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Corporate governance case study: SATYAM FIASCO

Corporate governance case study: SATYAM FIASCO

In December 2009, the board of directors of Satyam computer services, the then India fourth largest IT Company, announced their unanimous decision to invest $1.6 billion in buying management stakes in two non- IT firms, Maytas Properties (real estate) and Maytas Infra (infrastructure). Immediately, Satyam shareholders, investors and the stock market reacted against this major decision to enter non-IT segments facing a global slowdown due the financial crisis, and seemingly made to only serve the self interest of Satyam CEO and his family. Even though the BoD had withdrawn its decision shortly after, it was clear that Sataym corporate governance wasnt as good as it should be for a more than once Golden Peacock Global awarded company, and the role of the board members in general and especially the independent directors supposed to act in the best interest of shareholders and investors, was bring to spotlight. Later, CEO Ramalinga Raju confessed massive fraud by falsifying accounts for years, overstating revenues and inflating profits by $1 billion, leading to a real Fiasco of Satyam1.

In this paper, we will analyze and discuss the following issues: Satyam corporate governance The controversial decision and its circumstances Analysis and recommendations

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Corporate governance case study: SATYAM FIASCO

Satyam corporate governance

India's SEBI (Securities and Exchange Board of India: the regulator for the securities market in India) Committee on Corporate Governance defines corporate governance as the "acceptance by management of the inalienable rights of shareholders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is about commitment to values, about ethical business conduct and about making a distinction between personal & corporate funds in the management of a company2. The board of directors, which is at the top of the managerial structure, has a critical corporate governance function as the important internal monitor of the firm. The Directors have a fiduciary duty to act in the best interests of the company in order to improve its profitability and value. They have also a duty of care by well assessing risk while considering strategic decisions. Also, they must put the interests of shareholders, ie the corporation, before their own individual interests. The Indian law requires that any BoD should have an optimum combination of executive and independent Directors with no less than the half of the board comprising of independent ones in the case of an executive chairman. Clause 49 of the SEBI listing agreements defines independent directors as follows:For the purpose of this clause the expression independent directors means directors who apart from receiving directors remuneration, do not have any other material pecuniary relationship or transactions with the company, its promoters, its management or its subsidiaries, which in judgment of the board may affect independence of judgment of the directors.3 Established by B. Ramalinga Raju and his brother-in-law, D. V. S. Raju, Satyam Computer Services Limited was incorporated in 1991 as a public limited company to become over the 90s a leading global consulting and IT services company and among the fewest Indian IT services companies listed on the New York Stock Exchange. It was ranked as Indias fourth largest software exporter, after TCS, Infosys and Wipro. The 1990s were an era of considerable growth for the company. It also caused the formation of a number of subsidiary companies such as Satyam Renaissance, Satyam Info way,

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Corporate governance case study: SATYAM FIASCO

Satyam Spark Solutions and Satyam Enterprise Solutions; Satyam Info way (Sify) incidentally became the first Indian internet company to be listed on the NASDAQ4. On 2009, the BoD of Satyam was composed by nine members comprising five independent directors: Dr. Srinivasan, a management consultant and a visiting professor at several US universities. Prof. Papelu, a professor at the famous Harvard Business School Dham: renown to be father of the Pentium Prof. RAO , dean of the Indian Scholl of Business T. R. PRASAD, Former politician Prof. Raju: chairman of the naval research board

Regarding the qualifications of the board members, it appears that the independent directors are imminent personalities who dont have seemingly any interest link with Satyam operations. Its also clear that they dont have a wide knowledge in the IT and BPO area and the Satyam operations, so we can assume that they must rely completely upon the advice, information and judgment of executive management for any decision. Analysis of attractive commissions and stock options allocated by Satyam to the independents directors for 2007-08, leads to question the real independence of these members. Indeed, stock options were given with a striking discount of nearly IN 498 per Share for a ruling price of INR 500 per share4. The case of Prof. Papelu who get a interesting INR . 9.2 million Professional commission for conducting training programs for Satyam employees undermines seriously its total independence from the management. In the case of executives board members, later investigations conducted by the Andhra Pradesh police and Central agencies have confirmed that the promoters had indulged in insider trading of the companys shares to raise money used to their individual benefits, failing to their legal and fiduciary duty to protect the assets of the company5. The audit committee, though headed by an independent director, failed to detect such practices.

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Corporate governance case study: SATYAM FIASCO

The Controversial decision and its circumstances

On December 16th 2008, Satyam board unanimously decided to acquire management stake in two Heyderabad-based Maytas firms by investing: $1,3 billion for a 100% stake of Maytas properties, a real estate company $ 0,3 billion for a 51% stake of Maytas Infra which carry out infrastructural

projects. The Satyam CEO family own about 38% of the two firms, while they hold only 8,5% in the Satyam company. The board blindly preferred to serve the interest of minor shareholders, ignoring to submit such a major decision to the approval of the stakeholders majority, especially when similar case in 1992 had been actively denounced by shareholders and the board had then promised never to invest in CEO family run businesses6. Institutional investors reacted vehemently against this decision stating that the two firms are largely overvalued against their book worth of only $ 225 million; indeed the real estate sector globally faces a major slowdown because of the financial crisis. At a strategic level, its reasonable to discuss the soundness of this decision of Satyamone of the world's largest implementers of SAP systems- to enter a risky non-IT segment, when HCL a major competitor of Satyam invest $800 million to acquire a SAP consulting firm1. It was a real threat to Satyam market-share and the board is supposed to respond to it by strengthening the company in this segment. The defection of four independent directors after the withdrawal of the decision leads us to ask about their real intentions and contribution in the fiasco. We think that they should have stayed in the board to solve the problem instead of leaving and thus weakening more the Satyam position.

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Corporate governance case study: SATYAM FIASCO

Analysis and recommendations7

As the development of the scandal of Satyam shows, CEO Raju is largely responsible for the Fiasco. According to his confessions, the decision of acquiring the two firms was a last attempt to correct false accounts of in Satyam Books. Independent directors played a passive and negative role by supporting unanimously the acquisition proposal instead of seeking the company best interest. The auditing process both externally and internally failed to detect the fraud. According to a panel discussion organized in New York by the Jindal Global Law School in February 20097, Indian government should perform reforms in order to prevent such scandals to reoccur. The current norms on corporate governance in India do not go far enough to deal with independence of the board in controlling shareholder situations. Some of the possible reforms are as follows: Making nomination committees mandatory for Indian companies.

- Other processes relating to the functioning of independent directors may induce greater credibility in board decision making. These include: The requirements of lead independent directors, Executive sessions among independent directors without the

presence of management, Appointment of advisors (such as lawyers and accountants) by

independent directors to advise them on significant transactions involving a company. Such advice would be provided independent of the management or controlling shareholders. Regarding the fraud and the audit process, there is clearly a case for reforms in the audit system such as:

The appointment of auditors ought to be shifted from the purview of

the controlling shareholders to the independent audit committee so that auditors do not owe any allegiance whatsoever to the controlling shareholders, and that the process of appointment and removal of auditors is effected in a manner that is truly independent of controlling shareholder

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Corporate governance case study: SATYAM FIASCO


- There is a case for the establishment of a body such as the Public Company Accounting Oversight Board (PCAOB) (that was established in the U.S. a few years ago), as that body would review the intensity and the integrity of audits by auditors on an annual basis. - There is need for auditor rotation as it prevents creation of any affinity between auditors and controlling shareholders, and avoids capture of the audit process by insiders in companies. - Auditor liability is currently an unresolved question, and the affixation of liability for malfeasance needs to be clearly defined. In some countries, the public regulatory authorities (such as the securities regulator) could directly initiate action against auditors and the merits of such an approach require careful consideration.

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Corporate governance case study: SATYAM FIASCO

The Satyam case raised questions about corporate governance in a major Indian IT company and impacted adversely the Indian Market as a preferred destination for IT outsourcing and investment. In our point of view, the chairman and executives directors, dishonestly failing to their fiduciary duty, took a major responsibility in this scandal. By their passive acting, the independents directors failed to perform their duty and to live up to the stakeholders expectations, and thus accelerated the Fiasco. Reforms in corporate governance of Indians company should be performed by regulators in order to prevent such scandals in the future.

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Corporate governance case study: SATYAM FIASCO

1. Scandal at Satyam: Truth, Lies and Corporate Governance, Publ i s hed: J anuary 09, 2009 i n I ndi a K nowl edge@Wharton 2. 3. 4. 5. "Report of tbe SEBI Committee on Corporate Governance, February 2003". SEBI Committee on Corporate Governance. SATYAMANYTHING BUT SATYAM by A.C. Fernando , 2010,LIBA (Loyala Institute of Business Administration) 5Satyam investigators uncover systemic insider trading, 21 April 2009, %22_insider_trading.html. Page 15 of the present case Recommendations came mainly from the following blog:

6. 7.

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