Reforming corporate governance

The Economic Times, March 14, 2009

By Pradeep S Mehta

The Satyam scandal was unique in many ways. Satyam chairman Ramalinga Raju’s candid confession, when seen in the context of various business criminals who would never have done so, except in the recent case of Madoff is quite unusual. The fact that Satyam was awarded the Golden Peacock award in corporate governance in September 2008 brings in both hubris and complacency.

The scandal has also generated a significant decline in peoples’ trust in business, which is aided by the economic downturn and its adverse consequences. A survey of 200 opinion leaders in select metros of India during November-December, 2008, showed a declining trend in trust in all institutions. Business trust decline was the highest, which is what this article takes a look at, explores lack of good corporate governance and suggests ways forward.

In spite of what the government says, Satyam is not a stand-alone case. There have been similar cases in the past, such as the Dharma Teja in India and Enron or WorldCom in the US. Many of our big corporate houses are exposed greatly in enterprises abroad, which are facing a financial crunch. Shares have been pledged to raise further loans to put into other group companies which are bordering on the edge of sickness. When the chips are down, business crimes have a tendency to go up.

Independent directors: Due to the Satyam fiasco, much and necessary focus has been on the role of independent directors (IDs), as they were found sleeping. IDs are responsible for two things: overseeing strategy and overseeing financial propriety and legal compliances. But quite often their role is compromised by the fact that they do not have the time or the wherewithal, and/or are wined and dined by the management in a way that they turn a blind eye to the goings on in the company.

In the case of Satyam, IDs were paid handsome commissions on profit, in addition to one of them getting lucrative consultancy assignments. Remuneration to IDs needs to be regulated in a manner that will ensure that they adhere to their cardinal responsibility without fear or favour: by doing away with commissions on profit and restricting their remuneration to reasonable sitting fees. Simultaneously, they should be protected from any liability, so that they are empowered to discharge their responsibilities.

Whistleblowers: Secondly, the whistleblower mechanism needs to be encouraged and institutionalised. the media and regulators are the two external whistleblowers, often acting on suspicious movements in the company, while employees are the internal ones. The Enron fiasco was unravelled by one of its employees: Sherron Watkins, while the WorldCom skeleton came out of the cupboard, when its employee Cynthia Cooper spilled the beans.

Following the Satyadev Dubey murder in Bihar, who exposed the road building contractors mafia, the Supreme Court directed the government to legislate a whistleblower protection law, but we are yet to see any sign of the same. This now becomes more essential because the Competition Act, 2002, about to be implemented, provides for amnesty to whistleblowers if they spill the beans on any cartelising activity that the company may be involved in. In fact, evidence from various western economies show this is one of the strongest provisions which help enforcement agencies to prosecute corporate crimes .

Role of auditors: Auditors are required to check the accounts faithfully, yet they fail. In the Satyam case itself the global firm PwC had to be hauled up and its partners who were signing the balance sheet have been put in jail. PwC has long been Satyam’s auditors, and thus would have developed a cosy relationship with the management. Companies are also required to keep internal auditors, but that too seem to have failed in this and other similar cases.

Firstly, rotation of auditors should be mandatory after every three years, and a strong disincentive by way of heavy fines should be legislated to ensure that auditors do their job properly.

Promoters and management: The Indian case is again unique as compared to several western countries. Most companies here are managed by promoters as against the ones in western economies. Hence, we need homegrown solutions to tackle this issue. For vanishing companies the Companies Act already prescribes barriers that such promoters will be barred from raising further capital in the market and their names are put on the government’s website, etc.

A suggestion has also been made that promoters should be barred from holding management positions after some time. How far this can work in India and whether professionals can also be fully relied upon to provide fair and sanguine management to a company is doubtful. But at the least, when promoter-managers are caught in a crime their punishment should be exemplary and the trial must be conducted on a day-to-day basis with a time limitation.

Enforcement system coherence: Like the Mumbai carnage case, the Satyam case has thrown up another challenge: multiplicity of agencies and laws. Both Sebi and the Serious Fraud Investigating Office had to approach the local courts to get an access to Raju to even conduct investigations.

In both cases, there is a constitutional provision which creates such anomalies, because law and order is a state subject and the Union government can only proceed in cooperation with the state agencies. Other than that, even in the case of central oversight, there are three agencies directly concerned: Sebi, SFIO and the registrar of companies. Indirectly, the income-tax authorities will also be involved quite deeply to look at the case from the fiscal angle.

Consequent to the Mumbai carnage we now have a National Investing Agency and lessons can be drawn for dealing with corporate crimes as well, where a national body can take over swiftly. In both cases there are crucial international linkages as well. We need coherence in the enforcement rubric so that the perpetrators do not get away in the overlapping functions of several agencies and laws.

The concept of corporate governance hinges on total transparency, integrity and accountability at every level of management. In order to raise the bar of corporate governance standards, these factors must be taken into consideration in crafting corporate governance structures and practices for any country or company.

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