The purpose of this case report is to review the case on the Governance Failure at Satyam. Satyam Computers, a large information technology services company in India, was founded in 1987, by brothers B. Ramalinga Raju and B. Rama Raju. It was very successful and provided services to a wide range of customers. Once renowned for its corporate governance, the company would later become known world-wide for the fraud it committed. It is described as a major blunder and one of the largest scandals in corporate India. It became a huge embarrassment to the structure of India’s regulations and governance. It caused many to question the practices and norms accepted in the corporate world. This report will cover how and why the fraud was able to occur, how was it exposed, and ways to ensure that nothing of this magnitude will happen again.
Circumstances for Fraud Exposure and Reasons for Fraud
On December 16, 2008, Satyam attempted to acquire a 51% stake in Maytas Infra, a company listed in the Bombay Stock Exchange for $1.3 billion and 100% of Maytas Properties for $300 million. The companies were in the construction and real estate business, and the company borrowed $300 million to add to the $1.2 billion of cash that it currently had. The reasoning for the acquisitions was to combat the slow growth in the IT industry, but the acquisitions were essentially for the families and friends of the chairman, Ramalinga Raju. They were awarded a good stake in each company, and the investors did not like the move. It caused a 55% decline in Satyam’s ADRs. Due to this reaction, Satyam called off the acquisition the next day, but the damage was done, as the share prices fell 30% in the Indian stock exchange. The substantial related party transactions involved, is what started to raise suspicion on the corporate governance practices. About a week later, the World Bank suspended them for 8 years from doing business with them because Satyam was accused of offering bribes to gain lucrative contracts. This caused the independent director to resign as he took responsibility for not voting against the acquisition and the board meeting scheduled for December 29th was canceled and 4.41 million shares were sold. It decreased the family’s stake from 8.65% to 5.13%. In his resignation letter to the Securities and Exchange Board of India , B. Ramlinga Raju admitted to fraud by falsifying financial statements and creating $50 billion worth of non-existent cash balances.
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I believe that Raju committed the fraud for numerous reasons. The main reason was to prevent his company from being stripped from him. The company quickly became a public company but was a private traditional family run company. According to Exhibit 2 in Governance Failure at Satyam, the board of directors consisted of the two brothers and two other employees under Satyam, along with five independent directors. This made it easy for Raju to manipulate the board and he could exploit his position to approve of his initiatives. The board is supposed to work in the best interest of the stakeholders. Without the presence of an independent board, the other directors were reluctant to speak up and go against the CEO. Another reason was to manipulate his own compensation. When the governance structure is less effective CEOs can increase their compensation, so by misstating performances and stated that the company overachieved the CEO could receive more compensation. At the time PwC were their external auditors. Satyam was paying twice as much as the rest of the industry. Due to the large amounts of money being paid by Satyam, PWC seemed to be overlooking some obvious red flags for fraud. I believed that they could have been aware of the situation which allowed the scam to continue.
Evaluating Corporate Governance
The dynamic of the board of the directors may prevent fraud to the financial statements. The first step is that the board should be a separate entity from the company top managers. This will allow for a well needed check and balance between managers and the Board. The CEO shouldn’t be allowed to appoint members of the board because that increases the risks of fraud. The chair shouldn’t also be CEO as shown in this case that created a biased board so, he could falsify statements and convince them that acquiring a new company would benefit the company. Majority of the board should also be from outside of the company and have experience with being a director. One lesson learned about the audit committee is that they must rely on the financial statements that the senior management is presenting them. Other governance mechanisms that should be adopted to ensure compliance are encouraging reporting of possible infractions and carrying heavier punishments for fraudulent behavior. If Satyam’s board had been encouraged to report infractions, they could have stopped the CEO before he did as much damage. I believe that the board, audit committee, and external auditors should bear more responsibility. I believe that they should also be targeted to be punished, if they ignore obvious signs of fraud. Accountability is the most valuable asset when getting people to comply with governance standards. The punishments should be heavy but shouldn’t be harsh enough to deter managers from performing. Using the cognitive evaluation theory, we argue powerful expectations from external governance can potentially lead to financial fraud (Shi et al. 1258-128). In this article it states that doing this could impinge on top manager’ feelings of autonomy and crowd out their intrinsic motivation. Meaning too much pressure from external factors could cause managers to not push for expectations and not be motivated enough to perform.
Satyam was a huge blunder that could have been avoided, if the two brothers did not have too much power. He wanted to control everything but as a publicly traded company. It was failures from internal controls, external auditors and the board and audit committee.
- “Corporate Governance.” STRATEGIC MANAGEMENT: Concepts and Cases, Competitiveness and Globalization, by MICHAEL A. HITT, CENGAGE LEARNING, 2017, pp. 310–332.
- Gaur, Ajai, and Nisha Kohli. “Governance Failure at Satyam.” Harvard Business Publishing, 2011, hbsp.harvard.edu/import/672936.
- Shi, W., Connelly, B.L., and Hoskisson, R.E. (2016). “External corporate governance and financial fraud: Cognitive evaluation theory insights on agency theory prescriptions.” Strategic Management Journal, 38(6): 1268-128
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