Samsung: Case Overview

SAMSUNG
Case overview
Reports of exploding Samsung Galaxy Note 7 phones (Note 7) due to the
overheating of phone batteries started to emerge on 24 August, 2016, with five
cases of devices exploding while charging reported worldwide within a week. Users
uploaded pictures and videos of their phones overheating, exploding or catching
fire on social media platforms. This eventually led Samsung to halt all production of
the Note 7 and issue a global recall for their new flagship smartphone. The massive
recall cost Samsung billions in lost profits and adversely impacted its reputation
and credibility. This case delves into the events surrounding the unprecedented
Note 7 recall and allow a discussion of issues such as board composition and
corporate governance in Chaebols; corporate culture; supply chain management;
and risk and crisis management.
Samsung’s humble beginnings

Samsung Group is a South Korean multinational conglomerate founded on 1
March, 1938 by Byung-chul Lee. The group offers a wide range of products and
services under the Samsung brand through a large number of companies,
including Samsung Electronics (Samsung). Kun-Hee Lee is the president and
Chairman of the Samsung Group and Samsung Electronics. During the 1990s,
Samsung achieved several milestones in its mobile phone business. Its first
mobile phone handset was launched in 1991 and the wireless internet phone in
1999. Due to Kun-Hee Lee’s belief in the growth potential of the mobile industry,
Samsung’s main business strategy was to focus on the mobile phone business
and by 2012, it became the largest manufacturer of mobile phones.4 Currently,
Samsung has three main business units, namely Consumer Electronics, IT and
Mobile Communication, and Device Solutions.5 The main source of its revenue
is the Information Technology and Mobile Communications business unit, which
contributed 45% of Samsung’s total sales in 2015.6
Board of directors
In 2016, the board of Samsung was made up of nine members and headed by
Vice Chairman and Chief Executive Officer, Oh-Hyun Kwon. There were three
other executive directors (EDs) – Jong-Kyun Shin and Boo-Keun Yoon headed
the three main business units while Jae-Yong Lee was in charge of general
business administration. The remaining five members – Jae-Wan Bahk, Han-
Joong Kim, Kwang-Soo Song, Byeong-Gi Lee and In-Ho Lee – were independent
directors (IDs). The term of office of Samsung’s board members was three years.7
Samsung also established several committees under the main board, such as
the management committee comprising of only the three EDs with delegated
authorities including but not limited to the development of business strategic
plans, acquisition and sales of subsidiaries and basic operating principles.8
Kun-Hee Lee is widely known to be the man behind the success of Samsung. He
is seen as a visionary who saw the rise of emerging technologies and invested
heavily to bring Samsung to the forefront of the technology sector.9 In private, he
demanded a lot of attention, with senior executives welcoming him at the airport
on his return from overseas trips.10 However, following his hospitalisation in 2014,
Jae-Yong Lee, the only son of the Chairman, had been considered the de facto
leader of Samsung and was nominated to its board on 12 September, 2016. 11
Due to the Korean culture of not succeeding a living parent, the younger Lee did
not assume his father’s title as president and Chairman of Samsung. As such, the
management team of Samsung had not been operating with a clear leader. As
the de facto Chairman of Samsung, Jae-Yong Lee does not have full power and
authority.12
The Chaebol structures
A Chaebol is a family-run conglomerate organisation structure unique to businesses
in South Korea.13 It involves a highly complex and circular shareholding structure14,
which typically allows a single founding family to control a wide range of diversified
and legally independent affiliates.15 Through this structure, the Chairman of the
Chaebol can effectively control the entire group, giving him significant influence in
decision-making despite merely being a minority shareholder. In Samsung’s case,
as of 2012, the Lee family effectively controlled the entire Samsung group with
only 1.67% of the overall group shares.16 Furthermore, the dynastic dictatorship
characteristic of the Chaebol also tends to ensure that power is maintained through
family succession of the Chairman position, regardless of his managerial abilities.17
The complex circular shareholding structure of most Chaebols also tends to

expose itself to frauds, embezzlement and bribery, amongst other issues.18 The
complex structure is also compounded by close political connections with the
government, which is a common trait of the Chaebol structure. Power tends to
be wielded single-handedly by the Chaebol’s Chairman with little legal restraints.19
Samsung Group’s Kun-Hee Lee was convicted twice of bribery and tax evasion
but was never placed in jail. Instead, he received a pardon from the Korean
president due to his political connections and continued to manage the Group.20
Checks and balances on the controlling shareholder family have been found
to be severely lacking in Chaebols.21 The lack of transparency within Chaebols
is commonplace as major boardroom decisions are passed without much
disclosure to shareholders.22 Moreover, the lack of transparency also affects
Chaebol valuation,23 with Chaebols such as the Samsung Group often severely
undervalued. This phenomenon is known as the “Korean Discount”. For instance,
after the Note 7 incident, Elliott Associates estimated Samsung’s undervaluation
to be at least 70%.24
Corporate culture
Samsung’s corporate culture has its roots in the Japanese business culture. When
Byung-chul Lee founded Samsung, South Korea was a Japanese colony. In the
early years, the company competed in nascent industries that were dominated
by the Japanese - consumer electronics, memory chips and LCD panels. The
Japanese hierarchical labour model was ingrained in Samsung’s corporate
culture.25
Since then, seniority-based compensation and promotion systems were

developed. Coupled with a strong Confucian tradition and a lack of upward
mobility, the culture is one where mid-level managers were pressured to prove
themselves with short-term achievements. In this vein, “executives fret that they
may not be able to meet the goals and lose their jobs, even when they know
the goals are excessive”.26 Moreover, former employees shared that Samsung
engineers and mid-level managers were rarely given opportunities to challenge
management goals set by their superiors, even when they disagreed with the
goals. In this regard, Samsung, like many other companies in Korea, is viewed as a
workplace with high power distance and where saying ‘no’ is virtually forbidden.27
The dawn of a crisis

Samsung’s Note 7’s nemesis was the Apple iPhone 7 Plus.28 In early 2016,
after realising that Apple would not be launching new iPhones with revolutionary
innovations, Samsung was motivated to seize the opportunity to leap ahead of
its competitor. Samsung pushed the limits of engineering and created the Note
7 which had a high-resolution screen wrapped around the edges, iris-recognition
security features, and an even more powerful, fast-charging battery.29
On 2 August, 2016, Samsung unveiled its flagship smartphone model, the Note
7.30 On 19 August, 2016, sales started in 10 different markets, including South
Korea and the United States (US).31
On 24 August, 2016, initial reporting of the smartphone models “exploding”

surfaced in the news.32 Subsequently, users flooded social media platforms such
as YouTube33, Reddit, and Kakao Story34 with pictures and videos of their Note 7s
overheating, exploding or catching fire.35
Burn, burn, burn
By 1 September, 2016, 35 of such incidents were reported worldwide, with “battery
cell issues” cited as the main reason for the explosions. 36 Samsung officially
suspended sales of the Note 7 just two weeks after its launch in the US and
South Korea, and shortly after, began its first recall.37 In total, 2.5 million Note 7s
were sold as at 2 September, 2016.38 Samsung opted for voluntary replacement
of customers’ current devices with one of several options – a new Note 7, a
different phone, or refund upon request.40
Despite the ongoing barrage of negative media attention, Samsung issued an

official statement claiming that the Note 7s in China, Hong Kong and Macau were
unaffected and did not require any intervention.41
However, days after the ‘all clear’ statement, Samsung Hong Kong released
another statement confirming that nearly 500 sets of affected phones were
sold between 26 August, 2016 and 1 September, 2016.42 Samsung reassured
consumers that phones sold at approved affiliates or merchants in Hong Kong and
Macau after 1 September, 2016 remained unaffected, and advised buyers to use
the International Mobile Station Equipment Identity code to verify if their phones
were affected by the recall. Samsung also publicly apologised and promised to
provide affected customers with new handsets.43
By 14 September, 2016, further reports of Note 7s catching fire surfaced in

several local media outlets and approximately 1,900 Note 7s were being recalled.
Samsung had to deal with yet another blow in consumer confidence in its ability to
correctly diagnose and provide solutions to the problem at hand.44
External parties’ involvement

Just a week earlier, on 8 September, 2016, the US Federal Aviation Administration
and numerous airlines all over the world told flight passengers not to turn on
or charge the Note 7 while on board aircrafts. Soon after, due to the ongoing
safety concerns, the US Consumer Product Safety Commission (CPSC) issued
an announcement urging the suspension of all sales and exchanges of the Note
7.45 Meanwhile, Samsung announced that it would resume selling the Note 7 in
South Korea on 28 September, 2016.46 In response to Samsung’s voluntary recall,
the former ED of the CPSC, Pamela Gilbert, remarked that “Samsung’s voluntary
recall is completely unusual; companies don’t issue recalls without the CPSC. The
gap between Samsung’s announcement and the CPSC directive shouldn’t have
happened that way at all”.
Turning point or adding fuel to the fire?

In what seemed to be a critical turning point of the Note 7 saga, Samsung
announced on 16 September, 2016 that customers could exchange their Note 7s
for “fault-free” replacement phones with green battery indicators to differentiate
the new batch of phones from potentially faulty older devices.48 Moreover, on
29 September, 2016, in a move to recover consumer confidence, Samsung
announced that “1 million people globally are using Galaxy Note 7 smartphones
with batteries that are not vulnerable to overheating and catching fire”.49 Two days
later, Samsung resumed the sale of the Note 7 smartphone model in South Korea,
while the replacement of the Note 7 was in full swing in the US.50
However, on 5 October, 2016, a Southwest Airlines flight was evacuated as a

Note 7 device made popping noises and started emitting smoke on the plane.51
Subsequently, more news reports regarding explosions of Note 7 devices
surfaced52 and Samsung was informed by the CPSC that it could face an unusual
second recall of the Note 7. With widespread news of exploding Note 7s, many
phone carriers such as AT&T and T-Mobile finally decided to cease the sale and
replacement of the Note 7 devices from 9 October, 2016. 53
Beginning of the end

On 10 October, 2016, Samsung made the decision to temporarily suspend
production and halt worldwide sale and replacement of the Note 7.54 Three
days later, CPSC officials expanded the recall to all 1.9 million Note 7 devices in
circulation, including all replacement devices.55 As a result, Samsung slashed its
third-quarter profit guidance by a third, to US$4.63 billion, reflecting the earnings
impact from the crisis. Estimated losses for the discontinuation were massive,
amounting to US$9.5 billion in sales and US$5.1 billion in lost profits.56
Furthermore, the US Department of Transportation, with the Federal Aviation
Administration and the Pipeline and Hazardous Materials Safety Administration,
issued an emergency order to ban all Note 7 smartphones from air transportation
in the US.57 In response, Samsung promptly set up “customer service points” at
airports across the globe, where Note 7 users could exchange their devices and
obtain refunds.58
By 4 November, 2016, nearly 85% of all Note 7 devices in the US were replaced
through the US Note 7 Refund and Exchange Program.59 Samsung also released
a software update, limiting the phone’s ability to charge beyond 60%, along with
a persistent return reminder message. A month later, Samsung forced existing
users to return all Note 7s in circulation. They partnered with telecommunication
companies to issue a software update to disable charging of the Note 7 altogether,
rendering them useless.60
After the storm

On 23 January, 2017, Samsung held a press conference to announce the cause
of the Note 7 malfunctions and countermeasures that were put in place. Samsung
had testing laboratories in all of its factories and tested more than 200,000 Note 7
batteries. Separately, Samsung worked with three independent test laboratories.
Samsung’s test results corresponded to that of independent laboratories, where
issues with batteries from two separate manufacturers were identified.61
Furthermore, Samsung acknowledged that it was overly aggressive in attempting

to create a powerful battery which could fit into the slim design profile of the phone.
This stemmed from Kun-Hee Lee’s strong focus on design taking precedence
over other matters.62 Critics have commented that Samsung’s focus on speed and
internal demands to surpass its rivals signalled a collapse in its ability to innovate.63
Yong-Serk Kim, a former Samsung mobile engineer, said that the company’s
“overambitious attitude towards battery capacity and charging speeds” resulted in
the disastrous Note 7 situation.64 CPSC Chairman, Elliot F. Kaye, also commented
that Samsung had dedicated far greater resources than what the CPSC could
have offered in the Note 7 fiasco.65
Supply chain management
The process of producing a Note 7 battery began with Samsung specifying the
battery’s characteristics such as voltage and physical size to its suppliers. The
suppliers would then design and manufacture the batteries with its own unique
manufacturing processes. Samsung purchased over 60% of its Note 7 batteries
from a single supplier, Samsung SDI.66
By allocating a majority of its original lithium battery orders to a single supplier,

any quality and safety issues relating to the batteries would pose challenges in
selecting another supplier to produce the replacement batteries that matched the
quantity and quality required. This challenge proved to be too overwhelming for
the replacement battery manufacturer, Hong Kong-based Amperex Technology
Limited (Amperex).67 The initial batteries from Amperex worked fine in the earlier
Note 7 devices. However, Samsung increased its order to ten million new
batteries, and pushed the battery supplier to become its sole battery provider.
The quantity and quality demands proved too much for Amperex to cope with.
In the course of meeting the sudden demand, protrusions were left over from the
ultrasonic welding process and resulted in the short circuit of the battery. 68 The
errors eventually led to the second and final recall of the Samsung Note 7.69
Samsung’s process of outsourcing the majority of its Note 7 batteries to a single

supplier was noted to be rare and differed from other industry leaders such
as Apple, which has several suppliers in its battery supply chain. In addition,
Apple’s battery suppliers are delegated the task of performing either battery cell
manufacturing or battery assembly functions, which effectively spreads the risks
of product quality problems.70
The Note 7 featured hundreds of highly-engineered components manufactured

globally. This left Samsung with one of the most complex supply chains. As of
January 2015, Samsung ran mobile phone manufacturing facilities in six countries,
namely Vietnam, China, India, Brazil, Indonesia, and Korea. Complex supply chain
networks created challenges in communication, integration and collaboration
between internal departments and third-party vendors.71 Even though Samsung
is based in South Korea, only eight percent of Samsung’s mobile phones were
manufactured locally as of 2015.72
As technology continues to advance, current quality control and management
systems in the consumer electronics industry may be inadequate to handle the
increasing complex nature of supplier networks.73 The auditors of Samsung have
identified basic failures such as missing or uneven insulation tape, charge level
inconsistencies, thinner internal separators and the Note 7 battery’s higher energy
density as contributing factors to the model malfunctions.74
The fire in the phone manufacturing giant

Moving forward, Samsung has undertaken measures to improve its quality
assurance process. To address safety, Samsung has introduced an eight-point
battery safety check including charge and discharge test.75 According to the
Korean news outlet “Newsis”, Samsung may release only one premium model
annually to ensure its product quality.76
In June 2017, Samsung reportedly has plans to start reselling refurbished Note
7s again.77 Stakeholders will have to wait and see whether this move by Samsung
would pay off. Nevertheless, one thing is certain – Samsung will be under major
scrutiny for its upcoming mobile phone launches.
Discussion questions
1. Discuss potential challenges of the Chaebol structure to Samsung
Electronics’ corporate governance.
2. Discuss Samsung’s corporate culture and how it may have contributed to

the Note 7 crisis. What is the role of the board in fostering the right
corporate culture and how can the board ensure that the corporate culture
is cascaded throughout the entire organisation?
3. Do you consider the Samsung Note 7 crisis as a black swan event? Explain.
4. Management/Board of Directors have the responsibility to anticipate risks to

business and create a mechanism for managing them. Suggest what
Samsung’s board could have done to avoid the crisis?
5. Comment on the effectiveness of Samsung’s crisis management and
suggest what Samsung could have done to better manage the crisis.
6. Samsung was involved in a few controversies apart from the Note 7 crisis.
Identify some of them and evaluate if these scandals could be considered
governance failures.
Volkswagen: The Emission Scandal
VOLKSWAGEN: THE
EMISSION SCANDAL
Case overview
On 20 September, 2015, Martin Winterkorn, the Chief Executive Officer (CEO) of
Volkswagen Group, issued a statement admitting that Volkswagen had cheated
on emission tests for many years by installing “defeat devices” in its diesel cars.
The statement was made after the United States Environmental Protection Agency
(EPA) and the California Air Resources Board (CARB) revealed Volkswagen’s
manipulations that violated the legal emission standards. Volkswagen had initially
been given a chance to remedy the issue when EPA first made contact, but they
chose instead to continue cheating on the emission tests. Preliminary investigations
revealed that a Volkswagen technician had blown the whistle internally on the
deception in 2011. However, the warning call went unanswered. The objective
of the case is to allow a discussion of the corporate governance issues such
as the two-tier board structure in Germany; diversity and independence of the
supervisory board; employee and state representation on the board; boardroom
infighting; the role of regulators in the emission scandal; the culture created by the
top management within Volkswagen; and the effectiveness of the whistleblowing
system in Volkswagen.
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Volkswagen – The people’s car
Volkswagen is a car manufacturing company headquartered in Wolfsburg, Lower
Saxony, Germany. To date, it is the second-biggest automaker in the world,
boasting sales in over 150 countries, with 119 production plants in 31 countries
all over the world. In 2014, Volkswagen made profits of over €11 billion and
produced 10.2 million vehicles worldwide. Notable brands under the Volkswagen
Group include Bentley, Bugatti, Lamborghini, Audi, Porsche and Škoda.
Home of Volkswagen: The German state of

Lower Saxony
Lower Saxony, the German state where Volkswagen’s Wolfsburg headquarters
was located, was a significant shareholder of Volkswagen. The state held the
second largest stake in Volkswagen in terms of voting power (20.2%).
Despite not being a majority shareholder, Lower Saxony was granted various
privileges, including the ability to veto decisions such as shutting down or
relocating assembly plants as well as business acquisitions. This was because the
Volkswagen Law stipulated that voting on major shareholder meeting resolutions
required 80% agreement. In 2008, Porsche, which owned 31% of shares, wanted
to gain the majority stake in Volkswagen. They sought to amend the statutes to
have a freer hand over Volkswagen. However, even though Volkswagen’s directors
welcomed Porsche’s interest in increasing their stake in Volkswagen1, Porsche’s
plans were thwarted due to Lower Saxony’s opposition.
In 2005, the European Commission took action against Germany on grounds that
the Volkswagen Law restricted the movement of capital across European borders,
and the Law was amended in 2008. However, the rule requiring 80% majority
support was maintained and Lower Saxony’s 20% stake remained high enough to
block any decision that needed shareholder approval, such as a takeover. Under
normal German corporate law, companies needed at least 25% of votes.
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Despite further attempts by the European Commission to revoke the Volkswagen

Law, Ferdinand Piëch, the chairman of Volkswagen’s supervisory board at that
time, managed to obtain the support of Chancellor Angela Merkel. She made sure
that 80% majority rule was preserved even with the amended Volkswagen Law. 5
The maintenance of the 80% majority rule resulted in a win-win situation, with
Piëch remaining at the helm of the board and Lower Saxony retaining influence in
Volkswagen through its veto power.
Ferdinand Piëch: Dominance

or doom-inance?
Prior to becoming the chairman of the supervisory board in 2002, Piëch, a stellar
automotive engineer, was the CEO of Volkswagen since 1993.6 During his nine-
year tenure as CEO, he guided Volkswagen to overcome its inefficiencies and
turned a loss of €1 billion into a profit of €2.6 billion. He had also spearheaded
Volkswagen’s expansion into a 12-brand entity that produced a wide range of
vehicles such as fuel-efficient cars and 40-tonne trucks.7
Piëch’s vision was to transform Volkswagen into the world’s biggest and best
carmaker.8 Being a member of the Porsche-Piëch family – which controlled 51% of
Volkswagen’s voting rights – Piëch was able to hand-pick executives he favoured
and terminate those he disliked. 9, 10 Piëch’s autocratic management style made
many engineers and executives in Volkswagen fear him as they knew that they
might be fired instantly if he was displeased.11
In 2012, Piëch succeeded in installing his fourth wife, Ursula Plasser, previously
a kindergarten teacher, to the company’s supervisory board. Although many
shareholders protested her lack of competence and independence, they had
minimal influence as the Porsche-Piëch family held a majority of the voting
shares.12 Furthermore, the appointment was supported by David McAllister, the
state Premier of Lower Saxony, who mentioned that Plasser was well-versed in
Volkswagen’s inner workings and had close ties with Lower Saxony after living
there for a decade.13
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Volkswagen’s two-tier board structure
Under German company law, it is mandatory for all public companies to have two
boards – a supervisory board and management board. The supervisory board is
composed of 20 members, and the board appoints and oversees the members
of the management board, and authorises major business decisions. The Co-
Determination Act of 1976 stipulates that companies with more than 20,000
employees must have 20 seats in their supervisory board.
“Harmonious” labour relations:

Co-determination
Labour representation at the board level of German companies is governed mainly
by the One Third Participation Act and the Co-Determination Act. It is almost
exclusive to Europe, and to Volkswagen in particular, where employees are highly
empowered to influence top management decisions. The Co-Determination Act
applies to Volkswagen as the company employs more than 2,000 employees.
Under this Act, the supervisory board of Volkswagen must consist of an equal
number of shareholders’ and employees’ representatives or in other words a
50/50 co-determination.14
In addition, the Works Council15, formed to protect and defend employee interests,
elects employee representatives onto the supervisory board. 16 Members of the
works council are elected only by employees for a term of four years 17, with most
of them also being trade union officials or members.18
Are employees kings?

10 of the 20 seats on Volkswagen’s supervisory board were held by employee
representatives. Being the chairman of the Works Council and a member of the
board, Bernd Osterloh was a decisive figure. According to a source close to the
supervisory board, none of the employee representatives would vote against
Osterloh in a shareholder’s meeting.19
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In August 2014, employee representatives forced management to dismiss

McKinsey & Company (“McKinsey”) who were previously engaged to advise on a
€5 billion cost-savings plan introduced by Winterkorn. Osterloh was concerned
that McKinsey would propose a plan that mainly focused on headcount reduction
in Germany rather than curtailing spending on surging research and development
costs. This move was major setback to Winterkorn’s plans to close the profit gap
with its rivals.20
Back in 2008, it was revealed that managers at Volkswagen had endorsed

payments for high-class prostitutes, sponsored cash gifts for the mistresses of
trade union officials, and even provided free supplies of Viagra. Klaus Volkert, a
former chairman of the Works Council, was found to have received about €2 million
in unauthorised bonuses and to have paid vacations for his Brazilian mistress.
Piëch, who had been CEO when the alleged offences took place, referred to the
scandals as mere irregularities. An insider revealed that such inappropriate use of
company’s resources had spanned over a decade but no action had been taken
from within.21
How German uncovered the German scandal

It was John German, together with his colleague Peter Mock, who uncovered one
of the biggest corporate scandals in history. German was an American engineer
who co-led the International Council on Clean Transportation (ICCT), a small, non-
profit organisation that assisted in the reduction of vehicle emissions by providing
scientific and technical analyses to environmental regulators.22
Volkswagen had been struggling to establish a strong presence in the United

States (US), the second largest automobile market in the world. To appeal to
increasingly environmentally-conscious Americans and boost sales, Volkswagen
promised “clean diesel” vehicles.23 When German and Mock carried out emission
tests on US cars under normal driving conditions on roads instead of simulated
laboratory tests, the pair detected irregularities in the emission levels of the Passat
and Jetta models.24 The Passat and Jetta models emitted dangerous levels of
toxins of up to 25 and 35 times higher than the legal limit respectively. They
informed the EPA and CARB, which thereafter launched an official investigation
into the matter.
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After several months of talks between Volkswagen and the regulatory bodies,
Volkswagen claimed that it had identified the reasons behind the high emissions
and subsequently recalled over 500,000 US vehicles in December 2014.25 However,
further investigations thereafter showed that the emission levels still violated
the standards, and both EPA and CARB threatened to withhold certification for
Volkswagen’s 2016 diesel models.
On 3 September, 2015, Volkswagen finally admitted to cheating on US diesel

emission tests.26 This subsequently led to the uncovering of the fact that Volkswagen
had installed a “defeat” software since 2007 to drastically reduce nitrogen oxide
emissions when the automobiles were tested by the EPA in laboratories.27 Shortly
after the news broke, Winterkorn announced his resignation as the CEO.
Green or grim car of the year?

Volkswagen had a reputation for producing fuel-efficient and environmentally-
friendly cars. In 2009, its first diesel car, the Jetta model, won the “Green Car of
the Year” at the Los Angeles auto show. The same title was also awarded to its
Audi A3 model in 2010.28
Volkswagen’s commitment to sustainability had always been strongly emphasised

by the supervisory and management board. Winterkorn and Osterloh regarded
the sustainability report as the group’s business card. In 2014, Volkswagen held a
leading position in 11 international ratings and relevant indexes, and was ranked
highly as a sustainable automaker in the Dow Jones Sustainability Index, which
is a renowned benchmark for measuring the development of the world’s most
sustainable corporations.29
However, Volkswagen was stripped of its accolades after the scandal surfaced.
The company was also removed from the rankings of the Dow Jones Sustainability
Index on 6 October, 2015.30
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Winterkorn: A sweet corn or a prickly thorn?

Winterkorn was Piëch’s former protégé who had a strong background in
engineering with a doctorate in metal physics. In 1993, he joined Volkswagen as
the head of group quality assurance and was heavily involved with the technical
development, both at Volkswagen and its Audi subsidiary before becoming CEO in
2007.31 He had a similar goal to Piëch, which was to make Volkswagen the world’s
largest automaker by 2018.32 As CEO, Winterkorn led the company to record
profits33 and the company achieved the title of the world’s best-selling automaker
in 2015, surpassing Toyota, three years earlier than originally expected.34
Winterkorn had a reputation of being a micro-manager who paid extremely close

attention to detail.35 He continued to retain control over engineering details that
many other CEOs would relinquish fully to deputies.36 His micro-management
style had been criticised because it delayed model launches and hampered the
company’s ability to adapt to local markets.37 Several times a year, Winterkorn
would also personally test drive new vehicles during Volkswagen’s group
approval drive.38
Board games
Over time, Piëch became increasingly disappointed with Winterkorn as he felt that
Volkswagen’s performance had failed to break the dominance of Ford, General
Motors and Toyota in the US market.39 Volkswagen’s market share in the US had
declined from three percent in 201240 to 1.9% in 2015.41 Piëch subsequently
bypassed the supervisory board and told Der Spiegel, a German magazine,
that he was distancing himself from Winterkorn.42 This open display of animosity
revealed Volkswagen’s infighting and drama to the media.
Back in November 2006, Piëch had successfully ousted Bernd Pischetsrieder,

who had succeeded Piëch as Volkswagen CEO in 2002. The move came as a
surprise to many as the board had just extended Pischetsrieder’s contract for five
years in May 2006.43 Prior to ousting Pischetsrieder, Piëch had undermined his
successor in two notable ways. First, he imposed a new human resources director
against the wishes of Pischetsrieder and most of the board members. Second,
he openly expressed his disagreement regarding the extension of Pischetsrieder’s
contract.44
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Ferdinand had come to an end
Piëch launched an attempt in April 2015 to oust Winterkorn as CEO but his
attempt failed. This time, Lower Saxony, members of the Porsche family and
majority of the supervisory board, including Osterloh, backed Winterkorn. They
decided that the infighting had to come to an end. Piëch acquiesced, and agreed
to keep Winterkorn. Soon after, Piëch was given an ultimatum by key shareholders
and stakeholders to either resign or suffer the humiliation of being kicked out in a
board vote as they had lost confidence in him as chairman. Piëch and his wife then
resigned from their positions on the supervisory board.45 46
After Piëch resigned, the supervisory board chairmanship was temporarily

transferred to deputy chairman, Berthold Huber.47 Huber was the former chairman
of IG Metall, one of the largest unions in the world, where virtually all Germany’s
car workers are members.48
Whistle fell on deaf ears

Robert Bosch GmbH, one of Volkswagen’s key suppliers, had warned Volkswagen
in 2007 that the engine-control software it supplied to Volkswagen should only be
used for company test purposes and not for rigging emission tests. However,
Volkswagen proceeded to modify the software so that it could turn the vehicle’s
emission control system on during emission tests, substantially lowering the levels
of exhaust pollutants like nitrogen oxides released, and turn it off when the vehicle
was on the road to allow for maximum engine performance.49
Four years later in early 2011, a Volkswagen technician blew the whistle and
reported that the company was violating emission laws by concealing the real
emission levels of its diesel vehicles.50 An internal audit revealed problems with
Volkswagen’s diesel engines, but no further action was taken.
Problems in Volkswagen continued to snowball and eventually, the fact that

Volkswagen had been cheating on emission tests was discovered by the EPA and
CARB. Up to 11 million Volkswagen diesel vehicles around the world that were
equiped with the emissions cheating software had to be recalled.51
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Financial implications on Volkswagen

The day after the scandal was uncovered, Volkswagen’s share price plunged by
over 16.7% and wiped out more than €20 billion off its market value. It also faced
fines amounting up to a maximum of more than US$18 billion for its violations,
and a criminal investigation by the US Department of Justice.52 The firm had to
set aside €6.5 billion in provisions to cover potential costs related to the emission
scandal.53
Road block ahead

The emission scandal prompted authorities in the US, Europe and South Korea
to launch their own investigations into the matter.54 Customer confidence was
severely shaken and many affected drivers became frustrated because of the lack
of information about how their cars would be repaired. Furthermore, a recent survey
conducted in the United Kingdom found that more than half of the Volkswagen
customers had no intention of buying a Volkswagen diesel car in future.55
Less of the same

In October 2015, Volkswagen appointed Thomas Sedran, former General Motors
Co. manager, as head of group strategy, and Christine Hohmann-Dennhardt, a
former judge from Germany’s top court, to head its legal and compliance division.56
Moving forward, Volkswagen announced that it would cut annual investments

made by the group’s brand division by over €1 billion alongside its plans to
continue manufacturing environmentally-friendly cars such as electric cars and
plug-in hybrids.
270
All eyes on Müller
The industry’s attention was now focused on Matthias Müller, the newly appointed
CEO of Volkswagen, to see how he would steer Volkswagen out of this crisis.
Failure to deliver its promises on providing clean diesel had severely tainted its
reputation as a green company.58 With the odds clearly stacked against the
company, only time will tell how long it will take for Volkswagen to regain the trust
and confidence of the public in their brand.
1. Discuss the advantages and disadvantages of adopting a two-tier board
structure, and draw a comparison with the one-tier board structure.
2. Do you think organization culture at Volkswagen may have had a role to

play in this scandal?
3. What responsibility does the regulator EPA have in the emission scandal? To
what extent can blame be put on the EPA?
4. In 2011, a Volkswagen technician blew the whistle on how the company was
cheating on emission tests, but the warning went unanswered. Given that
the use of cheating devices had begun in 2007, what are the possible
reasons for the truth only being uncovered much later in 2015?
5. Going forward, how can Volkswagen (or any organization) improve

corporate governance to prevent a similar crisis from recurring? What kind
of checks and balances would be required to avoid similar risks in future?
271
YAHOO! THE$100 MILLION MAN
Case overview
In January 2014, Yahoo’s Chief Operating Officer (COO), Henrique De Castro, was fired after 15
months on the job. He left the company with an estimated US$103 million, which included a
hefty severance package worth US$58 million. The compensation package De Castro received
was an issue of contention, with commentators questioning the hefty severance package given
De Castro’s poor performance and his failure to satisfactorily boost Yahoo’s advertising revenue.
The objective of this case is to allow a discussion of issues such as the roles of the nominating
and remuneration committees in the hiring and remuneration of senior executives; design and
risks of executive remuneration packages; and the use of golden parachutes.
Decline of Yahoo’s digital advertising
In 2006, Yahoo lost out to Google in the takeover of DoubleClick and YouTube. These two
acquisitions became significant contributors to Google’s advertising revenue. Recent years have
also seen the online advertising industry undergoing a significant redistribution of revenues due
to a consumer shift in user platform from desktop to mobile. As a result, more advertisements
have been featured in mobile applications to complement traditional display advertisements.
This shift in consumer preference bode well for Yahoo’s rivals, Facebook and Google.
Facebook’s advertising revenue rose significantly, with performance advertising (i.e. a pricing
model that pays a marketing agency commission per new lead that the agency generates
through online advertising) experiencing its largest growth in 2009. Google acquired a mobile
advertising company, AdMob, in 2009 to further its foray into mobile advertising. Yahoo, on the
other hand, saw a decline in advertising revenue and soon slipped behind its rivals.
An analysis carried out by eMarketer, an independent market research company, revealed that
in 2012, Yahoo had the second largest market share in the U.S. market for digital advertising,
when CEO Marissa Mayer joined the company. As of 2013, however, Yahoo slipped to fourth
place. Yahoo’s decline was forecast to persist while Facebook and Google continue to be the
frontrunners in digital advertising. In an attempt to revive Yahoo’s advertising segment, which
contributed significantly to its total revenue, Marissa Mayer decided to hire Henrique De Castro as
COO.
Henrique De Castro
De Castro was poached by Mayer from her former employer, Google, in October 2012. He was
put in charge of strategic and operational management of Yahoo’s sales, media, business
development and operations worldwide.
De Castro’s job history includes senior executive positions in leading companies such as
Google, McKinsey & Company and Dell, where he was the Sales and Business Development
Director in the Western Europe region. Given his extensive experience as a senior executive,
Mayer was highly confident about De Castro’s capabilities for the role and expressly stated that
“his operational experience in Internet advertising and his proven success in structuring and
scaling global organizations [in Google] make him the perfect fit for Yahoo as we propel the
business to its next phase of growth”.
However, critics had expressed doubts on De Castro’s appointment due to changes in his
position at Google prior to his departure. De Castro had previously held the title of President of
“Global Media, Mobile & Platforms”, a position which was described as having “miscellaneous”
responsibilities. However, just prior to him leaving Google to join Yahoo, De Castro served as
Vice President of Google’s Worldwide Partner Business Solutions Group, where his responsibility
extended to Google’s business partners. He was also reputed to have a difficult personality and
thus was not considered to be a suitable candidate for the role of COO, which involves
networking with potential advertisers and attracting them to join Yahoo. Despite facing
widespread criticism, Mayer maintained her position and went ahead with the hire after
receiving board approval.
De Castro’s compensation package
On 15 October 2012, Yahoo made its offer to De Castro to serve as the company’s COO.
According to the employment offer letter filed with the U.S. Securities and Exchange
Commission (SEC), the De Castro’s compensation package was developed by Yahoo’s
Compensation and Leadership Development Committee (CDLC) based on the guidelines of the
CDLC’s charter. Under the contract, De Castro’s compensation package consisted of three main
components.
Firstly, De Castro would receive an annual base salary of US$600,000 and was eligible for an
annual bonus set at 90% of his base salary. Both the base salary and the bonus were subjected
to annual review by the Compensation Committee.
Secondly, he was also entitled to Long-Term Incentive Equity Awards. These included Restricted
Stock Units (RSUs) with a targeted valuation of US$18 million and a vesting period of four years;
Performance Stock Options (PSOs) with a similar targeted valuation and vesting period, but with
the first performance period being the first half of fiscal year 2013 instead of fiscal year 2012; and
a One-Time Make Whole Award in the form of RSUs, worth US$20 million with a vesting period of
four years.
Thirdly, De Castro was awarded a One-Time Make-Whole Bonus of US$1 million cash to
compensate him for forfeiting his previous employment benefits in Google. This bonus was
subjected to repayment within the first six months of his term as COO, notwithstanding any
potential termination of his employment.
The hefty compensation package was intended to provide competitive compensation to De

Castro, with one-time awards used as an incentive to join Yahoo, and equity awards as a
performance-based reward to align management decisions with shareholder interests. Long-
term equity incentives made up the majority of the compensation mix. Such equity grants, as
well as cash bonuses (excluding the one-time make whole bonuses), were subjected to the
Company’s “clawback” policies.
De Castro’s short-lived tenure
De Castro served in Yahoo from December 2012 to 16 January 2014. After a mere 15 months
as Yahoo’s COO, De Castro was dismissed by Mayer herself. Analysts speculated that De
Castro’s dismissal was due to friction between the two executives for at least six months prior to
the firing, and a less than satisfactory performance in boosting Yahoo’s advertising sales.
Yahoo’s display advertising revenues fell by seven percent in the third quarter of 2013. To make
matters worse, Facebook overtook Yahoo in becoming the second-largest seller of online
advertisements in the U.S. market, after Google. Once the market leader for online
advertisements, Yahoo was trailing behind competitors and had not been able to persuade big
marketers to return to its web portal. Analysts have attributed this to De Castro’s difficult
personality, resulting in the formation of poor client relationships. As a result, he was unable to
perform his role of increasing advertising revenues in the U.S. market effectively.
The profitable exit
Analysts found it highly ironic that De Castro failed to deliver given the compensation package he
was provided with to lure him from Google, calling the decision by Mayer a “misfire”. Adding
fuel to the fire, De Castro received a substantial severance package upon his termination despite
his failure to bring the advertising growth required to boost Yahoo’s revenue.
A SEC filing by Yahoo in April 2014 revealed that the package was worth US$57.96 million. This
included cash, RSUs that vested over time, stock options linked to performance, and make-
whole RSUs.
The compensation package, which was worth only US$17 million at the time the employment
contract was signed in 2012, was inflated to more than three times at the termination date.
Observers conjectured that three main factors contributed to the size of De Castro’s severance
package. The first factor was largely associated with the composition of the severance package.
It was structured in a way such that its value would rely primarily on the company’s performance
and how well its stock performed. The equity component caused a spike in the severance
package’s value, as Yahoo’s stock price had appreciated by nearly 160% from the date of
signing of the employment contract to the date of termination.
De Castro’s termination occurred when Yahoo’s stock price was at its highest in almost 10 years.
Analysts traced the increase in stock price to Yahoo’s 24% stake in China’s Alibaba Group. Such
gains had little or no relation to the business acumen of any Yahoo executive. In addition, it was
predicted that upon Alibaba going public on the New York Stock Exchange, Yahoo would be
able to reap a multi-billion dollar windfall from its holdings in the company. This would further
inflate the compensation packages of Yahoo’s senior executives.
The second factor which contributed to the size of De Castro’s severance package is the fact
that Yahoo had to compensate De Castro heavily when he was poached from Google. Of the
US$58 million package, US$31.18 million was in the form of make-whole RSUs. In Yahoo’s
2013 Proxy Statement, it was explained that these one-time make-whole RSUs were to “buy
out the compensation value that [the] new executives forfeited when they joined Yahoo”. The
Compensation Committee of Yahoo believed that these make-whole RSUs would “enhance
[the executive’s] immediate financial stake in Yahoo” and serve as “a retention mechanism”. De
Castro had clearly benefited from this philosophy.
Lastly, De Castro’s severance package was widely seen as a golden parachute. These golden
parachutes provide a “soft landing” for the executive upon termination. Such agreements may
arise from shareholder pressure and public scrutiny, which may lead companies to structure
severance packages to include less cash and more equity.
Yahoo’s Compensation Committee had defended De Castro’s large severance package,

asserting that “the Board believed at the time De Castro was hired that he had a unique set of
highly valuable skills and experiences that would be key to returning the company to long term
growth and success”. Clearly, De Castro’s appointment was a mistake and he was well
compensated for his failure.
1. Was the remuneration package awarded to De Castro when he left Yahoo reasonable? Why do
companies often make what appear to be excessive termination payments?
2. Discuss the merits and de-merits of using remuneration components such as sign-on bonuses,
make whole bonuses and golden parachutes, to attract and retain senior executives.
3. Discuss the role of Board of Directors (especially that of Nominating and Remuneration
Committee) in the hiring and remuneration of senior executives such as De Castro?
4. Discuss the role that a company’s shareholders should play in determining executive
remuneration packages. Cite some good examples or suggest some potential best practices in
determining executive remuneration/severance pay
5. Cite examples from India where remuneration of executives was raised as an objection/issue by
shareholders/other stakeholders. Are there any regulations in India that restricts executive pay?
TATA SONS
Case overview
On 24 October, 2016, Cyrus Pallonji Mistry (Mistry), then Chairman of Tata Group
and its holding company Tata Sons, was abruptly removed from his positions. He
was subsequently removed from the boards of some Tata Group companies and
thereafter resigned from the remaining boards. The day after his removal, Mistry
released a letter claiming that he had been nothing more than a “lame duck”
Chairman. He questioned the influence of Tata Trusts, Tata Sons’ controlling
shareholder, and that of Ratan Tata, his predecessor. Issues relating to fraudulent
transactions were also alleged by Mistry, which were refuted by Tata Sons. The
objective of the case is to allow a discussion of issues such as corporate governance
in family-owned companies; the powers of controlling shareholders; the role of
independent directors; the appointment and removal of key e x e c u t i v e s
f r o m management; governance of company groups and the role of regulatory
bodies.
The man behind the mystery

Mistry was born on 4 July, 1968 to a wealthy Parsi business family. His father,
Pallonji Shapoorji Mistry, was the Chairman of the Shapoorji Pallonji Group, a
diversified Indian conglomerate. In 1994, Mistry was appointed managing director
of his family company.
The Mistry family first became connected to Tata Sons in 1935 when Mistry’s
grandfather purchased a company with a 12.5% stake in Tata Sons. As of October
2016, the Shapoorji Pallonji Group was the single largest individual Tata Sons
shareholder with a stake of 18.5%. Mistry denied allegations that his family’s ownership
of a substantial equity stake equated to a special position in Tata Sons. The remaining
shares are controlled by Tata Trusts, Tata Group companies and members of the
Tata family. The ties between the Mistry and Tata families were further cemented by
the marriage of Mistry’s sister, Aloo, to Ratan Tata’s half- brother, Noel.
In 2006, Mistry joined the board of Tata Sons and was appointed as director in
several other Tata Group companies. In 2010, he was placed on a five-member
selection committee to search for the successor to Tata Group Chairman Ratan
Tata, who was due to retire in December 2012. While the search was ongoing, the
committee successfully proposed to lower the retirement age of Tata Sons’ non-
executive directors, including the Chairman, to 70 years from the current 75 years.
This was not the first time the Group had adjusted its mandatory retirement age
policy to influence retention and renewal policies.
Emerging from the shadows

The search committee struggled to find a suitable successor for an ‘icon’, which
Ratan Tata had become. One of Tata’s longstanding acquaintances said that the
Chairman was also convinced that he was ‘irreplaceable’. After a long
unsuccessful search by the selection committee for a suitable successor, Mistry
was approached to take over the role of Chairman by Ratan Tata and Tata’s
personal friend, Lord Kumar Bhattacharya, a member of the selection committee.
Mistry was seen to represent the ‘closest possible alternative’ to chair Tata Sons
and he subsequently recused himself from the selection committee. At that time,
Ratan Tata had endorsed the appointment of Mistry as his successor, whom he
held in high regard.
In November 2011, Mistry was appointed Deputy Chairman of Tata Group, to be
personally groomed by the outgoing Chairman. To avoid potential conflict of
interests, Mistry immediately resigned from his family’s company. One year later,
Mistry took over as the sixth Chairman of Tata Sons. He was the first Chairman in
74 years to have come from outside the Tata family. Upon his retirement as
Chairman, Ratan Tata was appointed as Honorary Chairman Emeritus of Tata
Sons. It was claimed by Tata Sons that Mistry had invited Ratan Tata to take up
this role.
Concurrently, many alterations were being made to Tata Sons’ Articles of

Association. As a result of these changes, the requirement of approval from
nominees of the Tata Trusts, who sit on the board of Tata Sons, was only limited to
eight distinct types of decisions. The alterations also gave directors nominated by
the Trusts more power in the appointment and removal of the Chairman. These
Trustee-nominated directors were also granted a special veto right to oppose any
decisions made by the board. In addition, a resolution was passed to allow the
Trusts to select the Chairman of the selection committee for Tata Son’s Chairman
and appoint three members to the selection committee. These changes granted
Tata Trusts greater control of Tata Sons. With Ratan Tata still heading the Trusts,
this marked the first time the roles of Chairman of Tata Trusts and Tata Sons were
occupied by different persons.
Back into the dark

To observers, it was clear that it would be difficult for Mistry to live up to the legacy
of his predecessor. The Group’s poor performance under Mistry was one of the
theories the public had about his abrupt ejection from the helm of Tata Sons on
24 October, 2016. However, earlier in June that year, Tata Sons’ Nomination and
Remuneration Committee had met with Mistry to assess his performance and it
was decided that Mistry would receive a six percent hike in salary and
commission.
However, this decision was not representative of Mistry’s approval throughout the
Group. In a 204-page affidavit issued later, Tata Sons detailed “disturbing facts”
which had contributed to Mistry’s ouster. Notably, it was said that Mistry was
reluctant to apply the terms laid out in Tata Sons’ Articles of Association. Mistry
had allegedly reduced the representation of Tata Sons’ directors on the boards of
other Tata Group companies and structured directorships in the various
companies such that he was the only director who sat on the boards of Tata Sons
and the Tata Group companies. Other issues highlighted revolved around Mistry’s
failure to distance himself from his own family business.
Prior to the commencement of the fateful board meeting on 24 October, 2016,

Ratan Tata had spoken personally with Mistry and offered him a chance to
voluntarily resign as Executive Chairman. However, Mistry had refused.
As soon as the board meeting began, a resolution was moved to remove Mistry as
the Chairman of Tata Sons. Six of the nine board members supported the removal
of Mistry, including the three newly-inducted directors brought in by Ratan Tata.
Two members abstained and Mistry, who could not vote, was ousted. At the
meeting, Ratan Tata was also appointed as the interim Chairman of Tata Sons.
Although he was ousted as Chairman, Mistry continued to retain his position as

director of various Tata Group companies. These directorships were said to be
contingent on his position as the Chairman of Tata Sons, and it was felt that his
continued presence as a director would be a “disruptive influence” on these
boards due to his hostility towards Tata Sons. In the days which followed, Tata
Group companies separately convened extraordinary general meetings (EGMs) to
remove Mistry from his directorship roles. However, after being ousted from Tata
Consultancy Services Ltd.’s board at the first of six planned EGMs, Mistry
resigned from the boards of all Tata Group companies, with the exception of Tata
Sons, on 19 December, 2016.
Conflicting clues
On 25 October, 2016 - one day after his losing his Chairman position on Tata
Sons’ board - Mistry wrote a letter to Tata Group stating his views about his
ousting. Mistry felt that “it was his duty to place before the stakeholders a full
perspective of facts and factors that were in play”.
In his letter, Mistry highlighted a number of main points. He raised the issue of
‘legacy hotspots’, which were legacy companies he had inherited from Ratan
Tata’s era that were dragging down the Group’s economic performance. Mistry
also labelled himself as a “lame duck” Chairman as he was unaware of Tata
Group’s venture into the airlines industry, with approval having been sought from
Ratan Tata instead of him. Mistry claimed that, moving forward, the sustainability of
Tata Group would depend on a governance reform to conform with company law
and global best practices. Most importantly, he called for shareholders’
independence to bring about the reforms that he sought.
The leaked letter, which was sent by email to the board, took the Tata boardroom
struggles public. As a result, the market regulator, Securities and Exchange Board
of India (SEBI), sought detailed explanations from the listed Tata Group
companies regarding the allegations contained in Mistry’s letter. In response, the
companies denied the allegations and claimed no wrongdoing. SEBI and the stock
exchanges also monitored the price movements and trading activities of the listed
companies of Tata Group.
As stock prices plunged, Ratan Tata issued a letter to employees to explain that
Mistry’s removal was ‘absolutely necessary’ for Tata’s future success, to reassure
them of the conglomerate’s stability and to prevent any further reputational damage.
He emphasized that Tata’s culture and values will hold strong during turbulent times
and advised employees to look towards the future rather than the past.
On 10 November, 2016, Tata Sons released a nine-page statement defending its

actions to dismiss Mistry as Chairman. With regards to the performance of the
Tata Group companies, Tata Sons claimed there was no profit on sale of
investments and no noteworthy divestments which had been planned in advance.
Furthermore, Mistry should have been aware of these hotspots when he took up
the position and yet, after almost four years, there had been no strategic
formulation for these legacy companies. The letter also highlighted a decrease in
dividend income from the Tata Group companies and an increase in debt,
expenses, and write-offs under Mistry’s tenure. Mistry’s investments had not been
paying off and his poor leadership was perceived as the primary cause for the
deteriorating performance of the Tata Group companies.
The letter also sought to clarify governance issues highlighted by Mistry. It was
explained that the role of the Trustee was to protect the assets of Tata Sons, and
Tata Trusts was used only to monitor the operations of Tata Sons. Amongst other
issues, the recent developments in The Indian Hotels Co. Ltd (IHCL) suggested
that Mistry had an ulterior motive to gain the control of IHCL via the backing of
independent directors of the board. Mistry was also accused of methodically
excluding other representatives from the board, and in so doing, he would be Tata
Group’s sole representative and hence would be able to seek control of the main
operating companies of the Group. The letter deemed that such actions would
have been detrimental to Tata Group. The letter again accused Mistry of
orchestrating Tata Group’s demise during his almost four-year tenure and promised
to uphold the highest standards and protect the interests of all stakeholders.
Fruitless struggle
Two months after being removed as Chairman, Mistry still retained his directorship
on the board of Tata Sons. However, an EGM had been proposed on 6 February,
2017 to remove him from the board of Tata Sons. In an attempt to prevent this,
Mistry petitioned the National Company Law Tribunal (NCLT). He sought interim
relief on three counts. Firstly, Tata would not dilute his family current holding of
18.5% by issuing new shares. Secondly, Mistry himself would not be removed
from the board of Tata Sons. Thirdly, the Articles of Association of the company
would not be altered without the consent of the NCLT.
Unfortunately for Mistry, the NCLT refused to grant him interim relief. His troubles
worsened when Tata Sons subsequently sued him for breach of confidentiality. The
conglomerate asserted that he had used confidential information and documents
in his petition.
Mistry challenged the NCLT’s ruling. On 2 February, 2017, he appealed to the

National Company Law Appellate Tribunal (NCLAT) for an injunction against the
EGM which was to be held on 6 February, 2017. Mistry’s appeal, however, was
rejected a day later. Without the interim relief, the EGM went forward as planned.
Are independent directors truly independent?
On 6 January, 2017, Nusli Wadia, the Chairman of the Wadia Group of companies,
wrote to SEBI, claiming that some of the independent directors of Tata Group
companies had a direct conflict of interest and should be removed from the
boards. Wadia was an independent director on the boards of Tata Steel, Tata
Motors and Tata Chemicals. However, he was removed from the boards of these
companies after he backed Mistry when the latter was ousted as Tata Sons’
Chairman. Wadia said he had no regrets, that he was not Ratan Tata’s ‘yes- man’
and he had to fulfil his fiduciary duties as an independent director. Wadia also
argued that promoters who had moved the resolution for the removal of
independent directors should not be allowed to vote.
A new beginning
A month later, on 6 February, 2017, Mistry’s reign came to an end at the EGM
when he was removed as a director of Tata Sons. At the EGM, 80% of the
shareholders voted in favour of his removal. Mistry’s ousting came after his
predecessor, Ratan Tata, lost confidence in him. As Ratan Tata remained as
Chairman of the Tata Trusts, which owned a 65% controlling stake in Tata Sons,
the outcome of the shareholder vote was not unexpected.
After the highly tumultuous period for the Indian conglomerate, Ratan Tata returned
to take charge as the interim Chairman for four months before a successor was
identified. However, some analysts had criticised the move as it potentially implied
Ratan Tata’s unwillingness to let go of the reins of the company.
A new puppet?
On 21 February, 2017, Natarajan Chandrasekaran became the new Chairman of
Tata Sons and was the third non-Tata family member to do so.
Chandrasekaran now faces the challenge of dealing with the reputational carnage
left behind in the wake of Mistry’s ouster. His software programming background
has raised concerns about his ability to run a diversified multinational conglomerate.
However, a Trustee of Tata Trusts highlighted that as a veteran, Chandrasekaran
would be able to bring to the table his numerous years of experience in Tata and
put to use the benefits of his established association with Ratan Tata.
Meanwhile, Ratan Tata continues to be Chairman of the two powerful Trusts that
collectively own two-thirds of Tata Sons and has no plans to step down in the
foreseeable future. On the day of his appointment, Tata Sons passed a resolution to
ensure Chandrasekaran would automatically cease to be a director of the
company and its affiliates when he ceases to hold office as the Chairman.
As leader of arguably India’s most well-known conglomerate, which had been

headed by a member of the Tata family for most of its 148-year history, it remains
to be seen whether Chandrasekaran can truly take the reins and lead Tata to
greater heights.
1. Comment on the challenges of family-owned companies and discuss how
this might have contributed to the corporate governance upheaval at Tata
Sons.
2. Discuss the role of Tata Trusts in the corporate governance of Tata Sons.
3. Mistry was the Chairman-cum-CEO at Tata Sons. What concerns does this
raise? Does the strong presence of the controlling shareholders mitigate
these concerns?
4. Is an independent director truly independent when the promoter is permitted

to propose and vote for his removal?
5. In light of the leaked email surfacing Tata’s struggles to the public, do you
think the Tata Group handled the crisis well? What could the Tata Group have
done to avoid loss of shareholder confidence?
6. Discuss corporate governance issues that arise in the case of a conglomerate

like Tata Group, with a holding company structure and various listed and
unlisted subsidiaries. What issues might arise from directors serving on the
boards of various companies within the Group? Should a director who serve
on the boards of a parent and subsidiary, or in multiple companies within the
Group, be considered independent?
Yes Bank Collapse
Some links are provided below to help understand the background to Yes Bank collapse. Any
additional information available in public domain may be used to gain better insights.
https://www.clearias.com/yes-bank-crisis-reconstruction/
https://www.globalbankingandfinance.com/yes-bank-case-study/
http://indiafa.org/2050-2/
https://www.newindianexpress.com/business/2021/feb/14/yes-man-the-rise-and-fall-of-rana-
kapoor-2263690.html
https://www.moneycontrol.com/news/business/its-curtains-to-7-year-old-court-drama-as-madhu-
kapur-family-buries-the-hatchet-with-yes-bank-5387131.html
Questions:
1. Discuss the role of founder promoters in the growth of a company. Can the failure of Yes Bank be
directly attributed to its former Chair person, Rana Kapoor?
2. Discuss the various steps taken by RBI. Do you think the central bank could have acted any
differently?
3. What is your view of the restructuring done at Yes Bank and further actions taken by the new
BOD. Do you think that Yes Bank could turn around?
4. Successive Indian Governments and RBI have followed a policy to not let any major bank (private
or public sector) collapse. Are they right in following this policy? Should regulators bail out poorly
performing private entities?
5. There were serious questions raised about the governance standards at Yes Bank during the long
legal battle between Rana Kapoor and the family of his co-founder Ashok Kapur. Could these have
pointed out that ‘all’s not well’? Discuss
INDIA’S LEADING & FINANCIAL SCAM
INDIA’S LEADING & FINANCIAL

SCAM
Case overview
In 2018, India’s non-banking financial companies (NBFC) sector was roiled by a series of
defaults by the Infrastructure Leasing & Financial Services Limited (IL&FS) group of companies,
with Rs848,000 crore of investor wealth vanishing within a few days. Several board members
resigned, the CEO of one of its defaulting subsidiaries quit abruptly, and multiple key
management personnel were replaced. The Group was further embroiled in money-laundering
charges levelled against 14 of its directors. The high-profile scandal led to investors losing faith
in India’s NBFC sector, which was an important driver of India’s economic growth, providing an
accessible source of funding for industries such as agriculture and real estate. It also sparked
public outcry and scrutiny as to whether enough was done by all parties involved in preventing
such a massive meltdown.
The objective of this case is to facilitate a discussion of issues such as board composition;
governance of company groups; overlapping directorships on boards of related companies;
non-segregation of shareholders, management and the board; risk governance and risk
management; financial management; investment governance; remuneration; and the role of
the government, regulators, auditors and credit rating agencies.
The rise of IL&FS

Incorporated in 1987, Infrastructure Leasing & Financial Services Limited (IL&FS) was the
brainchild of the late MJ Pherwani, the Chairman of the Unit Trust of India (UTI) and the National
Housing Bank (NHB) in India.1 The company was initially advocated by the Central Bank of
India (CBI), Housing Development Finance Corporation (HDFC) and UTI, with the objective of
providing finance and loans for major infrastructure projects in India. 2 This need was pertinent
especially because the only players at that time, the Industrial Development Bank of India
(IDBI) and Industrial Credit and Investment Corporation of India Bank (ICICI), were primarily
focused on private sector projects. IL&FS was supported by government-controlled entities in
the 1980s, including the CBI, UTI and HDFC.3
Over the last two decades, the focus in India turned towards infrastructure, and Prime Minister
Narendra Modi announced a major program to develop this area. The master plan included
the construction of highways, roads, tunnels and affordable housing, as well as renewable
power generation across the country between 2014 and 2015.4 This led IL&FS to utilise its
This case was prepared by Loo Kee Jeng, Wong Kang Ming, Cher Wen Ting, Tan Claris and Beatrice Ng, and edited by Isabella Ow under the
supervision of Professor Mak Yuen Teen. The case was developed from published sources solely for class discussion and is not intended to serve
as illustrations of effective or ineffective management or governance. The interpretations and perspectives in this case are not necessarily those of
the organizations named in the case, or any of their directors or employees.
Copyright © 2020 Mak Yuen Teen and CPA Australia.
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first-mover advantage to obtain projects through direct bidding or joint ventures. Its operations
quickly spread from Spain to China, with many offices set up worldwide. Businesses ranged
from sanitation projects and multilane highways to thermal power projects and solar parks,5
under a group structure comprising at least 24 direct subsidiaries, 135 indirect subsidiaries,
six joint ventures and four associate companies since its inception.6 Its subsidiaries included
transportation network building subsidiary IL&FS Transportation Networks Limited (ITNL),
engineering and procurement company IL&FS Engineering and Construction Co Limited, and
financier IL&FS Financial Services Limited (IFIN).
Too big to fail?

Until early August 2018, IL&FS scored AAA ratings from credit rating agencies,7 mostly due to
it being central in government infrastructure plans and its impressive list of top shareholders.
This helped IL&FS to secure funding from investors but also led to high debt levels. IL&FS’
total debt amounted to approximately Rs91,000 crore at its peak, with Rs57,000 crore due to
public sector lenders. The amount which IL&FS owed banks was over 10% of the net worth of
all public sector banks in India.8
The financing came from a variety of sources, with the large majority coming from public
sector banks and individuals who invested in its non-convertible debentures. IL&FS also raised
financing from other banks, financial institutions, NBFCs, corporations, and state governments.
Its subsidiary, IFIN, would then lend these funds as start-up capital to subsidiaries which would
partner with Public Sector Units as promoters in Public-Private Partnerships (PPPs).9
The PPP model allowed IL&FS to establish a significant presence in India’s infrastructure sector,
with more than 300 subsidiaries in roads, transport, energy, maritime infrastructure, water,
and urban management. However, IL&FS subsidiaries were not just private partners in the
PPPs. Some of these subsidiaries were established to provide a range of consulting services
to projects financed by the Group, forming an intricate relationship between Group entities.10
It was a combination of IL&FS’ substantial presence, vast clout, and systemic importance as
an NBFC that aided the Group in its planning and execution of scams. IL&FS squandered
public finances by being a financial institution which also entered into PPPs, and hired its own
subsidiaries as consultants for their own projects. This gave IL&FS the capacity to borrow large
sums from public banks and channel the money into joint ventures which it created with public
sector units, to form PPPs.11
Bubble waiting to burst

The modus operandi of IL&FS was simple: aggressively bag new projects, borrow to fund
them, and divert the money to repay lenders to earlier projects. From 2014 to 2018, although
its operating profit rose by 43% from Rs5,087 crore to Rs7,267 crore, its debt level rose by
87% – from Rs48,671 crore to Rs91,091 crore. This placed its leverage ratio at 13 times, vis-à-
vis what was considered a safe level of three times. The company’s high leverage was a result
of its sizeable capital requirement across subsidiaries, with a huge interest bill of Rs7,923 crore
in March 2018, a doubling from Rs3,970 crore in 2014.12
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Problems arose when IL&FS piled up too much debt to be paid back in the short term while
revenues from its assets were skewed towards the longer term, causing an asset-liability
mismatch. The Group first sent shockwaves across the market when it postponed a US$350
million bond issuance in March 2018 due to investors demanding a higher yield.13
Under increasing pressure from the Reserve Bank of India (RBI) – India’s central bank and
regulator of India’s banking sector – to identify and deal with bad loans swiftly, India’s banks
were wary of extending and rolling over loans if the credit risks were high. As a result, IL&FS
found it more challenging to refinance its debts as they came due.14
IL&FS’ net debt to earnings before interest, tax, depreciation and amortization (EBITDA) was
approximately 11 times at the end of March 2018. The ratio measures a company’s ability to
pay debt through its operating income, and analysts considered anything above five as a red
flag. This was followed by a series of downgrades in credit ratings starting from June 2018.15
When things started going south

June 2018 marked the start of a string of events which led to IL&FS’ downward spiral.16 That
was when four out of five subsidiaries of ITNL missed payments on debt due for that month,
forcing rating agencies to assign a default rating. Debt worth more than Rs28.5 billion would
face a default rating, while the debt for five projects anticipating termination stood at more than
Rs43 billion.17 In July 2018, ITNL continued to face difficulties in making payments due on its
bonds.18 This came after a series of warnings from rating agencies of the possibility of project
termination by the special purpose vehicles (SPVs) floated by several companies. Following
that, CARE Ratings downgraded ITNL’s bank facilities and debt instruments, citing “build-up of
liquidity pressure on the Group due to delay in raising funds”.19
In September 2018, IL&FS and its subsidiaries had defaulted on loans and inter-corporate
deposits to other banks and lenders. It had earlier defaulted on inter-corporate deposits to
Small Industries Development Bank of India (SIDBI) amounting to approximately Rs450 crore.20
On 4 September 2018, it was reported that IL&FS could not repay a Rs1000 crore short term
loan from SIDBI. As a result, SIDBI requested for the resignation of Swaminathan Mallikarjun
– IL&FS’ chief general manager in the risk management department – for the bad debt.21
SIDBI also threatened to file a case against IL&FS in the National Company Law Tribunal
(NCLT) for non-repayment.22 By mid-September, IL&FS and IFIN had accumulated a combined
Rs27,000 crore of debt rated as ‘junk’ by CARE Ratings and six other Group entities had
suffered downgrades with a negative outlook on an additional Rs12,000 crore of borrowings.23
Reactions
In late September 2018, IFIN informed the stock exchanges that it had defaulted on a Rs52
crore repayment of short-term deposits and Rs104 crore term deposit. It also failed to repay
five other bank loans and associated interest, which further exacerbated its position in the
market.24
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RBI then initiated a special audit on IL&FS and met the three largest investors of IL&FS – Life
Insurance Corporation of India (LIC), Japan’s Orix Corporation, and Abu Dhabi Investment
Authority – to discuss the large-scale defaults.25 As more debt deadlines loomed closer, IL&FS’
credit rating continued to experience sharp downgrades. Credit ratings agencies ICRA and
CARE Ratings cut their scores on a number of IL&FS’ debt instruments to ‘D’ on 17 September
2018, indicating actual or imminent default.26
At IL&FS’ Annual General Meeting on 29 September 2018,27 the board of directors rushed to
pass a motion to raise Rs4,500 crore through a rights issue, to be completed by the following
month. The board also raised the borrowing limit from Rs25,000 crore 28 to Rs35,000 crore. The
company appointed Alvarez & Marsal as a specialist agency to execute the debt restructuring
plan.29 But is this a case of “too little, too late”? What contributed to its troubles?
Shareholders blindsided
Most of IL&FS’ shares were held by Indian state-owned enterprises and private companies.
The main shareholders of IL&FS included LIC with 25.34%, Japan’s Orix Corporation with
23.54% and Abu Dhabi Investment Authority with 12.56%.30 These shareholders were found
not to be involved in the wrongdoings of the company. In contrast, the manner in which the
company was structured and managed by the board of directors and its executives was highly
questionable.31
Other than the major shareholders mentioned above, IL&FS Employees Welfare Trust also
had a substantial stake of 12%.32 This was a trust fund set up by the company to provide
financial assistance to its lower-income employees. However, this trust was found to be a shell
company that comprised mainly prominent board members who used their positions in it to
bring benefit to themselves, at a cost to the IL&FS Group companies. Less than one percent
of the funds that went through the EWT was used for the welfare of needy employees. Further,
around 3.1 million shares of IL&FS were distributed to managerial personnel and employees,
who were not meant to be the original beneficiaries of the trust.33
The Serious Fraud Investigation Office (SFIO), Delhi Police and tax authorities probed into
various suspected irregularities of IL&FS. The SFIO alleged that the management of IL&FS hid
non-performing loans, falsified accounts and concealed material information for their benefit.
The top management also allegedly milked the dividends and substantial sitting fees from
artificial profits booked by IFIN.34,35
Self-service
Industry observers felt that IFIN was run by IL&FS Chairman Ravi Parthasarathy and Vice
Chairman Hari Sankaran like a “personal fiefdom”. 36 According to an SFIO official, the “top
management used IFIN as a tool for personal gain”.37
Other than having highly suspicious transactions across the Group, there were also several
instances where the board of directors and management had arguably violated their duties by
having a conflict of interests. One such instance was when Group entities rented properties from
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certain employees or their family members and paid rental fees well above the market rates. 38
Other instances include a loan of Rs28.99 crore extended to Indus Equicap Consultancy Pte
Ltd, where one of the IL&FS directors was also acting as a director.39
Emails between the Group’s former management and borrowers showed that IFIN’s officials
enjoyed additional perks. For example, in 2014, S. Sivasankaran of the Siva Group – one of the
beneficiaries of IFIN’s sophisticated transaction arrangements – arranged for a helicopter tour
and ski resort stay in Norway for Parthasarathy. Viren Ahuja of Flamingo Group also arranged
for an internship at Moet Hennessy for the daughter of IFIN’s Chief Executive Officer (CEO)
Ramesh C. Bawa.40
Too big to comprehend

The highly complex structure of IL&FS made it extremely difficult to track the accounts of each
of its subsidiaries or associates. 41 The Group was thus able to easily hide fictitious transactions
and shift profits around the various Group entities to its advantage, making it virtually impossible
to verify the authenticity of its accounts.
Furthermore, IL&FS failed to accurately disclose the number of parties related to the parent
company. In its annual report, it was disclosed that the Group had 24 direct subsidiaries, 135
indirect subsidiaries, six joint ventures and four associate companies. However, when thorough
investigations were carried out, it was found out that there were in fact 347 companies under
parent company IL&FS.42
Funds were also found to be diverted across the multiple entities in the Group. According to
the report by the SFIO, the Group seemed to operate as a single entity without any proper
segregation between legal entities and separate management.43 This unlawful manipulation of
funds was concealed by IL&FS’s highly complex business structure44 and made it extremely
difficult for auditors to uncover discrepancies within reported figures in the Group.45
Merry-go-round
Intragroup transactions which were carried out by IL&FS were significant, specifically in the
form of loans given out by its finance arm, IFIN, to other companies within the IL&FS Group,
amounting up to Rs5,728 crore, Rs5,127 crore, and Rs5,490 crore in FY2016, FY2017 and
FY2018 respectively – well above the allowable regulatory limit set by the RBI for all three
years. The fact that it provided loans above their regulatory limit also suggested that IFIN had
insufficient working capital for these years.46
Using window dressing, IFIN also raised money through non-convertible debentures and
commercial papers. It kept only the minimum necessary cash required by RBI regulations while
the remaining profits were ploughed back to IL&FS as dividends. The payment of the dividends
back to IL&FS allowed IL&FS to continue showing healthy profits on a year-on-year basis in its
books, despite the catastrophic state of its finances.47
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A few of these transactions occurred across the entire period, including loans of Rs1,500
crore and selling off assets at heavily discounted prices. The loans made to a Group company
were routed through eight other companies, deceiving the regulators. Furthermore, it was
discovered that an asset was transferred from one entity in the Group to another at a value of
Rs30.8 crore based on an independent fair valuation. However, a year later, a committee of
directors resolved to sell the same asset to a third party at Rs1 crore.48 The auditors of IL&FS
failed to report these critical findings to the board.
The accounting firm, Grant Thornton, who were the internal auditors, discovered that
transactions amounting to over Rs13,000 crore were linked to irregularities such as conflict of
interests, inadequate risk assessment and deviation from bank norms. In 29 instances, loans
that were to be disbursed were instead rerouted to repay IL&FS’ existing debt obligations
with IFIN. Additionally, Grant Thornton uncovered advances to entities linked to senior IL&FS
executives or directors, resulting in conflicts of interest.49
Rules are meant to be changed

In investigating the intragroup transactions, the related party transactions (RPT) policy of IL&FS
came under scrutiny. It was found that IFIN had repeatedly diluted its RPT policies such that it
could continue lending to fellow Group entities, yet still obtain favourable ratings. While IL&FS
had a board-approved RPT policy for lending to Group entities, it made several changes to it
between 2015 and 2017 to dilute it.50
Under IFIN’s RPT policy, there was a list of circumstances under which RPTs were considered
to be ‘exempt RPTs’, and only required approval from a committee of directors. Such ‘exempt
RPTs’, unlike ‘non-exempt RPTs’, did not need to undergo further review by the Audit
Committee or require approval from the board and/or shareholders. In May 2015, the scope
of ‘exempt RPTs’ was expanded, and then further expanded in 2017 without approval from
the board.51
Another important aspect of handling RPTs was to determine the arm’s length pricing. The
standard was for the valuation to be conducted by independent valuers. However, IL&FS
amended its policy in 2015 to prescribe that valuations should be done by an “empaneled set
of independent valuers”. These valuers were essentially selected by the company, allowing it
to “get favourable reports for the transactions’ underlying values”. This suggested an element
of conflict of interest and was not consistent with having the valuation done independently by
a third party valuer.52
In 2014, the Audit Committee had highlighted to the statutory auditors the need to review the
RPT policy of IFIN. However, this review was instead delegated to the internal auditors, and it
was not until February 2016 that the evaluation was finally completed. Meanwhile, proposed
changes to the RPT policy were readily accepted by the Audit Committee without much
deliberation prior to the completion of the review. To make matters worse, several findings of
deficiency in internal controls pointed out by the auditors in February 2016 fell on deaf ears,
and no follow-up action was taken.53
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Where was the board?

“The rest of the board [excluding Ravi Parthasarathy] exists only for decorative purposes.”
– Andy Mukherjee, a Bloomberg columnist54
IL&FS’ 15-member board consisted of a majority of non-independent members.55 Amongst

the five who were declared independent, three have been on the board for more than ten
years.56
The roles of IL&FS’ Group directors also extended to its subsidiaries, with a core group of
directors sitting on the subsidiaries’ boards. For instance, Ravi Parthasarathy was Chairman of
IL&FS Group’s board and was on IFIN’s board as well; 57 whilst Arun Kumar Saha held the roles
of joint Managing Director and CEO of IL&FS Group,58 as well as director of IFIN. Sankaran,
the Vice Chairman of the IL&FS Group board, also concurrently served as a director of IFIN.59
The IL&FS board was made up mainly of nominee directors representing the various institutional
shareholders. Major shareholders seemed to turn a blind eye in managing their investments in
the Group across the years.60 Ironically, the bulk of the information was uncovered by a probe
led by RBI. RBI itself had a nominee director, Bijender Kumar Singal, on the Group’s board.61
As the empire he built up crumbled in front of his very own eyes, Parthasarathy abruptly left
the company due to “medical reasons”62 on 21 July 2018,63 along with a handsome retirement
package.64 The public questioned the legitimacy of the reason behind his shock departure,
speculating that there was possible mismanagement.
The second shock came with Bawa’s resignation as Managing Director and CEO of IFIN on 21
September 2018.65 On 1 October 2018, the Indian Government issued lookout notices across
the country’s airports for the two, along with two other IL&FS directors, due to likelihood of
them fleeing the country. This came immediately after the government’s decision to freeze
bank accounts, credit cards and all assets of the various directors involved.66
Parthasarathy, through his lawyers, claimed that freezing his accounts was essentially “a
situation of life and death”, as the costs of his ongoing cancer treatment far exceeded the
monthly limit of monies he was allowed to use. 67 He further applied to the government to allow
him to travel for continued treatment for throat cancer at a London hospital.68
Paper tiger
Since 9 March 2015, the Nominating and Remuneration Committee (NRC) of IL&FS Group
consisted of Sunil B. Mathur as Committee Chairman; Harish Engineer (resigned with effect
from 15 September 2017), Michael Pinto, and Sankaran (joined in FY2018). 69 After Engineer’s
resignation, the NRC appointed Parthasarathy as a member.70
However, board members not officially in the NRC could influence the appointment of
independent directors.71 In an investigation undertaken by the Enforcement Directorate (ED)
against IL&FS CEO Saha (non-NRC member), it was revealed that in an email response to
Sankaran (NRC member), he requested the independent director be “non-intrusive” and
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“obedient”.72 In a separate probe conducted by the SFIO, it was also found that the pay
component was also decided by the board of directors, rather than the NRC.73
Remuneration – Up, up and away74

The annual reports of IL&FS show that the average percentage increase in managerial
remuneration was 66% from 2017 to 2018. In comparison, the average percentage increase
in the salaries of employees other than managerial personnel in the same period was 4.44%.75
In the previous four years, although the net profit of parent firm IL&FS increased from Rs210
crore in FY2015 to Rs450 crore in FY2018, the consolidated net profit of the IL&FS Group
declined steeply from Rs80 crore to a loss of Rs2,090 crore across the same period. In fact, the
Group has been posting losses for three consecutive years since FY2016. This was attributed
to the Group’s rapid expansion and inability to monetise its infrastructure assets, resulting in
its consolidated liabilities increasing from Rs68,000 crore in FY2015 to Rs99,950 crore by
FY2018. The substantial amount of debt was only supported by Rs7,400 crore of equity.76
Despite the poor performance by the IL&FS Group, neither nominee directors nor independent
directors implemented pay cuts for directors. In fact, the reverse happened.77
Parthasarathy’s total emoluments shot up by 144% in FY2018 compared to year before,

though the bulk of the increase was from retirement benefits. However, his salary component
also contributed to this increase, rising from Rs5.806 crore in FY2014 to Rs9.212 crore in
FY2018, during a period when the Group’s financials were not in good shape. Further, despite
him serving on the IL&FS board for only half of the financial year, his FY2018 salary saw a rise
from the FY2017 full-year management salary of Rs9.034 crore.78
Similarly, between FY2015 and FY2018, Sankaran’s total remuneration increased by 61% to
Rs7.76 crore, while Saha’s increased by 20% to Rs7 crore.79
Additionally, there was a performance-related pay component to the remuneration packages

which was contingent on the revenue and profit of IL&FS. Parthasarathy’s performance-related
pay as of March 2018 amounted to Rs6.24 crore despite the loss-making performance of
the Group.80 It was also further revealed that six senior management personnel were paid
an aggregate of Rs76 crore as performance-related pay from FY2014 to FY2018. IFIN also
continued to pay large commissions and sitting fees to these same individuals.81
Risk? What risk?

The role of the Risk Management Committee (RMC) is to review areas such as asset-
liability management, credit, liquidity and market risk, capital adequacy and compliance with
regulations. Since FY2015, the RMC consisted of Saha, R. C. Bhargava, Michael Pinto, and
S. Bandyopadhyay – the LIC nominee and then-managing director of LIC Pension Fund,
who resigned from the board on 3 April 2017 – and was succeeded by Hemant Bhargava,
managing director of LIC.82
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Despite its importance and the increased risks and debt levels, the RMC only met once
between FY2015 and FY2018. This can be compared to IDFC Bank, another infrastructure
finance company, where its RMC met 14 times between FY2015 and FY2018.83
When queried about the lack of RMC meetings, a former IL&FS senior director said it was
“not necessary”. He said that all the issues relating to the risks faced by the company and its
impending financial problems were on the key agenda whenever the board of directors met.84
Mis-investment
IL&FS had significant exposure in its investments, with IFIN managing most of these
investments. IL&FS’ investments totaled Rs12,775.4 crore as at 31 March 2018, but it also
made provisions of Rs158.5 crore for the diminution in the value of investments. In addition,
there were unaccounted additional provisions amounting to Rs3,491.9 crore.85
Despite the large investment amounts in IL&FS, the Group did not have a board-approved
investment policy, nor stringent guidelines to manage the investment risk across Group entities.
In addition, it was stated that business strategies of the Group were “never deliberated from
the risk perspective”, and that “credit risk and linkage with liquidity risk was never identified in
credit and investment decisions”.86
These lapses in investment risk should have been discussed by IL&FS’s Investment Review
Committee (IRC). However, this committee had not met for three years since 5 October 2015.
In the absence of IRC meetings, investment-related proposals were instead approved by
IFIN’s Committee of Directors (CoD) of six persons, namely Parthasarathy, Sankaran, Bawa,
Saha, Vibhav Kapoor, and Karunakaran Ramchand. 87 In addition, there was no proper system
implemented for monitoring the end use of funds.88
These observations point to serious lapses in the approval process for investment transactions,
which allowed huge loans to be extended to certain entities, even after the risk management
team advised against it.89 Based on a forensic audit report prepared by Grant Thornton, there
were 18 instances where the CoD approved loans totaling approximately Rs2,400 crore to
borrowers who appeared to be in potential stress, despite adverse assessments by the risk
management team. Additionally, there were another 16 cases amounting to Rs1,922 crore
where the CoD authorised loans at a negative spread or limited spread, to borrowers which
were facing liquidity issues.90
Moreover, there were up to eight instances, amounting up to Rs541 crore, where short-term
facilities at IFIN were lent out for the long-term instead. These long-term loans went ahead
despite the troubles and financial difficulties faced by the company, and no precautionary
measures were undertaken by the risk management team to mitigate the inherent risks they
were taking on.91
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The ‘yes’ men
The IL&FS crisis also called into question the role of the internal auditors who failed to notice
the problems that had been developing on IL&FS’ balance sheets for several years. The Audit
Committee (AC) ignored whistleblower complaints and RBI inspection reports, and failed to
make independent and unbiased judgments. Instead, the AC allegedly “chose to live in denial”
and were overly dependent on management viewpoints.92
In 2017, a complaint by a whistleblower was allegedly covered up by the top management of

IL&FS in collusion with the company’s independent directors.93 The whistleblower complaint
was received in March 2017, but it was only discussed by the AC nine months later in December
2017. SFIO’s investigations found that the AC, instead of inquiring into the allegations made
in the complaint, simply accepted the viewpoint of the management and did not make any
independent assessment of the allegations.94
In addition, the response of the AC to various issues such as the definition of Group companies,
calculation of the net owned funds and capital adequacy ratio were all made in tandem with
IL&FS management’s viewpoints. There was no independent verification or inspection carried
out by the AC to challenge these viewpoints.95
Most notably, in the third quarterly FY2017-2018 internal audit report, it was found that a
facility, Golden Glow Estates which had turned into a non-performing asset was a loan that
was in or close to being in default. This needed to be addressed by way of income and interest
reversals, but no such action was taken by the AC.96
Hiding in plain sight – External audit

“We are not expecting an auditor to detect a needle in a haystack, but if an elephant is in a
room, they ought to find it.”
– Injeti Srinivas, Ministry of Corporate Affairs secretary97
The external auditors were affiliates of Deloitte Haskin and Sells LLC (Deloitte), KPMG India,
and EY India Ltd. These firms covered the audits for IL&FS and its main subsidiaries – IFIN
and ITNL.98 Deloitte was the statutory auditor of IL&FS between FY2007 and FY2017, while
KPMG affiliate BSR & Associates LLP (BSR & Associates) was appointed as a joint auditor
for FY2018.99 Meanwhile, SR Batliboi & Co (SR Batliboi), an affiliate of EY, had also audited
accounts of IL&FS.100
There were a host of allegations against the auditors, from missing out on the sprawling IL&FS
Group structure and not flagging out the asset-liability mismatch on the company’s books, to
the inappropriate valuation of assets and inadequate recognition of non-performing assets.101
However, throughout the audit process, one key issue the external auditors faced was that the
prescribed regulations under the Institute of Chartered Accountants of India (ICAI) did not allow
the principal auditor to look into the audit of subsidiaries.102 In the case of IL&FS, ITNL and IFIN,
the principal auditors only audited part of the accounts and relied on the opinion of auditors of
subsidiaries. Furthermore, 35 different audit firms were engaged to audit more than 300 Group
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subsidiaries.103 This resulted in difficulties for the external auditors to identify the exact number
of subsidiaries in IL&FS, and they could not comment on the under-reporting due to the lack
of direct line of sight. In addition, the limited exposure to subsidiaries prevented auditors from
detecting diversion or misuse of funds. In spite of this, it was clear that IL&FS was experiencing
a full-blown solvency crisis. Hence, it remains questionable why the auditors did not utilise their
professional discretion to raise the relevant questions in a timely manner.104
ICAI was prompted to initiate action against BSR & Associates for professional misconduct
under the Chartered Accountants Act, 1949. 105 According to the accounting regulator, the
auditors had failed to highlight the RBI’s inspection report, which had considered IFIN as being
over-leveraged. The auditors also did not report IFIN’s negative cash flows and adverse key
financial ratios.106 Although BSR & Associates had raised queries in May 2018, at least 17 of
the company’s loan facilities were being used for evergreening – a tactic used to conceal loan
defaults by issuing new loans to help delinquent borrowers repay or pay interest on old loans
– the auditors ultimately did not highlight it in their report.107
Caught in the act

According to the SFIO, Deloitte had disregarded the RBI’s regulations, turned a blind eye to
IFIN’s evergreening of loans, and failed to cross-check any of the “tutored end-use certificates”
the company used to mislead lending banks.108
A member of the senior management in Deloitte sent an anonymous letter to the Indian
government and revealed that Deloitte was fully aware of all the irregularities going on in IL&FS.
Deloitte was paid Rs20 crore yearly for its auditing and consulting work and it was alleged
that, in return, Deloitte colluded with the IL&FS management and assisted it to cover up the
company’s accounts year after year. Deloitte was alleged to have engaged a senior tax advisor
to come up with a complex system for IL&FS to evade taxes.109
Deloitte was also said to have been awarded advisory contracts by IL&FS in exchange for
“giving a favourable view”.110
(Dis)credit rating agencies

A forensic audit conducted by Grant Thornton discovered that credit rating agencies continued
to award high credit ratings to IL&FS despite being aware of the weak financials of the Group.111
During its special audit, Grant Thornton noted that credit rating agencies had multiple concerns
for the past seven years about the operations of the IL&FS Group, but continued to assign
consistently high ratings, only reversing or downgrading them after mid-2018.112 Two of India’s
top credit rating companies, ICRA and CARE Ratings, continued to award high credit ratings
to the borrowings of IL&FS and its subsidiaries till August 2018.113 In addition, India Rating &
Research Pvt Ltd gave an excellent long-term credit rating for IL&FS even though its subsidiary,
ITNL, had already defaulted on its repayment obligations previously.114
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These three credit rating agencies together helped the IL&FS Group to corner over two percent
of all commercial papers, one percent of all corporate debentures, and almost one percent of
all banking system loans outstanding at the country level. The Group’s aggregate borrowings
amounted close to an astounding Rs100,000 crore.115
The Enforcement Directorate – the law enforcement agency and economic intelligence agency
responsible for enforcing economic laws and fighting economic crime in India – also uncovered
that IL&FS’ senior management had interfered in the ratings review to upgrade the ratings of its
Group entities.116 They intentionally provided incorrect or incomplete information to the credit
rating agencies to avoid rating downgrades. IL&FS also paid large sums to keep ratings private
when favourable ratings were not obtained. Lastly, IL&FS management also allegedly exerted
pressure on rating agencies by threatening to approach other competitor rating agencies when
desired ratings were not given.117
A half-asleep giant
The role of the RBI was also called into question by the SFIO, which said that timely intervention
by the central bank could have led to early detection of the crisis in the IL&FS Group. The SFIO
further highlighted that IFIN – which was at the core of the investigation – was allowed to
operate despite RBI raising red flags. SFIO said that the RBI should have instead conducted
an internal probe and taken “appropriate action”.118
RBI had repeatedly pointed out non-compliance with the Group exposure norms and incorrect
calculations of net owned funds in its inspection reports from 2015 onwards. Yet, no penalties
were imposed during the period and IFIN was allowed to continue business as usual without
any corrective actions.119
RBI only took action in November 2017 by conveying the proposed necessary changes to
IFIN.120 Hence, in its charge sheet, SFIO suggested that RBI should conduct an internal inquiry
with regard to the reason for the delay and thereafter take appropriate action and implement
suitable policy measures to prevent such fraudulent activities in the future.121
The aftermath
On 15 September 2018, the government appointed former LIC Chairman, Sunil Behari Mathur,
as IL&FS Group Chairman.122 A week later, DSP Mutual Fund’s sale of Dewan Housing Finance
(DHFL) commercial papers at a high yield triggered panic in equity and bond markets.123 The
stock market crashed by 1,500 points as investors doubted the sustainability of the NBFC
business model of financing long-term lending by short-term borrowing. The IL&FS crisis
sparked vast outflows in liquid funds in September 2018. There were also fears of contagion in
mutual funds, who were major investors in NBFC commercial papers, as shadow banks faced
difficulties in raising funding.124
Although an announcement was released, the rights issue by IL&FS never materialised due
to the Indian government stepping in. On 1 October 2018, an NCLT judgment allowed the
Indian government to take steps to take control of the company and arrest the spread of the
contagion to the financial markets. The move caught investors by surprise. A new board, led
173
by Kotak Mahindra Bank managing director Uday Kotak, was constituted. However, experts
commented that the new board members lack sufficient expertise in the infrastructure sector
to effectively rescue IL&FS.125
On 5 March 2019, the new government-appointed board of IL&FS charged 14 former directors
of IFIN for facilitating money laundering, sanctioning loans in violation of rules and causing
“huge financial stress and losses” to the company via the issuance of show-cause notices.126
A month later, Sankaran, former Vice Chairman of IL&FS, was arrested by SFIO for causing
wrongful loss to IL&FS, as well as on fraud charges. He was accused of abusing his powers
in IFIN through fraudulent conduct and in granting loans to entities which were not credit-
worthy or were classified as non-performing accounts, causing loss to the company and its
creditors.127
The ICAI found the statutory auditors of IL&FS and two of its subsidiaries, ITNL and IFIN to be
“prima facie guilty” of professional misconduct. These included Deloitte, BSR & Associates,
and SR Batliboi.128
Rising from the trenches

On 31 October 2018, the newly appointed Kotak-led board submitted a revival plan for the
troubled company. Apart from preparing a roadmap to revive IL&FS, the plan also acknowledged
that “the mess was a result of greed, mismanagement, and deliberate oversight”.129
In its second report, the board informed the NCLT of its plan to focus on vertical as well as
asset-level resolution. It stated that this was because it was impossible to find a remedy for the
Group with the overwhelming Rs91,000 crore debt. The resolution would involve significant
capital investment from strong and credible investors, which was not feasible given the current
situation.130
On the issue of the audit of subsidiaries, international laws have made it clear that the
principal auditor is expected to review all the subsidiaries of the company, no matter its size.
The Securities and Exchange Board of India was thus prompted to issue a circular, which
mandated that listed entities must conduct a limited review of the audit of all the entities which
accounts are to be consolidated. This would ensure that, in future, principal auditors of listed
companies have a certain degree of weight in the audit of subsidiaries.131
So…what next?
A year after the IL&FS scandal, the NBFC sector continues to struggle, especially those geared
towards lending to real estate firms.132 Defaults are continuing to occur, which is a cause for
concern for the India economy as many loans go towards construction projects which are
highly dependent on them. NBFCs which specialise in home loans have also been slow in
disbursement, leading to poor consumer sentiment. The Indian government has announced
measures to provide last-mile funding to stuck projects,133 but experts believe that capital
needs to be raised from overseas and systematic reforms are the key to tackling the root cause
of this crisis.
174
1. Was the collapse of IL&FS due to its business model, poor financial management, weak
risk governance and management, poor corporate governance and/or other factors?
Evaluate their relative importance to the collapse.
2. IL&FS Group has a complex structure with many subsidiaries and other Group entities.
Discuss the challenges from the perspective of the holding company, Group entities and
directors within the Group. To whom do directors of these different entities owe duties
to in such situations? How can the Group board of directors ensure that there is good
governance throughout the Group?
3. Discuss the issues of overlapping directorships and nominee directors in the IL&FS
Group. Discuss whether the directors had adequately discharged their fiduciary duties.
4. Discuss the role of auditors in this case. What in your view can be done to avoid lapses in
audit practices?
5. Identify the key conflicts of interest involving directors, management, auditors, ratings
agencies and other key players. To what extent did they contribute to the collapse of
IL&FS? How can such conflicts be mitigated?
6. Evaluate the roles of different stakeholders in the collapse of IL&FS. Who were most
culpable? Explain.
Endnotes
1 The Telegraph. (2016, March 11). ‘Mystery’ deaths in scandals. Retrieved from https://www.telegraphindia.
com/india/mystery-deaths-in-scandals/cid/1667829
2 Parmar, B. (2018, September 28). Debt and defaults: What happened to IL&FS. Money Control. Retrieved
from https://www.moneycontrol.com/news/business/companies/debt-and-defaults-what-happened-to-ilfs-
2952381.html
3 The Economic Times. (2018, October 3). IL&FS: The crisis that has India in panic mode. Retrieved from
https://economictimes.indiatimes.com/industry/banking/finance/banking/everything -about-the-ilfs-crisis
-that-has-india-in-panic-mode/articleshow/66026024.cms?utm_source=contentofinterest&utm_medium
=text&utm_campaign=cppst
4 Reuters. (2018, September 25). IL&FS - its recent troubles and why investors should care. Retrieved from
https://energy.economictimes.indiatimes.com/news/renewable/ilfs-its-recent-troubles-and-why-investors-
should-care/65952988
5 Shukla, S., & Sinha, S. (2019, August 28). A year after IL&FS collapse: Debt, destruction and dithering. The
Economic Times. Retrieved from https://economictimes.indiatimes.com/industry/banking/finance/ a-year
-after-ilfs-collapse-debt-destruction-and-dithering/articleshow/70868024.cms?from=mdr
6 Dey, S. (2019, March 22). IL&FS’ systemic structural flaw. Business Standard. Retrieved from https://www.
business-standard.com/article/companies/il-fs-systemic-structural-flaw-119032001078_1.html
7 Borate, N. (2019, July 2). Why credit grades given by rating firms are under lens. Livemint. Retrieved from
https://www.livemint.com/politics/policy/why-credit-grades-given-by-rating-firms-are-under-lens-1562087
147473.html
175
8 Asthana, S. (2018, December 27). Flashback 2018: When IL&FS nearly sank the financial system. Money
Control. Retrieved from https://www.moneycontrol.com/news/business/economy/flashback-2018-when-ilfs-
nearly-sank-the-financial-system-3300731.html
9 Karthik, M. (2019, August 10). In the shadows of a debt crisis: A closer look at how IL&FS episode unfolded
and impacted the larger economy. Centre for Financial Accountability. Retrieved from https://www.cenfa.org/
national-financial-institutions/in-the-shadows-of-a-debt-crisis-a-closer-look-at-how-ilfs-episode-unfolded-and-
impacted-the-larger-economy/
10 Ibid.
11 Ibid.
12 Ray, S. S. (2018, October 3). IL&FS risk: Leverage rose to 13, but risk panel met just onc e in 4 years. Financial
Express. Retrieved from https://www.financialexpress.com/industry/ilfs-risk-leverage-rose-to-13-but-risk
-panel-met-just-once-in-4-years/1334839/
13 Thomson Reuters. (2018, September 25). IL&FS Crisis: Everything You Need To Know About Company’s
Recent Troubles. Retrieved from https://www.ndtv.com/business/il-fs-crisis-everything-you-need-to-know-
about-companys-recent-troubles-1922150
14 Ibid.
15 Ibid.
16 Lele, A., & Mukul, J. (2018, July 18). Three decades of Ravi Parthasarathy led to ILFS’ lateral growth. Business
Standard. Retrieved from https://www.business-standard.com/article/companies/three-decades-of-ravi
-parthasarathy-led-to-il-fs-s-lateral-growth-118072401393_1.html
17 Metro, G. (2018, July 20). ITNL runs into trouble, plans to terminate contracts for Gurgaon Metro. Business
Standard. Retrieved from https://www.business-standard.com/article/companies/itnl-runs-into-trouble-plans-
to-terminate-contracts-for-gurgaon-metro-118071901456_1.html
18 The Hindu Business Line. (2018, July 22). Debt downgraded, IL&FS road arm says facing default. Retrieved
from https://www.thehindubusinessline.com/news/debt-downgraded-ilfs-road-arm-says-facing-defaults/
article24488739.ece
19 The Hindu Business Line. (2018, September 10). CARE downgrades IL&FS debt instruments, bank facilities.
Retrieved from https://www.thehindubusinessline.com/money-and-banking/care-ratings-downgrades-ilfs-
debt-instruments-bank-facilities/article24914106.ece
20 Saxena, R. (2018, September 28). RBI Asks Shareholders To Rescue IL&FS. Bloomberg Quint. Retrieved from
https://www.bloombergquint.com/business/rbi-asks-shareholders-to-save-ilfs
21 Dalal, S. (2018, September 4). IL&FS defaults on Rs. 1,000 crore short term loan from SIDBI. MoneyLife.
Retrieved from https://www.moneylife.in/article/ilfs-defaults-on-rs1000-crore-short-term-loan-from-sidbi/
55209.html
22 CNBC. (2018, September 25). Sidbi to file case against IL&FS for non-payment of deposits, says report.
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23 Mukherjee, P., Choudhury, S., & Roy, A. (2018, September 25). Factbox: IL&FS - its recent troubles and why
investors should care. Reuters. Retrieved from https://in.reuters.com/article/india-il-fs/factbox-ilfs-its-recent-
troubles-and-why-investors-should-care-idINKCN1M51UY
24 Tendolkar, A. (2018, September 27). IL&FS Financial Services defaults on loans worth Rs. 440 crore.
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25 Saxena, R. (2018, September 28). RBI Asks Shareholders To Rescue IL&FS. Bloomberg Quint. Retrieved from
https://www.bloombergquint.com/business/rbi-asks-shareholders-to-save-ilfs
26 Antony, A., & Suresh, A. (2018, September 18). As Debt Woes Spread, India’s IL&FS Ratin gs Cut to Lowest
Levels. Bloomberg Quint. Retrieved from https://www.bloombergquint.com/business/moody-s-unit-cuts
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176
27 Saxena, R. (2018, September 30). IL&FS AGM: Three-Pronged Strategy To Return To Solvency. Bloomberg
Quint. Retrieved from https://www.bloombergquint.com/markets/ilfs-outlines-three-pronged-strategy-to
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28 Sharma, R. (2018, September 28). Red sea: Ahead of AGM, IL&FS trips up. Financial Express. Retrieved from
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29 Mehta, S. (2018, October 1). IL&FS lenders seek resolution plan before mulling more loans. The Economic
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30 Chaki, D., & Laskar, A. (2018, September 26). ADIA, Orix Corp in talks to jointly bail out IL&FS. Livemint.
Retrieved from https://www.livemint.com/Companies/MxCbOHCMT1seQ8E7ZZ0DqI/ADIA-Orix-Corp-in
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31 Rebello, J., & Sinha, S. (2018, October 2). IL&FS crisis: Shareholders await guidance from new board. The
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32 Dalal, S. (2018, October 12). IL&FS Top Management: Planned Enrichment through Employee Trust; Jobs
and Contracts for Families. Moneylife. Retrieved from https://www.moneylife.in/article/ilfs-top-management-
planned-enrichment-through-employee-trust-jobs-and-contracts-for-families/55538.html
33 Rajput, R. (2019, February 23). IL&FS employee welfare trust under ED lens. The Economic Times. Retrieved
from https://economictimes.indiatimes.com/industry/banking/finance/ilfs-employee-welfare-trust-under-ed-
lens/articleshow/68121452.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst
34 Moneylife. (2019, May 31). SFIO Files Charge Sheet against IFIN; Names Auditors, Directors, Key Employees
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35 Rai, D. (2019, July 24). Top management of insolvent IL&FS rewarded themselves as best performer. India
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36 Indo-Asian News Service. (2019, June 1). Parthasarathy and Sankaran ran IL&FS as personal fiefdom.
Business Standard. Retrieved from https://www.business-standard.com/article/news-ians/parthasarathy-and-
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38 Asthana, S. (2018, November 1). Opinion | IL&FS mess a result of greed, mismanagement and deliberate
oversight. Money Control. Retrieved from https://www.moneycontrol.com/news/business/companies/
opinion-ilfs-mess-a-result-of-greed-mismanagement-and-deliberate-oversight-3118831.html
39 Singh, S. (2019, March 5). 14 ex-directors of IL&FS get notice for laundering, fraud, payoffs. The Indian
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40 Financial Express. (2019, June 25). Former IL&FS top brass drew hefty pay as firms financial health suffered.
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41 Financial Chronicle Bureau. (2018, September 25). Complex web of subsidiaries brought IL&FS to its knees.
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-ilfs-its-knees
42 Asthana, S. (2018, November 1). IL&FS mess a result of greed, mismanagement and deliberate oversight.
Money Control. Retrieved from https://www.moneycontrol.com/news/business/companies/opinion-ilfs-
mess-a-result-of-greed-mismanagement-and-deliberate-oversight-3118831.html
43 Times of India. (2018, November 12). SFIO to probe IL&FS financial arm’s dealings with group entities.
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&utm_medium=text&utm_campaign=cppst
177
44 Dey, S. (2019, March 22) IL&FS’ systemic structural flaw. Business Standard. Retrieved from https://www.
business-standard.com/article/companies/il-fs-systemic-structural-flaw-119032001078_1.html
45 Upadhyay, J. P. (2019, May 21). Inside the audit lapses that led to IL&FS crisis. Livemint. Retrieved from https://
www.livemint.com/companies/news/inside-the-audit-lapses-that-led-to-il-fs-crisis-1558456079750.html
46 Bamzai, S. (2018, November 6). IL&FS: Was everyone asleep at the wheel?. Deccan Chronicle. Retrieved from
https://www.deccanchronicle.com/opinion/op-ed/061118/ilfs-was-everyone-asleep-at-the-wheel.html
48 The Economic Times. (2018, November 2). IL&FS Financial Services exposure to group companies breaches
RBI norms in FY16-18: Board. Retrieved from https://economictimes.indiatimes.com/news/economy/policy/
ilfs-financial-services-exposure-to-group-companies-breaches-rbi-norms-in-fy16-18-board/articleshow/
66473861.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst
49 Rajput, R. (2019, March 4). Grant Thornton opens first IL&FS can of worms, and its Rs 13,000 crore worth of
fishy deals. The Economic Times. Retrieved from https://economictimes.indiatimes.com/industry/banking/
finance/grant-thornton-flags-rs-13000-crore-ilfs-dealings-as-suspect/articleshow/68248706.cms?from=mdr
50 Upadhyay, P. (2019, June 4). IL&FS Financial Services diluted policies to continue lending to group companies,
SFIO says. Bloomberg Quint. Retrieved from https://www.bloombergquint.com/law-and-policy/ilfs-financial
-services-diluted-policies-to-continue-lending-to-group-companies-sfio-says
51 Ibid.
52 Ibid.
53 Ibid.
54 Hazari, H. (2018, September 17). Behind IL&FS Default, A Board that Didn’t Bark When It Was Supposed To.
The Wire. Retrieved from https://thewire.in/business/behind-ilfs-default-a-board-that-didnt-bark-when-it-was-
supposed-to
55 The Economic Times. (2018, October 2). Here are 15 members of IL&FS board that were sacked by govt.
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board-that-were-sacked-by-govt/articleshow/66042966.cms?utm_source=contentofinterest&utm_medium
=text&utm_campaign=cppst
56 Infrastructure Leasing & Financial Services Limited. (n.d.). Annual Report 2016-2017. Retrieved from https://
www.ilfsindia.com/media/1872/ilfs-ar-2016-17.pdf
57 Indo-Asian News Service. (2019, August 21). ED lays bare IL&FS cabal modus operandi of Rs 7,400 cr loot
and scoot (IANS Exclusive). Retrieved from https://www.outlookindia.com/newsscroll/ed-lays-bare-ilampfs
-cabal-modus-operandi-of-rs-7400-cr-loot-and-scoot-ians-exclusive/1601002
58 Panda, S. (2019, December 21). Former IL&FS directors got lucrative paychecks even as firm collapsed.
Business Standard. Retrieved from https://www.business-standard.com/article/companies/former-il-fs
-directors-got-lucrative-paychecks-even-as-firm-collapsed-119122100018_1.html
59 Indo-Asian News Service. (2019, August 21). ED lays bare IL&FS cabal modus operandi of Rs 7,400 cr loot
and scoot (IANS Exclusive). Retrieved from https://www.outlookindia.com/newsscroll/ed-lays-bare-ilampfs
-cabal-modus-operandi-of-rs-7400-cr-loot-and-scoot-ians-exclusive/1601002
supposed-to
61 Infrastructure Leasing & Financial Services Limited. (n.d.). Annual Report 2016-2017. Retrieved from https://
www.ilfsindia.com/media/1872/ilfs-ar-2016-17.pdf
62 The Endeavour Editorial Club. (2018, October 5). How India fended off a financial meltdown. Retrieved from
https://endeavour.home.blog/2018/10/05/how-india-fended-off-a-financial-meltdown/amp/
63 Raj, A., & Sood, V. (2018, September 26). Were LIC, HDFC aware of brewing IL&FS crisis?. Livemint.
Retrieved from https://www.livemint.com/Companies/oMCSRyBOLIdxn4qSmnYq8J/Were-LIC-HDFC-aware-
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178
64 Sharma, R. (2018, September 19). IL&FS clears pay hike even as it faces rating downgrade. Financial Express.
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grade/1318401/
65 Business Today. (2018, September 22). IL&FS financial arm’s CEO Ramesh Bawa quits as company defaults
on LC payments. Retrieved from https://www.businesstoday.in/current/corporate/il-and-fs-financial-services-
ceo-ramesh-c-bawa-quits-company-defaults-on-lc-payments/story/282726.html
66 Sharma, R. (2018, November 27). Ex-IL&FS boss Ravi Parthasarathy applies for overseas travel for treatment.
Financial Express. Retrieved from https://www.financialexpress.com/industry/ex-ilfs-boss-ravi-parthasarathy-
applies-for-overseas-travel-for-treatment/1394867/
67 Vyas, M. (2019, January 16). NCLT reserves order over allowing former IL&FS directors access bank accounts.
Livemint. Retrieved from https://www.livemint.com/Companies/sW8OFvK7jSV1Nj8PehMleK/NCLT-reserves
-order-over-allowing-former-ILFS-directors-acc.html
68 Sharma, R. (2018, November 27). Ex-IL&FS boss Ravi Parthasarathy applies for overseas travel for treatment.
Financial Express. Retrieved from https://www.financialexpress.com/industry/ex-ilfs-boss-ravi-parthasarathy-
applies-for-overseas-travel-for-treatment/1394867/
supposed-to
70 Infrastructure Leasing & Financial Services Limited. (n.d.). Annual Report 2018. Retrieved from https://www.
ilfsindia.com/media/2022/annual-report-fy-2018.pdf
71 Indo-Asian News Service. (2019, July 19). Jailed Arun Saha centrifugal force in fixing rating agencies at IL&FS.
Moneylife. Retrieved from https://www.nationalheraldindia.com/india/jailed-arun-saha-centrifugal-force-in
-fixing-rating-agencies-at-ilandfs.
72 Ibid.
73 Financial Express. (2019, June 25). Former IL&FS top brass drew hefty pay as firm’s financial health suffered.
75 Mondal, D. (2018, October 3). IL&FS chairman Ravi Parthasarathy got 144% salary hike in FY18. Business
Today. Retrieved from https://www.businesstoday.in/current/corporate/ilfs-chairman-ravi-parthasarathy-salary-
hike-in-fy18/story/283604.html
supposed-to
77 Ibid.
78 Ibid.
79 Ibid.
80 Financial Express. (2019, June 25). Former IL&FS top brass drew hefty pay as firm’s financial health suffered.
Today. Retrieved from https://www.indiatoday.in/diu/story/top-management-of-insolvent-il-fs-rewarded-
themselves-as-best-performer-1573102-2019-07-24
supposed-to
179
83 The News Scroll. (2019, May 13). MCA wants to question ernstwhile IL&FS ’independent directors’.
Outlook. Retrieved from https://www.outlookindia.com/newsscroll/mca-wants-to-question-erstwhile-ilampfs
-independent-directors-ians-exclusive/1533901
84 Gupta, S. D. (2018, October 6). IL&FS crisis: Risk panel review was not needed, says former director.
Business Standard. Retrieved from https://www.business-standard.com/article/economy-policy/il-fs-crisis-risk
-panel-review-was-not-needed-says-former-director-118100600063_1.html
85 Indo-Asian News Service. (2019, August 21). IL&FS antics: Lending behemoth without ‘investment policy’.
The Economic Times. Retrieved from https://cfo.economictimes.indiatimes.com/news/ilfs-antics-lending
-behemoth-without-investment-policy/70764936
86 Indo-Asian News Service. (2019, August 16). Key committees in IL&FS did not meet for years: RBI. The
Economic Times. Retrieved from https://cfo.economictimes.indiatimes.com/news/key-committees-in-ilfs-did-
not-meet-for-years-rbi/70694589
87 Sinha, S. (2019, June 5). IL&FS case: Lookout circulars issued against six IFIN ex-directors. The Economic
Times. Retrieved from https://economictimes.com/industry/banking/finance/lookout-circulars-issued-against
-six-ifin-ex-directors/articleshow/69657918.cms
88 Dalal, S. (2019, August 19). IL&FS Mess: Long Delays and Confused Submissions by the Board. (n.d.).
MoneyLife. Retrieved from https://www.moneylife.in/article/ilfs-mess-long-delays-and-confused-submissions-
by-the-board/57952.html
89 Sinha, S. (2019, March 5). IL&FS sends show cause to former board of IL&FS Financial Service Ltd. The
Economic Times. Retrieved from http://economictimes.indiatimes.com/articleshow/68263383.cms?from=mdr
&utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst
90 Rukhaiyar, A. (2019, March 4). IL&FS ignored risk assessment reports while extending loans: audit. The Hindu.
Retrieved from https://www.thehindu.com/business/ilfs-ignored-risk-assessment-reports-while-extending
-loans-audit/article26425683.ece
91 Rajput, R. (2019, March 4). Grant Thornton opens first IL&FS can of worms, and it’s Rs 13,000 cr worth of
fishy deals. The Economic Times. Retrieved from https://economictimes.indiatimes.com/industry/banking/
finance/grant-thornton-flags-rs-13000-crore-ilfs-dealings-as-suspect/articleshow/68248706.cms?utm_source
=contentofinterest&utm_medium=text&utm_campaign=cppst
92 Indo-Asian News Service. (2019, June 5). How IL&FS (IFIN) audit panel lived in denial deliberately. National
Herald. Retrieved from https://www.nationalheraldindia.com/economy/how-ilandfs-ifin-audit-panel-lived-in
-denial-deliberately
93 Asia Times. (2019, June 11). Auditors under fire over India’s IL&FS crisis. Retrieved from https://www.
asiatimes.com/2019/06/article/auditors-under-fire-over-indias-ilfs-crisis/
94 Livemint. (2019, June 9). Whistleblower sought to uncover IL&FS fraud in 2017, but top-brass covered it.
Retrieved from https://www.livemint.com/companies/news/whistleblower-sought-to-uncover-il-fs-fraud-in-
2017-but-top-brass-covered-it-1560065276527.html
95 Indo-Asian News Service. (2019, June 5). How IL&FS (IFIN) audit panel lived in denial deliberately. National
Herald. Retrieved from https://www.nationalheraldindia.com/economy/how-ilandfs-ifin-audit-panel-lived-in
-denial-deliberately
96 Ibid.
97 Upadhyay, P. (2019, May 21). Inside the audit lapses that led to IL&FS crisis. Livemint. Retrieved from https://
98 Ibid.
99 Jain, R. (2020, April 21). IL&FS Case: High Court Quashes SFIO’s Criminal Complaint Against Deloitte, BSR.
Bloomberg Quint. Retrieved from https://www.bloombergquint.com/law-and-policy/ilfs-case-high-court-
quashes-sfios-criminal-complaint-against-deloitte-bsr
100 CNBC. (2019, June 3). RBI bars auditor SR Batliboi from handling bank audits in FY20. Retrieved from https://
www.cnbctv18.com/finance/rbi-bars-auditor-sr-batliboi-from-handling-bank-audits-in-fy20-3566341.htm
180
102 Ibid.
103 Dave, S., & Shukla, S. (2019, June 5). Serious Fraud Investigation Office lens on IL&FS auditors. The
Economic Times. Retrieved from https://economictimes.indiatimes.com/industry/banking/finance/serious
-fraud-investigation-office-lens-on-ilfs-auditors/articleshow/69658026.cms?from=mdr
105 Ibid.
106 Ibid.
107 Financial Express. (2019, June 20). IL&FS scam: Audit firm noted lapses by IFIN but looked the other way.
Retrieved from https://www.financialexpress.com/industry/ilfs-scam-audit-firm-noted-lapses-by-ifin-but-
looked-the-other-way/1611741/
108 The Economic Times. (2019, June 12). IL&FS: ED summons IL&FS’s auditors in money laundering case.
Retrieved from https://economictimes.indiatimes.com/markets/stocks/news/ed-summons-ilfs-auditors-in
-money-laundering-case/articleshow/69749391.cms?from=mdr
109 Communist Ghadar Party of India. (n.d.) IL&FS Scandal and the Role of Auditors. Retrieved from http://cgpi.
org/2019/06/24/ilfs-scandal-and-the-role-of-auditors/
111 Business Today. (2019, July 21). IL&FS crisis: SEBI expands probe in role of credit rating agencies. Retrieved
from https://www.businesstoday.in/current/corporate/ilfs-crisis-sebi-expands-probe-in-role-of-credit-rating-
agencies/story/366369.html
112 Ibid.
113 Basu, A. (2018, October 7). IL&FS and the La-La Land that is Indian Credit Rating. The Wire. Retrieved from
https://thewire.in/business/ilfs-moodys-fitch-care-icra-rating-companies
114 Ibid.
115 Ibid.
116 Business Today. (2019, July 21). IL&FS crisis: SEBI expands probe in role of credit rating agencies. Retrieved
from https://www.businesstoday.in/current/corporate/ilfs-crisis-sebi-expands-probe-in-role-of-credit-rating-
agencies/story/366369.html
117 Rajput, R., & Sinha, S. (2019, July 22). IL&FS’s rating agencies made professional compromises, says Grant
Thornton. The Economic Times. Retrieved from https://economictimes.indiatimes.com/industry/banking/
finance/gt-report-lists-out-issues-of-professional-compromises-by-the-cras-who-rated-ilfs/articleshow/7029
6758.cms
118 Rajput, R. (2019, June 3). RBI: SFIO says RBI could’ve acted faster on IL&FS. The Economic Times. Retrieved
from https://economictimes.indiatimes.com/industry/banking/finance/sfio-says-rbi-couldve-acted-faster-on-
ilfs/articleshow/69626233.cms?from=mdr
119 Ibid.
120 Ibid.
121 Ibid.
122 Saha, M., Mishra, L., & Saha, L. M. M. (2018, September 15). Bhargava quits as crisis-hit IL&FS appoints
Mathur as chairman. The Hindu. Retrieved from https://www.thehindu.com/business/Industry/bhargava-quits-
as-crisis-hit-ilfs-appoints-mathur-as-chairman/article24956678.ece
123 Mahesh, P. (2018, September 22). DHFL paper sale by DSP triggered panic. The Economic Times. Retrieved
from https://economictimes.indiatimes.com/markets/stocks/news/dhfl-paper-sale-by-dsp-triggered-panic/
articleshow/65908110.cms
181
125 Shah, P. (2018, October 3). Can the Centre’s white knights rescue IL&FS?. The Hindu Business Line. Retrieved
from https://www.thehindubusinessline.com/money-and-banking/can-the-centres-white-knights-rescue-ilfs/
article25105611.ece
126 Press Trust of India. (2019, March 5). IL&FS board charges former directors of money laundering and criminal
intent. The New Indian Express. Retrieved from https://www.newindianexpress.com/business/2019/mar/05/
ilfs-board-charges-former-directors-of-money-laundering-and-criminal-intent-1947221.html
127 Press Trust of India. (2019, April 1). First arrest in IL&FS case, former vice chairman Sankaran in SFIO custody.
Business Standard. Retrieved from https://www.business-standard.com/article/companies/first-arrest-in-il-fs-
case-former-vice-chairman-sankaran-in-sfio-custody-119040101323_1.html
128 Srivats, K. R. (2018, December 7). IL&FS crisis: CA Institute holds statutory auditors ‘prima facie guilty’. The
Hindu Business Line. Retrieved from https://www.thehindubusinessline.com/companies/ilfs-crisis-ca-institute
-holds-statutory-auditors-prima-facie-guilty/article25692562.ece
130 Press Trust of India. (2018, December 4). Group-level resolution for crisis, debt unlikely: IL&FS board. The
Economic Times. Retrieved from https://economictimes.indiatimes.com/industry/banking/finance/group
-level-resolution-for-crisis-debt-unlikely-ilfs-board/articleshow/66934411.cms?from=mdr
131 Upadhyay, J. P. (2019, May 21). Inside the audit lapses that led to IL&FS crisis. Livemint. Retrieved from
https://www.livemint.com/companies/news/inside-the-audit-lapses-that-led-to-il-fs-crisis-1558456079750.
html
132 Mulye, P. (2020, June 3). A timeline of the crises that brought India’s $370 billion shadow banking sector to its
knees. Quartz India. Retrieved from https://qz.com/india/1860466/how-indias-nbfc-crisis-deepened-from-ilfs-
defaults-to-covid-19/
133 Sharma, A. (2019, September 14). FM announces Rs 20,000 crore fund to provide last-mile funding for
housing projects. The Economic Times. Retrieved from https://realty.economictimes.indiatimes.com/news/
industry/fm-announces-rs-20000-crore-fund-to-provide-last-mile-funding-for-housing-projects/71125555
182
INFOSYS LIMITED:
MURTHY’S LAW
Case overview
A company once known for its corporate governance, Infosys Limited (Infosys)
was thrust into the spotlight when its first non-founder CEO was accused of
overpaying for an acquisition of a company where he has a conflict of interest.
Other issues soon arose, including criticisms about severance packages paid
to departing senior executives and a significant increase in remuneration for the
CEO. The founder, former CEO and former Executive Chairman, N.R. Narayana
Murthy, publicly criticised the company. The objective of this case is to allow a
discussion of issues such as remuneration policies; golden handshakes; conflict
of interest; roles of founders in governance; outsider CEOs; roles of the board and
management; and importance of transparency and disclosure.
The birth of a tech giant

Infosys is an Indian multinational company, providing business consulting,
outsourcing and information technology services. It was co-founded by Nagavara
Ramarao Narayana Murthy, along with six other co-founders in 1981. Infosys
was the first Indian company to be listed on the NASDAQ Stock Market. 1 It is
currently India’s second largest IT services company,2 with a market capitalisation
of US$42.4 billion.3
This is the abridged version of a case prepared by Chester Ng Keng Hao, Nio Jing Rong, Sally Choo Qing
Lei and Ung Zi Qing under the supervision of Professor Mak Yuen Teen. The case was developed from
published sources solely for class discussion and is not intended to serve as illustrations of effective
or ineffective management or governance. The interpretations and perspectives in this case are not
necessarily those of the organisations named in the case, or any of their directors or employees. This
abridged version was edited by Isabella Ow under the supervision of Professor Mak Yuen Teen.
Copyright © 2018 Mak Yuen Teen and CPA Australia.
235
Infosys Limited: Murthy’s Law
The gold standard in corporate governance

“Good corporate governance is about maximizing shareholder value on a
sustainable basis while ensuring fairness to all stakeholders: customers, vendor
partners, investors, employees, government and society.”
– N. R. Narayana Murthy, founder of Infosys4
Since its inception, Infosys has bagged many corporate governance awards
such as the Corporate Award for Corporate Governance from the Bombay Stock
Exchange (BSE) in 2000 and the Golden Peacock Award at the 16th London Global
Convention on ‘Corporate Governance and Sustainability’ in 2016.5,6 Infosys’
corporate governance framework aims to effectively engage with stakeholders
and help the company evolve with changing times. The company makes the
board of directors the core of its corporate governance practice to oversee its
management, ensuring that long-term interests of stakeholders are fulfilled.7
Remuneration policy
Infosys’ remuneration policy states that the remuneration of its Chief Executive
Officer (CEO) is tied to performance. According to the company’s annual report,
performance-based equity and stock options for FY2017 were granted to the CEO
while restricted stock units and employee stock ownership plans were used for the
Chief Operating Officer (COO). The approvals of both the board and shareholders
were sought through a postal ballot. Remuneration of key managerial personnel
was also clearly disclosed in the annual report.8
Key personnel
As one of the company’s co-founders, Murthy led Infosys for 21 years as CEO till
March 2002. Subsequently, from 2002 to 2006, Murthy was Infosys’ Executive
Chairman and Chief Mentor.9 In 2011, Murthy retired and was conferred the title
of Chairman Emeritus.10 His successor, Ramaswami Seshasayee, served as the
company’s Non-Executive Chairman11 from 2011 to 2017. However, during that
period, Murthy returned to Infosys on 1 June 2013 as Executive Chairman to lead
the company into a high-growth trajectory following a slip in its performance. 12
Slightly over a year later, on 11 October 2014, Murthy abruptly announced his
‘second retirement’ and reverted to his position as Chairman Emeritus.13
236
Nandan Nilekani, another of Infosys’ celebrated co-founders, served as the
company’s CEO from 2002 to 2007, after taking over the position from Murthy.
During his tenure, the company’s revenue grew from Rs 2,603.6 crore in 2002 to
Rs 13,149 crore in 2007. Subsequently, Nilekani was the company’s co-chairman
and a member of its board. After leaving Infosys in 2009, he became the first
Chairman of the Unique Identification Authority of India with the rank of a cabinet
minister in India.14
In June 2014, Dr Vishal Sikka was appointed CEO and managing director
of Infosys.15,16 Prior to joining Infosys, he had strong credentials at software
corporation SAP AG (SAP) and played a part in developing one of SAP’s most
successful products, SAP HANA.17 With Sikka’s track record, Infosys believed
that he would play a key role in developing the company and securing its future
success.18 Sikka’s appointment was significant as it was the first time in Infosys’
history that it would be led by a non-founder.19 However, Sikka’s tenure was
peppered with a number of unfortunate incidents, resulting in doubts being raised
on his leadership.
Revolution and innovation

“We can be the next generation services company, as differentiated and iconic as
we once were, a company that admires its past and builds on it, or we can be a
somewhat improved, but dying, previous generation company that is mired in the
past.”
– Vishal Sikka, CEO of Infosys20
As the new CEO of Infosys, Sikka had different ideas and strategies for the
company. The Infosys founders had built the company on a more conservative
approach; being cautious in acquiring firms, and having in place a remuneration
structure where the highest compensation in the firm hovered around the median.
In contrast, Sikka had ambitious goals for the IT company. He laid down a blueprint
for Infosys to become a US$20 billion company by 2020 with a strategy of “new,
renew”. Its plans included prioritising and greater allocation of resources for its top
100 clients, pushing towards automation in its existing commoditised businesses,
providing new services such as big data, analytics, and digital asset management,
as well as to make more acquisitions.21
237
A glitch in the matrix

In 2015, Infosys acquired Panaya Ltd (Panaya), an Israeli software-as-a-service
company that offers automation and enterprise software solutions. Infosys paid
US$200 million, even though a previous estimation valued it at only US$162
million. The acquisition was in line with Infosys’ redeveloped “new, renew” strategy,
to bring in innovation and to stay competitive.22,23
The valuation of US$162 million was made by private equity firm Israel Growth
Partners, one of Panaya’s shareholders with a 12.31% stake in the company. It
was also reported that Hasso Plattner, SAP’s co-founder and Sikka’s former boss,
had an 8.33% stake in Panaya at the time.24
On 19 February 2015, a whistleblower sent information to the Securities and

Exchange Board of India and the U.S. Securities Exchange Commission,
questioning the high price of the acquisition and alleging that Infosys’ board did
not address “serious corporate governance issues and conflict of interest issues”
regarding Sikka.25,26
It was reported that Infosys’ then-Chief Financial Officer (CFO), Rajiv Bansal, had
walked out of the board meeting regarding the Panaya acquisition as he felt that
Infosys overpaid for the acquisition and was upset that he was not involved in the
due diligence process prior to the acquisition. 27,28 Further, Bansal believed that the
acquisition was ill-conceived and would not add value to Infosys.29
In response to the allegations, Infosys issued a media response denying

any wrongdoing, asserting that the allegations were “false, malicious and
defamatory”.30 The company further justified the acquisition price, stating that a
third-party valuation was done by Deutsche Bank, and that the acquisition price
was within the recommended range.31
238
A golden handshake or two
“This concern was dismissed by the former chairman as a mere “housekeeping”
matter. So much for good governance!”
– N. R. Narayana Murthy 32
In October 2015, Bansal left the company with a severance pay of Rs 17.38 crore. 33
It was noted that even though the severance was agreed upon in October 2015,
meeting minutes were only recorded in January 2016 and the details were only
disclosed in June 2016.34 In view of this, then-Chairman Seshasayee reportedly
said that it was merely a “housekeeping matter”, and the late recording “was not
a cause for concern”.35 Infosys mentioned in a statement that the minutes were
not disclosed due to the sum of his compensation package and an “enhanced
non-compete and non-disclosure agreement” but declined to clarify what the
agreement was.36 Furthermore, it was the first time Infosys offered such severance
package to former heads of finance and CFOs.37
Murthy, however, viewed this as a corporate governance issue and alleged that the
severance package was “hush money”. 38 Two investigations, conducted by Indian
law firm Cyril Amarchand Mangaldas and accounting firm KMPG, were launched.
However, both investigations revealed no wrongdoing.39 When questioned about
this incident again in November 2016, Sikka mentioned that in retrospect the “[the
severance package] was larger than it should have been”, and admitted that the
decision, made over a two-day period, felt fair at the time.40
In December 2016, a similar incident happened when the Chief Compliance Officer
and Executive Vice President of Infosys, David Kennedy, was offered US$868,250
as part of a generous severance package, which again drew flak. 41 Infosys justified
that the severance was paid out in accordance with an agreement included in
Kennedy’s employment contract.42
“Compassionate capitalism”
In February 2016, Infosys gave Sikka a significant pay increase, purportedly
for helping the company to “regain industry-leading numbers”. Post-revision,
Sikka’s compensation jumped to US$11 million in 2017, from US$7.08 million
the year prior.43 Defending the decision, Seshasayee commented that Sikka’s
compensation was benchmarked against comparable U.S. companies.44
239
During the company’s 2016 Annual General Meeting, Murthy and three other co-
founders abstained from voting on this matter. Murthy was reported to have said
that by proposing such a significant increase in CEO compensation, the board
placed him in a “moral dilemma”.45 Infosys was previously built on Murthy’s
philosophy of “compassionate capitalism” – the ratio between the median salary
and the highest compensation paid out should ideally be 50 to 60. Under the new
compensation structure, the CEO compensation sharply increased by 55%, in
contrast with the former average salary increment of six percent to eight percent.46
New blood
Apart from questions raised on the company’s remuneration policies, other
aspects of Infosys’ corporate governance came under scrutiny as well. In January
2016, Punita Sinha, wife of India’s Minister of State of Finance, Jayant Sinha, was
appointed as an independent director of Infosys. 47 In India, the Ministry of Finance
would screen applications and approve tenders for government contracts.48
Murthy abstained from voting as it went against his principle of not accepting any
politically-connected individuals onto Infosys’ board. Sikka and the rest of the
board voted in favour of Punita’s appointment as she came from a good academic
and investment background.49
In July 2016, Murthy recommended Seshasayee to appoint D. N. Prahlad, one

of the company’s longest-tenured employees, as an independent director. This
raised scepticism as Prahlad is a distant relative of Murthy. 50 Three months later, in
October 2016, Infosys announced the appointment of Prahlad as director. Several
proxy advisory firms were dissatisfied as it seemed that Murthy was finding
attempts to gain control of the board.51 Later, in January 2017, Prahlad was made
the fifth member of the nominations and remuneration panel, responsible for the
pay of the executives, including the CEO.52
System incompatibility
In February 2017, it was reported that Infosys’ founders, specifically Murthy, had
voiced concerns about the drop in governance standards in Infosys. According
to Murthy, several former and current employees, former directors and investors
were disappointed with the board and the management’s governance.53
240
Murthy believed that since the Nomination and Remuneration Committee held a
meeting to discuss the prevailing severance pay practices of the company, Bansal’s
severance pay should not have been given the green light. He cited examples of
eminent CFOs and key employees who held important “secrets”, as Bansal did,
but did not receive such generous severance payments when they left.54
In view of the founders’ concerns, Seshasayee refuted all claims of corporate

governance weaknesses raised and emphasised a “commitment to maintaining
the gold standard of governance that this company is known for”. 55 Furthermore,
in respect of Sikka’s pay hike, Seshasayee pointed out that 98% of shareholders
had approved his remuneration.56 Later that month, Infosys announced that the
concerns with executive pay have been addressed.57
In a public interview held in mid-July 2017, Murthy publicly expressed regret for
leaving Infosys in 2014.58 He had earlier sent a letter to the Infosys board on 8 July
2017, addressing the whistleblower’s complaint and requested for the publication
of the investigation into the Panaya deal and high severance packages.59
Murthy highlighted that the whistleblower accused various stakeholders such as

the Chairman of the Board, Chairman of the Audit Committee, Chairman of the
Remuneration Committee, CEO, and others of being complicit to a certain extent
in the series of events. In his letter, he further wrote that when the whistleblower’s
complaints surfaced, his advice to Seshasayee to conduct the investigation in a
transparent way was disregarded. Furthermore, Murthy expressed dissatisfaction
that his queries about the special treatment of Bansal went unanswered. 60 The
whistleblower also contended that there was an email from Kennedy to Sikka
saying that Kennedy “could not hide the Bansal agreement from the board and
the CFO any longer”. Lastly, the whistleblower alleged that the auditors, KPMG,
had brought this email to the attention of Kennedy and Sikka, requesting for
clarification.61 In his letter, Murthy also raised certain outstanding questions on
corporate governance issues he felt the company should address, and offered his
take on how the company should proceed to correct its corporate governance
lapses.62
It was also reported that Murthy had sent an email to his advisors stating that three
independent directors on Infosys’ board had informed him numerous times that
Sikka “is not CEO material but CTO material”.63
241
Reboot required
Between June and July 2017, four senior-level executives resigned from Infosys
consecutively. These included head of Americas, Sandeep Dadlani, who oversaw
nearly one-third of the company’s annual business. Dadlani’s resignation was
followed by the that of Yusuf Bashir, managing director of Infosys’ US$500 million
innovation fund, and Ritika Suri, head of mergers and acquisitions.64
The relentless disputes between the Infosys’ board and Murthy eventually
culminated in CEO Sikka’s resignation on 18 August 2017. 65 According to Sikka,
he “grew tired of constantly defending against unrelenting, baseless and increasing
personal attacks”, resulting in a shift in focus away from his original aim of growing
the company.66
Infosys’ board disclosed that “Murthy’s continuous assault, including this latest
letter” was the primary reason for Sikka’s resignation. In the board’s statement
to the BSE, it stated that “Murthy’s letter contains factual inaccuracies, already-
disproved rumours, and statements extracted out of context from his conversations
with board members”.67 The board referred to Murthy’s previous statements over
corporate governance weaknesses as a “misguided campaign” and reassured
stakeholders that the company would continue to uphold the highest corporate
governance standards.68
Upon the announcement of Sikka’s resignation, Infosys’ stock price fell by 9.6%69
and dropped again by 5.4% during the following week to a three-year low of Rs
874,70 resulting in a US$5.2 billion plunge in total market value.71
Less than a week after Sikka’s resignation, there were calls for Seshasayee’s
departure and Nilekani’s return due to investors’ lack of confidence in the
company.72 On 24 August 2017, Nilekani took over from Seshasayee as Chairman,
and Murthy was finally convinced that corrective actions on corporate governance
had begun.73 To soothe investors’ concerns, Nilekani said that the board would
deliberate on a shareholder consultation process to engage the company’s
stakeholders.74 It was also reported that a majority of Infosys’ board had offered to
resign as part of a board restructuring to revert it to a ‘clean slate’ before Nilekani’s
return.75
242
Following the Nilekani’s return, Infosys’ share price rose 3.14% to Rs 941.15 on
BSE. Investors were relieved by the promise of stability returning to the company.76
Return of the old guard and inception of the

new
With Nilekani taking over, the focus is once again on Infosys’ values, CLIFE –
“client value, leadership by example, integrity and transparency, fairness and
excellence”.77 Nilekani highlighted his intention to bring back the good corporate
governance principles the company once had and to find a suitable CEO for
Infosys.
However, months after Sikka’s resignation, Nilekani still did not make the
investigation about the Panaya acquisition public. In October 2017, the company
stated: “After careful reconsideration, the company has concluded that publishing
additional details of the investigation would inhibit the company’s ability to conduct
effective investigations into any matter in the future”. 78 Infosys still stood by the fact
that there was no wrongdoing on its part.79 This again drew negative comments
from Murthy, with him expressing his disappointment in co-founder Nilekani.80
In the same statement, Infosys confirmed that it had adopted a practice of

disclosing severance payments to key managerial personnel at the time of their
departure.81
On 2 January 2018, Salil Parekh took over the reins of Infosys as the new CEO.
With over three decades of experience in the IT services industry, Infosys was
confident of his abilities to lead the company.82 With new leaders taking the wheel,
all eyes are now on Infosys as it moves forward, hopefully still with its priorities on
corporate governance in place.
243
1. Infosys has won multiple awards for good corporate governance. What
were some red flags that could have signalled the deteriorating corporate
governance standards in the company?
2. There were many issues at Infosys that had apparent as well as implied
conflicts of interests- discuss. What in your view, should have done to uphold
high corporate governance standards that the company was known for?
3. How could Infosys have better managed succession of CEOs? In your

discussion, draw parallels to family-type companies that have successfully
transitioned to being professionally managed by outsiders.
4. Identify and comment on some of the key corporate governance challenges

in companies with highly influential founders.
5. Were the actions of N.R. Narayana Murthy, the founder, former CEO and
former Executive Chairman, justified? Was he playing the role of an activist
shareholder? Explain.
6. Proxy advisory firms had raised some concerns about governance practices
at Infosys. Discuss the role of Proxy advisory firms in the context of
corporate governance in India.
244
Endnotes
1 India Today. (2009, December 17). 1981-Infosys is formed: Knowledge warriors.
Retrieved from http://indiatoday.intoday.in/story/1981-Infosys+is+formed:
+Knowledge+warriors/1/75430.html
2 PTI. (2018, June 27). Infosys to announce June-quarter results on July 13. The
Times of India. Retrieved from https://timesofindia.indiatimes.com/business/india
-business/infosys-to-announce-june-quarter-results-on-july-13/articleshow/
64768109.cms
3 Infosys Limited. (n.d.). About Us. Retrieved from https://www.infosys.com/about/
Pages/history.aspx
4 Infosys Limited. (n.d.). Corporate Governance. Retrieved from https://www.infosys.
com/investors/corporate-governance/pages/index.aspx
5 Infosys Limited. (n.d.). Industry Awards & Accolades Across the Years. Retrieved
from https://www.infosys.com/about/awards/Pages/all-awards.aspx
6 IBS Center for Management Research. (n.d.). Corporate Governance at Infosys.
Retrieved from http://www.icmrindia.org/casestudies/catalogue/Corporate%20
Governance/CGOV001.htm
7 Ibid.
8 Ibid.
9 Crunchbase. (n.d.). N. R. Narayana Murthy. Retrieved from https://www.crunchba-
se.com/person/n-r-narayana-murthy
10 AFP. (2013, June 1). India’s Infosys recalls founder Narayana Murthy as woes
mount. The Straits Times. Retrieved from https://www.straitstimes.com/asia/indias
-infosys-recalls-founder-narayana-murthy-as-woes-mount
11 Moneycontrol. (2017, August 24). R Seshasayee steps down as Infosys Chairman:
All you need to know. Retrieved from http://www.moneycontrol.com/news/
business/companies/r-seshasayee-steps-down-as-infosys-chairman -all-you-need-
to-know-2369421.html
12 The Indian Express. (2015, June 23). NR Narayana Murthy rules out returning to
Infosys again. Retrieved from http://indianexpress.com/article/business/companies/
nr-narayana-murthy-rules-out-returning-to-infosys-again/
13 PTI. (2014, June 13). Narayana Murthy plans life after ‘second’ retirement from
Infosys. Business Today. Retrieved from https://www.businesstoday.in/management/
leadership/narayana-murthy-retiring-2nd-time-chairman-emeritus-oct-11/story/
207200.html
245
14 Sushma, U. N. and Punit, I. S. (2017, August 25). The world ain’t so flat after all, Mr
Nilekani?. Quartz India. Retrieved from https://qz.com/india/1061484/infosys-the-
world-aint-so-flat-after-all-mr-nilekani/
15 Johnson, T. A. (2014, June 12). Former SAP executive Vishal Sikka to be first
non-founder CEO of Infosys. The Indian Express. Retrieved from http://indian
express.com/article/business/companies/former-sap-executive-vishal-sikka-to
-be-first-non-founder-ceo-of-infosys/
16 Infosys Limited. (2014, June 12). Infosys to appoint Dr. Vishal Sikka as Chief
Executive Officer & Managing Director. Retrieved from https://www.infosys.com/
newsroom/press-releases/Pages/ceo-announcement.aspx
17 The New Indian Express. (2017, August 18). Vishal Sikka was a far-thinking
transformer; how well do you know him? Here’s a 10-point cheat-sheet. Retrieved
from http://www.newindianexpress.com/business/2017/aug/18/vishal-sikka-was
-a-far-thinking-transformer-how-well-do-you-know-him-heres-a-10-point-cheat-
sheet-1644882.html
18 Sen, A. (2014, June 13). Vishal Sikka as CEO ends Infosys’s founder-led era. Live
Mint. Retrieved from http://www.livemint.com/Companies/LUsI2Z43IVqt62hIog1
awJ/Infosys-names-former-SAP-executive-Vishal-Sikka-as-CEO.html
19 Ibid.
20 Sushma, U. N. (2017, May 23). In one para, the Infosys CEO has provided a new
mission statement for Indian IT. Quartz India. Retrieved from https://qz.com/india/
989572/in-one-para-infosys-ceo-vishal-sikka-has-provided-a-new-mission
-statement-for-indian-it/
21 Sen, A. (2015, May 12). Infosys CEO Vishal Sikka readying blueprint to become
$20-billion company by 2020. The Economic Times. Retrieved from https://
economictimes.indiatimes.com/tech/ites/infosys-ceo-vishal-sikka-readying-blue-
print-to-become-20-billion-company-by-2020/articleshow/47240265.cms
22 Sood, V. (2017, February 20). Rajiv Bansal walked out of Infosys board meet on
Panaya acquisition. Hindustan Times. Retrieved from https://www.hindustantimes.
com/business-news/rajiv-bansal-walked-out-of-infosys-board-meet-on-panaya
-acquisition/story-1GPyUFAk3IGhboFSHJwk5J.html
23 Shah, B. (2017, February 20). Whistleblower’s exposé says Rajiv Bansal walked out
of board meet on Panaya acquisition. YourStory. Retrieved from https://yourstory.
com/2017/02/whistleblower-says-rajiv-bansal-walked-out-panaya-acquisition-
board-meet/
246
25 Zachariah, R. (2017, February 17). Sebi examining letter from Infosys whistleblower.
The Economic Times. Retrieved from https://economictimes.indiatimes.com/markets/
stocks/news/sebi-examining-letter-from-infosys-whistleblower/articleshow/57195
281.cms
26 ET Bureau. (2017, February 20). Infosys now faces anonymous complaint on
governance issues. Retrieved from https://tech.economictimes.indiatimes.com/
news/corporate/infosys-now-faces-anonymous-complaint-on-governance-issues/
57242564
27 Shah, B. (2017, February 20). Whistleblower’s exposé says Rajiv Bansal walked out
of board meet on Panaya acquisition. YourStory. Retrieved from https://yourstory.
com/2017/02/whistleblower-says-rajiv-bansal-walked-out-panaya-acquisition-
board-meet/
29 Ibid.
30 ET Bureau. (2017, February 20). Infosys now faces anonymous complaint on
governance issues. Retrieved from https://tech.economictimes.indiatimes.com/
news/corporate/infosys-now-faces-anonymous-complaint-on-governance
-issues/57242564
31 Ibid.
32 Sen, A. and Sood, V. (2017, August 29). Narayana Murthy backs Nandan Nilekani
to fix governance lapses at Infosys. Live Mint. Retrieved from http://www.livemint.
com/Companies/4MzoucwGPdhwoyvQRBcf0I/Narayana-Murthy-defends-role-in
-Infosys-row.html
33 Ibid.
34 Sood, V. (2017, February 16). At first, Infosys didn’t record minutes of Rajiv Bansal
severance pay meeting. Live Mint. Retrieved from https://www.livemint.com/
Companies/TwW19vZbfW5Mw9Malrqc6M/At-first-Infosys-didnt-record-minutes-
of-Rajiv-Bansal-seve.html
35 Ibid.
247
36 Sood, V. (2016, May 29). Infosys reveals it paid outgoing CFO Rajiv Bansal over
Rs23 crore. Live Mint. Retrieved from http://www.livemint.com/Companies/qTHnr
1EWhxnKrize8OakjI/Infosys-reveals-it-paid-outgoing-CFO-Rajiv-Bansal-over-Rs23.
html
37 Ibid.
38 Balasubramanyam, K. R. (2017, February 10). Corporate governance badly down
at Infosys, board needs an overhaul: NR Narayana Murthy. The Economic Times.
Retrieved from https://economictimes.indiatimes.com/opinion/interviews/no-talks-
on-strategy-with-vishal-sikka-infosys-founder-nr-narayana-murthy/articleshow/
57070727.cms
39 Infosys Limited. (2016, October 21). Company Statement: Addressing all Queries
Concerning Payment to Former CFO. Retrieved from https://www.infosys.com/
newsroom/press-releases/Pages/concerning-payment-former-CFO.aspx
40 Mendonca, J. and Mahaligam, T. V. (2016, November 16). We need to work
through short term visa pain: Vishal Sikka. The Economic Times. Retrieved from
https://tech.economictimes.indiatimes.com/news/corporate/we-need-to-walk-
through-short-term-visa-pain-vishal-sikka/55448261
41 Velayanikal, M. (2017, April 3). What happens when a multi-billion-dollar firm’s
founders lock horns with its board. Tech In Asia. Retrieved from https://www.
techinasia.com/founders-multi-billion-dollar-infosys-lock-horns-with-board
42 Deccan Chronicle. (2017, October 27). Infosys ‘standardises’ severance packages
of employees. Retrieved from https://www.deccanchronicle.com/business/
companies/271017/infosys-standardises-severance-packages-of-employees.html
43 Sen, A. (2016, February 25). Infosys raises CEO Vishal Sikka’s annual salary
to $11 million, hands out more stock options. The Economic Times. Retrieved
from https://economictimes.indiatimes.com/tech/ites/infosys-raises-ceo-vishal
-sikkas-annual-salary-to-11-million-hands-out-more-stock-options/articleshow/
51130087.cms
44 Ghoshal, D. and Punit, I. S. (2017, February 14). After a messy boardroom glitch,
Infosys looks to reboot the system. Quartz India. Retrieved from https://qz.com/
908913/narayana-murthy-vs-vishal-sikka-after-bitter-boardroom-bickering
-infosys-crawls-back-from-the-brink/
45 Ibid.
46 Phadnis, S. (2017, February 9). Inside story of the tensions between Infosys CEO,
founders. The Economic Times. Retrieved from https://economictimes.indiatimes.
com/news/company/corporate-trends/inside-story-of-the-tensions-between
-infosys-ceo-founders/articleshow/57052487.cms
248
48 Murlidharan, S. (2016, January 15). Punita Sinha at Infosys: Why it’s plain illogical to
apply Caesar’s wife puritanism here. Firstpost. Retrieved from http://www.firstpost.
com/business/punita-sinha-at-infosys-why-its-plain-illogical-to-apply-caesars-wife
-puritanism-here-2585696.html
50 Ibid.
51 Sood, V. (2017, February 17). An uneasy truce at Infosys. Live Mint. Retrieved from
http://www.livemint.com/Companies/7B8NagALbqdMI6lC76op7H/An-uneasy
-truce-at-Infosys.html
52 Ibid.
53 Ibid.
54 Balasubramanyam, K. R. (2017, February 10). Corporate governance badly down
at Infosys, board needs an overhaul: NR Narayana Murthy. The Economic Times.
Retrieved from https://tech.economictimes.indiatimes.com/news/corporate/
infosys-founder-murthy-raises-questions-about-hush-money-seeks-overhaul
-of-board/57073077
55 Mundy, S. (2017, February 14). Infosys rejects founder’s claims of corporate
governance failings. Financial Times. Retrieved from https://www.ft.com/content/
80bc263e-f20b-11e6-8758-6876151821a6
56 Ibid.
57 Reuters. (2017, August 18). TIMELINE: Infosys CEO Sikka resigns, bruised by
disputes with founders. Retrieved from https://www.reuters.com/article/us-infosys
-ceo-chronology/timeline-infosys-ceo-sikka-resigns-bruised-by-disputes-with
-founders-idUSKCN1AY0UY
58 Patankar, S. (2017, July 17). Leaving Infosys my biggest regret: Narayana Murthy.
The Times of India. Retrieved from https://timesofindia.indiatimes.com/business/
india-business/leaving-infosys-in-2014-biggest-regret-says-narayana-murthy/
249
59 ET Online and Agencies. (2017, August 18). Narayana Murthy hits back at Infosys
board, says not chasing money or power. The Economic Times. Retrieved from
https://economictimes.indiatimes.com/tech/ites/narayana-murthy-hits-back-at
-infosys-board-says-not-chasing-money-or-power/articleshow/60117186.cms
60 ET Online. (2017, August 18). Panaya: How one Infosys acquisition kicked off the
big storm. The Economic Times. Retrieved from https://economictimes.indiatimes.
com/tech/ites/panaya-how-one-infosys-acquisition-kicked-off-the-big-storm/
61 Ibid.
62 ET Online and Agencies. (2017, August 18). Narayana Murthy hits back at Infosys
board, says not chasing money or power. The Economic Times. Retrieved from
https://economictimes.indiatimes.com/tech/ites/narayana-murthy-hits-back-at
-infosys-board-says-not-chasing-money-or-power/articleshow/60117186.cms
63 Mumbai Mirror. (2017, August 19). ‘He is not CEO material, just chief tech officer’.
Retrieved from https://mumbaimirror.indiatimes.com/mumbai/cover-story/he-is
-not-ceo-material-just-chief-tech-officer/articleshow/60127070.cms
64 Ibid.
65 ETMarkets.com. (2017, August 18). Why Vishal Sikka quit as Infosys MD: Full text
of his resignation letter. The Economic Times. Retrieved from https://economic-
times.indiatimes.com/markets/stocks/news/full-text-vishal-sikkas-resignation-letter
/articleshow/60113647.cms
66 Marandi, R. (2017, August 18). Infosys plunges on governance turmoil. Nikkei Asia
Review. Retrieved from https://asia.nikkei.com/Business/Companies/Infosys
-plunges-on-governance-turmoil
67 Sengupta, R. (2017, August 18). Vishal Sikka blames Narayana Murthy for
resignation as Infosys CEO. Times of India. Retrieved from https://timesofindia.
indiatimes.com/business/india-business/vishal-sikka-blames-narayana-murthy-for
-resignation-as-infosys-ceo/articleshow/60115668.cms
68 Marandi, R. (2017, August 18). Infosys plunges on governance turmoil. Nikkei Asia
Review. Retrieved from https://asia.nikkei.com/Business/Companies/Infosys
-plunges-on-governance-turmoil
69 Choudhury, S. R. (2017, August 22). Its CEO quit, then investors hammered Indian
tech giant Infosys — it may get worse. CNBC. Retrieved from https://www.cnbc.
com/2017/08/22/infosys-ceo-vishal-sikka-quits-his-resignation-could-create
-more-uncertainty-hurt-the-stock.html
250
70 Zachariah, R. and Partha S. (2017, August 22). Sebi scanner on Infosys stock
movement, corporate governance. The Times of India. Retrieved from https://
timesofindia.indiatimes.com/business/india-business/sebi-scanner-on-infy-stock-
movement-corp-governance/articleshow/60165784.cms
71 Choudhury, S. R. (2017, August 22). Its CEO quit, then investors hammered Indian
tech giant Infosys — it may get worse. CNBC. Retrieved from https://www.cnbc.
com/2017/08/22/infosys-ceo-vishal-sikka-quits-his-resignation-could-create-more-
uncertainty-hurt-the-stock.html
72 Sen, A. and Sood, V. (2017, August 24). Infosys row: Chorus grows for Seshasay-
ee’s exit, Nandan Nilekani’s entry. Live Mint. Retrieved from https://www.livemint.
com/Companies/oYnEEvSaZafP2HiiaFT9vN/Infosys-row-Chorus-grows-for-Ses-
hasayees-exit-Nandan-Nile.html
73 Reuters. (2017, August 29). BRIEF-Infosys founder Murthy believes corrective
actions on corporate governance already begun with Nilekani as chair. Retrieved
from https://www.reuters.com/article/brief-infosys-founder-murthy-believes-co/brief
-infosys-founder-murthy-believes-corrective-actions-on-corporate-governance
-already-begun-with-nilekani-as-chair-idUSFWN1LF0LO
74 The Hindu Business Line. (2017, August 24). With Nilekani’s return, Infy goes back
to its roots. Retrieved from https://www.thehindubusinessline.com/info-tech/with
-nilekanis-return-infy-goes-back-to-its-roots/article9830338.ece
75 Business Standard (2017, August 24). Infosys board members to resign for
Nandan Nilekani’s return. Retrieved from https://www.business-standard.com/
article/companies/infosys-board-members-to-resign-for-nandan-nilekani-s-return
-report -117082400393_1.html
76 PTI. (2017, August 28). Infosys shares end over 3% higher on Nandan Nilekani’s
return. Live Mint. Retrieved from http://www.livemint.com/Money/WrR3a3HF6CM
oxJcW3SV7VP/Infosys-shares-rise-over-4-as-investors-welcome-Nandan-Nile.html
77 Phadnisi, S. (2017, October 24). Nandan Nilekani may announce fresh strategy for
Infosys. The Times of India. Retrieved from https://timesofindia.indiatimes.com/
business/india-business/nandan-nilekani-may-announce-fresh-strategy-for-infosys/
78 Punit, I. S. (2017, October 25). What will it take to satisfy Infosys’s Narayana
Murthy?. Quartz India. Retrieved from https://qz.com/1110527/nandan-nilekanis
-clean-chit-to-sikkas-infosys-leaves-narayana-murthy-disappointed/
79 Narayanan, M. (2017, October 25). Infosys gives Panaya deal a clean chit: Is
Nandan Nilekani implying Narayana Murthy was overreacting?. FirstPost. Retrieved
from http://www.firstpost.com/business/infosys-gives-panaya-deal-a-clean-chit
-is-nandan-nilekani-implying-narayana-murthy-was-overreacting-4173161.html
251
80 PTI. (2017, October 25). Infosys: Narayana Murthy stands firm on allegations,
questions board on ‘poor governance’. FirstPost. Retrieved from http://www.
firstpost.com/business/infosys-narayana-murthy-stands-firm-on-allegations
-questions-board-on-poor-governance-4173265.html
81 The Hindu Business Line. (2017, October 24). Infosys net profit up 3.3% at Rs
3,726 cr. Retrieved from https://www.thehindubusinessline.com/info-tech /
infosys-net-profit-up-33-at-rs-3726-cr/article9921316.ece
82 Your Story. (2018, January 3). 5 things to know about Salil Parekh, the new Infosys
CEO. Retrieved from https://yourstory.com/2018/01/who-is-infosys-ceo-salil-
parekh/
252
Cadbury and Kraft: A Bittersweet Moment
Cadbury and Kraft:

A Bittersweet Moment
Case Overview
After four months of bitter resistance, Cadbury shook hands with
Kraft at midnight on 18 January 2010. Cadbury’s board “unanimously”
recommended that the final takeover bid of US$19.5 billion or 840p
per share be accepted by Cadbury’s shareholders. The combined
group would own 40 confectionery brands each with annual sales of
more than $100 million, making the group the world’s largest candy
maker. However, public discontent brought Kraft under fire from British
politicians, together with increased fears of job cuts in Britain. Time will
tell whether the takeover truly created value. The objective of this case
is to allow a discussion of issues such as the role of takeovers as a
corporate governance mechanism; the pros and cons of a takeover from
the viewpoint of different stakeholders; the role of the board, shareholders
and regulators in takeovers; the powers of the board and shareholders of
acquiring and target companies in takeover situations; and differences in
the governance of takeovers in different jurisdictions.
The Story of Cadbury plc

For many years, Cadbury had been the leading global confectionery
company. Cadbury was an ever-present member of the FTSE100 since
the commencement of the index in 1984. It produces 7.3 per cent of the
world’s chocolate, 27 per cent of the world’s gum, and 7.4 per cent of
Felyna Lee, Joshua Lim and Kevin Teo prepared this case under the supervision of Professor Mak Yuen Teen.
The case was developed from published sources solely for class discussion and is not intended to serve as
illustrations of effective or ineffective management.. Consequently, the interpretations and perspectives in this
case are not necessarily those of the organisations named in the case, or any of their directors or employees.
This abridged version was prepared by Joanna Ng Yi Mei under the supervision of Professor Mak Yuen Teen.
Copyright © 2011 Mak Yuen Teen and CPA Australia
152
the world’s candy. Cadbury had a market share of 10.1 per cent of the
global confectionery market, more than 1 percentage point higher than
its closest competitor, Mars. Under the leadership of CEO Todd Stitzer,
Cadbury’s revenue in 2008 was a whopping £5.384 billion with a profit
of £366 million1. Compared to its competitors like Hershey’s, Mars and
Nestlé, Cadbury was also less reliant on holiday season sales because
of its numerous year-round products like Halls cough drops.
In 2008, family-controlled Mars announced its merger with Wrigley to

form the world’s leading confectionery company, relegating Cadbury to
second place. In May 2008, the company completed the demerger of
its confectionery and beverage businesses. Under this demerger, the
confectionery unit was separated from its North American beverage unit
which was renamed Dr Pepper Snapple Group (DPS). This reversed
the initial merger of the two companies, Schweppes and Cadbury, to
create Cadbury Schweppes in 1969. According to Stitzer: “Separating
these two great businesses will enable two outstanding management
teams to focus on generating further revenue growth, increasing margin,
and enhancing returns for their respective shareowners”.2 Larry Young
became the President and CEO of DPS. The demerger followed calls
by some institutional investors for the two businesses to be split up. The
increased competition and the decrease in Cadbury’s size following the
demerger made the company an open target for potential takeovers.
Kraft Launches First Takeover Bid

Kraft Foods Inc was the second largest confectionery, food and beverage
corporation in the world after Nestlé SA, with revenues of US$40.4 billion
and profit of US$3.02 billion in 2008. On 7 September 2009, Kraft initiated
its takeover bid of Cadbury for US$16.7 billion (£9.8 billion), offering
US$4.92 in cash and 0.2589 new Kraft shares per Cadbury share. This
was a premium of 31 per cent from Cadbury’s closing price of £5.68.
Kraft believed a takeover would significantly expand the global reach of
both businesses and create synergies worth US$625 million in the form
of cost savings in operations, administration and marketing. In return,
Kraft vowed to save workers’ jobs at Cadbury’s factory in Somerdale,
Bristol that was to close as production was shifted to Poland.
153
Analysts, however, suggested that the initial offer by Kraft significantly

undervalued Cadbury as it valued Cadbury at less than 15 times EBITDA
when Cadbury arguably deserved more than 19.5 times EBITDA. Kraft’s
offer was “emphatically rejected” by Cadbury’s board, led by Roger
Carr. Cadbury’s board was made up of 9 members, 6 of whom were
independent directors. Calling the offer “derisory”, the board claimed that
Kraft was attempting “to buy Cadbury on the cheap.”3
Bank of America Merrill Lynch sales specialist Simon Archer published a

note revealing that “Stitzer admitted that there is some strategic sense in
combining the two companies and he doesn’t expect Kraft to walk away,
so he said his job is to get as much value as possible”4. Stitzer also spoke
of the “complementary elements” of the two companies, which conflicted
with Cadbury’s original stance that Kraft’s offer is “fundamentally
undervalued” and “made no strategic or financial sense”.
Although the Cadbury family does not own Cadbury anymore, Cadbury
family members had been hostile to the takeover. However, the family
had little influence on the deal, as family representation on the board
ended in 2000 when Chairman Dominic Cadbury retired.
Approaching the UK Takeover Panel

On 22 September 2009, Cadbury approached the UK Takeover Panel,
asking it to impose a deadline for Kraft to make a formal offer. The City
Takeover Code governs any firm bidding for a company that is listed on
the London Stock Exchange and any company on the receiving end of
such an approach. Cadbury wanted a “put-up-or-shut-up” action, which
would force Kraft to make a bid within one month or thereafter stay away
from Cadbury for at least six months. Cadbury shares hovered around
£7.90 (US$12.80) and analysts suggested that Cadbury would worry
about losing this premium if a potential takeover dragged on.
On 30 September, 2009, the UK Takeover Panel agreed to Cadbury’s

request and announced a deadline of 9 November for Kraft to make a
bid for Cadbury. Cadbury’s share price then rose to £7.96 following the
Takeover Panel’s decision, 11 per cent above Kraft’s original offer.
154
The Government Voices Its Concerns

The UK government, which usually takes an open approach to takeovers
by overseas firms in light of its commitment to open markets for trade
and investment, seemed not in favour of the takeover of home-grown
chocolate champion Cadbury. UK Business Secretary Lord Mandelson
slammed Kraft’s takeover attempt of Cadbury and cautioned against the
long-term effects and obligations of transparency and accountability of
foreign ownership.
The Financial Services Secretary (City Minister) Paul Myners was also
apprehensive that too many British companies were being lost to foreign
hands because their shares are owned by international funds which do
not care much for domestic heritage. He said, “It is easier to take over a
company here than anywhere else in the world.5”
Kraft’s Second Takeover Bid Offer

Kraft officially launched a takeover bid for Cadbury on 9 November 2009,
just hours before the 5pm GMT deadline imposed by the UK Takeover
Panel. This second offer valued Cadbury at 717p (£7.17) per share,
lower than the initial 745p per share offer that was rejected in September.
Cadbury’s management was naturally against this but Kraft wanted to
appeal to Cadbury’s shareholders this time. Irene Rosenfeld, CEO and
Chairman of Kraft Foods, said,
“We believe that our proposal offers the best immediate

and long-term value for Cadbury’s shareholders and for
the company itself compared with any other option currently
available, including Cadbury remaining independent.”6
The official launch of this hostile takeover bid gave Kraft 28 days to
publish an offer document detailing the offer for shareholders. It then
had up to 60 days to gather enough shares to complete the deal. Kraft
offered Cadbury shareholders 300p and 0.2589 new Kraft shares for
each Cadbury share, which was the exact offer as that in September.
155
However, the decreased value of Kraft shares and currency shifts meant
that it was now worth less.
Carr did not back down and described Cadbury as “an exceptional
standalone business”7. Cadbury also had home ground advantage, with
Lord Mandelson warning that Kraft would face a backlash if it tried to buy
Cadbury on the cheap.
The Potential Arrival of the White Knights and Share

Price Fluctuations
On 18 November 2009, confectionery conglomerates Hershey and
Ferrero were holding preliminary talks about a possible bid.
Nomura analyst Alex Smith commented that investors might have a

preference to back the alliance with family-owned Ferrero. This acquisition
aided Cadbury, as it was weak in the Ferrero strongholds of France,
Germany and Italy. However, it was doubtful whether family-controlled
Ferrero had the financial means to support this merger.
On the other hand, Hershey and Cadbury had a strong cultural fit, which
meant fewer job cuts than a Kraft takeover. Cadbury’s American chief
executive had twice attempted unsuccessfully to merge both companies.
Hershey had the licence to sell Cadbury products in the US, and the
controlling trust behind Hershey was rumoured to have wanted to create
a consolidated global confectionery market.
On 23 November 2009, Nestlé also joined the Cadbury takeover game

as a potential counter-bidder, a move that sent Cadbury shares to a
two-month high since September. Bloomberg reported that Nestlé was
considering its options with bankers aiming to participate in a break-up
bid for Cadbury.
Excited by the prospect of a bidding war, investors pushed Cadbury’s

share price up 13.5p to 814p overnight. Cadbury shares were then worth
43 per cent more than in early September, before Cadbury had rejected
Kraft’s first offer.
156
In the meantime, Kraft started the formal 60-day timetable for its takeover
bid by issuing a 180-page circular stating that Kraft and Cadbury would
be a good fit, creating a “global powerhouse”8 in confectionery. Also,
Kraft was optimistic about the acquisition benefitting each other in their
various stronghold markets.
Escalating Resistance To The Takeover

The increased possibility of Cadbury being sold to a foreign firm stirred
strong emotions from Cadbury’s stakeholders. The general public
lamented the loss of 186 years of British heritage, while politicians and
the 4,500 UK and Irish workers feared the worst for their jobs and pay
cuts.
On 10 December 2009, Cadbury’s workers union Unite announced a

“Keep Cadbury Independent” campaign to resist Kraft’s advancement.
“We must see off the Kraft bid and any others which do not have this
company and its workforce’s best interests at heart,” said Len McCluskey,
Unite’s assistant general secretary. It was a well-known fact that despite
whatever good intentions Kraft may have had, mergers and acquisitions
have historically led to job losses during restructuring and integration.
Further, the amount of debt that Kraft would be assuming to realise this
deal left an “irresistible imperative”9 to cut expenses and streamline the
workforce. After garnering much support from the public, Unite and the
workers later took the campaign to the UK Parliament on 16 December.
UK nationalistic sentiment ran high, with Liberal Democrat leader Nick

Clegg leading the pack in stating that it was “plain wrong” that the state-
owned Royal Bank of Scotland helped Kraft raise the money. RBS was
one of a few banks which shared £120 million in fees to aid the takeover.
Clegg referred to Lord Mandelson’s statement that the government would
mount a huge opposition to Kraft’s takeover and asked “Why is it RBS
should now want to lend vast amounts of our money to Kraft to fund it?”10
Cadbury put up a strong fight and issued an official Defence Document

on 14 December against Kraft’s bid. The chocolate maker raised targets
for the next four years and pledged to hand more cash to shareholders if it
157
could remain independent. Cadbury repeatedly insisted that the US$16.3

billion (£9.8 billion) bid was far too low, and Carr urged shareholders at a
news conference not to sell themselves short.
Kraft Sells Pizza Business to Nestle to Fund Cadbury

Offer
As the 19 January deadline imposed by British takeover rules loomed
near, Kraft needed to win over at least 50 per cent of Cadbury’s
shareholders or stay away from Cadbury for at least six months. On 5
January 2010, Kraft sold its pizza business to Nestlé for US$3.9 billion
to help fund its offer for Cadbury. Kraft’s North American pizza business
was the world’s largest, reaping US$291 million in profits for 2009. It was
an attractive offer Nestlé did not reject. Reports deemed this as Kraft’s
move to dissuade Nestlé from competing in the bid for Cadbury.
Following its successful sale, Kraft sweetened the deal for Cadbury
shareholders and announced that those who elected to accept the
“Partial Cash Alternative” would get more cash in lieu of stock - 60p more
per Cadbury share or 240p more per Cadbury American depository
share (ADS)11.
However, not all of Kraft’s shareholders supported the acquisition.

Renowned investor Warren Buffett, one of Cadbury’s major shareholders,
was one of them. Owning a 9.4 per cent stake in Cadbury, Buffett said if he
had the chance to vote against the deal he would, as the proposed “bad
deal” has left him feeling “poor”. Kraft’s proposed bid risked undervaluing
Kraft’s stock, and he sent an indirect warning to the company not to pay
too much in cash or shares on the deal.
Cadbury Releases Final Defence Document

On 12 January 2010, Cadbury’s board published another document, which
was seen as the last line of defence to reject Kraft’s bid. It reiterated the
board’s opinion of Kraft’s “derisory” offer, attacking Kraft’s management
and revealing that it beat its own target for operating margins in 2009.
158
Carr mentioned that Kraft’s latest offer was even more unattractive than
it was when Kraft made its formal offer in December.
At this point, attempts to thwart the completion of the deal were becoming
increasingly futile. Hedge and mutual funds bought up more than 25 per
cent of Cadbury’s shares in hopes of a deal. The final straw came when
Franklin Templeton, a large mutual fund with a 7 per cent stake, indicated
it would accept an offer of 830p (£8.30).
The Kraft Takeover

On 19 January 2010, Cadbury board advised its shareholders to accept a
new offer of 840p a share - valuing the company at £11.5bn ($18.9bn).12
The deal was a significant increase on earlier Kraft bids. Consequently,
Hershey dropped its plans to acquire Cadbury.
The deal became final after Kraft secured acceptances from shareholders
representing 71.73 per cent of Cadbury. On 2 February 2010, Cadbury
officially became a part of Kraft and was delisted from the London Stock
Exchange on 8 March 2010.13
The takeover of Cadbury by Kraft was met with continued disapproval

from the UK public, as Cadbury was regarded as part of British culture. To
them, losing Cadbury to Kraft was akin to losing a part of British legacy.
On 3 February 2010, Stitzer announced his intention to stand down as

CEO of Cadbury after a 27-year career at the company. Andrew Bonfield
also announced his intention to step down as CFO. Stitzer, on his
resignation, thanked everyone for being involved in a good fight for the
Cadbury bid defence and wished Rosenfeld all the best in taking Cadbury
to greater heights. On the same day, Carr announced his intention to
step down as Chairman of Cadbury.
159
Discussion Questions
1. Hostile takeovers are often argued to be an important corporate

governance mechanism. Do you agree?
2. Was the takeover of Cadbury by Kraft good from a corporate
governance standpoint? Who benefited from the takeover? Explain
the divergence of interests for different stakeholder groups.
3. What should be the role of government in regulating takeovers?
4. Warren Buffett, a major shareholder of Kraft, said if he had the
chance to vote against the deal he would. How much say should the
shareholders of acquiring and target firms have in takeovers?
5. Why are hostile takeovers relatively rare in Asia?
6. What are the rules governing takeovers in India?
160
RINO: Reversing into Trouble
RINO: Reversing
into Trouble
Case Overview
The stock of RINO International Corporation (RINO) traded at more than
US$30 during its heyday. However, RINO was not spared in 2010 which
saw the uncovering of questionable business practices in many Chinese
companies listed in the United States and Canada through reverse
mergers. As of 22 July 2011, RINO’s stock had fallen to US$0.40. The
objective of this case is to allow a discussion of issues such as the method
used by Chinese companies to list on stock exchanges in the US using
reverse mergers, the risks associated with complex corporate structures
that are used to facilitate such listings, and corporate governance and
accounting issues in Chinese companies listing in the US through reverse
mergers.
A R(H)INO’s Route to NASDAQ

Reverse mergers are an alternative route to initial public offerings (IPOs)
for companies seeking to list on the US markets, and it has become a
popular way for many Chinese companies like RINO to seek additional
capital because of its more relaxed requirements.
In 2006, Zou Dejun began to look for opportunities to list his firm Dalian
RINO Environment Engineering Science and Technology Co. Ltd. (Dalian
RINO International Corporation (Nevada)
100% 100%
Innomind Group Limited Rino Investment (Dalian) Co., Ltd.

(“Innomind Group”) (BVI) (“Rino Investment”) (PRC)
100% 100%
Dalian Innomind Environment Dalian RINO Heavy

Engineering Co., Ltd. Industries Co., Ltd.
(“Dalian Innomind”) (PRC) (“Rino Heavy Industries”) (PRC)
Contractual
Arrangements
Dalian Rino Environment Engineering Science

and Technology Co., Ltd. (“Dalian Rino”) (PRC)
100% 100% 100%
Rino Technology Dalian RINO Environmental Dalian RINO Environmental

Corporation Engineering Design Co. Construction and Installation
(“Rino Technology”) Ltd. Engineering Project Co. Ltd.
(Nevada) (“Dalian Rino Design”) (“Dalian Rino Installation”)
(PRC) (PRC)
Figure 1: RINO Group Structure
Source: 2009 RINO Annual Report
RINO) on the US markets to access funding. Through a contact, Zou

found a Nevada-based shell company, Jade Mountain Corporation, that
was listed on the Over-the-Counter Bulletin Board (OTCBB) but which
was largely inactive.
On 5 October 2007, the reverse merger between Dalian RINO and
Jade Mountain Corporation took place through Innomind Group Ltd
(Innomind), a single shareholder company1. A share exchange transaction
of 17,899,643 shares of common stock was issued to Innomind Trust,
essentially giving Innomind control as the trust’s beneficiaries were Zou
and his wife, Qiu Jianping2. When the reverse merger was completed,
Jade Mountain changed its name to RINO International Corporation3
(see Figure 1 for the group structure).
RINO’s only source of operating profits is through a contractual

arrangement with the China-incorporated company Dalian RINO, which
dictated that 100 per cent of Dalian RINO’s profits was to be channeled
into Innomind’s wholly-owned subsidiary.4 The Chairman of RINO was
Qiu, while the CEO was Zou. Zou was also the CEO of Dalian RINO.
Innomind’s sole shareholder is a relative of Zou and Qiu.
Although trading on the OTCBB did bring in new capital, Zou had set his
sights on a listing on NASDAQ. He took steps to ensure that RINO met
NASDAQ’s listing requirements. In 2008, Frazer Frost, a US-based audit
firm and Rodman & Renshaw, an investment bank with experience in
helping Chinese companies list on the NASDAQ, were hired. In July 2009,
RINO was successfully upgraded from the OTCBB to the mainboard of
NASDAQ. In the first six months of its listing on NASDAQ, RINO raised
about US$1 billion through share issues and stock warrants.5
The Man Behind The Wheel

Zou is well-known in his home country and was viewed as a promising
star in the environmental engineering industry. His background is a
classic rags-to-riches story, having worked his way up from serving in
the navy to a technician in a local machine repair shop, before obtaining
a degree in Electronic Automation at Liaoning Broadcast University. He
saw great potential in the waste water treatment industry and started
his first venture, Dalian Yingkun Energy and Environmental Engineering
soon after. In 2003, he founded Dalian RINO and became its CEO.6
Board Composition
RINO’s board comprised three independent directors – Professor Quan
Xie, Kennith Johnson and Zhang Weiguo – and two non-independent
directors, Zou and Qiu7.
The husband-wife pair of Zou and Qiu had a large presence in RINO’s
management and board through their shareholdings and positions in
RINO’s subsidiaries. The three independent directors lacked industry
experience although they were from diverse backgrounds. Professor
Quan was an academic in the environmental and life sciences discipline,
Johnson was a CPA and had extensive experience in public and
corporate auditing, while Zhang was the Chief Operating Officer of the
Chinese milk formula company, Synutra, and was responsible for its US
operations and strategy.
Board Committees
The audit, nomination and compensation committees were made up of
the same people: Johnson, Zhang and Professor Quan. This fulfilled
NASDAQ’s requirements of having at least 3 independent directors on
the audit Committee8. The directors each chaired a committee. Johnson
was the chairman of the audit committee; Zhang chaired the nomination
committee and Professor Quan the compensation committee.
Director Compensation
The independent directors were each paid cash retainers of US$2,000
per quarter and US$500 for each board or committee meeting attended9.
On top of this, Johnson received 2,000 shares in 2009 for his role as
chairman of the audit committee but there were no additional fees or
benefits for other directors. The non-independent directors did not
receive director fees or benefits.
Although the 2009 annual report indicated that the board of directors met
six times during the year, it reported that the fees paid to both Zhang and
Professor Quan’s to be only US$8,000 – which was only the guaranteed
basic cash retainer amount for a year.
CFO Turnover
RINO had three different chief financial officers (CFO) in three years:
Bruce Carlton Richardson served from October 2007 to September 2008,
Qiu from October 2008 to April 2010, and Ben Wang from May 2010.
Trouble Looms in Muddy Waters10

On 10 November 2010, Muddy Waters, a short-seller, issued a report
which questioned RINO’s actual financial situation. Among the allegations
were accounting irregularities in RINO’s 2009 revenues, which differed
substantially between its results reported in the US (US$193 million) and
its results in its Chinese regulatory filings (US$11 million). Muddy Waters
estimated its actual 2009 revenues to be under US$15 million.
To make matters worse, none of this income was transferred from Dalian
RINO to RINO as agreed. Instead, the capital raised by RINO was diverted
to fund Dalian RINO’s China operations. In addition, RINO’s CEO, Zou,
publicly confirmed that of its six major flue gas desulphurisation (FGD)
contracts, two were non-existent and the remaining four had “issues” 11.
Suspicions were heightened when RINO did not report any tangible
assets as would be consistent with a manufacturing firm. RINO’s tax
disclosures to the SEC and RINO’s reported zero tax in China, both of
which did not match its reported revenues.
Questions About the Auditor’s Role

The discovery of these irregularities by a short-seller firm, instead of an
audit firm, begs the question as to the competency of RINO’s auditor.
First and foremost, Frazer Frost is a relatively small firm and did not
have local operations or an office in China. Instead, employees travelled
to China from their California headquarters to perform audits, which cast
doubts on their capability in performing audits effectively.
The audit partner, Susan Woo, did not have significant experience
in auditing listed companies in the US, much less overseas-based
companies. She had 13 years of accounting experience specialising in
international tax and finance. Moreover, checks revealed that almost all
of Frazer Frost’s listed clients were China-based companies.
The Fallout
One day after the release of the Muddy Waters’ report, RINO stated that
it had begun an internal review12 and five days later, RINO decided to
postpone its Q3 2010 earnings conference call. After the confirmation
of fraudulent accounting practices, RINO’s audit committee issued a
statement declaring that it will conduct a thorough investigation.
After the allegations by Muddy Waters, RINO’s stock collapsed by 60 per

cent from US$15.52 to US$6.07 over six days. On 11 April 2011, SEC
suspended RINO from trading13. Compared to a year ago, RINO’s stock
had fallen almost 80 per cent.
Closing the Loophole

The discovery of RINO’s accounting fraud, together with scandals
involving many other Chinese reverse merger companies, led the US
Securities and Exchange Commission (SEC) to tighten requirements for
listing through reverse mergers. The new rules required companies to:
1. complete at least one year of “seasoning period” trading in either the
US over-the-counter market or on another US-regulated or foreign
exchange;
2. maintain a minimum closing stock price of US$4 (US$3 or US$2 in
the case of NYSE and Amex, depending on the listing standard) per
share for 30 of the 60 days before the date that listing begins; and
3. timely file all required periodic financial reports with the SEC or other
regulatory authority, including at least one annual report containing
audited financial statements for a full fiscal year commencing after
the filing of the above information.14
Cross-Border Issues
The SEC and the China Securities Regulatory Committee (CSRC) had
signed a memorandum of understanding to improve cross-border
cooperation and collaboration in 1994. However, the SEC does not have
any say on the reporting procedures of Chinese companies to China’s
State Administration for Industry and Commerce (SAIC), which requires
all local and foreign companies to submit their business operating reports
(including annual financial statements) annually.
Before the new rules, NASDAQ did not require foreign companies to
submit reports that were lodged in their home countries. This meant that
RINO had needed to comply only with the Sarbanes-Oxley Act, NASDAQ
listing rules and other applicable corporate laws in US.
1. What are the key corporate governance issues in this case?

2. What additional corporate governance issues could arise from a
foreign listing through a reverse merger in the US?
3. From a corporate governance perspective, what are some of the key
red flags that indicated fraud in RINO International?
4. Chinese model of governance is considered less transparent
compared to western models. Do you agree? Briefly discuss
governance in Chinese businesses
5. Are there any examples of Indian companies using reverse merger
to list in US markets?
6. Are there any specific rules/regulations in India concerning reverse
mergers?
PCCW Privatisation
Scandal
Case Overview
After a 97 per cent fall in its share price over eight years, the management
of PCCW Limited proposed to privatise the company by buying out
the shares held by minority shareholders. In doing so, the company
management, led by Richard Li Tzar-kai, allotted shares to insurance
agents on condition that they would vote in favour of the resolution, thus
going against the spirit of the prevailing corporate governance rules in
Hong Kong. After a protracted legal battle, the courts disallowed the
controversial vote. The objective of this case is to allow a discussion
of issues such as corporate governance in a management-controlled
company, the roles and effectiveness of different corporate governance
mechanisms, the protection of minority shareholders’ interests in a
privatisation situation, and business ethics.
PCCW: A Chequered Past

Founded by Richard Li Tzar-kai, the son of Hong Kong tycoon Li Ka-shing,
PCCW Limited (PCCW) is the holding company of HKT Group Holdings
Limited (HKT), which operates primarily in the telecom, broadband and
multimedia industries. It also has interests in the broadband sector in the
United Kingdom and a property development company in Hong Kong.
In 1999, PCCW acquired highly-prized waterfront real estate from the
government without a public auction. This was highly criticised by the
media and other property developers.1 In 2000, the company acquired
Hong Kong Telecom (HKT) for US$41 billion, marking the largest merger
in Asia at the time. However, due to debt incurred during the process,
intense competition in the local telecom sector and the challenge of
an international joint venture with the Australian telecommunications
company Telstra Corporation, the share price plunged 97 per cent from
a peak adjusted price of $131.75 between 2000 and 2008. PCCW was
removed from Hong Kong’s benchmark Hang Seng Index in June 20082.
Richard Li attempted to sell his stake in the company in 2006. The

Chinese Government thwarted this attempt by blocking the sale through
its control of China Netcom, which owned a 20 per cent stake in PCCW3.
In 2008, PCCW’s businesses were hit hard by the global recession. Profit
slumped 20 per cent in the first half of the year4. However, some key
financial indicators, such as EBIDTA and earnings per share remained
stable. After declaring a dividend of HK$0.133 per share, PCCW ended
the year with a stable financial position despite the impact of the crisis.
The Board of Directors

As at 31 December 2009, the PCCW board comprised a total of 15
directors, including five executive directors, four non-executive directors
and six independent non-executive directors.
40 per cent of the board is made up of independent non-executive

directors, although the sixth independent non-executive director,
Edmund Tse Sze Wing, was only appointed in September 2009. This
fulfilled the minimum standards specified in both the Hong Kong Listing
Rules and Hong Kong Code of Corporate Governance. PCCW requires
each independent non-executive director to submit an annual written
confirmation of his independence from the company. In accordance with
the Company’s Articles of Association, at each annual general meeting,
one third of directors are subject to retirement by rotation. Each non-
executive director also has a term of three years and the maximum term
of office for each non-executive director is three years5.
The Vote Buying Scandal

After his attempt to sell his stake in PCCW was thwarted by the Chinese
government, Richard Li began a three-year campaign to privatise the
company. Since PCCW is listed on the Hong Kong Stock Exchange, the
privatisation scheme was governed by both the Companies Ordinance
(CO) as well as the Code of Takeovers and Mergers (Takeovers Code).
Under the headcount rule of the Companies Ordinance, if three-fourths
of members vote either in person or by proxy in favour of a proposal,
it is binding on all members. In other words, at least 75 per cent of the
shareholders, regardless of the number of shares each shareholder
owns, were required to approve the privatisation proposal6.
Under a scheme announced on 30 October 2008, Li and China Netcom

offered to pay HK$15.9 billion to buy out minority shareholders. This would
lift Li's stake in PCCW from 27.7 per cent to 66.7 per cent and Netcom's
stake from 19.8 per cent to 33.3 per cent. Minority shareholders were
offered HK$4.50 per share, representing a huge discount from the peak
share price of HK$131.75 attained before the merger with HKT in 2000.
However, in response to the offer, the price of PCCW shares increased
from HK$2.90 on 14 October 2008 before trading of the counter was
suspended to HK$3.58 on 5 November 2008 when trading resumed.
At the shareholders' meeting to approve the proposal, management
was accused of vote manipulation and rigging. Yet, the proposal was
eventually approved with 80 per cent support7.
On receiving a complaint from the well-known HK governance activist

David Webb, the Securities and Futures Commission (SFC) investigated
allegations of vote buying. Investigations revealed that 1,000 share board
lots were distributed to insurance agents of Fortis Insurance Company
(Asia), previously owned by PCCW. The shares were given in return for
the assurance that the agents would sign proxy forms to vote in favour
of the proposal. This scheme was allegedly conceived by Francis Yuen,
part of Richard Li’s buyout group, and instructions were given to Inneo
Lam, Regional Director at Fortis, to distribute the shares to 500 Fortis
agents. Without these insurance agents, the buyout plan would only gain
marginal support, with 903 approving and 854 opposing8. Such a slim
majority would not have met the headcount rule’s requirement of 75 per
cent support by number of shareholders.
Initially, the Court of First Instance approved the privatisation plan.

Following the ruling, the Court of Appeals granted leave to the SFC to
appeal against the verdict9. The SFC applied to the court to veto the
results of the shareholder meeting. On 11 May 2009, the Court of Appeal
ruled that there was a clear manipulation of the vote and the extent of
the manipulation raised doubts on the fairness of the voting results. In
addition, the court said that vote manipulation is an act of dishonesty and
the court could not sanction such an act. The judge made the following
observation, referring to elderly minority investors who had invested in
PCCW:
“These people have put their life savings into it, and they’ve got
nothing left. Look what happened - it [the stock price of PCCW]
has gone down from HK$120 to nothing! It’s pathetic … there’s
a difference between a takeover and a squeezing out10.”
Questions of Shareholders' Rights, Ethics and Legality

The scandal raised questions about how privatisation proposals should
be determined and whether the splitting of votes violates the letter or
spirit of rules designed to protect minority shareholders.
Many institutional investors, having invested for the short term, accepted
the proposal due to the premium of the offer price over the prevailing
market price. However, the Court of Appeals highlighted the plight of
retail investors, saying, “These small shareholders are not realising their
investment but in fact are being left behind ... I can’t see it's going to do
the company any good.”11
Another important issue was that the buyout plan was drafted in a manner
that would greatly benefit Richard Li and China Netcom. According to
the proposal, after PCCW was privatised, Richard Li and China Netcom
would be awarded a special dividend that would cover the entire cost of
taking the company private, plus provide an extra HK$2.9 billion once
the process was completed.12 Since management did not justify the
decision to award the special dividend to the parties making the buyout
offer, one of the judges hearing the case commented that the proposal
was “outrageous”13. These issues exacerbated the concerns of minority
shareholders, many of whom were elderly investors who had to leave
the meeting before casting their vote since it dragged on for more than
7 hours14.
The evidence of vote rigging did not technically violate Hong Kong’s market
regulations because there were no laws against splitting shareholder
votes. However, since it went against the spirit of the headcount rule,
Richard Li and China Netcom had to withdraw the proposal based on the
Court of Appeal judgement.
1. What are the key reasons for public companies to consider
privatization? Cite examples from different parts of the world
2. The privatization of PCCW required the approval of 75 per cent of
shareholders (or their proxies) present at the shareholders' meeting.
In your view, was this fair to small shareholders? How about large
shareholders?
3. In major corporate transactions, such as the PCCW privatization,

different shareholders may have different interests and preferences.
How should the board and regulators balance the interests of these
different shareholders?
4. If majority shareholders are in favour of a major corporate action,
should it be held back till minority shareholders agreement is also
received?
5. Why are privatization efforts are rare in India? Cite
examples/incidents of public companies attempting to go private
6. Are there any regulatory/governance mechanisms in India to
protect interests of minority/small shareholder?

Samsung: Case Overview

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Copyright © 2020 Mak Yuen Teen and CPA Australia.