Sucheta Dalal :Where Dishonesty's The Best Policy (10 June 2002)
Sucheta Dalal

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Where Dishonesty's The Best Policy (10 June 2002)  

The speed with which the US Congress has conducted the Enron investigation and the broad sweep of issues raised during the hearings had brought a slew of controversial corporate practices tumbling out into the open. We now know that many top US corporations with lily-white reputations had been cooking their books. We also know that the desperation to show higher profits was due to obscenely high salaries and stock options that CEOs were paying themselves. We know that deregulation of utilities such as power and water needs re-evaluation, since too many power producers and traders have been caught indulging in rampant manipulation of price and demand-supply, at the cost of ordinary people. Finally, we know that the concept of professionally managed companies with independent audit and compensation committees ensuring good corporate governance has failed. They could neither detect fudged accounts nor check skyrocketing CEO salaries.

The US and the rest of the corporate world is now watching what happens in the aftermath of Enron. The wide-eyed prediction is that when the dust settles from all the investigations, not only are criminal indictments likely, but so are accounting and corporate governance reforms. The rest of the world is expected to take its cue from these reforms to implement domestic changes.

While we will undoubtedly see some post-Enron reforms, the changes are no longer expected to be smooth or evangelistic. Corporate lobbies and their support groups such as auditors and accountants, who were in complete disarray when revelations about Enron, Xerox, Global Crossing, Adelphia Communications, GE and others began to hit the headlines, are now gathering their forces together and it is well known that they wield considerable influence over US policymakers.

As the International Corporate Governance Network has said: “Given the power of corporate lobbyists, government control often equates to de facto corporate control anyway”. Their power is visible in the fact that not one out of more than 50 proposed reforms — from changes in pension rules to increased control over auditors — has become law. A major accounting proposal faltered in the Senate Banking Committee after lobbying by business opponents. The New York Times reports that auditors have launched a “complexity defence.” They claim that audits involve close-call judgements that reasonable experts could debate, and it is not fair “to beat up on auditors as they wrestle with the finer points of derivatives or lease receivables.”

How will India react to global changes or lack of them? After all, what has shocked Americans does not necessarily shock Indians. For instance, if the Rigas family of Adelphia Communications (which owned only one-fifth of the company) treated it like a private piggy bank and used company funds to pay for a private jet, personal share purchases, movie productions, a golf course and apartments totalling a whopping $3.1 billion, then much the same is happening in India.

Almost every top corporate house owns private aircraft, which is used exclusively by the promoter family (they do occasionally allow it to ferry senior executives or conduct in-flight meetings, but these are exceptions). A corporate jet becomes an important status symbol only when it is used for holidays at Goa or a quick dash to a Delhi power-do. One industrialist turned politician, with several defaulting companies, converts his corporate aircraft into an air taxi for the exclusive use of himself and his MP friends. It wins him friends and silences detractors. Investors who eventually pay for these jet-setting lifestyles never see the bills for these expensive sorties. Industrialists who continue to default on loans to financial institutions have brazenly built palatial bungalows in Mumbai — one of the most expensive cities in the world — with no questions asked by investors, bankers or their lenders. The bungalows are not financed from their dividend income.

If Deloitte & Touche, Adelphia’s auditor, was napping, so too are auditors of top Indian companies. The Rigas bought timber land, which was transferred to the family for a pittance. Indian industrialists have mastered this trick a long time ago. Most major groups rushed to acquire real estate during the bubble days of 1995-96 when property prices skyrocketed. Large chunks of property was purchased through private investment companies of the industrialists and funded through inter-corporate loans from the listed companies. When the property bubble burst, these properties were quietly transferred to the listed companies at inflated prices.

If the Rigas owned a hockey team, our industrialists with delusions of regal grandeur are building polo teams. Heads of financial institutions want expensive corporate palaces as headquarters from which they preside over crumbling financial empires. One spanking new corporate palace was recently built although the empire itself has vanished.

Adelphia and other examples show that there was nothing complex in detecting most cases of stripping shareholders’ wealth. But if US auditors with their precious Generally Accepted Accounting Principles could look away so resolutely, would new reforms make them more alert especially when the expectation of sweeping change ebbs everyday?

The noted economist Paul Krugman writes in his NYT column that statistics for the last five years show a dramatic divergence between profits that companies reported to investors and other measures of profit growth. This suggests that many, perhaps most, large companies were fudging their numbers, he says. According to Krugman the fatal flaw in a system that “lavishly rewards executives for success” is that those very executives control much of the information available to outsiders and use it to fabricate the appearance of success. And that they are getting away with it too. Most CEOs who opted for early retirement and nine-figure nest eggs are unlikely to pay with jail sentences, he says. This means that dishonesty is, hands down, the best policy.

Where does that leave us? Dishonesty has always been the best policy here. No industrialist has been punished for diversion of funds, inflating project costs or stock market manipulation. Instead, they are abetted by generous institutional lenders, somnolent independent directors, lethargic regulators and a slow judicial system. The bad news is that it would leave Indian investors worse off than before. If business lobbyists stall reforms in the US, or dilute them, the prospect of sweeping reforms in India will immediately recede. Institutional investors such as mutual funds will have no incentive to assert their rights as shareholders. This will only keep the secondary capital markets shallow and volatile and the Initial Public Offering market dormant and distrustful.

-- Sucheta Dalal