The Hindu Business Line : Satyam fraud: Misplaced faith in self-regulation

The Satyam debacle will raise many questions but the key query is: What price the social responsibility of businesses? Milton Friedman, writing about the social responsibilities of business, was acerbic: “The discussions of the ‘social responsibilities of business’ are notable for their analytical looseness and lack of rigour. What does it mean to say that ‘business’ has responsibilities? Only people can have responsibilities. A corporation is an artificial person and in this sense may have artificial responsibilities, but ‘business’ as a whole cannot be said to have responsibilities, even in this vague sense...”

Issues of ethics

Yet, a corporate’s pursuit of profit cannot ignore society or obligations to it. A company’s independence to make profits ends at that point where it starts affecting other members of society. That is why the various social-control mechanisms to keep corporations in check. But when these systems are obviously not robust enough, and corporates are not self-regulating, they raise issues of ethics and the interest of stakeholders.

As Edward Freeman, who suggested the stakeholder theory, says, “it’s not useful anymore to separate questions of business and questions of ethics.” An integrated way of thinking about business and ethics is via responsibility of action. That is, “businesses and executives are responsible for the effects of their action. They are responsible precisely to those groups and individuals that they can affect or be affected by...”

The Satyam debacle has destroyed in no small measure the stakeholder value, especially that of the shareholder. While their plight is understandable, it must also be realised that they are as much, if not more, responsible for the situation they find themselves in. The very shape and idea of the shareholder has changed. No longer do shareholders come in as providers of capital who will remain invested for reasonably long periods. Now, they are investors aiming to make quick money. This is true also of institutions such as mutual and pension funds. The interest of these ‘investors’, as opposed to ‘shareholders’, is short term. When the average duration of an equity investment by a US mutual fund is 11 months, what would be its long-term interest in the company?

In pursuit of profits

With shareholder value redefined by time, managements are left looking for quick profits. In the effort to retain shareholder interest, managements have become slaves to the stock market. The market is greedy and has an insatiable demand for profits. The practice of quarterly reporting worsens matters as corporates feel obliged to show growth in every reporting period. This is difficult to achieve from core activities, so managements turn to financial re-engineering. While attempts have been made, through incentives, to ensure that managers do not misuse the wealth that is not theirs, they have done just that and repeatedly. This is what led to Enron, WorldCom, Arthur Andersen... The situation is worse when the so-called ‘owners’ (though promoters would be the better term as they usually hold low with little of their own money invested) do the fudging.

The light-touch regulation and the misplaced faith in a self-regulating market have left corporates to their devices. They, in the pursuit of profits, give short-shrift to good governance practices leading to such crisis as that at Satyam. Besides the corporates, the Satyam debacle is a severe indictment of the systems and regulatory practices and, crucially, the auditors.

Some blame must also attach to the media that are perhaps collectively the most influential with the people than any other institution. They aid in information processing by selecting the most relevant information for their set of readers and, more importantly, by cross-checking the veracity of the news. This iterative approach gives the media the watchdog role. But have the media played this role? Not really, because oftentimes journalists simply do not know what is happening even with the companies they track. Journalist may plead, variously, work pressures, lack of expertise, or voluminous and opaque corporate reports. But with a larger informing role, it is incumbent upon journalists to consult experts and do diligent follow-ups.

Also, media have a tendency to quickly lionise seemingly successful businesspersons. A look at scamsters over time would reveal this pattern: Media initially hailing them and promptly throwing them to the wolves once the truth emerges. Media must be more careful in its reporting of corporates and their chieftains. They are, as it were, informal regulators and watchdogs of the corporate governance process.

Confidence takes a beating

The Satyam debacle will hopefully bring in changes to the corporate governance framework. Though the outlook appears bleak, there is opportunity too. But there could be changes in the way business is perceived and practised. One obvious development could be consolidation. But with large corporates seemingly having feet of clay, there could be a shift to disaggregation.

To spread the risk, contracts may be handed out to a number of medium-size companies, rather than one giant. This is especially true of the outsourcing industry where confidence has no doubt taken a beating, post-Satyam. But as confidence returns, there could be a shift towards more small/medium players rather than one large company. This will raise opportunities for system integrators who will have the ability to manage work handed out to diverse players and integrate them for delivery.

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