The Satyam Scandal: The Past and Future of India's Economy

The heated wave of criticism against Bernie Madoff has barely came to a conclusion when, as the global media reported, another round of scandal emerged. The “Indian Madoff”, Ramalingam Raju (see left), the chairman of India’s fourth-largest IT company Satyam Computer Services, shocked investors with a letter that admitted his culpability of compiling fraudulent financial statements. This announcement to the public not only caused investors to scramble to retrieve their investments, but also put a red light over the worldwide confidence on India’s vast economic growth and success in its niche IT market. Ironic enough, the Obama administration issued a budget letter for fiscal year 2010 last week, stressing that the economic blueprint should be as much about morality as fiscal policy. Maybe this serves as a wake up call for Indian regulatory bodies; a time for Indian corporations to shed their outdated and controversial methods of doing business and learn from the success of respectable corporations around the world. In the subsequent analysis, instead of laying out the logistics of the Satyam scandal from beginning to end and the public criticisms against the company’s management team, I wish to embark on a road less traveled and examine some issues that are worth our attention. In particular, I believe there are creditable lessons to be learned from the scandal. While there are certainly external factors which hinder the economic growth of India such as the poor market environment and power of suppliers that governs the production rate of the country, I believe India should take steps in strengthening its internal operations and culture for the sake of a better future. Through the discussion, I hope to suggest ways that India, in its vibrant stage of economic growth, can potentially rise to a powerful position like the United States and contribute to the global economic realm.

In Raju’s startling four-and-a-half page letter to his board of directors as well as the Bombay stock exchange, he uncovered the fact of inflating the amount of cash on financial statements by nearly one billion and incurred a liability of $253 million on funds arranged by him personally. In Satyam’s quarterly report for September 2008, he overstated revenues by 76% and profits by 97%. Upon submitting his resignation, Raju confessed personal inability to close a small discrepancy that grew beyond control. “What started as a marginal gap between actual operating profit and the one reflected in the books of accounts continued to grow over the years. It has attained unmanageable proportions as the size of company operations grew significantly,” he wrote. “It was like riding a tiger, not knowing how to get off without being eaten.” The question is: how did Raju get away with all this fraud? I suggest we trace the cause back to the legacy of License Raj, a period of heavy government intervention and bureaucratic control of the economy from 1947 to 1991. During that era, India's GDP growth rate was as low as 5%, lowest among developing countries and more than half of China's. Businessmen were forced to work with politicians and pay bribes to regulators and government. Companies often run separate accounts to avoid taxation. Wharton management professor Jitendra Singh said in an interview, “In the bad old days, particularly pre-1991, when the License Raj held sway, and by design, all kinds of free market mechanisms were hobbled or stymied, and corruption emerged almost as an illegitimate price mechanism, a shadowy quasi-market.” All in all, corruption was prevalent and the level of ethical standards was very low in India. Yet, corruption was not the sole reason for India’s economic failure. Corruption led to the emergence of a trend, whereby people lost incentive on product development and focused instead, their energy on cultivating people in positions of power. In the years following 1991, although India engaged itself in an economic reform, such distorted cultural norms remained in existence in society. Even though government control loosened up over the years, and significant economic growth occurred in India, corruption was not seen to have decreased. Faster growth gave regulators and governmental bodies new grounds to extract payments, such as land regulation, spectrum allocation or college admissions. In order to be competitive in the international market, companies need efficient approval from the government. This also gave regulators much more leverage over private institutions. In a survey by Transparency International in 2005, India was ranked 89th in the Corruption Perception Index, with a CPI Score of 2.9 over 10 when the average is 4.1.

Corruption could be a significant brake on India’s economic rise. CLSA India analyst Bhavtosh Vajpayee called the scandal “an accounting fraud beyond imagination and an embarrassing and shocking episode in Indian corporate governance.” The Satyam scandal undoubtedly shook India to the core. It pulled out many issues that the Indian government and corporations are facing. It brought to the attention of the public that their investments and trust are not safe in the hands of Indian corporations. It raised one prominent question: Is the Indian economy doomed under such vicious state of economic environment? Possibly, and if so my suggestions to rectify the situation would be: first, to reform the economic system in the country; and second, to learn from the United States. To begin with, a thorough reform is definitely necessary. Propositions should be made to govern the relationship between institutions and regulatory bodies. Detailed codes of conduct should be established and firmly adhered to. Regulatory bodies should be set up to make sure fairness is upheld. Simply take a well-developed country as an example, the mentioned criteria are inherent in success of those countries. Such reform is necessary if India hopes to gain significant growth and a solid position in the international economic realm.

The next aspect is to learn from the United States. I am not suggesting that the United States is free from corruption and unethical practices. In fact, from a recent research conducted by the Marist College Institute for Public Opinion in New York, nearly 60% gave the worst grades to Wall Street executives for honesty and ethical practices. Yet, my point is, despite the economic downturn and financial instability, the Obama administration signaled a candid call to return to ethics and responsibility in his 2010 budget titled A New Era of Responsibility - Renewing America's Promise. Obama's message in the budget says, "The time has come to usher in a new era— a new era of responsibility in which we act not only to save and create new jobs, but also to lay a new foundation of growth upon which we can renew the promise of America." In a website documenting Obama’s campaign, it laid out Obama’s ethics rules which included the creation of a centralized internet database for lobbying reports and ethics records; establishment of an independent watchdog agency to oversee the investigation of congressional ethics violations, and; restrict political appointees on their participation of regulations or contracts directly relating to their prior employer for two years. The Obama administration took solid steps to address the issue of ethics in his political regime. This is crucial in setting an example for institutions in their establishment of corporate governance. It also lays a foundation for the Indian government and corporations on the approach necessary to succeed and rise to power. Drawing from the United States’ biggest accounting fraud, the Enron fiesco, the country swiftly acted on and corrected its accounting systems to avoid similar issues happening again. India should respond to its problem of corruption with the same attitude. All in all, it definitely will be a tough process to bring India out of its corruption practices and into the international business realm. However, with persistence, India will one day come out of its shell and become a butterfly.

The Bailout Plan: Bailing out corporations or top executives?

The recent financial turmoil has undoubtedly put the world in chaos. With multi-billion dollar corporations filing bankruptcy and announcing mergers that are critical in order to maintain existence in the business realm, the government is throwing out billions of dollars at the expense of taxpayers to avoid the demise of those bulge-bracket corporations. Amongst the heated discussion with bailout plans for the collapsing corporation, top executives were found running away with millions in compensation and living lavishing life amidst the crisis their companies are facing. With regards to this, Obama imposed a $500,000 mandatory salary cap for top executives. This generated another heated wave of complains from top executives, demanding to be compensated with better terms. In this blog, I examined a post entitled “Shameful.” by Andrew Crane and Dirk Matten, two business professors in York University, Toronto, who compared the idea of corruption in poorer countries to executives demanding additional compensation with regard to Obama’s $500,000 mandatory salary cap proposal. Next, I responded to a post entitled “So, you really can’t manage on half a million?” by Lauren Bloom, founder and CEO of Elegant Solutions Consulting, where she heavily criticized on the executives’ threat against Obama’s limit on their salary. My responses to the posts and links to the two blogs can be found subsequently.

‘Shameful’.
Comment

The example brought about with the corruption perception index is a very stimulating idea. How shameless it is for bankers to take home bonuses from bailout funds financed by the government, which came out of taxpayers’ pockets, when the bankers were the ultimate culprit of their companies’ failure. You mentioned, “This ‘height of irresponsibility’ (Obama) will ask for new rules for the game. Obama will hardly avoid addressing this problem of executive compensation.” Obama certainly took a firm stance in the issue fairly swiftly. He imposed a mandatory salary cap of $500,000 a year for top executives who resides in companies that receive funds from the bailout plan, whereby additional compensation to come in the form of stock.

I agree completely with the idea that, “Being rewarded for success – fine. But more often than not, the link between stock prices and individual managers’ performance is more than tenuous.” Yet, as this compensation issue continues to unfold, it is all the more upsetting, and shocking, to read news reports that these executives are actually exploring ways to go around the salary cap that Obama imposed. They threaten to pull out stakes and resign from their positions if the Obama administration formalizes those limits. Honestly, how much more shameless can these executives be? In fact, most of my friends who just graduated make around $50,000 annually as they enter the workforce, one-tenth of the proposed half-million dollar annual limit. To think these top executives would be about to find a position with better pay in this market is like kids believing that Santa exists.

I believe people who should be running corporations should not be these bankers who seem to be motivated solely by the instrumental satisfaction of attaining great financial compensation. There are abundant amount of qualified people who are willing to put in a hard day’s work for the opportunity to be part of a multi-billion dollar, bulge-bracket corporations, for reasons that go beyond financial satisfaction. These people understand that there are times when money cannot trade for satisfaction. They understand that past a certain threshold, money provides little satisfaction. What they want is to make a difference in the world. And I believe these people, who have a far more profuse and concrete prospect of the company, should be the very ones running multi-billion dollar corporations. Perhaps this issue will have a cleansing effect in the highest reaches of corporate power, as the greedy step down to make room for the virtuous.

So, you really can’t manage on half a million?
Comment

I am in complete agreement with your position in this compensation issue. Like you said, “running your business into the ground was a firing offense, not a reason to demand a higher salary.” I was doing some research on the web, and I came across the Stakeholder Theory. Allow me to share it here with you. The Stakeholder Theory is a business ethics theory that addresses the morals and values in managing an organization. In general, it suggests that when making decisions, whether major or minor decisions, companies should consider the interests of its stakeholders – that is, the interests of individuals who have invested in the fortunes of the company. If we adhere to this theory, all taxpayers are now stakeholders of companies which received bailout funds from the government. Those top executives who are compensated with the bailout funds should be reporting to the taxpayers. And by demanding for more compensation, they are being irresponsible and inconsiderate with the interests of their companies’ stakeholders.

Without a doubt, those top executives whose morals are blinded by attaining the greatest possible financial rewards should be heavily criticized. And I agree to Obama’s $500,000 mandatory salary cap proposal. However, I suggest Obama to make amendments to the proposal. As with the current proposal, a $500,000 mandatory salary cap for top executives might put pressure on the recruitment of talented individuals that are capable to lead corporations out of the financial crisis. In addition, potential investors might be reluctant to lay their money on corporations without a sound management team. This in turn, transfers the pressure to taxpayers, as the government continues to bailout companies with funds from taxpayers. I believe executives should be rewarded by success, possibly in financial terms. Hopefully, the economy turns around soon enough, and my suggestion is that those executives who have the ability to rescue their firms out from the turmoil should be rewarded with a certain percentage of the company profit, while the rest goes to repaying taxpayers. This sounds more like a fair deal, right?