Question

Satyam Computer Services (now called Mahindra Satyam) 16 was formed by Ramalinga Rau in 1987, in India. The company expanded rapidly, specializing in information technology and computer software, and became an important outsourcer of computer systems and customer services worldwide. While the company remained under family control, its shares were listed in India in 1981, and subsequently on U. S. and European stock exchanges. The company received several awards for corporate governance and accountability.
In October 2008, a financial analyst expressed concern about large cash balances held by Satyam in non- interest bearing bank accounts. However, it seems that this concern was ignored by investors. Markets did become concerned, however, in December 2009 when it became public that Satyam planned to buy two companies to, it claimed, diversify its operations. The plan had been approved by Satyam’s Board of Directors. However, the two target companies were controlled by members of Mr. Rau’s family, and it was feared that the purchases were really a way for Satyam to transfer money into the hands of family members ( presumably, by overpaying for the acquisitions). Satyam’s share price fell and four of five independent directors resigned. The company reversed these transactions, but sustained a major drop in its reputation. Numerous analyst sell recommendations followed and its share price continued to fall. Satyam hired Merrill Lynch, a leading financial management and advisory firm, to advise it how to recover. However, Merrill Lynch soon resigned from its engagement, citing suspicion of fraud.
In January 2009, Mr. Rau admitted that he had been overstating the company’s financial performance for years to meet analyst earnings expectations. This was done by creating fictitious non- interest bearing bank accounts on company books, and by reporting fictitious interest earned on these accounts. Fictitious invoices were also created to inflate reported revenue, and liabilities were underreported. Other tactics included adding fictitious employees to the company’s payroll, diverting the cash paid for their salaries to other family- owned companies. The total overstatement amounted to about US$ 1.47 billion. Satyam shares quickly lost 82% of their remaining market value. As in the case of Enron and WorldCom (Section 1.2), the whole Indian stock market fell by about 13%, suggesting that investors were losing faith in Indian financial reporting in general.
Mr. Rau, his brother (a managing director), the firm’s head of internal audit, and its CFO were quickly arrested by Indian authorities and charged with fraud. Several company auditors were also arrested. It appeared that the auditors were paid about twice the fee that other audit firms would have charged.
Serious questions were raised about why the company’s Big Four auditor and Board of Directors had apparently not discovered the fraud, and about the quality of corporate governance in India.
To prevent even more serious collapse of confidence, the Indian government moved to put Satyam up for auction. The successful buyer paid only about one- third of the company’s pre- crisis market value. The rescue was successful, and both Satyam and Indian stock markets have since recovered.
Since Satyam securities were traded in the United States, the SEC became involved. In April 2011, the SEC charged five India- based affiliates of Satyam’s Big Four auditor with audit failures. They were also censured by the PCAOB (Section 1.2). The auditors were fined $ 6 million, required to take training, and prohibited from accepting any new U. S.- based clients for six months. Satyam was fined $ 10 million on related charges.

Required
a. To what extent did family control of Satyam contribute to the fraud? What agency problem increases when control of a publicly traded firm is concentrated in a small group of insiders, such as a family? Explain one signal that a firm with concentrated ownership can adopt to reduce this increased agency problem. Did the signal work in this case?
b. Satyam’s Board of Directors apparently did not discover, or did not question, these fraudulent transactions, despite including five prestigious independent directors.
Explain why it is difficult for a firm with an entrenched and powerful management to obtain directors who are truly independent.
c. In fairness to the independent directors, they may have been at an information disadvantage. Explain why. Does information disadvantage fully explain the independent directors’ apparent failure to discover the fraud? Explain. See also Chapter 12, Problem 21 re: independent directors.
d. Satyam’s financial statements were prepared under Indian accounting standards, which differ in many ways from IASB standards. Outline potential benefits to a country from adopting IASB standards in place of its local GAAP. What factors in the adopting country reduce these benefits? Would this fraud have occurred if Satyam had reported under IASB GAAP?



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  • CreatedSeptember 09, 2014
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