The Hindu Business Line : Satyam’s flawed ownership model

Satyam’s ownership model is not the best from the perspective of combining enterprise, global capital and good governance. Companies earnest about their long-term engagement with global businesses will choose to showcase their high inside ownership and persuade customers to trust them, says G. RAMACHANDRAN.

Satyam does not represent India’s entrepreneurial strengths and innovative capabilities.

Satyam Computer Services Limited (Satyam) is in deep trouble and despair. Its employees and shareholders have learnt through the confession of Mr B. Ramalinga Raju, its founder and the principal entrepreneur-manager, that it does not have the huge sums of cash that its balance sheet shows.

Satyam is not as rich as it claims. Satyam did ordinary things but presented them smartly as extraordinary. Its Web site explains ‘success’ as having an eye on the outcome all the time. Satyam had its eyes and hands on the numbers that measure success. It surely has manipulated the outcomes — revenues and profits — so as to present the appearance of being a successful company. The others fell for it. It is now Satyam’s turn to fall — in public.

Satyam’s plight has quite justifiably sent shock waves across the world. Condemnation and criticism have been expressed in powerful phrases by those who have a record of sobriety. But the more worrisome comments pertain to the future of India’s share of the global economy and the huge talent pool in the domains of information technology and computing.

Surely, the worries are for real. They are serious. Does Satyam represent the entrepreneurial and innovative India that the world has come to take note of and grudgingly laud? Is Satyam the face of India Inc. the world looks up to for solving business problems and serving the complex needs of its citizens?

The answer is in the negative to both. Satyam does not represent India’s entrepreneurial strengths and innovative capabilities. It is not the face of India Inc. There are other companies that have the integrity and the competence to serve the world’s needs.

Roots of the problem

Satyam is a victim of three factors. The factors are not the causes of the global and colossal fraud. But they provide an enabling environment for abuse and delusion. First, it is a publicly-owned company that can raise capital inexpensively if its existing shareholders assigned it a high value.

Second, it is a publicly-owned company in which Mr Raju could own a very small fraction of the ownership stock. He could overstate profits with the objective of influencing other shareholders. The overstatement never hurt him because his own share of the real profits has remained very small. Third, Satyam could preserve its fictitious profits without having to pay big taxes because its profits were protected significantly from the normal tax laws.

There are numerous companies in India that operate within the same framework but not all of them should be regarded as clones of Satyam.

Consider Wipro, a peer of Satyam where Mr Azim Premji, its founder and principal owner, owns a very large part of its equity. The compulsion to overstate profits does not arise since Mr Premji would be deluding himself.

Consider Infosys Technologies, another peer. It does not have a significant owner whose stakes are very high. But its founders and the thousands of employees own shares in Infosys and get involved in the company’s communication within and to the external world.

Moreover, the independent or the outside directors of Infosys understand that their own reputation or ‘stock’ would be judged on how well Infosys performs in the short run and in the long term.

Enterprise economy

India is among the world’s foremost ‘enterprise’ economies. It has a huge population of entrepreneurs. These self-taught entrepreneurs bring all the necessary capital, business wisdom and managerial acumen to the table. They run their businesses with significant pride and the permissible integrity. They earn handy profits and maintain a low profile as long as they are owned privately.

There is no pressure to overstate their profits because these private firms have no need to attract capital from the public through bond and equity offerings.

The ‘going-public’ transaction changes these. The pressure to keep their firms’ bonds and equities in high esteem and, therefore, in high demand pushes firms into overstating their profits. India’s enterprise economy will not fail to take note of the colossal fraud on a global scale at Satyam.

Those with sound business models will invest in and engage in ethical and innovative practices. It is very likely that they would continue to attract equity from private equity firms. It is likely that many firms funded with private equity will not go public.

And, those that have gone public will be aware of the wrong signalling that would result from the decline of the inside or promoter’s equity. Reliance Industries Limited is an apt example. Though it is colossal in size and in activities, its inside ownership has always been big. Mr Mukesh Ambani — the principal owner — will not feel rich if a third of the company’s profits were his and if all of the profits were fictitious.

Flight to quality

Satyam’s ownership model is not the best from the perspective of combining enterprise, global capital and good governance. If some firms conform to the Satyam model and yet remain loyal to innovation and integrity it is because of the commitment of their inside owners to these virtues. But it would certainly become more difficult for firms to signal their commitment to high productivity, innovation, good ethics and integrity.

So, a flight to quality is likely. Companies that are earnest about their long-term engagement with global businesses will work towards a rapid rise in their inside equity. They will choose to showcase their high inside ownership and persuade customers to trust them. Listing on the New York Stock Exchange (NYSE) and inviting high-profile independent directors will be weaker substitutes for such signalling. Satyam has a listing on the NYSE.

Satyam had the best preacher in corporate governance on its board: Professor Krishna G. Palepu of the Harvard Business School (HBS).

Professor Palepu is HBS’ director of research and the senior associate dean for international development. His principal research interests include corporate governance, disclosure strategy and the role of the board of directors in enhancing the value of corporations. Shareholders of Satyam got little from his formidable competence. It is a pity.

Tax them normally

Companies such as Satyam get away with overstating their earnings because they derive the benefits of overstatement. They do not pay taxes on the fictitious revenues and profits. There are no penalties. This asymmetry should be addressed. Even as India’s policy-makers search their souls and look for ways to cut the incidence of fraud, they need to revisit their notions of competitiveness.

The belief that exempting firms such as Satyam from service tax and corporate income tax will make them competitive, is a little ludicrous. Though they may pay the minimum alternative tax, the benefits of overstatement exceed the cash paid out as taxes.

Satyam would not have overstated its revenues and profits if it had to back both with real cash. A big part of the blame for the colossal fraud belongs to India’s trade and fiscal policymakers.

(The author is a financial analyst. Feedback may be sent to blfeedback@thehindu.co.in)

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