The guys at Knowledge@Wharton – they have conducted an interesting postmortem on the Satyam disaster – beat me to the way I wanted to start this post-
When terrorists attacked Mumbai last November, the media called it “India’s 9/11.” That tragedy has been succeeded by another that has been dubbed “India’s Enron.”
What next, I add, that will fit the “India’s X” template? I did not write about it sooner because I was waiting for the government to intervene; the Indian government and its regulators work on the lines of a typical Bollywood movie – the cops arrive after everything has happened showing how regulations are utterly useless.
Notwithstanding the post title, I am not too interested in knowing how Raju managed to pull off this scam – there are a myriad ways to do it, as any accountant will tell you. He couldn’t have done it alone – there have to be people in the finance division who were aware of it, but who chose to keep quiet or even helped him; the CFO of the company has supposedly attempted suicide, and Raju did not mention his name in the list of those who were “not to blame”; perhaps that is a clue. Whether the auditors – PWC – colluded (more likely) or were duped (less likely, but it is possible), the fact is the Satyam balance sheet has a billion plus dollar hole in it. And some think that Raju has not yet told the truth and things are worse than they appear.
The typical response to any such disaster is a demand for tougher laws; the US enacted SOX – the Sarbanes-Oxley Act – in 2002 after the Enron-Arthur Andersen meltdown. But as Vipin points out in a post written much before the Satyam scam was revealed, Enron complied with every requirement of that act but it failed nonetheless. If someone really wants to do something, he will find a way to do it – where there is a will, there is a way. The only thing tough regulations do, particularly when it comes to equity listing agreements with stock exchanges, is that it raises compliance costs and small companies are not able to afford it. K@W has a couple of interviews on corporate governance (a new buzzword for everyone to remember), the first on SEBI’s Clause 49 of the Equity Listing Agreement that companies sign with stock exchanges, and the second on “independent directors”, and one of the interviewees, a professor at Wharton – Jitendra Singh – had this to say-
Just the other day, I was talking with a friend and colleague of mine who is a professor at the University of Toronto. He said he had just taken public a firm where he was the founder from the AIM (Alternative Investments Market) at the London Stock Exchange. This is a Canadian company that is going public in the U.K. This is a midsize company, [where] revenues may be less than $50 million a year. He said they did a very careful analysis of listing in New York, and found the cost of complying with Sarbanes-Oxley would be about $3 million. Now for the firm that has $50 million in revenue, this may be the better part of the profits it is making. So obviously this is a very serious consideration. They went to AIM and that’s where they listed it — and it’s a public company right now.
This time though, surprisingly, I have been reading views wherein “enforcement” of existing laws is demanded. That would be a good thing if we know what is it exactly that needs to be enforced? As I see it, regulations of a preventive nature are like a missile defense shield – they won’t work if the enemy launches a hundred missiles simultaneously at you. So it is pointless to have too much of them. What is needed here is a guaranteed second strike capability – that is, once a Satyam-like disaster occurs, those who suffered at the hands of people like Raju should be able to sue the pants off them, and the process should be a quick one. If it takes ten years, the laws are worthless.
About “independent directors” – and this is why most government regulations are useless, particularly the Clause 49 mandate, a variant of the “tragedy of the commons” applies to them. People who don’t have a material interest in something won’t bother about what happens to it. If a director does not own a substantial number of shares in a company, how does it matter to him how the business of a company is run? While an argument can be made that such a director has his reputation to worry about, and that reputation is more important than tangible wealth, I suggest that such a director will make himself believe that nothing will go wrong. To give an innocent example – I can think of worse things – how many of you believe that you will stub your toe tomorrow morning? Its only after the shit hits the fan that seers and pundits forecast the past. An example – the Economic Times which is setting its front page on fire with its coverage of the Satyam fiasco had nominated Ramalinga Raju’s BYR Raju Foundation for “Corporate Citizen of the year” for this year’s ET Awards.
In the case of Satyam, the aborted Maytas deal proved that the independent directors were all either asleep or were flying kites. I quote from the first K@W article I linked to-
Even if outside directors were unaware of the true state of Satyam’s finances, some red flags should have been obvious. According to Aron, Satyam is one of the world’s largest implementers of SAP systems. In an effort to compete against Satyam, HCL recently acquired Axon, an SAP consulting firm, at a cost of $800 million. (Editor’s note: See interview with HCL CEO Vineet Nayar.) Aron notes that any Satyam director should have been puzzled that the company was proposing to invest $1.6 billion in real estate at a time when a competitor as formidable as HCL was gunning for one of its most lucrative markets. “IT is a highly capital-intensive business, especially in India,” says Aron. “What on earth would compel Satyam to invest $1.6 billion in real estate at a time when competition with HCL was about to grow more intense? That is what the directors should have been asking.” Instead, he adds, like the dog that didn’t bark in the Sherlock Holmes story, the matter was allowed to slide.
So, instead of making foolish demands like specifying a minimum number of “independent directors”, shareholders should be allowed to elect whosoever they think is fit to represent their interests on the BoD.
The bottom line? Let Precrime remain confined to Philip K Dick’s sci-fi shorts; we cannot prevent every billion dollar heist. But as long as we have systems in place which allow victims to get their money back, we should be okay.