Abstract
Satyam Company is a good example of companies that have failed due to fraud and embezzlement of funds by senior officials. Based on the findings from different scholars, the company lacked independent directors, thus giving room for wrongful misappropriation of funds.
Its external auditors also colluded with the directors to defraud the investors. The company had a weak internal control system and in its operations, the promoters held executive position, and thus they had great influence on the company’s decisions.
This essay is prepared based on the requirement of the course as directed by the tutor. This paper seeks to advise the management team of Satyam Ltd. on the best corporate culture to adopt in its administration.
The report is based on the view that the management of Satyam Company has reported at least one incidence involving misappropriation of funds by some irresponsible financial controllers.
Therefore, the aim of this study is to analyse the company’s corporate governance critically and evaluate the strengths and weaknesses of its internal control system before coming up with the necessary recommendations.
The recommendations that will be given at the end of the essay will be based on the provisions of the UK code on corporate governance.
Introduction
In the modern world, the scope of corporate governance has changed due to the high number of companies that have failed due to misappropriation of funds. It has been taken to include the accountability concept especially in the accounting department.
The need for sound corporate governance has been perpetuated by the nature of modern businesses, which are run by third parties on the behalf of the shareholders or owners. A number of factors have facilitated the need for improved corporate governance.
Firstly, most businesses today are in the form of companies, which are owned by a great number of shareholders who are scattered, and thus cannot control the affairs of the firms (Varottil, 2010).
Secondly, the shareholders may require professionals to manage their businesses. This aspect creates a principal-agent relationship between the shareholders and the directors of the company.
Therefore, the concept of corporate governance becomes essential since for the shareholders’ interests to be secured there must be a control of the directors’ actions.
This essay therefore seeks to identify the shortfalls in the control system of Satyam Company and advise the company accordingly.
Literature review
Corporate governance denotes the way in which firms are managed effectively (Bhasin, 2013). It outlines the rights and obligations of all the interested parties such as the directors, shareholders, and creditors among others.
Corporate governance also outlines the decision-making procedures and explains the role of each stakeholder in the process. It defines the corporate structure of the company clearly by outlining the role that each stakeholder is expected to perform.
Owners of modern businesses employ managers to run the businesses on their behalf (Atesci, Bhagwatwar, Deo, Desouza & Baloh, 2010). This scenario results in a conflict of interest between the owners and managers as the latter would like to maximise their earnings at the expense of the owners.
In addition, the failure of large companies across the world has contributed to the need for a well-outlined set of rules defining corporate governance.
Governments in most countries across the world have recognised the need for corporate governance and thus they have established uniform laws governing the conduct of agents in a bid to reduce agency risks involved.
In this essay, corporate governance in the UK and India will be given as examples of good corporate governance and the recommendations will be based on the two aforementioned nations.
Corporate governance in United Kingdom
Corporate governance in the UK is based on the provisions of the UK Corporate Governance Code and the companies Act (Armour, Deakin, & Konzelmann, 2003). The code outlines the rights and obligations of the shareholders and insists greatly on the shareholders interests.
It calls for the existence of a board of directors in every company whether private or public. There is a requirement that a majority of the directors in the board to be independent directors who are elected through a poll in an annual general meeting (Aguilera & Jackson, 2003).
The board also comprises other ex-official members drawn from a cross section of professionals. In a bid to protect the shareholders’ interests, non executive directors are required to dominate the board and only a few executive directors are incorporated in the board.
The Chief Executive Officer of the company in the UK serves as the chairman of the board, but his/her powers are controlled by the other board members (Dewing, 2003). Any decision involving large amounts of money must be agreed upon by all members before it is executed.
The directors have expressed and implied powers that they can use to make certain decisions. However, in most cases the shareholders must be called upon to pass certain decisions involving their interests. In the UK, companies are largely governed by the corporate charter (Denis & McConnell, 2003).
On the other hand, the stock markets govern the sale and purchase of securities in the market. Every company is required to submit a copy of its bylaws to the registrar of corporations. The bylaws must conform to the corporate charter laws, and thus any contradicting provision in the bylaws is regarded null and void (Aguilera & Jackson, 2003).
In addition to the provisions of the corporate charter, companies whose stock is listed in the London Exchange market (LSE) must comply with certain requirements.
With the adoption of the companies Act, the LSE was given the full mandate to see that the companies apply the statutory provisions regarding the exchange of stock. Among the requirements of “the LSE is that all listed companies must have independent directors dominating the board of directors” (Armour et al., 2003, p.541).
Decisions made by these directors are expected to be independent and none of the directors should be left to make decisions without involving the rest of the team. In a bid to maintain the independence, the independent directors cannot hold managerial positions or any other position in the company.
The companies listed in the stock market are also expected to hold board meetings at regular intervals (Denis & McConnell, 2003).
The management is barred from attending these meetings in a bid to ensure that the independence of the directors is maintained. Board members form committees from among themselves. The committees are charged with the responsibility of recruiting new members into the board.
Corporate Governance in India
India has for a long period lagged behind in the efforts to establish corporate governance principles. In 2011, the country demonstrated attempts to come up with a set of rules that would define its corporate culture (Varottil, 2010).
India’s parliament passed the Companies Bill that outlines the principles of governance in companies. Before the enactment of this bill into law, the Securities and Exchange Board of India (SEBI) governed India’s corporate structure.
SEBI was not effective until 2000 when a committee was appointed to offer recommendations on the changes that would make it effective in its corporate governance provisions (Henley, 2006). The committee came up with recommendations that were implemented in the year 2000.
The committee wanted the composition of the board of directors to include both executive and non-executive directors in the same ratio. The committee also recommended that an independent director should head the audit committee.
The composition of the audit committee was to be comprised of at least three directors with the financial controller regarded as a member. The recommendations placed the directors in a fiduciary relationship with the company. The salary of the directors was to be fully disclosed and approved by the shareholders.
Satyam Computer Services Limited
The company opened its doors in 1987 (Henley, 2006). It was formed as a private company with B. Ramalinga as the main shareholder. In 1990s, it invited the public for subscription of its shares, and thus it turned public. The company’s main objective was to offer IT services.
The Indian company was identified as one of the main suppliers of software and it was later listed in the New York Stock Exchange (Athreye, 2005), which is an indicator that the company was financially sound. During the same period, the company managed to open subsidiaries across the world.
Later on, Satyam signed merger agreements with several companies across the world (Bhasin, 2013). The reputation of the company spread fast internationally since the company offered solutions to the ever-emerging IT problems.
Due to its ever-growing reputation, the company managed to attract investors from all corners of the world and acquired new customers each day.
Satyam scandal
The company’s setbacks started in 2009 when its promoters decided to buy a stake from the Matyas firms without involving the shareholders. The law requires the directors of a company to convene a general meeting to deliberate on the viability of an investment (Pillania, 2012).
The shareholders may approve the transaction or reject it altogether. The promoters argued that the investment did not require the approval by the shareholders and they went ahead with the transaction. The directors of the company approved the deal without informing the shareholders.
The decision received opposition from the shareholders especially when they learned that Raju’s relatives owned the Matyas (Varottil, 2010).
On learning the shareholders’ mood, the directors revoked their earlier decision, thus making it impossible for the transaction to be executed. This decision by the directors did not go well with the company’s reputation as it had the effect of lowering the market value of the company’s stock.
The company’s main promoter, Ramalinga Raju, later admitted that he had engaged the company in ghost transactions leading to loss of huge amounts of shareholders’ capital (Henley, 2006).
Consequently, the market value of the company’s stock was slashed by more than 75% immediately Ramalinga confessed to the allegations (Bhasin, 2013).
Before he resigned from his position as the executive director of the company, Raju confessed of ballooning the company’s profits to induce investors to invest their funds in the company’s stock.
This confession resulted in a further fall in price of the company’s stock. The year 2009 saw the company incur huge losses due to the disclosure by Raju (Henley, 2006).
Raju was accused of falsifying the accounts of the company, manipulating balance sheet items by presenting assets that never existed, and presenting fake account balances at the end of the financial year (Khanna, 2009).
These evil acts were perpetuated by the fact that Raju held the senior most position in the company and he was thus in a better position to manipulate the company’s financial accounts. There were no internal control checks, and thus the fraudulent activities could not be easily detected (Kapur & Ramamurti, 2001).
Governance issues surrounding Satyam Company
Insider dealing is a common scene in the company. The laws governing the directors’ dealings with a company deny them the right to participate in decision making as to whether a transaction should be approved without first declaring their interest in the transaction (Pillania, 2012).
Investigations into the Satyam saga revealed that an insider trading formed the better part of the company. Right from the promotion of the company, the promoters acquired land from the sale of shares to Raju’s relatives.
The investigating committee revealed that the company raised huge amounts of money from sale of shares within a very short period. The committee further argued that such huge turnover of shares could not be achieved without an insider transaction (Afsharipour, 2009).
The company’s insider dealing is also evident in the last attempt by the directors of the company to invest in the Matyas Company. The firm belonged to Raju’s relatives and its price was inflated to benefit the seller. The top officials of the company initially purchased the largest part of stock of the company.
The latter then disposed of the shares at a higher price when the company was seen to be failing. The officials used the secret information they had about the company to make secret profits at the expense of the shareholders. This aspect is a clear indicator of poor corporate governance in the company.
The auditors’ report was questionable since the audit fee paid to the auditing firm that had the responsibility of reporting to the shareholders on the company’s financial statements was too high as compared to the fee charged by similar audit firms (Gupta, Nair & Gogula, 2003).
The financial statements were doctored with the help of the auditors of the company. The audit committee of the company was aware of the misrepresentation of accounts, but it too colluded with the auditors to defraud the shareholders (Singh, Kumar & Uzma, 2010).
Companies whose stocks are listed in the New York Stock Exchange have the obligation of establishing a nomination board manned by independent directors (Pillania, 2012).
The company ignored this provision and never set the committee as per the requirements of the New York stock exchange, which was made possible by the fact that the Indian governance structure did not expressly provide for the formation of the committee (Afsharipour, 2009).
Therefore, it was not mandatory for the company to set a nomination committee.
Management control system in Satyam Company
The term ‘management control system’ (MCS) as used in this context refers to the internal checks in the management (Kapur & Ramamurti, 2001). The system involves a number of control measures to ensure that policies and strategies formulated are implemented effectively to achieve the organisations’ goals.
Continuous assessment of the management teams’ conduct is desirable. MCS works very close with corporate governance for the benefit of the company (Nikam, Ganesh & Tamizhchelvan, 2004).
Due to this close relationship between the two, failures of either of them may result in the failure of the other, thus exposing the company to the danger of extinction. MCS in Satyam Company was questionable and so was its corporate culture. The company’s failure can thus be attributed largely to the lack of effective MCS.
Recommendations
Though the fraud can be attributed to numerous factors, the main cause of the fraud was lack of properly defined set of rules governing the conduct of business in the company.
Lack of proper implementation of the already existing rules inside the company’s corporate governance could also be cited as a factor that led to this fraud (Khanna, 2009).
In the light of the fraud case involving Satyam Computer Company, the Indian capital market should focus on reducing such instances by applying the following two approaches, viz. the preventative and palliative measures (Bhasin, 2013).
The palliative control measures, if well invoked, will help in detecting fraudulent activities by altering the current verification procedure and implementing new improved procedures that are not known by many.
On the other hand, the preventative measures focus mainly on detecting and controlling fraudulent acts at earlier stages before huge losses are incurred. The latter is the best option since it produces effective results both in the short run as well as in the long term.
The other thing worth recommending to the company is the separation of obligations between owners of the company and directors. Clear separation should be observed between the shareholders and directors of the company.
In the case of Satyam Company, director Ramalinga Raju owned a better portion of shares in the company (Varottil, 2010). In addition, he served as the executive director of the company, which could lead to decisions that are not in favour of the company.
Such a director will have great influence on other directors since the rest of the director will look at him/her as their employer and will tend to follow his/her directions unquestionably.
There should be a group of independent directors in the company charged with the responsibility of recruiting directors based on their qualifications and expertise (Khanna & Palepu, 2005).
On the other hand, he directors should not remain in office when their terms expire. Instead, they should be elected to serve for a maximum of one year after which another recruitment exercise is carried out. However, the retiring directors should not be denied the chance to serve the company if they are re-elected.
A proper code of conduct similar to the one in the UK example given above should be established with trust and honesty being the backbone of the code. Continuous assessment should be carried out from time to time to ensure that all the staff members of the company observe the code’s provisions.
Division of responsibilities is also another important factor that Satyam Company should embrace. An executive director should have his/her roles defined and s/he should not be allowed to hold any other position.
The directors should work as a team and no director should be allowed to make certain critical decision on his/her own. There is also need for independent internal auditors in addition to the external auditors who will maintain proper accounts in the company and help detect fraud when being executed (Henley, 2006).
The internal auditors should work closely with their external counterparts and even work together when need arises.
Reporting on the financial accounts is the responsibility of the directors (Khanna & Palepu, 2005). The directors thus ought to maintain an objective and purposeful relationship with the auditors to ensure that the report presented to the shareholders reflects the true and fair view of the company’s financial status.
Additionally, the directors should outline their role of ensuring that proper accounts have been prepared and present the same to the shareholders along with the auditors’ report. However, the independence of the auditors should be observed closely to avoid collusion with the management.
Clear penalties should be well spelt for auditors who collude with the management to give misleading reports (Shamir, 2004). Directors are chosen under the watch of shareholders in the annual general meeting.
Their selection is not based on their expertise, but rather on merit and ability to hold such position (Atesci et al., 2010). The directors should be offered continuous training on the corporate culture to make them understand the scope of the fiduciary duties that they owe the company.
Conclusion
Satyam Company’s failure was due to poor governance. The company had a poor management control system. There was a separation of responsibilities between the owners and directors as the main shareholder of the company, Raju Ramalinga, held the position of an executive director in the company.
Lack of properly defined division of responsibility between the two gave the director a good opportunity to defraud the company of its funds since the other board members could not question his decision. The company had a weak internal control system, and thus the fraud could not be detected in time.
In a bid to cut down cases of fraud and misappropriation of funds by some individuals, there has to be strong internal controls manned by independent directors. Directors should also be trained on their rights and obligations in the companies that they run.
The company therefore need to borrow some of corporate governance practices from the UK Code of corporate governance. The code for example requires that the board of directors be comprised mainly of the non-executive directors.
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