Surviving 'India's Enron'
by Pramit Pal Chaudhauri
Originally published in the Far Eastern Economic Review, January 14, 2009
The arrest last week of Satyam Computer Services, Ltd., Chairman B. Ramalinga Raju for falsifying corporate figures is being called "India’s Enron." The Indian government’s decision to replace Mr. Raju’s entire board underlines how great a shock the Satyam fraud has been to the Indian establishment. Indeed, this is the first time the government has superseded a private corporate board. But then Satyam, once the country’s fourth-largest information-technology firm, is more than just any old company—it’s long been seen as an icon of the new Indian economy.
The fraud was revealed when Raju sent a fax to the Securities Exchange Board of India on Jan. 7 and admitted Satyam had falsified profits and that its 50 billion rupees in cash reserves were notional. An earlier attempt to fill this financial hole by buying up the Maytas real-estate firms of his sons had been shelved because of shareholders’ outcry at what seemed like crony capitalism. When DSP Merrill Lynch, after inspecting Satyam’s books, concluded it could not find a merger partner and that, as legally required, it would have to report why to SEBI, Raju realized the game was up. The confessional fax followed.
In part because Mr. Raju’s version of events has yet to be verified, the larger consequences of the Satyam scandal for India are unclear.
The fallout could be severe. India’s growth story has been fundamentally different from China’s in a number of ways. But a crucial difference has been that foreign investment into India has been largely through stock purchases rather than, as in China’s case, the building of plants.
Investors have placed their bets on the Indian private sector, that it would both grow and become more professional. As a senior Citigroup executive told the press, "The India story has been whether a dynamic private sector can outgrow a dysfunctional government."
The question being asked is whether Satyam is a sign that even the Indian corporate story is less than what it seemed. This is not merely because Satyam was in 2007 India’s 19th most valuable company, but also because it was a firm from a sector heralded as emblematic of an India matching the best standards in the world.
Most investors have so far treated Satyam as a one-off, the odd rotten apple that inevitably comes up in a capitalist barrel. Maintaining this viewpoint will depend on three things:
First, evidence that Satyam’s ability to cook its books for several years was more about its auditor, Pricewaterhouse, and Mr. Raju’s celebrity status than the Indian regulatory system. On paper, the country’s financial regulations and corporate governance standards are broadly on par with the West. However, implementation is a different story. For example, of the 100 posts in the Serious Fraud Investigation Office over 30 are presently vacant. A ban on fully owned subsidiaries of multinational auditing firms means Indian-based firms are small and parochial.
Second, indications that the Indian government and its corporate sector are genuinely interested in plugging whatever gaps the Satyam scandal may reveal. Also, how severely and quickly will justice be dispensed to the investors. At last count, four different inquiries have been launched by central government agencies. More may come at the state level. By chance, the country’s 52-year-old Companies Act is before a parliamentary committee for revision. The Satyam scandal is likely to mean severer penalties for fraud in the new act, including the right to class-action lawsuits. The Securities and Exchange Board of India (SEBI) has already set up a panel to review all quarterly audit reports of the 80 firms that makeup the two major stock-market indices.
Third, an understanding of why such a firm, whose peers had operating profits of 20% or more, had to play around with its accounts. Preliminary evidence indicates Satyam never actually developed a business model on par with other big software firms like Infosys and Wipro. It won outsourcing contracts by bidding 20% to 30% less, even if it made no money on them.
Mr. Raju, fearing, as he wrote, "that poor performance would result in a takeover," hid this by inflating profits. He probably funneled his own wealth into realty with the idea of having Satyam later takeover these real-estate assets with its nonexistent profits. If this is proven, it will almost come as a relief to corporate India. Satyam failed because it was unprofitable and, ultimately, the market caught up with it.
India is facing a broad corporate transition. In the past, its companies were either small and family-owned or large and state-owned—and neither had any incentive to prioritize corporate governance. Today, more and more Indian firms are becoming profit-driven, professionally managed and, thanks to a need to tap foreign capital, incentivized to clean up their financial act. All three credit-rating agencies that provide corporate governance advice in India agree on this general trend.
Making that transition is difficult. A survey last year of some 6,000 listed Indian firms by India Forensic and the Bombay Stock Exchange’s figures for members who handed in corporate governance reports come up with roughly the same figure: about 20% of listed Indian firms fall short. The majority of these are, no surprise, state-owned or mom-and-pop concerns.
Satyam, for all its glitter, was a firm whose owner ran his software company in the manner his forefathers did land deals. It failed to make the jump between the two centuries, as will many others. But enough Indian firms are succeeding to give foreign institutional investors a reason to maintain a stake in the India growth story.
Pramit Pal Chaudhuri is senior editor of the Hindustan Times, New Delhi, a former Asia Society Bernard Schwartz Fellow, and a member of the Asia Society International Council.