ethical applications would have a serious impact on the future business activities, as varied dimensional aspects theory approaches proposed by Laznaick and Dimitriou (1995, cited by Dimitriou et. al., 2011) would have moulded the different business situations to large extent to increase the organizational outcome and effectiveness. 1.1 Satyam Case Scandal & its Ethical Implications The Satyam case scandal was one of the most classic cases of fraudulent accounting, which had a serious impact on its business activities, reputation and its earnings. The Satyam case scandal was a result of sheer negligence by the management towards it fiduciary duties, accounting procedure and lack of corporate social responsibility. One of the major reasons as observed by the analyst behind this kind of negligent behaviour would be due to the greed to earn more revenue just to satisfy the stakeholders and the shareholders. The major need that led to this kind of illegal behaviour was due to greed overshadowing, lack of responsibility to meet the fiduciary duties and the fierce competition just to impress the stakeholders and investors. Apart from negligence to responsibility and duties towards the company ethical policies and procedures the company management planned to acquire 51 percent stake in Maytas infrastructure, which was one of the leading construction and infrastructure development companies (Caraballo, Cheerla and Jafari, 2010). In April 2008 the company CEO had acquired 37 stakes and the total turnover generated was almost $300 million with a net profit of $ 20 million (Caraballo, Cheerla and Jafari, 2010). In the same year the company had published its first IFRS audited financial statements and five members of the boards had approved the proposal to acquire a stake in the Maytas infrastructure and other properties (Caraballo, Cheerla and Jafari, 2010). However, without the shareholders approval, the company went ahead with the decision, which led to chaotic outcome. The decision regarding the acquisition backfired as the investors threatened to take action against the management of the company and sold most of its shares. The World Bank condemned the company to conduct any kind of business activities for continuous 8 years (Caraballo, Cheerla and Jafari, 2010). Four independent directors quit the Satyam board and as per SEBI orders, they were asked to disclose the pledged shares in the stock exchange. After the confession made by the CEO, it been observed that he had committed several illegal issues, which were not only unethical but also has severe impact on the employees of the organization. If the management of Satyam Corporation would have followed the Utilitarianism concept, then it would have given the employee, a clear idea about the distinction between right and wrong. The utilitarianism concept lays emphasis on the fact that an activity can be either right or wrong and develop a technique that defines the moral value of a particular action (Taylor et. al., 2005). 1.2 Code of Ethics of the Australian Accounting Profession The APESB Board also known as The Accounting Professional & Ethical Standards Board is a professional organization designed to maintain a code of professional conduct among the different accounting bodies and professionals. It was established by CPA Australia and by Institute of Chartered Accountants, which has been made specifically for the accountants of Australia for their convenience. It was established in the year 2006 with the sole objective of providing accounting guidelines to the accountants of Australia. As per the principles and guidelines of the APESB, every audit engagement should be accompanied by an external and internal auditor. The main crux of these guidelines would be not only engaged shareholders for suiting decision but also be true to their accounting nature, which will lead to transparent decision making. As per the investigation procedure of the Satyam scandal, it was found out that the rules and regulation of the accounting policies were not well defined and did not lead to accurate decision making prior to these scandalous incidents. 2 Earnings Management 2.0 Earning Management: Generic Definition & Meaning Earning Management has received considerable attention from shareholders and stakeholders since the past few years, after the recent collapse of several organizations due to their manipulation of accounting policies and procedures. Although, there have been various monitoring financial guidelines and policies, which have acted as a cushion to protect potential investors and also help them providing their equitable rights. These monitoring devices are also popularly known as corporate boards, audit committee and the directors in the corporate governance board (Rao, Tilt and Lester, 2012). The main objectives of these devices would be to protect the interest of these shareholders and stakeholders and also value the financial and human capital. This also includes the timing of the actual expenses like advertising, research and development expenses, etc. To a certain extent, it includes recognition of revenues and expenses by advancing recognition through realization of credit sales. This financial procedure is effectively monitored for the betterment for the company’s brilliant financial performance through the procedure of earning management. It not only helps in transparent decision making but the earnings are manipulated through the biasing of accrual managerial decisions, structuring of transactions and the erosion of usefulness of earnings. Earning Management: Fraudulent, Real & Accrual Accounting The procedure of using fictitious accounting transactions which are generally prevented by the GAAP (Generally accepted accounting principles), is known as fraud accounting. The most common forms of fraudulent activities include 1) reporting fictitious revenues 2) understating liabilities and expenses 3) improper valuation of assets and liabilities (National Fraud Authority, n.d.). On the other hand, the procedure of creative accounting is used to create loopholes in the company’s regulatory system. In USA this procedure is a part of fraud accounting, but in the UK, it is used to provide flexibility in the existing accounting and regulatory system of the company. The process of internal audit adds significant value by prevent fraud accounting within the company and improving financial control (National Fraud Authority, n.d.). Audit failure leads to misappropriation of funds and non detection of fraudulent activities within the company. Accrual accounting on the other hand proves to be beneficial because it helps in measuring the effectives of accrual base accounting procedure (Action Fraud, 2013). Accrual based earning are helpful in understanding the different normal and abnormal components of the accrual based accounting. The total earning represents the actual components of the actual contribution and the difference between the net profit and cash flow from operation. It is logically associated with the growth of the company, realization of revenues and also the balance of the property. Real accounting on the other hand helps managers to provide earnings by change in the timing and the structure of investing, financial and operating decisions (Enomoto, Kimura and Yamaguchi, 2013). Regulatory authorities impose certain restrictions because it has the potentiality of reducing the outside investor’s profit and also in the turn of the events should provide investor protection. Earning Management at Satyam Corporation Ltd From the Satyam case it is observed that the CEO had claimed in the letter that managing director and other top employees had benefited in monetary terms from the inflated revenues. He had admitted of his faults in the letter stating that he had deliberately created a gap in the accounting procedure between the actual operating profit and the one reflected in the accounting books over the last few years. Eventually, the acquisition did not get carried out due to the scandalous event, which was a mere feeble attempt to fill the gaps of fictitious assets with real ones. It is observed from the above case study that the scandalous accounting activity had components of fraudulent accounting and real earnings management. As mentioned before fraudulent accounting involves the falsifying of accounts in the books of journal and ledger by the auditor, director or any other member of the organization. This requires overstating of assets and understating of liabilities and can take for a variety of reasons like to obtain additional financing from a bank, reporting of unrealistic profits, inflating the share price and achieve performance related bonus activities. 3 Corporate Governance 3.0 Corporate Governance Mechanism Corporate governance lays emphasis on relationship of the management of the company with the shareholders, stakeholders, debtors, creditors, suppliers, community organizations and the board of directors (Paton, Juleff and Schachler, 2007). Corporate governance framework depends upon institutional, legal and regulatory environment (Paton, Juleff and Schachler, 2007). There are multitude of factors that affect the corporate governance and decision making of the company. Corporate governance is affected largely by the relationship among the above mentioned participants of the company (OSL, 2013).The owners of the company including institutional and equity investors have the right on corporate governance. However, the individual shareholders do not usually seek corporate governance rights but are more concerned about getting fair treatment from the management of the company (OECD, 2004a). Creditors play an important role in the governance systems and serve as an external monitor in the corporate performance (OECD, 2004b). 3.1 Corporate Governance Mechanism as Remedial Measures in Satyam Corporation Ltd There is not a single model framework for a good corporate governance system, but there are certain elements that fall under the category of good corporate governance system. Good corporate governance has been associated with a successful company. The economic situation of the country may depend largely on the efficiency of the companies (NAB, 2011) however, the effective decision making ability of the board of the company also is a major contributing factor to the success of the company (NAB, 2010). The essence of a good corporate governance system depends upon the ability of the board of directors exercising their freedom within a framework of effective accountability (Kim, 2011). In the case of Satyam, the practice of good corporate mechanism was absent and it resulted in a scandalous event, which affected the profitability, reputation and also welfare of the employees. The director had overstated the assets of the employees to obtain additional financing and also gain the trust of the stakeholders, shareholders (Heinrich, 2005). The employees of the organization were the ultimate sufferers and it affected their professional/personal life to a large extent (EOG, 2013).The practice of good corporate governance system could have alleviated the situation to a large extent and have helped in the enhancing the performance of the employees. The shareholders of the company should have been supportive and understanding the gravity of the situation after the declaration made by the CEO, so that there is an increase in the organizational outcome and commitment (Dunphy, Benn and Griffiths, 2003). Shareholders should have regularly monitored the performance of the company because it would have helped in providing significant input which would have accelerated the company’s progress in return (Clarke, 2007). The presence of a good corporate governance system within a company helps in providing a certain degree of confidence that helps in smooth functioning of the entire organization (CGR, 2013). This mechanism would have helped in alleviating the relationship between the shareholders and the management. This is because conflicts related to governance may arise out of power vested upon the controlling majority shareholders over minority shareholders. 3.2 Corporate Governance Mechanism with Reference to OECD Principles The OECD principles provide a framework and guidelines, which would have helped in facilitating the relationship between the shareholders and the management. The policy framework acts as guidance and helps in developing a smooth relationship between the employees and the management also. The OECD principles could have helped in solving down the complexity of the problems to a certain extent and have helped the management of Satyam in transparent financial disclosure. These principles were meant highly relevant to the corporate failure and would have solaced the shareholders. Solacing the shareholders was prerequisite as it would have prohibited them to take a drastic and serious measurer against the management of Satyam by filing suit against the company people. It is observed that the OECD principles would not only have acted a guide, but would have also permitted in solving the complexity of the financial problems. Reference List Action Fraud, 2013. False Accounting Fraud. [Online] Available at: < http://www.actionfraud.police.uk/fraud-protection/false-accounting-fraud > [Accessed 04 September 2013]. Caraballo, C., Cheerla, A. and Jafari, O., 2010. Satyam: Brotherly Demise the Rise and Fall of Ramalinga Raju [pdf] Available at: < http://www.managedecisions.com/blog/wp-content/uploads/2010/07/Project_Term-Paper_SatyamScandal.pdf /> [Accessed 04 September 2013]. CGR, 2013. The Right Fit in Values [Online] Available at: < http://corpgovrisk.com/ > [Accessed 04 September 2013]. Clarke, T., 2007. International corporate governance: A comparative perspective. London: Routledge. Dimitriou, C.K et al., 2011. The Impact of a Hotel’s Business Ethics on Employee Job Satisfaction and Organizational Commitment [pdf] Available at: [Accessed 04 September 2013]. Dunphy, D. C., Benn, S. and Griffiths, A., 2003. Organizational change for corporate sustainability: A guide for leaders and change agents of the future. London: Routledge. Enomoto, M., Kimura, F. and Yamaguchi, T., 2013. Accrual Based and Real Earning Management. [pdf] Available at: < http://www.rieb.kobe-u.ac.jp/academic/ra/dp/English/DP2012-13.pdf > [Accessed 04 September 2013]. EOG, 2013. Corporate Governance [Online] Available at: < http://emeraldoilandgas.com/corporate_govenance > [Accessed 04 September 2013]. George, R. T.D., 2011. Business ethics.7th ed. New Delhi: Pearson Education India. Heinrich, A., 2005. Why corporate governance in the Russian oil and gas industry is improving. Emerald Group Publishing Limited, 5(4), p.03-09. Kim, S.W., 2011. The quality impact of governance change on board decision making. Asian Journal on Quality, 12(1), p.1598-2688. NAB, 2010. NAB’s Compliance with the ASX Corporate Governance Principles and Recommendations with 2010 Amendments [pdf] Available at: < http://www.nab.com.au/wps/wcm/connect/9a7636004a3aeb569b6e9f64a865bf36/Corporate-Governance-Checklist.pdf?MOD=AJPERES&CACHEID=9a7636004a3aeb569b6e9f64a865bf36 > [Accessed 04 September 2013]. NAB, 2011. Corporate Governance [pdf] Available at: < http://www.nab.com.au/wps/wcm/connect/7a1183004a3aea539b3d9f64a865bf36/Corporate-Governance-2011.pdf?MOD=AJPERES&CACHEID=7a1183004a3aea539b3d9f64a865bf36 > [Accessed 04 September 2013]. National Fraud Authority, n.d. National Fraud Reporting Centre. [Online] Available at: < http://www.cumbria.police.uk/admin/uploads/attachment/files/Advice_and_Info/Fraud/False_Accounting_fraud.pdf > [Accessed 04 September 2013]. OECD, 2004a. The OECD Principles of Corporate Governance [pdf] Available at: [Accessed 04 September 2013]. OECD, 2004b. OECD Principles of Corporate Governance [pdf] Available at: < http://www.oecd.org/corporate/ca/corporategovernanceprinciples/31557724.pdf > [Accessed 04 September 2013]. OSL, 2013. Corporate Governance [Online] Available at: < http://www.oilsearch.com/Corporate-Governance/Overview.html > [Accessed 04 September 2013]. Paton, C., Juleff, L. and Schachler, M.H., 2007. Corporate governance in the financial services sector. Emerald Group Publishing Limited, 7(5), p.623-634. Pollock, J.M., 2011. Ethical dilemmas and decisions in criminal justice.7th ed. Connecticut: Cengage Learning. Rao, K.K., Tilt, C.A. and Lester, L.H., 2012. Corporate governance and environmental reporting: An Australian study. Emerald Group Publishing Limited, 12(2), p.143-163. Taylor, G., Tower, G., Zahn, M.V.D. and Neilson, J., 2005. Corporate governance determinants on Australian resource companies’ financial instrument disclosure practices. Asian Review of Accounting, 16(1), p.56-73. Read More