This case illustrates the downfall of Satyam, one of the biggest IT giants in India, because of the fraudulent activities carried out by its founder Mr. Ramalinga Raju and his associates. Business world at that point had garnered immense respect for Satyam in terms of risk management and corporate governance practices and Satyam was ranked as the fourth largest IT Company in India. This was the case before December 16, 2008, when Satyam promoter Mr. Ramalinga Raju proposed his intent to acquire Matyas Infra and Matyas Properties.
When this announcement of acquisition reached to the public, investors had a tremendously negative reaction towards Satyam’s decision. Satyam founder eventually admitted fraud in a financial statement revealing that he had been cooking the books of Satyam for quite some time. Raju and his team manipulated cash balance, bank balance, accrued interest figures, overstated debtors and understated liability in order to manipulate the share prices of the company in the market by misleading its investors and the public.
After admission of fraud, share prices of Satyam sharply fell down and Satyam was eventually removed from the New York stock exchange and the Bombay stock exchange. The US investors initiated several class action suits against Satyam for its fraudulent activities and top executives of Satyam were charged with violation of federal securities laws by issuing false and misleading financial statements. The Satyam scandal has shaken the roots of the Indian financial market and has put a big question mark on corporate governance and how far corporations (people) can go to enhance their own personal benefits.
Major Issues in the Case Corporate governance Satyam failed to follow the corporate governance practices that every firm was meant to follow, it looked for loop hopes that could be tweaked to enhance the company’s profit and hide liabilities from the investors as well as the general public. The Satyam Board was composed of ‘chairman-friendly’ directors who failed to question management’s strategy. They were also extremely slow to act when it was known that the company was in financial distress. The Board ignored critical information related to financial wrongdoings before the company ultimately collapsed.
Agency problems The Chairman (Ramalinga Raju) and the CFO (Srinivas Vadlamani) worked together to defraud the stakeholders for their personal gain, while the investors thought that the company was generating revenues, and investing in different areas. Clearly, the Chairman and CFO had personal gain in mind rather than company benefit. There also seems to be conflicting interest of the management and the shareholders i. e. the management wanted to take over two construction companies Maytas properties and Maytas Infra which was against the interest of the shareholders. Arguments
It’s hard to imagine a leading company like Satyam manipulating its financial statements but in this highly competitive industry it is necessary to remain profitable in order to survive in the long-run. This is perhaps the reason why Satyam resorted to manipulating its financial statement. We can see that there were large amount of manipulation in the income statement as well as in the balance sheet of Satyam’s financial statements. Manipulation in the Income Statement The income statement consisted of some inconsistencies that were made intentionally to maintain the level of profitability of the company.
The amount of sales revenue has been overstated by Rs. 588 crore i. e. was recorded as Rs. 2700 crore instead of Rs. 2112 crore. The operating profit margin was recorded as Rs. 649 crore (i. e. 24 % of the sale revenue) when the actual operating profit margin was Rs. 61 crore (i. e. 3 % of the sales revenue). The number of employee was also manipulated i. e. it was recorded as 52000 employees when the actual number of employees was only 43622 employees.
Manipulation in the Balance Sheet The balance sheet also seemed to have some level of inconsistencies from the actual value that were done intentionally to show a strong liquidity position of the company. The cash balance that was recorded as Rs. 5361 crore consisted of non-existence amount of Rs. 5040 crore i. e. the actual cash balance was Rs. 321 crore. The assets side also consisted of accrued interest of Rs. 376 crore which was non-existent and the debtors amount was overstated by Rs. 490 crore i. e. the actual value of debtor was Rs. 2161 crore whereas the recorded value was Rs. 2651 crore. The liability side of he balance sheet was understated by Rs. 1230 crore which was the amount borrowed from the known sources by Mr. Raju to ensure the operations are running.
Even after such manipulations the regulatory authorities, the independent executive and the external auditors were not able to raise the red flag which shows that there is a huge hole in the corporate governance. The company also seems to be having conflicting interest between the management and the shareholders. The company was looking to diversify its business by taking over the construction companies Maytas Properties and Maytas Infra at a cost of 1. billion dollars. Satyam was looking to enter the real-estate business but this was a surprising strategic decision for the shareholders. The shareholders wanted Satyam to expand in related businesses.
The negative reaction of the shareholders toward the decision caused the share prices to fall by 70% in a just a few days of the decision. Managerial Implication Agency problem The problem of motivating one party to act on behalf of another can be called the principal-agent problem or agency problem for short. (Wikipedia, 2013) Agency problems arise in a variety of different contexts.
The agency problem usually refers to a conflict of interest between a company’s management and the company’s stockholders. The manager, acting as the agent for the shareholders, or principals, is supposed to make decisions that will maximize shareholder wealth. However, the decision must be in the favor of all parties but it was not the case with Satyam. Satyam decided to acquire Maytas Properties and Maytas Infra. The shareholders resisted the decision claiming it to be unrelated business and acquisition should not take place with Maytas which became a finishing blow to the company.
Corporate governance and business ethics Corporate governance refers to the system by which corporations are directed and controlled. The governance structure specifies the distribution of rights and responsibilities among different participants in the corporation (such as the board of directors, managers, shareholders, creditors, auditors, regulators, and other stakeholders) and specifies the rules and procedures for making decisions in corporate affairs. (Wikipedia, 2013) Governance is a mechanism for monitoring the actions, policies and decisions of corporations.
On a quarterly basis, Satyam’s earnings grew. Mr. Raju admitted that the fraud which he committed amounted to nearly $276 million. In the process, Satyam violated all the rules of corporate governance. The Satyam scam has been an example for following poor governance practices. The issue of governance rose at Satyam because of non fulfillment of the obligation of the company towards its stakeholders like separating roles of board and management, and also the role of CEO and chairman.
Business ethics reflects the philosophy of business, one of whose aims is to determine the fundamental purposes of a company. Business ethics are implemented in order to ensure that a certain required level of trust exists between consumers and various forms of market participants with businesses (Investopedia, 2013). The culture in Satyam, especially dominated by the board, symbolized such an unethical culture. Satyam as the smallest of the four players was under pressure to show good results in order to survive.
Apart from this there was greed causing them to indulge in unethical behavior. On the one hand, Raju’s rise to stardom in the corporate world joined with immense pressure to impress investors made him a compelled leader to deliver outstanding results. On the contrary, Mr. Raju had to suppress his own morals and values in favor of the greater good of the company. The lure of big compensation to members further encouraged such behavior. In the end the fraud came to an end and the implications were great. Alternatives
The failure of company like Satyam which had been awarded for its corporate governance and risk management creates a dilemma for the investors as to which company to believe and invest. Hence, investors, board, government intervention, accounting standards and ethics and Code of conduct must all work hand in hand to resolve the issue. Investors play an important role in detecting fraudulent activities of a company. They must ensure that information about the company is latest and from trustable source. Hence, they should take more care and compare the trend of the company with the industry before investing.
Board must monitor the ethical policies and the way they are being maintained in the company. Transparency and effectiveness in auditing and regulatory checks through internal and external auditors and monitoring agencies should be maintained as it helps to build and maintain trust and loyalty from stakeholders, increase goodwill and investor’s confidence and establish long lasting credibility for the company. Government should play an active role in company’s affair, frequently checks of the company’s performance and take necessary steps to discourage malpractice and falsification.
There is a need to create strong measures to prevent fraudulent activities from happening in future and the auditing firms also need to be brought under the regulatory umbrella. Moreover, all companies need to practice ethical behavior. Every company should also have its own fraud detection mechanism. It is also important for companies to establish an organizational culture, which supports ethical conduct through a code of conduct and properly laid out corporate governance policies and procedures.