Reading the Satyam Scam

“Earlier industrialists and then defence contracts financed political parties. Nowreal estate does, especially in the states because chief ministers have easier access to it. The kickbacks are huge” – CharlesCorrea (Interview, Times of India,10 September 2008). From "Maytas, Hyderabad Metro and the Politics of Real Estate" in the EPW which notes "In the 10 days since the revelation of the massive fraud at Satyam, there has been much speculation that the holes in the software company’s books were caused by the promoters’ links with Maytas, the infrastructure company that in recent years has become the favourite of the government of Andhra Pradesh. This article puts under the magnifying lens the award in 2008 of the massive Rs 12,000 crore contract to Maytas to build and operate the Hyderabad Metro."

Reading the Satyam Scam

Will the truth ever come out? What is this sham of corporate governance?

In a confession that led to his arrest and turmoil in corporate India, B Ramalinga Raju, the former chairman of Satyam Computer Services, India’s fourth largest information technology company, stated that he had manipulated accounts to inflate
revenues and profits. The result was a collapse in the value of the company’s stock and dissolution of its board. Raju’s confessionessentially stated that having doctored the firm’s accounts formany years, he was left with hugely overstated cash reserves and understated liabilities that amounted to a shortfall of more than Rs 7,000 crore in the company’s balance sheet. This was impossibleto fill without the infusion of resources from outside. When his effort to get Satyam to “takeover” two companies owned by his family – Maytas Properties and Maytas Infra – in order to fill this
hole with real assets failed because of shareholder resistance, he decided to reveal the fraud.

There could be many explanations for why this high profile company in an industry that has reported consistently strong revenue growth, export expansion and profitability, and is supported by the State with special tax benefits, chose to inflate profits that must have already been favourable by overall industry
standards. One allegation that has surfaced is that this was part of an effort to inflate stock values and the wealth of the promoters. Another allegation that is reportedly being investigated is that the manipulation of accounts followed the siphoning of resources from the company to expand the wealth of promoters, who had a relatively small and declining shareholding in Satyam. Speculation aside, the actual details of what transpired at Satyam Computer Services prior to the confession will
emerge only after much time, if at all they will.

One problem is that it is difficult to accept the former chairman’sconfession at face value, because it implicitly suggests that Satyam was performing much worse than other leading IT companies. Satyam was undertaking activities similar to these companies and like them had leading Fortune 500 companies among its clients. Its billing and its costs could not have been very different. So it does not seem surprising that the audited balance sheet of the company showed that the ratio of profits before tax to total income in Satyam in the financial year ending March 2008 was 27.8%, as compared with 32.3% in the case of Infosys, 23.1% in TCS, 23.1 and 19.2% in the case of Wipro. Yet
we are being told to believe that Satyam’s profit figureswere hugely exaggerated leading to the gaping hole in its balance sheet.

The big question is to what extent the Satyam scam is linked to the explosive growth under the current Congress ruled government of Andhra Pradesh of the Maytas companies, which have emerged as the favoured contractors of the state government and have bagged projects worth over Rs 30,000 crore in irrigation, ports, and the Hyderabad Metro. While Satyam was projected by the previous Telugu Desam Party government in Andhra Pradesh as well, there is no question that Maytas has become what it is
during the Congress regime. Since the award of large government contracts almost always involves payoffs, the moot question is how much of the hole in Satyam was created by the extraction of resources to fuel Maytas’ growth. As the detailed discussion in the article on Hyderabad Metro elsewhere in this issue reveals,
there is much to suspect in the favours showered on Maytas. The Satyam trail then would lead to the mainstream political parties and the incentive to hush up the story will be strong.

Whatever the actual scam, an issue that needs examining is why conventional monitoring and disciplining mechanisms failed in this case, permitting accounting fraud over a long period. To start with, this huge fraud, which also involved declaring cash
reserves that did not exist, was completely missed by a high profile board, which even agreed to allow the promoters to use these nonexistent reserves to buy two unrelated companies in which the latter have a major stake. The board included distinguished
independent directors, who, according to reports, were being paid huge fees for their professional services. This gives rise to the criticism that the practice of managements paying independent directors could lead them to take a “soft” view of matters and nottake their monitoring role seriously. Given the fact that the board
of directors is the institutional form through which the top management is disciplined, especially in a firm like Satyam, where there are a large number of investors other than the promoters who collectively own a very large share of equity but individually do not have an influential holding, the board ought to have exercised
its functions, vis-a-vis the top management, the promoters, and the other shareholders, in the best tradition of business ethics. There is reason to believe that it failed in this respect.

A related failure was the inability of the firm’s auditors, Price Waterhouse Coopers, one of the big four, to detect manipulation of this magnitude. As has been noted, the search for large fee incomes and the competition between auditors to increase market share results in a situation where auditors take the claims of their large clients and the documents they produce at face value and do not carry out the minimal checks which would possibly have revealed the fraud at Satyam, whatever it may be. Here again, the fact that the monitor is paid by the monitored seems to be a major source of the problem.

Hence, these and other failures of the regulatory mechanism need to be investigated as well. It must lead to comprehensive reform that ensures that we do not have other Satyams because of the weaknesses of the institutional and regulatory environment.

Economic & Political Weekly EPW january 17, 2009