| Satyam: How guilty are the independent directors? | |
| ACCOUNTANCY | | Asish K Bhattacharyya / New Delhi January 12, 2009, 0:05 IST | |
Shareholders have lost Rs 13,600 crore in Satyam shares in less than a month. The market capitalisation fell to Rs 1,607.04 crore on January 9, 2008, from Rs 15,262 crore at the end of trade on December 16, 2008, the day when Satyam had announced the Rs-8,000 crore acquisition deal of two firms promoted by the kin of the IT firm’s former chairman Ramalinga Raju. On January 7, Ramalinga Raju tendered his resignation and confessed to a close to Rs 7,800-crore accounting fraud.
The episode has international ramifications. Satyam serves as the back office for some of the largest banks, manufacturers, healthcare and media companies in the world, handling everything from computer systems to customer service. Clients have included General Electric, General Motors, Nestlé and the US government. In some cases, Satyam is even responsible for clients’ finances and accounting. Investors in USA have initiated tawo class action suits against the company for its American Depository Receipts.
Uncertainty surrounds the survival of the company. Customers are reassessing their contracts with the company and its 53,000 employees are in a shock.
The Satyam (Satyam Computer Services Limited) episode is tragic. However, this tragic episode has the potential of turning the year 2009 into a watershed year in the history of corporate governance in India. The world knows that India is perennially weak in law implementation.
The government and regulators can take this opportunity to establish that they have the will and machinery to enforce laws. So far, the government and regulators have shown signs of swift actions. On January 9, 2008, the government superseded the board of the company and decided to appoint 10 nominee-directors. Regulators have initiated investigations and have promised appropriate penal action against those who will be found guilty. We have to wait and watch whether these immediate responses are backed up by credible action.
Those who do not directly deal in the stock market or who do not have direct interest in the theoretical discourse on corporate governance are bewildered by the magnitude and scope of the corporate fraud. Some are angry with the board and particularly with independent directors, while others are sympathetic to them. Similarly, some have already pronounced the auditor guilty, while others are not so sure that the auditors are expected to detect management fraud. Some feel that regulators have to take the blame.
The Satyam episode has brought out the failure of the present corporate governance structure. The present corporate governance structure hinges on the independent directors, who are supposed to bring objectivity to the oversight function of the board and improve its effectiveness. Stakeholders place high expectation on them. But is the expectation misplaced? Perhaps, yes.
An individual independent director cannot play an effective role in isolation. Even if a particular independent director is highly committed, she can only ‘watch’ wrong doing and at best initiate a discussion, but alone she cannot stop a decision even if it is detrimental to the interest of shareholders or other stakeholders. Neither can she blow the whistle outside the board room (e.g. to regulators) because board proceedings are considered confidential.
The only way independent directors can stop wrong decisions is by acting collectively. Even then they can seldom be expected to stop ‘management fraud’ since turning independent directors into policemen in the board room will have excessive detrimental effects on the independence of directors, the freedom of enterprise of the managers and the costs of governance.
In discharging its responsibility of ensuring adequate and effective internal control the board must depend on other institutions of corporate governance such as internal audit, external audit, and legal counsel. Therefore, the effectiveness of independent directors depends significantly on the independence and effectiveness of those institutions. Independent directors may not be in a position to stop management fraud perpetrated at the highest level, but with high level of commitment and due diligence they should be able to identify signals that indicate that everything is not hunky dory.
Although, at this stage, it is difficult to say anything definitely about the performance of independent directors in Satyam, it appears that independent directors, particularly those who were members of the audit committee failed to apply due diligence.
This conjecture is based on the fact that the accounting fraud was perpetrated over a long period of five to seven years and that DSP Merrill Lynch, who were hired to identify some partners for the company could within a week smell accounting fraud. Moreover, as reported in many news papers, some customers, including the World Bank, were complaining of fraudulent and unethical practices by the company. This leads to the conjecture that independent directors lacked commitment, at least collectively.
This brings us to the fundamental question of what incentives should be provided to independent directors to ensure their commitment to board responsibilities. At a theoretical level, two types of incentives work. One is monetary incentive, which is to compensate independent directors adequately. And the second is the threat of losing hard-earned social stature and personal reputation. It appears that both types of incentive failed in case of Satyam.
The independent directors on the board included Vinod K Dham (famously known as 'father of Pentium’ and an ex-Intel employee), M Rammohan Rao (Dean of Indian School of Business), U S Raju (former director of IIT Delhi), TR Prasad (former union cabinet secretary), M Srinivasan (retired professor from many US universities) and Krishna Palepu (Professor at the Harvard Business School).
The company in its corporate governance report for 2007 did not name Palepu as independent director, perhaps because he received Rs 87 lakh from the company towards consultancy fees. Each individual director received around Rs 13 lakh for the year 2007 for say 100 hours of work (a survey in US reveals that independent directors in large companies devote 50-100 hours per annum to carry out board responsibilities).
Keeping in view the compensation levels in India, the compensation should be considered good. It is not only in Satyam that independent directors showed lack of commitment. In the case of Enron, WorldCom and other companes in which corporate governance failed independent directors failed to perform effectively.
If an individual considers certain responsibilities as peripheral and if the chance of failure in performing those duties coming to light is low, it is likely that he will shirk those responsibilities, because in that case the cost of failure to the individual is low. Independent directors are human beings and therefore, we should not expect them to behave differently from a rational human being.
If the regulators fail to assess the performance of the board on regular basis, albeit indirectly through scrutiny of filings, and if law enforcement agencies fail to penalise errant independent directors, the present corporate governance structure will remain ineffective.
However, the solution is not simple. If independent directors are held liable for corporate fraud and severe penalties are imposed on them, it will be difficult to induct right people as independent directors in the board and companies will be deprived of the collective wisdom of people who can make a difference in the performance of companies.
Perhaps, it is the time to have a relook at the present corporate governance structure. It will require innovation in its true sense to develop a better model. Let regulators, industry and academia join hands in this endeavour.
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