On 19th and 20th December, a galaxy of academics met in Mumbai for a seminar on the securities market by an institute set up by the Securities and Exchange Board of India (SEBI). Although corporate governance was just one session on the second day, it was the most discussed issue since the Satyam imbroglio was played out on the eve of the meeting. Chairman B Ramalinga Raju’s misfired heist to seize the cash horde lying at Satyam Computers aided by a star-studded board of directors caused much consternation among the star speakers, ministry officials and regulators. So much so that the SEBI chairman, CB Bhave, announced on the sidelines of the conference that the regulator would look into the Satyam issue. It was a foolish move. A few days later, SEBI exonerated the Satyam board of any procedural wrongdoing, thereby inflicting more damage on the concept of good governance by reducing it to a set of procedures.
Good governance is not about ticking off check boxes on a compliance form. Obviously, even SEBI doesn’t quite get it. That is why, despite mandating adherence to a corporate governance code, companies have done exactly what they want to, before and after the code was mandated. Despite SEBI’s clean chit, the fact remains that the Satyam management’s action caused unprecedented outrage among shareholders, which sent its share value crashing and forced the management to reverse its dubious decision.
As we know, on Tuesday 16th December, all hell broke loose when Satyam Computer Services Limited announced its audacious plan to acquire controlling interest in Maytas Infrastructure and Maytas Properties for a whopping US$1.6 billion. The promoter family has a large stake in these two companies; Maytas is Satyam spelt in reverse. The move aimed at transferring over Rs6,000 crore of cash from Satyam’s shareholders to the pockets of the Rajus who control both Satyam and Maytas.
Mutual funds and institutional investors were outraged. They threatened legal action; Templeton Mutual Fund got into activist mode and announced that it would go to any extent to block the deal. On Tuesday evening, fund managers and large investors were spewing outrage at the action. The deal was announced after the Indian markets had closed, but Satyam’s ADR crashed over 50% when it opened for trading in the US. The word corporate governance, or the lack of it, was freely bandied around in this case. But remember, the deal was cleared by its board of directors, in spite of the fact that promoters hold a stake of only 8.6% in the company.
After a poor attempt to defend the decision, Raju gave in and cancelled the deal next day. The share price still crashed 30% on Wednesday and continued to fall. In another ill-considered move, the company hastily announced a buyback, which did nothing to stop the slide as another bombshell was dropped the following week. The World Bank confirmed that it had blacklisted Satyam for eight years “for giving improper benefits”, or bribes to Bank employees.
As questions flew thick and fast about Satyam’s atrocious actions, a few so-called independent members of Satyam’s stellar board of directors stepped forward but only to defend the deal. They had no regrets about going along with Raju. Despite shining academic achievements and extraordinary careers, they seemed oblivious to the fact that Raju was committing daylight robbery to which they were willing accomplices. They were happy to accept the justification that buying large infrastructure companies in an economic recession was good for Satyam and its shareholders.
What really was Raju’s game? And why did the board rubber-stamp it? We pieced together what must have really happened inside Satyam. Raju went to the US a few months ago and apparently met a few large investors and investing banks to sound them out about investing a part of Satyam’s money in infrastructure. Raju argued that the IT services business was cash flow positive and did not call for substantial expansion or capital expenditure right now. So, the money lying with Satyam could not be profitably utilised. He argued that infrastructure offered far greater opportunity and, on this count, Satyam had already made a lot of progress. Maytas Infrastructure had got listed and has bagged major infrastructure projects in a fast-growing Indian state, Andhra Pradesh, from where he hails. Raju came back and briefed the board that foreign investors had looked favourably at the idea. The board asked him what the next step was. Raju said that Satyam will utilise its cash to buy a large stake in Maytas Infrastructure and Maytas Properties. The board asked him about SEBI regulations, since Maytas Infrastructure and Satyam are both listed companies. The board insisted that everything should be by the rulebook, said a member. At that stage, directors such as TR Prasad, former cabinet secretary, were mainly focused on fair valuation of Maytas. Since these two were primarily asset-based companies with land, structures, cash and some contracts, they went by asset values. They gave the job of valuation to Ernst & Young (E&Y), which has denied it and therein lies another story. In the midst of the controversy, Ramalinga Raju told the media that the valuation was done by one of the big four accounting firms. But each of them has denied it, apparently because the assignment was not given directly to E&Y but routed through another firm. Shouldn’t this needless subterfuge have alerted the board? In 2007, E&Y gave Ramalinga Raju its often controversial but much-hyped award of Entrepreneur of The Year. Was Satyam worried that an E&Y valuation would seem like a quid pro quo?
Anyway, it came up with a valuation of Rs6,400 crore, the core of which was 6,500 acres of land value multiplied by the ‘market rate’. One of the directors apparently objected and said the valuation should not be based on market value but the registration value prescribed by the government. Raju said that the registration value is usually much lower (this is no longer true in places like Mumbai and Kolkata where municipal authorities frequently revise registration values making them closer to market values, so that they can collect more revenues). To this, certain board members seem to have said that in which case they need to first fix the value according to government rates and then separately justify the increase from that valuation. A director is also understood to have objected to the sweeping valuation method adopted by E&Y which simplistically multiplied acreage with so-called market rates; they wanted a more segmented approach, valuing each asset segment differently, at least breaking them up into components such as only land and land with structures, etc.
In all these discussions, the board was only concerned with two aspects – following the regulations (SEBI and company law issues) and valuation. It is not clear if anyone mentioned the fact that the slump in realty has affected land prices as builders rush to liquidate unaffordable land banks. Strangely, the aspect of money being transferred to the family does not seem to have come up at all. Were the directors, earning fat sitting fees, too polite to ask?
Dr Krishna Palepu, the high-profile Harvard professor from Andhra Pradesh who ironically specialises in strategy and governance, was not physically present but hooked up through video conferencing. Although he regularly lectures on corporate governance, a transfer of US$1.6 billion or 90% of the free cash, from an IT services company effectively into the promoters’ pockets to fund completely unrelated business of property and infrastructure, did not strike him as odd. The fact that it was a related party transaction too did elicit a debate, although the board knew that the Rajus controlled Maytas and had a significantly larger stake in those companies.
According to one of the directors, the US investors reacted sharply to money going into property because they have just witnessed the devastation caused by real estate speculation. None of the directors raised the issue of money going into the pockets of the promoters of Maytas. The main debate was on valuation. Interestingly, the CEO of Maytas Infra is PK Madhav. He was a director of Nagarjuna Finance earlier and has been arrested along with KS Raju, chairman and managing director of Nagarjuna Fertiliser, in an old case of default concerning Nagarjuna Finance.
Somebody who knows the Maytas story well had some key additional points to make. Maytas
Infrastructure won the bid for Hyderabad metro rail project on the basis of a ‘negative grant’. This meant that Maytas not only did not need any grant but offered to pay the state government. No other bidder had offered this. Only in September 2008, the Delhi metro chief E Sreedharan, in a letter to the Planning Commission, had said that granting 296 acres of prime land to the promoters for commercial exploitation was a ‘scandal’ in the making. He also hinted at corruption when he said, “there is something more to it than meets the eye.” Sreedharan said, “It is apparent the BOT operator has a hidden agenda which appears to extend the metro network to a large tract of his private land holdings so as to reap a windfall profit of four to five times the land price.” The Congress government in Andhra Pradesh then jumped into the fray and demanded an apology from Mr Sreedharan who has not bothered to oblige them. The Maytas consortium then dropped Sreedharan from the project. Our sources also confirm that Maytas probably hoped to make bumper profits from real estate. The promoters are rumoured to have around 2,000 acres of land where the first phase of the metro project ends with a silent understanding that they would be allowed to develop another five to seven kilometres stretch of land after the metro ends.
Now that The World Bank has also banned Satyam for eight years for bribery, Sreedharan’s statements appear more worrying. Even business-wise, banking on land to reap profits and offering a negative guarantee also seem like potential blunders after the real estate bust and global economic slowdown. Our sources say, a disappointed bunch of politicians apparently want to cut loose from the deal and have begun to demand money from the consortium, especially with the general elections round the corner. That is rumoured to be yet another motivation to push through the Satyam-Maytas deal. It is also a possible explanation for Satyam not putting money into Maytas but rather into the hands of the Rajus. Satyam has not been forthcoming with any explanation about why the money should go to them. Our source says, this is probably why Raju backed out of the deal so quickly – it was apparently not because of the backlash from institutional investors, as is popularly perceived. They can now tell the politicians ‘we tried to raise money, but look what has happened.’
If that is, indeed, the hidden story behind the deal, it still leaves us with the issue: what about the stellar board of independent directors? According to one source, Dr Palepu of Harvard played a key role in convincing the rest of the board about the acquisition of Maytas. We specifically asked Dr Palepu about several rumours swirling around his role in selling the idea to the board. There is even talk about Dr Palepu not being very ‘independent’ in his approach because of a business school that he wants to start in Andhra Pradesh in collaboration with Harvard. Had Satyam promised to support his venture? Dr Palepu had not responded to our email at the time of going to press. However, Dr (Mrs) Mangalam Srinivasan, an exceptionally qualified, US-based academic, resigned at the end of December 2008 accepting moral responsibility for not casting a ‘dissenting vote’. She reportedly said in her resignation letter that although she had raised many issues “relating to procedures” and “expressed reservations” during the deliberations, she did not formally dissent.
So far, all the other ‘independent’ directors (see Box) are firmly glued to their chairs and have even argued that they did nothing wrong. Will some more of them follow Dr Srinivasan’s example? Or, are fat sitting fees paid to independent directors such a powerful magnet? After all, Dr Palepu earned Rs92 lakh from Satyam and other directors earned as much as Rs13 lakh, plus perks. Many board members are probably worried that if they quit just now, no other company will invite them as a director. After all, corporate India makes no bones about the fact that it does not value too much independence.
This is where the Satyam story rests now. What Satyam did was not way out of line. A list of poor governance practices would cover the Who’s who of Indian companies. There is no obvious remedy. One option in cases like Satyam is a corporate raid. After all, the Rajus own just 8.6%. But unless institutional investors muster enough gumption to get together and replace the board (which will inevitably lead to a political tangle), this episode too, will end up as another example of how misaligned the interest of the average shareholder is with that of the dominant ones.
In the aftermath of the Satyam scandal, many experts are saying that the company will find it difficult to rebuild investors’ trust. Don’t believe them. Those of us, who have been tracking corporate behaviour for a long time, know that if public memory is short, that of investors (including institutional investors and fund managers) is even shorter. Many companies have done worse than what Satyam did, without protest. After all, everybody knows that Satyam was among the infamous K-10 companies that Ketan Parekh was ramping up furiously in 1999-2001. Moreover, in another controversy in mid-2000, Satyam Computer merged Satyam Enterprise Solutions (SES) in a manner that gave a windfall to Srini Raju who was running SES. KPMG had then fixed the merger ratio at 1:1. But before the merger, Satyam Computer renounced 800,000 shares of SES in favour of Srini Raju at a price of Rs10 when they were trading at Rs1,500. The 1:1 merger ensured that Srini Raju got 800,000 shares of Satyam Computer at Rs10. Investors were incensed when the information leaked out and the stock collapsed. Foreign funds expressed outrage and sold heavily. But the story was soon forgotten.
At that time, some ‘old economy’ business leaders had sniggered with glee that a new-economy, tech company, with its perceived virtuousness, had ‘defrauded’ investors. The information hit the public domain through a newsbreak on the website www.indiainfoline.com. Satyam added fuel to the fire by explaining that the news was old hat and the merger had happened a year ago. It also claimed that shareholders had, in fact, been informed and the merger was by shareholders and the High Court. Obviously, it was communicated in a way that nobody understood the implications of Satyam’s actions. Since the news broke a day before the annual general meeting, angry investors shouted at the management; but stunningly, CEO Ramalinga Raju did not even bother to show up at the meeting.
That was not the only time Satyam has displayed dubious governance. Its FY2001 results were flashed on two websites 15 minutes before the board meeting was scheduled to start. In August 2002, the Department of Company Affairs questioned its accounting methods, but that investigation was buried. Analysts, who tracked Satyam in the mid-1990s (before the big software boom), say that a private company of the Raju family had built all its software campuses. Although no wrongdoing was alleged, there was suspicion that Satyam’s construction cost was somehow higher than those of Infosys or Wipro. None of this came in the way of Satyam’s share price rising from Rs119 in 2001 all the way to Rs452 by 2007. Or putting together a star-studded board of independent directors.
What does all this tell you? Investors do not shun a company for bad governance. That is a naïve interpretation of how things work in the corporate and investment world. The Maytas affair will soon be forgotten, if its performance improves or its share price increases. On Monday, 31 May 2000, after its self-serving merger, the scrip hit a low of Rs1,900 but bounced back with incredible ferocity to sail past Rs2,500 on Wednesday. That is how little the governance issue affected investors. As commentator James Grant had said after the Enron episode: “People are not intrinsically greedy. They are only cyclically greedy.” In the next upcycle, greed will overcome goodness and all will be forgotten about Satyam (or Zee or Global Tele), until the next bust.
Shareholders of the World Unite
Corporate raider Carl Ican, who was recently in the news for shaking up Yahoo!’s management has some savagely telling observations about American corporations and their boards. He says, “Many American corporations are dysfunctional because corporate democracy is a myth in the United States. They run like a decaying socialistic state. Our boards and CEOs exist in a symbiotic relationship where the boards nourish the CEO with massive stock options that are re-priced downward if the company’s stock declines – making them forever valuable. They reward the CEO with pay packages and bonuses when the stock is floundering or the CEO is leaving the company. Corporate performance and the shareholders’ welfare seldom enter the picture. What kind of democracy is this? There is no accountability.
The inherent quid pro quo is to pay the board huge retainers for attending several meetings per year and rubber stamp ill-conceived CEO proposals. In turn, a CEO can fly around the world on the company’s private jet on the ‘business’ of visiting all the world’s greatest golf courses while he runs the company – and the value of your stock – into the ground. The average shareholder can do nothing about it.”
He further says, “Board members receive expensive tickets to important sporting events, the theatre, and are also treated to the use of the company’s fleet. Worst of all, the board itself is not made accountable because corporate board elections are generally a joke.
Board meetings are often a complete travesty. I know because I have sat and do sit on a number of boards where I am in the minority. Because of this, today our economy is in a major crisis. Many of our companies are incapable of competing. Additionally our banking system has issued mortgages that cannot and will not be paid back. We are in this situation because there is no leadership in the executive suite. Why did we get here? Because in corporate America there are no true elections. It is tyranny parading as democracy. It’s a poison running through the blood of corporate America. Perhaps, with enough public support, the lawmakers and regulators will take note.
When you rid a company of a fruitless board, the rewards are often enormous because the underlying company and its employees can be excellent. It is the top-level management that hangs like an albatross around the company’s neck. Years from now historians will marvel why we the shareholders – the legitimate owners of companies – did not do something effective about removing terrible managements. We can do something about the current situation. I will discuss in future entries how simple it can be and what has constrained us from taking action.” – from www.icahnreport.com
Satyam’s Glittering ‘Independent’ Directors
Dr (Mrs) Mangalam Srinivasan: Director since July 1991; resigned at the end of December 2008. Has been associated with University of California at Berkeley, American University in Washington DC, Harvard University, Northeastern University and Tufts University in Boston in
senior positions. As expert in cybernetics, she has worked with US Government Departments, US National Academy of Sciences and US National Science Foundation and the UN. Was Scientific Advisor to the government during Indira Gandhi’s tenure.
Vinod K Dham: Director since 2003; is famous as the ‘Father of the Pentium’ and was also on President Bill
Clinton’s Advisory Commission on Asian Americans and Pacific Islanders.
Dr Krishna G Palepu: Director since 2003; is the Ross Graham Walker Professor of Business Administration at the Harvard Business School and Senior Associate Dean, Director of Research. Dr Mendu Rammohan Rao: Dean of Indian School of
TR Prasad: Former cabinet secretary, Government of India.
Prof VS Raju: Former director of IIT Delhi. Was part-time member of Telecom Regulatory Authority of India and is now chairman of the Naval Research Board (DRDO).