Satyam, Scamalinga, and the role of boards

In the aftermath of the Satyam scam, one area that is clear as mud from media outpourings is the role of the board. Not what it was (nobody knows that) but what it should have been.

1. I find it hard to believe that so many people were shocked and surprised by what happened at Satyam. I am also amazed that Mr Scamalinga got any awards. Everybody in the stock market knew that Satyam was not exactly a model of governance, unlike Infosys and Wipro . That is why its P/E traded at a discount to Wipro and Infosys. Scamalinga bought an internet company in the late 90s which created a hubub as it was a questionable buy, and he paid far too much for it. The market punished the Satyam stock then.

2. So what has this got to do with the board? Everything. Anyone who is joining a board is of a certain seniority, which means contacts and the ready ability to check out the reputation of a company or individual. How/why did these stalwarts who joined Scamalinga's board not know what kind of guy he was? It was common knowledge that the company dressed its numbers - though nobody knew the extent. Nobody respectable should join a board like that. One check most investors do is to scan the list of board members to get comfort that the board has people of stature. If a company cannot get good directors, that is a clear red flag that something is wrong. By joining the Satyam board, the board members endorsed the company. The question is why.

As for the organisations that gave him awards, the less said the better. I am of the view that people are more concerned with the position you have attained than the results you have produced, and are more concerned with the results than the means. Member of the Board, wow! Never mind that you slept through every meeting, or endorsed dodgy decisions.

3. What are the responsibilities of the board? It is necessary to distinguish between three external influences on a company - the external directors, the external auditors and the regulators. The prime responsibility of preventing scams is that of the regulators, and the prime responsibility of detecting a scam lies with the auditors. Those are not the remit of the Board. The external board has to operate off numbers provided by the company and verified by the external auditors. There is no way for independent board members to know what is 'real'. I have operated as an executive director and as an external director, and can state categorically that if you are not part of the day to day management of the company, there is no way to know what the costs and margins really are at any point of time. The Board is responsible for the key task of hiring and firing the CEO and for providing direction, especially in key decisions (eg acquisitions, like Maytas) - both moot points in a family run company. If a board member feels he cannot influence these two things, he is merely a rubber stamp, and shouldnt be there.

4. So if the prevention and detection of scams is not the preserve of the board, does this mean the board is off the hook? No. The board does have an audit committee. This committee should look into the appointment of the external auditors and how much they are paid (did the external director(s) on the audit question why PWC was paid way over the norm by Satyam?). The auditors are supposed to be appointed by the shareholders, not the management. The audit committee has a role to play there. Moreover, the audit committee must have an idea of how the audit is being performed and be satisfied that due process is being followed, and must meet the auditors independent of the management of the company, to allow them an opportunity to state whether the management is applying undue pressure on the auditors.

And what happens to the board in a situation like Satyam's? Whether or not there is a legal liability, there is a downside. In the case of Satyam, the principal of ISB lost his job. The other people are certainly going to suffer a loss of reputation at the very least. Would you want one of them on your board? No. Even if you were looking for someone pliable, the answer would have to be no. They are done. They will also likely get hauled over the coals in the investigation.

5. The last point is governance. Some companies have a governance committee, which most often focuses mainly on key appointments . That is probably not enough. In the post Enron and now post Satyam era, investors are going to be keen to get reassurance on this key area. Those companies that can demonstrate good practices will increasingly be rewarded by the market. There is going to be a clear opportunity here for a financial win for shareholders. Clearly an area for Boards to reflect on strategically in the context of shareholder value creation, quite apart from any fiduciary responsibility.