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INTRODUCTION
Neharika Vohra
Professor
Indian Institute of Management, Ahmedabad
e-mail: neharika@iimahd.ernet.in
T
he shocking resignation of Mr. B Ramalinga Raju, the Founder and Chair-
man of Satyam, on January 7, 2009, came as the climax of twenty-two
days of drama that started on December 16, 2008, with the negative reaction
of shareholders towards the proposed acquisition of Maytas Infrastructure (a fam-
ily-owned company of Mr. Raju) for $1.6 billion.
On January 2, 2009, Mr. Raju disclosed to the stock exchange that his family had
pledged all its shares held in its holding firm, SRSR Limited, to institutional lenders,
following which, in the next two days, the share of the Raju family in Satyam fell
from 8.6 per cent to 3.6 per cent. During the intervening period, three of the inde-
pendent Directors at Satyam resigned. On January 7, Mr. Raju confessed to his crime
and absolved all the top functionaries of Satyam stating that they had no clue as to
what was being done by him to orchestrate the elaborate fraud. Mr. Raju’s letter to
the board stated that Satyam’s balance sheet as on September 30, 2008, carried ficti-
tious cash and a bank balance of Rs. 5,040 crore. In addition, it carried an equally
KEY WORDS made-up accrued interest of Rs. 376 crore. There was an understated liability of Rs.
1,230 crore and an over-stated debtors’ position of Rs. 490 crore.
Financial Fraud
Corporate Governance This corporate drama left the spectators, including the employees of Satyam, its
investors and auditors, those working in the IT industry, outsourcing industries,
Corporate Social
regulators, Indian citizens, competitors of Indian IT industry, and all the well-wishers
Responsibility
of India in a state of shock. Since then, much has been discussed and written, and
Business Ethics actions have been taken to address the issue.
Code of Ethical Conduct
A case has been filed against Mr. Raju under relevant sections of the Indian Penal
Regulatory Reforms Code— conspiracy (sec. 120-B), criminal breach of trust (sec. 406), cheating (sec. 420),
Role of Auditors
DISCLAIMER: This Colloquium is based on information available at this time in the public domain pertain-
Leadership ing to the Satyam case. It is intended to serve as an analytical framework for understanding the issues in-
volved. It is not intended to portray the actions of any individual or individuals as right or wrong in the legal,
Global Outsourcing business or any other sense.
D
uring the U S Presidential transition, Mr. Rahm tion in 2001, or Bernard Madoff’s global Ponzi scheme
Emanuel, President Obama’s Chief of Staff, ob- in 2008, the collapse of Satyam provokes emotional out-
served that it was important to “never waste a rage and offends us at several levels. We are troubled
crisis.” A genuine crisis permits an executive, or a com- by the financial damage to innocent parties, on one hand,
munity, to take bold, transformative action with maxi- and by the questions that are raised about the culture
mum support and minimal objection. In my opinion, that generated such behaviour, on the other.
such a situation exists in India following the financial
There is another troubling aspect to these cases. In each
collapse of Satyam, and it calls for an authentic commit-
instance, we know that the orchestrators of the fraud
ment from the business community to support essential
reforms in corporate governance and ethics. did not act alone. There were accomplices who aided
and abetted the master schemers in their devious work.
The collapse of Satyam is a tragedy for the company’s Why did so many others participate in these plans? Was
many innocent investors, employees, and customers. As it the incentives, pressures to conform, charismatic lead-
with the ethical failures of executives at Enron Corpora- ership, or shared values that led others to cast their fate
with the villains? As one reporter asked of Satyam, “How
2 did B Ramalinga Raju, the Chairman of one of India’s
http://economictimes.indiatimes.com/Infotech/Software/US_
organisation_to_award_Satyam_for_talent_training_programme/ largest information technology companies, carry out the
rssarticleshow/4059516.cms biggest financial fraud in this country’s history? Appar-
3 Statement on Auditing Standards (SAS) No. 70, Service Organiza-
tions, is a widely recognized auditing standard developed by the
American Institute of Certified Public Accountants (AICPA), available 4 http://www.techworld.com.au/article/272984/satyam_fraud_has_
at http://www.sas70.com/about.htm ramifications_outsourcers?pp=2
W
hen a fraud occurs at a large and high-pro- problem was that somebody had to run the sale and do
file company like Satyam, regulators need so quickly. If nothing were done, both clients and em-
to respond decisively at three levels. First, ployees would have left in droves within days and there
they need to act swiftly to protect in- would have been nothing to sell.
vestors and other stakeholders in the Moreover, Satyam was a large com-
company. Second, they should take pany with global visibility and glo-
steps to punish the guilty. Third,
Satyam was a large bal clients. These clients expected
regulators must take proactive meas- company with global continuity of service, and failure to
ures to prevent a loss of confidence visibility and global meet this expectation could affect the
in the governance of the corporate entire off-shoring model which had
clients. These clients
sector as a whole. How did Indian created so many jobs in India.
regulators fare on these three counts? expected continuity of
There was no time for the sharehold-
service, and failure to
The disclosure of the fraud at Satyam ers to meet and elect a new board.
coincided with a complete govern- meet this expectation There were only two choices. First,
ance vacuum at the Company. Three could affect the entire off- the existing board could have met for
weeks earlier, a shareholder revolt
shoring model which had the sole purpose of co-opting a new
had forced the company to abandon set of directors and then the old board
a merger transaction that was a thinly created so many jobs in could have gracefully withdrawn
disguised bailout of a company own- India. from the scene. This was difficult be-
ed by the promoter family. By ap- cause the potential incoming direc-
proving this related party transaction tors would have feared that the
which provided little strategic or financial benefits to stigma of the old board would attach to them too and
Satyam while draining its cash, the Satyam Board in- would have been reluctant to come on board.
cluding its independent directors lost all their credibil-
The second option was for the government to invoke its
ity. A week before the fraud, it was disclosed that the
statutory powers and seek judicial intervention. This is
promoters had pledged their entire shareholding in
what the government did, and the Company Law Board
Satyam and that all these shares had probably been sold
(a quasi judicial body) passed an order for dismissing
by the lenders.
the old board and appointing a new board. This was a
This governance vacuum effectively left the company very creditable regulatory response to the Satyam fraud:
in the laps of the regulators. The promoters were gone; a new board was put in place in less than a week and
and the independent directors who would normally take the worst was averted.
charge in a situation like this had no credibility left. It
Thereafter, however, things have not gone too well. The
was easy to see that Satyam needed to be sold, but the
government and the new board have tended to forget
E
fficient capital markets depend upon firms to cedures. Though auditors often claim that it is not their
provide reliable reports about their economic job to detect fraud, audit technology is always improv-
performance. Since managers have incentives to ing and in fact can be quite effective at fraud detection.
distort these reports, investors and creditors, as well as The worrying issue is auditor independence, which has
other stakeholders, rely on external auditors to provide proven to be a problem in many large audit failures. If
assurance that firms’ financial reports are faithful rep- an auditor is not independent from the client, then he/
resentations of performance. Assurance audits are not a she may fail to exert sufficient effort to detect a prob-
new business phenomenon; they have existed for cen- lem, or even after having discovered a problem, may
turies. Nonetheless, over the past few years, we have fail to report it. In this essay, I review and evaluate some
seen a number of major financial reporting scandals of the major steps that have been taken or considered in
around the globe – including MCI Worldcom, Parmalat, recent years to increase auditor independence.
Enron, and, most recently, Satyam – that have demon-
strated that old though the audit process might be, we Reputation, Litigation, and Regulation
are still far from getting it right. The fundamental problem with the existing system of
The issue in bad audits of large global companies is of- audits is that auditors are both engaged and paid by the
ten not incompetent auditors. Large accounting firms same managers who may be responsible for misreport-
make substantial investments in recruiting and training ing. Auditors have incentives to comply with these man-
bright auditors and in developing appropriate audit pro- agers in order to protect their fees. Still, there are factors
Notwithstanding these potential costs of conducting A strategy to increase audit independence that some
independent audits, it is evident that many times audit countries have considered is mandatory rotation of au-
firms and individual auditors turn a dit firms. The European Union’s
blind eye to blatantly fraudulent re- ninth directive requires firms rotate
The fundamental problem
porting on the part of their clients. their auditors every eight years. The
Auditors have too often aligned their with the existing system of argument for rotation is that as the
own interest with those of their cli- audits is that auditors are auditor-client relationship lengthens
ents. Clearly, in these cases, the mon-
both engaged and paid by over time, the marginal cost of con-
etary benefits to the auditor of ducting the audit decreases, and the
colluding with the client have out- the same managers who net economic benefit to the auditor
weighed the expected costs of the may be responsible for of retaining the client increases. Ad-
collusion being detected. misreporting. Auditors ditionally, clients become more famil-
iar with the auditor’s procedures and
Steps to Increase Auditor have incentives to comply can develop skills to circumvent these
Independence with these managers in procedures. Rotation brings a new
In recent years, many steps have been order to protect their fees. audit firm with more clear-eyed per-
taken to limit the economic benefits sonnel and new procedures. Unfor-
of collusion. For example, some coun- tunately, rotation necessarily means
tries have severely restricted the auditor’s ability to pro- that the fresh auditor is inexperienced in the ways of
vide non-audit services to the client. The fear is that the the client. The empirical evidence seems to suggest that
auditor’s remuneration through non-audit services may a client’s reporting problems generally take place in the
be so large that the auditor may collude with the client first few years after a new auditor is engaged, and that
on reporting issues. The empirical evidence on the effi- longer auditor tenure seems to result in better report-
cacy of this restriction is mixed, and some studies sug- ing. Perhaps a better alternative is imposing rotation of
gest that an auditor who provides non-audit services to audit partners, as Sarbanes-Oxley does. The lead part-
her client gains valuable client-specific expertise that can ner in the audit is required to be rotated after five years.
enhance an audit. However, there is no denying that non- This preserves the audit firm’s expertise in the audit.
audit services were a large source of income for audi-
None of these remedies get to the heart of the problem –
tors, and, for a while before the restriction came into
that auditors are paid by the very managers whom they
effect, it seemed like non-audit services were the driv-
are trying to monitor. One solution that has been pro-
ing force in the international accounting firms.
posed in recent year is that mandatory audits be
Another potential threat to independence comes from scrapped in favour of mandatory financial statement
the “revolving door.” It has been a common practice for insurance. If clients are required to obtain insurance for
individual audit personnel to leave the firm and join the the correctness of their financial statements, then insur-
client. Potential employment creates an inducement for ance companies will hire auditors to provide assurance.
I
am writing this piece from the Board-room per- I was in the Quarterly Board Meeting of Mastek when I
spective, being in a company in the same sector as was called out, very unusually, and was given the news
Satyam and someone who knew Mr. Raju and his about Mr. Raju’s resignation and attendant confession.
family personally. The first reaction was that of shock and disbelief. Later,
I
n an article (2007) titled, “Business Ethics: The Next The only key document available in public domain is
Frontier for Globalizing Indian Companies,”7 the au- the letter dated January 7, 2009, written by Mr. Rama-
thors had argued that it is in the long-term interest linga Raju to the Board of Directors of Satyam Compu-
of the globalizing Indian company to take a proactive ter Services, in which he has talked about having inflated
posture on the ethics issue, rather than do nothing and revenues, profits, and bank balances (among other
just wait for the inevitable tightening of the regulatory things) over a long period of time. He has described his
screws. position as akin to “riding a tiger, not knowing how to
get off without being eaten.” He has also tried to justify
The authors had recommended that globalizing Indian
the inflated and false figures on the plea that the com-
companies go beyond mere “compliance” with the regu-
pany would otherwise have been taken over, thereby
lations – by “creating an ethically sound working envi-
exposing the gap between reality and the reported fig-
ronment within the organization” and by “leadership
ures – a classic example of circular logic, if nothing else.
at all levels setting an example for ethical behaviour.”
The authors had also emphasized the critical role to be The Business Ethics Perspective
played by the leader (the CEO) in “making ethics an in-
tegral part of the organization’s culture.” What does the term “ethics” mean? The Markkula Center
for Applied Ethics at Santa Clara University, USA, de-
The Satyam Imbroglio fines ethics as “Standards of behavior that tell us how hu-
man beings ought to act in many situations in which they
Coming to the Satyam imbroglio, the findings of the
find themselves” – as members of a family, citizens,
various investigating agencies are yet to be made pub-
businesspeople and so on.
lic. It would, therefore, not be proper to come to any
definitive conclusions on what exactly was done by The Center also lists what ethics is not:
whom, and with what intent. This analysis, therefore,
• Ethics is not the same as feelings (of comfort or dis-
suffers from the limitation of insufficient information.
comfort)
• Ethics is not religion (because ethics applies also to
7 Seshadri, DVR; Raghavan, Achal and Hegde, Shobitha (2007). “Busi-
people who are not religious)
ness Ethics: The Next Frontier for Globalizing Indian Companies,” • Ethics is not just following the law (because law may
Vikalpa, July-September, 61-79.
have its own limitations)
Our Vedas and scriptures offer abundant guidelines on If we now apply this “Mind- Map” model to the Satyam
how CEOs ought to conduct themselves. “Being free case, the four powerful influences that were apparently
from greed,” “looking after the interests of all stakehol- at work on Mr. Raju take shape as follows:
ders,” and “following the path of righteousness” are val- • Passion/Mission in Life: This is the over-arching
ues repeatedly mentioned in such guidelines. long-term goal that drives the actions of the entre-
On the face of it, the Satyam imbro- preneur. In Mr. Raju’s case, we could
glio is a consequence of such basic hypothesize that his mission in life
values having been given the go-by Most individuals would was to be seen as one of India’s most
by a small set of people in positions like to think that they take successful businessmen, having es-
of great responsibility. Making a ba- tablished from scratch a world-class
decisions in a rational business organization in the global IT
sic assumption that Mr. Raju’s letter
truthfully describes what he had way; but the reality is that services industry. Additionally, he
done over the years, let us try to get emotions tend to overrule possibly wanted to become one of the
some understanding on why he ap- wealthiest business leaders in India.
rational thinking at times The relentless drive that he brought
parently took that path.
of pressure. to the company over the years clearly
The Entrepreneur’s Mind-map signals his burning desire to be “the
biggest and the best” in the eyes of
We will use the model, “The Entrepreneur’s Mind-Map” the industry and public.
as a framework for this analysis (Figure 1). In this con-
ceptual model, we see decisions and actions taken by any • Self-image: This refers to how Mr. Raju saw himself
entrepreneur to be the result of four powerful influences that and his role in Satyam. Was he the “owner” of the
are constantly working on him/her. Depending on the in- enterprise? Or did he see himself as a “manager” ap-
fluences that are more powerful at a particular point in pointed by the shareholders to manage the resources
time, or over a long period, the entrepreneur would be of the company, make it grow, and generate profits?
impelled to act in one manner or the other. This, in turn, The contents of his letter dated January 7, 2009, to
the Board indicate that he saw himself as the owner,
Figure 1: The Entrepreneur’s Mind-map rather than a manager. This, in spite of the fact that
he and his family, along with trusts (collectively
“What is My Mission in Life?” called “Promoter and Promoter Group”), owned only
Passion/ Society and 8.74 per cent of the shareholding.
Mission in Life Government
This self-perception is not uncommon among entre-
“Find a Balance” “Role Clarity” preneurs and their start-ups, which change later into
Rational vs.
The Self image broadly-held companies. The “baby” (the company)
Entrepreneur
Emotional (Johari Window) grows up, so to speak, and gets adopted by a group
“Defining Moments” “Owner vs. Manager” of guardians (the new shareholders) at the invitation
of the “father” (the entrepreneur); but the father is
Stakeholders (customers,
employees, shareholders,
unable (or unwilling) to acknowledge their presence
suppliers) or their role, or grant them their rights as guardians.
“Communication/ In short, the entrepreneur wants sole control and
Alliance-building”
“ownership” in perpetuity, regardless of financial
A Model developed by Seshadri, DVR and and legal realities.
Raghavan, Achal (2006)
F
ew topics in management literature have flour- of an organization as the yardstick to determine profit-
ished as dramatically as leadership. The role of a ability and performance, have contributed to a tsunami
CEO has been glamourized to such an extent that of corporate scandals in the last decade. In some cases,
management has now become passé. Today everyone greed, unrealistic aspiration, and moral failure of the
is striving to be a leader. The CEO has been attributed CEOs have led to their downfall. The dark side of such
with a disproportionate amount of organizational suc- leaders is often not visible to the followers and by the
cess. The analysts who use only financial performance time it is noticed, it is too late. Satyam is one such case
S
’ atyam’ seems to have transitioned from being a large stakes (100% and 51%) in two promoter-owned
common noun (meaning truth in Hindi) to companies. The two companies, Maytas Properties and
becoming a proper noun (the leading company) Maytas Infrastructure (the word Maytas is Satyam writ-
to a verb, and an adjective representing a fraud of a huge ten backwards), are promoted by the family of the Ex-
scale. ecutive Chairman of Satyam, Ramalinga Raju. The latter
is a listed company. In a remarkably noisy protest against
The Story Till Now – Act I, Scene I the move by investors, including the usually sleepy
The brief story till now has been as follows. Satyam, one mutual funds, perhaps for the first time in the history of
of the leading software and Business Process Out- corporate India, a reversal of the perverted decision oc-
sourcing (BPO) companies of India, declared after mar- curred within 24 hours of the announcement. While the
ket closure on December 16, that it was planning to buy combined valuation of $ 1.6 billion for the property and
infrastructure companies sounded astronomical, given
9 the steep fall in real estate prices over the past few
O’Conner P M G and Day D V (2007). “Shifting the Emphasis of Lead-
ership Development: From “ME” to “All of Us” in Conger J A and months and the further expected fall over the next few
Riggio R E (Eds) The Practice of Leadership: Developing the Next months, the so called synergies between the three firms
Generation of Leaders, San Francisco CA: Jossey-Bass, 64-86.
The press release of December 16, clearly stated: ‘Its Prof. M Rammohan Rao (Dean, Indian School of Business)
Compensation: 13,20,000 + 10,000 shares sold at nominal
Board of Directors has approved the proposals to ac- value of Rs. 2 each of market price of over Rs.500.
quire 100 per cent stake in Maytas Properties and 51 per
Mr. V P Rama Rao
cent in Maytas Infra.’ It further affirmed that the acqui-
Compensation: 1,00,000 + 10,000 shares sold at nominal
sition of Maytas Properties would be immediate at $1.3 value of Rs. 2 each of market price of over Rs.500.
billion and the acquisition of Maytas Infra would be ap-
Dr. (Mrs.) Mangalam Srinivasan
proximately 0.3 billion (because of the uncertain price Compensation: 12,80,000 + 5,000 shares sold at nominal
which would apply to a takeover offer as mandated by value of Rs. 2 each of market price of over Rs.500.
law). This certainty of transaction and price are impor- Mr. T R Prasad
tant as some of the independent directors would subse- Compensation: Rs. 12,53,333 + 10,000 shares sold at
quently try to weasel away from the decision stating that nominal value of Rs. 2 each of market price of over Rs.500.
it was contingent upon a valuation being done. Till this Prof. V S Raju
point, all evidence led to a gruesome violation of the Compensation: Rs. 12,53,333 + 10,000 shares sold at
nominal value of Rs. 2 each of market price of over Rs.500.
fiduciary duties of the directors of this company, rather
than an outright fraud. This view was enhanced by the Source: Company Annual Report, 2008
release of the minutes of the meeting much later which
showed not just what was going on, but also a more failed on these counts, whether by omission or by com-
deliberate attempt at asking some of the right questions mission.
and being satisfied by whatever silly answers came their
Subsequently, other skeletons started tumbling out of
way. The independent directors of Satyam were clearly
the closet. First, of the so-called 6,800 acres of ‘land bank’
well-fed at Satyam (see chart).
(land under development) by Maytas Properties and
The other body which clearly did not perform the task valued at $ 1.3 billion, only 100 acres could be verified.
presented to it was a committee of the Board, known as Second, the promoters of Maytas Infrastructure owned
the Audit Committee. This committee is mandated by not 35 per cent of the company but closer to 85 per cent
the listing agreement of the stock exchanges and violat- of the company as revealed by CNBC, a business chan-
ing this ‘agreement’ can have serious consequences un- nel. While the promoter holding was shown at around
der the law. The functions of Satyam’s Audit Committee 36.6 per cent, many questionable names appeared in the
included “Oversight of the company’s financial report- public shareholding list. These shareholders, holding
ing process and disclosure of financial information to more than 40 per cent in the company, had been issued
ensure that the financial statements are correct, suffi- equity shares pre-IPO at a price lower than the issue
cient and credible,” and “Reviewing with the manage- price. Thus promoters were holding as much as 85 per
ment, performance of statutory and internal auditors, cent in one of the companies sought to be bought by
and adequacy of the internal control systems.” Satyam, though stated to be owned by them only to the
extent of 35 per cent. Third, while a lawsuit in Texas,
With the spending of the entire cash reserves of the com- US, seeking over a billion dollars in compensation and
pany on a related party transaction by the company at a also punitive damages, was initiated in 2007, it had not
gross overvaluation— both internal audit and internal been reported to the Indian exchanges or to the SEC.
control issues would need to be studied. It is now clear This is a serious non-disclosure of material facts even
that the committee did nothing, as the proposal came though it is only of a contingent liability. Further devel-
up directly before the Board. The committee grossly opments including losing an offshoot case in London
Conclusion
Neharika Vohra
T
here are many issues that are important and need the issues revolving around measuring the performance
to be attended to. We need to understand the of organizations holistically rather than single-mindedly
real meaning of corporate social responsibility maximizing wealth of shareholders quarter after quar-
— the same group that has perpetrated the fraud had ter; pressures created by the obsessive need to grow at
also set up the Byrraju Foundation and Satyam Founda- about 40 per cent every year; role of independent direc-
tion. One of the main contributions of the foundation tors; and the basic questions about human nature and
has been the setting up of EMRI and the emergency ser- its compliance with the unethical demands of charis-
vices call number, ‘108’ in August 2005, which currently matic leaders. Hopefully, future researchers and prac-
operates in eight states and aims to respond to 100 mil- titioners will be able to engage in this debate and draw
lion emergency calls by 2010; further, in July 2008, they important insights for management of large entrepre-
launched the ‘104’ Mobile Health Service for providing neurial organizations.
healthcare to rural Andhra Pradesh.10 Then, there are
1 Papri Sri Raman (June 23, 2008) Emergency? Indians can dial 108 for
help Online document available at http://www.topix.net/forum/com/
say/TM7TKK91JVINTSGAU