Corporate Governance

Introduction

Corporate Governance refers to the way in which a company’s top managers carry out their responsibilities as well as authority and most importantly how they account for this authority in relation to the company’s stakeholders (those who have entrusted them with the organisations resources and assets). Corporate governance is in particular concerned with the possible abuse of power and the need for integrity, accountability and openness in the decision making processes and practices of the firm. The case of the fraud that has been taking place at Satyam, is a good illustration of the significance of good corporate governance and the possible consequences of its failure.

            According to Leahy (2009a), study shows that companies which score highly (more than 50 points out of 100) in rankings  used to measure corporate governance have a very stable gross profit and enjoy higher net worth returns as compared to those organisations which score less in these rankings. This article shows that investors tend to reward Indian companies whose corporate governance was above average with better market valuations. The study which was conducted by Standard & Poor’s found that an upward movement even by a single unit in an organisation’s corporate governance ranking directly yielded an improvement in the company’s market valuation (Leahy, 2009a).

Admission to fraud by the former chairman of Satyam Computer Systems will have detrimental effects on the market valuation of this company as it implies low corporate governance. This admission has caused Satyam’s reputation and credibility to drastically suffer reducing its competitive edge in the market. Besides this, Satyam Company is a very large organisation with up to 53000 employees and clients in more than 60 countries worldwide. The company is also listed on three international stock exchanges. This implies that it has a large number of stakeholders in employees, customers, members, and the larger public whose interests have been put at risk. This calls for the need for immediate remedial steps particularly those that will initiate within the company. Management control systems may also need to be restructured for Satyam to have sound corporate governance. To establish the needed changes and how the management control systems can be restructured, there is need to first of all analyse the current situation so as to identify where the problem is.

The Current Situation

            The problem at Satyum originated with Ramalinga Raju’s admission that had been manipulating the company’s accounts for several years to show the extremely inflated profits as well as assets that were fictitious (Leahy, 2009b). This fraud is biggest corporate scandal in India in the last two decades and the first high-status causality since the onset of global economic/financial crisis. The disclosure of this fraud will not just affect only those companies that are clients of Satyum. The damage is larger that what it seems, apart from the stake holders of the company, revelation of the fraud will damage the country’s reputation as hundreds of large and well established companies that have entrusted critical data as well as computer systems to Indian companies that outsource their services are likely to be alarmed. Satyam has clients in very large multinational companies such as Nestle, General Electric, Unilever, Cisco, Sony and even the World Bank (Leahy, 2009b). These are companies any business organisation dreams of having as clients and would not want to lose at any expense. Unfortunately for Satyam, it might lose these and more others because of the organisation’s lack of sound corporate governance (Tucker, & Leathy, 2010).

            The current situation implies that there exist shortages in the regulation of outsourcing companies and how they are audited. The news of the fraud also had a drastic effect on India’s stock markets. It is worth to note that its revelation caused the value of Satyam shares to decrease by up to 80 percent (Leahy, 2009b). This caused the Sensex index to fall by seven percent. According to Raju, the fraud started as a cover up in which the company’s profits were inflated to mask a poor quarterly performance and eventually got out of hand. According to Mr. Raju’s confession, last quarter’s account ended last September and included a large quantity of money (£728 million) of which up to 94% was fallacious (Leahy, 2009b). The operating margin was also inflated from the real figure of 3% of revenue to 24 % (Leahy, 2009b). Mr. Raju claimed that neither he nor his family benefited from the fraud.  He also maintained that the rest of the board members were not aware of the fraud.

            The actions of Mr. Raju, who is also the founder of the company, negate the main themes of corporate governance which are accountability, integrity and openness at the highest level of an organisation particularly one that is owned by the public. The fact that Raju had attempted to make Satyam acquire Maytas infrastructure companies that are controlled by his family show there was no transparency in decision making processes particularly by the top management. The fact that the rest of the board members have not been aware of this fraud for several years also indicates lack of transparency and openness within the organisation. The decision by the Raju, as the chief executive to cover up for loses using frauds shows no integrity on his part. It is obvious that that some people particularly those from the firm that did auditing for Satyam, PWC were paid to manipulate the figures that resulted top the fraud. From the current situation, it is clear that Satyam actually had no corporate governance, as there has been no accountability, openness and integrity. Apart from Mr. Raju, it is clear that the rest of the board members can not account for the authority that has been bestowed to them by the company’s stakeholders, in other words, they have not been doing their work.

            Satyam’s scandal is a clear case of failure of corporate governance and if the problem is to be addressed, it is essential that it is looked at in this light. Satyam operates in the IT outsourcing industry where trust is very critical. Global institutions and in particular financial ones rely on the integrity of the IT outsourcing firms to ensure that their data systems which are very critical and confidential are kept running at all times and are secure. If Satyam somehow recovers from this scandal, it is going to be very challenging for the company to convince investors as well as clients that they can be trusted. It is obvious that there is need for the company to introduce some changes that will ensure that the fundamental tenets of the corporate governance principles; transparency, accountability and fairness are upheld. As an international company, it is inherent for the future changes to be aligned with international good practice if the company is to capture investor and client confidence worldwide.

Recommendations for future Changes within the Company in the Context of International Good Practice

            International good practices require the accredited institution to take responsibility in what ever is done in its name. This is ensured through corporate governance. Study shows that corporate governance increases the credibility of an organisation and helps to attract investors in spite of the organisation’s legal form or its size. Changes needed in Satyam should be those that deal with the major worries of stakeholders and investors.

            There is need for change in financial disclosures of the company. Satyam should in future be disclosing it’s financial and operation results as it is without manipulating the figures (Fiscor, 2005). It is the responsibility of the board of directors to ensure that the financial and operating results of the firm are revealed to all stakeholders and particularly the shareholders. The board should provide disclose this information in an appropriate manner so that the stakeholders understand the current state of affairs of the firm and the future developments (Monks & Minow, 1991). The board of directors should also be qualified enough to identify inherent risks and avoid them. Any plans to add assets to the firm should be communicated and shareholders consent sought before proceeding (Atkins, 1995). The risks associated with acquiring new assets should also be communicated clearly to stakeholders.

The board should also disclose its responsibilities concerning financial communications. The board’s responsibilities in overseeing of the process of producing financial statements should be described to the stakeholders (Liss, 2003). This is important as it supports the notion that the board of directors plays a role in creating a general context of transparency. Generally, it is believed that the board is responsible for reporting on the financial as well as operating results of the company. Most corporate governance codes describe the fundamental responsibility of the board as evaluating financial statements, approving and then submitting them to stakeholders and particularly the shareholders ((Liss, 2003). Defining and disclosing the responsibilities of the board in this specific area gives comfort to investors, shareholders and other stakeholders as they understand that the presented financial statements accurately indicate the company’s situation.

The company should also fully reveal any significant transactions conducted with related parties (Berenbeim, 2004). This is important as shareholders like knowing that the management is running the firm with their best interest in mind and not just for a few related parties to unduly benefit. Best practice requires members of the board as well as managers to reveal any material interests they might have in transactions affecting the firm (Liss, 2003). Any important related-party transaction, its nature and type, as well as the decision making process used in approving related-party transactions need to be disclosed to al stakeholders. It is also important for the company to disclose its objectives to the stakeholders and seek their consent. The basic corporate objective of the company should be to maximise shareholder value.

Regarding ownership and rights of shareholders, it is important for Satyam to disclose the structure of beneficiary ownership to any interested parties (Fiscor, 2005).  Any changes in the amount of shares owned by substantial investors should also be communicated. This s important to investors when making investment decisions particularly with regard to whether the company applies equitable treatment all shareholders.

Best Practice requires any rules as well as procedures that govern the acquisition of corporate control by the company in the capital markets and any significant transactions such as acquisitions, mergers or sales of considerable portions of the company’s assets to be revealed to all the stakeholders (Liss, 2003). It is also suggested that consent be sought from shareholders and all the procedures involved in these transactions be disclosed to them. Best practice also suggests that the shareholders be allowed to know the identity of the bidder and sometimes be given the chance to approve it.

There is also need for change in the governance structures as well as policies of Satyam. This is with particular regard to the structure, role as well as functions of the board of directors.  It is important for the composition of board to be disclosed and any affiliations of these members with the company be revealed (IRRC, 1999). Good practice proposes that a certain percentage of the members of the board of governors should consist of independent individuals who are neither family nor friends of the company’s founder.

These individuals should have the necessary qualification and integrity so that they can make objective and independent decisions and at the same time contribute towards adding value to the board (Liss, 2003). This is to enhance transparency, accountability and fairness which are the fundamental tenets of the corporate governance principles. While some countries as well as codes such as in India tolerate a combined chief executive officer and chairman, best practice argues that separation of the two posts and their responsibilities is desirable (IRRC, 1999). This is because it fosters a balance of power within the organisation’s leadership structure. There is need for a chair of the board who is independent in Satyam. This is important and might prevent the recurrence of a scandal such as the present one as it ensures that no single individual might have to consider applying this so that no single individual has unregulated control of the firm.

The role and functions of the board must clearly be disclosed to the shareholders (Preston, 1995). Most codes hold directors accountable for the management of the firm. In India, the board’s responsibilities include compliance with standards, risk management, internal controls, and fraud detection among several others. The current situation implies that these roles have not clearly been communicated and the board even seems not to understand what its roles are. For example, none of the directors was aware of the fraud and the risk the company has been exposed to for the past several years. Disclosure of the board’s functions roles and functions might play a great part in preventing a recurrence of the ongoing scandal.

            Emphasis should also be put on the existence of company code of ethics (Colin, 2000). Governance structures that intend to support and maintain that code of ethics should be established and the rules as well as procedures governing it be disclosed. A code of ethics that is maintained is crucial as it promotes risk reduction, transparency and good business practices.

            The company’s board of directors needs to disclose and give assurance to the company’s stakeholders on its risk management activities, objectives and systems (Monks & Minow, 1991). The board needs to come up with and disclose a provision that will help them in identifying as well as managing the effects of activities that are risk bearing. The reporting should include the existing mechanisms for identifying risks.

            To prevent a recurrence of the ongoing crisis in the company, it is important for Satyam’s board to be confident of the independence of the company’s external auditors and that the auditor’s integrity has not in any way been compromised (Frederick, 2004). The board needs to disclose to the stakeholders the process used to appoint and interact with these auditors. This would prevent cases of people being paid to manipulate figures as the current situation at Satyam implies.

How the Satyam’s Management Control Systems may need to be Restructured

            Management control systems refers to those systems which collects and uses information to assess the performance of various organisational resources such as human, financial, physical and the organisation as a whole in view of the organisational strategies (Anthony, & Govindarajan, 2007). These systems affect how organisational resources behave to implement a firm’s strategies. Management control systems also refer to the process by which a company’s top management influence their juniors and subordinates to implement the firm’s strategies. It involves coordination,  resource allocation, performance measurement  and motivation. Management control systems are important because they enable managers to steer the firm towards achieving its strategic objectives (Anthony, Govindarajan, 2007).  Management control systems involve and greatly depend on the behaviour of managers. It covers all aspects of a company’s operation and is centred on  responsibility centres. Management control system is based on a financial structure and uses managerial control which is planned data as well as actual data as its sources of information.  It encompasses  many control tools including management accounting systems and organisational controls. It also draws contributions from organisational behaviour as it entails communication and motivation of employees towards achieving organisational goals.

Based on the ongoing crisis at Satyam, it is clear that there is a problem with the management control systems and particularly the management accounting systems.  Management accounting includes a myriad of practices such as product costing and budgeting. One of the areas that need to be focused on in the restructuring in the company’s management control system is management accounting. Management accounting consists of three major branches; differential accounting, management/responsibility accounting and full cost accounting. The fraud implies that this tool is not working as it should be. There is need to develop the system such that accounting information is available at the same to all stakeholders and not just a few people (the board of directors) or one person, the chairman of the board.

In most companies, management control systems are not subjected to external scrutiny. The implications are that most people including the organisation’s shareholders are not aware of the control systems that influence the manager’s behaviour. Since Satyam is an organisation that is partly publicly owned, putting these systems under external scrutiny would help eliminate the occurrence of crises and issues such as the one the company currently is experiencing.

            It is important for management control systems to be applied at lower levels than the board. This is because it is managerial decision making and as well as control that most affect a company’s financial performance through productivity. This will help increase efficiency and ultimately improved financial performance.

            There is also need for the information systems of the company to be aligned with leadership and the way decisions are made. A responsible decision should be based on information. Before using information, the decision-maker should evaluate its quality and ensure that it is accurate. In the case of Satyam, it is obvious that the board has no access to the right information yet it is the decision making body of the organisation. Restructuring of the organisation’s management control system should focus on making the accurate information available to the board for use to make decisions to avoid the recurrence of a crisis such as the present one.

Conclusion

            Corporate finance and management control systems of an organisation are inter-related and very critical to its financial performance. The case of Satyam indicates weaknesses in the two crucial aspects of the organisation. The fraud has serious implications for Satyam and there is the possibility that the organisation might go bankrupt. It is clear that an acquisition is the only way for this company to survive. If it manages to survive the fraud and come up again, changes and restructuring will have to be made in its corporate governance as well as management control systems so that they are in line with international good practice particularly if the organisation is to continue operating as an outsourcing company. This case is a clear indication of the effects of failure and malpractice of corporate governance. It is therefore inherent for all organisations, in spite of their industry and size to ensure that their corporate governance structures are inline with the suggested international good practice.

References

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