Case Study: “Governance Failure at Satyam”:
Satyam Computer Services limited is a company that was founded by Ramalinga Raju and his brother Rama Raju. Despite gaining important awards for better corporate governance and its founder Ramalinga will be remembered for steering the biggest scandals in India’s corporate industry. The irony is that the term ‘Satyam’ means “truth”. It is clear that its’ business practices do not regard what the company name means as analyzed in this paper.
- Discuss the circumstances under which the Satyam scam was exposed. What according to you were the reasons of the fraud?
The failed attempt by Satyam to procure stakes at both Mytas Infra and Mytas properties in 2008 resulted to exposure of the scam (Gaur & Kohil 4-6). Satyam planned to borrow $300 million to finance the deal which would add to more than $ 1 billion in cash it purported to have. However, the deal never took off because investors resisted to provide capital which led to Satyam calling off the deal. However, the deal raised red flags about its business practices that precipitated to suspension of its dealings with the World Bank it for 8 years (Gaur & Kohil 4-6). What followed was the resignation of one of the company’s independent director (Mangalam Srinivasan) and the Investment Bank DSP terminated its contract with Satyam after discovering financial irregularities. Soon after an email relating to the fraud and falsification of documents was sent to the board by a former executive. This precipitated Ramalinga Raju resignation letter to SEBU in which he admitted to defrauding investors by falsifying the financial statements (Gaur & Kohil 4-6).
Reasons of the fraud: Ramalinga admitted that he defrauded the system to avoid detection of the company’s low profit margins and to maintain the stock market prices of the company shares (Gaur & Kohil 4-6). According to him this was avoid any hostile takeovers. Ramalinga further claimed that he never reaped anything from the scam but there exists no plausible explanation to his healthy earnings from the company and the high profit margins of his peer companies. According to Grover other reasons include, the corporate governance was weak hence it failed in monitoring the company actions, the independent directors held dubious roles because it is astounding that they never discovered about the scam and finally the failure of all the levels of auditing (50-57).
- Could this fraud have been prevented? Who could have prevented it? How?
Indeed, it could have been avoided. The company had several systems of governance that would have discovered about the massive scam and prevented it. However, all its internal controls were weak (Sharma 136-140). The independent directors could have prevented it by enforcing their authority by questioning how the firm had such huge amount of money in cash. The board of directors could have emphasized the need for transparency and accountability by all senior executives and next level employees; and frequently checked the firm’s performance in the market to ensure necessary steps are taken to prevent falsifications or malpractices (Sharma 136-175). The audit committees could have ensured that the financial disclosures actually reflected the financial position of the firm.
- Critically evaluate the corporate governance mechanisms adopted by Satyam?
Satyam has over the years won three important awards for good governance. First, it was recognized nationally and was awarded the Golden Peacock award in 2002. Secondly, it was rated the best in corporate governance by IRGR both 2006 and 2007. Thirdly, it received global recognition in good governance by being awarded the Golden peacock award in 2008, a few months before the exposure of the scam (Gaur & Kohil 1-6). Satyam complied with the law and regulations in its composition of board and committees members. It adhered to governance standards that were beyond what was prescribed in the law. Shareholders elected board directors to enforce the company principles. The management was responsible for developing and implementing policies and procedures to ensure maintenance of company values. It even had models and ratios for predicting financial frauds (Gaur & Kohil 1-6). It is ironical that despite, the existence of such control mechanisms none detected the well planned scam.
- What characteristics of the board of directors play a role in preventing financial statement fraud?
The board should exercise their authority by monitoring the business and ethical practices and the manner in which they are applied. Qualified and skilled directors are accountable for all accounts information disclosed to the stakeholders (Sharma 136-175). Independent directors in audit committees should promote transparency through disclosing financial information that reflect the company financial position. Board directors should active and not inactive in management of company affairs, hence they should often check the firm performance to prevent malpractices (Sharma 136-175). They should act in good faith for the benefit of the company stakeholders.
- What lessons about the audit committee can be learned from this case?
A significant lesson learnt is that, following auditing methods that rely more on good faith and trust instead of verifying the financial information disclosed provides an opening for fraudsters (Gaur & Kohil 4-6). Internal controls are weakened in cases where the scam source comes from the top, therefore, the responsibility of reassuring investors and shareholders is left to the external auditors if they do their duties diligently (Grover 50-57). Independent directors in the auditing committees should ensure autonomy of internal auditors to ensure they don’t get comfortable with fraudulent accounting practices as a result of cozy relationships with the management. It is the duty of auditors to verify the financial information disclosed to ensure they provide a true picture.
- What other governance mechanisms should be adopted to ensure compliance?
The government should enforce that companies should establish sufficient internal control mechanisms. Additionally, it should set stringent laws and strengthen institutions responsible for taking actions against fraudsters (Grover 50-57). The authority and responsibilities of independent directors should be clearly defined. The Models for detecting fraudulent activities should be enhanced by integrating with the new accounting technologies. A whistle blower policy should be developed and implemented to increase the abilities of directors detecting malpractices of falsification of account documents. External auditors should maintain their autonomy while conducting auditing duties and the government should ensure that auditing companies that collude with fraudsters are blacklisted immediately (Grover 50-57).
It is important to note that, all the right mechanisms were available but they lacked the strength and capacity to control the company’s operations. The board directors and management should strengthen and improve the capacity of intern auditor’s abilities to monitor and verify accounts information. Board directors should make independent judgments and ensure adherence to company articles. Auditors should always adhere to good auditing practices that require them to compare company financial statements and bank statements.
Ajai S. Gaur & Kohil N. Governance failure at Satyam. Richard Ivey School of Business Foundation. 2011.
Grover, N. “The Satyam Scam: A Corporate Governance Perspective.” SSRN Electronic Journal, doi:10.2139/ssrn.2470971.
Sharma, J. P. “Corporate Governance Failure: A Case Study of Satyam*.” Indian Journal of Corporate Governance, vol. 3, no. 2, 2010, pp. 136-175, doi: 10.1177/0974686220100204.