Oh the irony. “Satyam” means “truth” in Sanskrit, a fitting name then for the fourth largest company in India’s booming information technology sector – a company that named the World Bank and a series of international blue chip businesses among its clients. But not anymore.

The company, it now turns out, was a scam. Its chairman and founder, Ramalinga Raju, resigned in January after sending a letter of confession to his board. Some $1.5bn of the company’s funds were “non existent”, Mr Raju said, as was 95 percent of the revenue it reported in its last financial statements.

Naturally, this was bad news for Satyam’s investors: they were wiped out in a stroke. But it is bad news for India too. The chairman of the country’s financial regulator, the Securities and Exchange Board of India, said it was an event of “horrifying magnitude.” If the November terrorist attacks in Mumbai gave this emerging world power its 9/11, now it had its very own Enron.

The fear now among India’s business and political elite is that the Satyam scandal will scare off foreign investors and – more specifically – cripple its IT sector. Outsourcing is a massive business for India, but it relies on the trust of foreign companies. They will not let Indian companies handle their sensitive data or take responsibility for business processes if they cannot trust their probity. Satyam looked like a safe pair of hands. It was listed on the New York Stock Exchange, had business operations in 66 countries, and counted 185 companies in the Fortune 500 among its clients. It won awards for its standards of corporate governance.

Perhaps the most alarming aspect of the fraud is that it seems to have been going on for a long time. Mr Raju confessed that he had been fiddling the company’s financial records for the “last several years” – all under the noses of Satyam auditor, PricewaterhouseCoopers. In his contrite letter he argued that he had not benefited financially from the fraud, and was simply trying to keep the business going. Once he had started to cook the books, “It was like riding a tiger, not knowing how to get off without being eaten.”

That tiger started to nip Mr Raju’s ankles in December, when Satyam launched a $1.6bn offer to buy two property companies largely owned by Mr Raju and his family and run by his sons. Analysts said the bids massively overvalued the target businesses and would have used up all of Satyam’s cash reserves. Its shares started to fall, and within hours the company announced that it had scrapped the idea. Institutional investors were angry that Satyam’s nine-member board had approved the deal in the first place. It just didn’t seem to make sense: why would a leading IT company want to start investing in property?

Logical conclusion

Mr Raju’s resignation letter revealed the true logic behind the aborted deal. It was a final desperate effort to cover up the accounting fraud by bringing some real assets into the business, he said. When it failed, Satyam started to unravel. Within days, the World Bank said it had barred Satyam from offering it computer services for eight years, citing concerns about corruption, data theft and bribery. Other customers started to voice their concerns about fraud and accounting irregularities. Satyam directors started to resign. And then Mr Raju confessed.

In his letter, Mr Raju tried to take full responsibility for the fraud. Investigators will test the credibility of that claim. The government has already replaced all of Satyam’s board directors, and, at time of writing, Mr Raju was pondering the consequences of his actions from the comfort of a Hyderabad jail cell.

What are the consequences for corporate India? “If there were one or two more such accounting scandals in the next six months, it would make international investors more wary,” says Michael Useem, professor of management at Wharton, the business school. “One example would put people on guard; several examples would be enough to tell big investment money managers that they have to be especially careful working in that environment. [but] Don’t assume other firms are guilty,” he says.

Unrelated events

Mr Useem’s colleague, Mauro Guillen, a Wharton management professor who has studied corporate governance in emerging economies, says that India has good grounds to argue that Satyam’s problems are not systemic. “India is not perceived like Russia – it is neither everyone’s darling nor the plague,” he says. “This works to the country’s advantage because it deflects the blame of such occurrences to the way governance works in emerging economies rather than to India. What regulators in India need to do in response to Satyam is to find out quickly if other companies have been doing similar things. The proper response is to deal with and defuse the problem as soon as possible.” However, the fact that Satyam had a listing in the US but still had such serious governance problems “makes this case particularly disturbing, says Mr Guillen.

Corporate India has tried to contain the damage so far. Rajeev Chandrasekhar, president of the Federation of Indian Chambers of Commerce and Industry, has called upon regulators “to move quickly to demonstrate that this is an exceptional case among corporations, and that investors need not worry about Indian corporate governance and accounting standards.”

But the scandal is bound to put Indian companies under the spotlight. The Satyam affair is “a major eye opener and will bring into renewed and critical focus the role of independent directors, auditors, company management, [the] CFO and other key persons involved,” said Suresh Surana of Astute Consulting. Richard Rekhy, chief operating officer of the global consultancy firm KPMG in New Delhi, has espoused similar views. “The Satyam crisis is not only a wake-up call that has shocked us all, but it is also a great opportunity for everybody to look at the quality of corporate governance more seriously,” he said. For a long time, “many found the subject boring, but that has changed now. We were busy pursuing a high-growth economy and neglected important things like instituting an ethical corporate governance mechanism.” Mr Rekhy said that as yet unpublished KPMG research shows that “integrity and ethical values are not given enough attention” in Indian companies.

The Asian Corporate Governance Association (ACGA) 2007 ranking of corporate governance placed India third out of 11 Asian countries, behind Hong Kong and Singapore, but far ahead of China, in ninth place. India’s financial-reporting standards are high and the SEBI is independent of the government. But regulatory enforcement is weak, the rules contain large loopholes, and shareholders tend not to make their views known. The Confederation of Indian Industry, has demanded that the loopholes in regulation, accounting, audit and governance that allowed such lapses be addressed with urgency. The government has introduced a new companies bill, which would allow shareholders to pursue class-action lawsuits, but it isn’t certain to make it onto the statute book – elections have to be called in the first half of this year.

True, shareholders protested about Satyam’s planned December acquisitions, but that was a rarity, and by then it was too late. Often, Indian shareholders don’t understand governance rules and corporate legislation anyway, observers say. Until they stand up and complain, what incentive is there for companies to change?

Compounding the problem of ineffectual shareholders is the fact that India’s corporate landscape is still dominated by family-owned businesses. According to a survey on Indian corporate governance by Moody’s Investors Service, such firms have specific characteristics compared to companies with more widespread share ownership. The survey looked at corporate governance practices of 32 Indian companies in 16 prominent family groups, covering a broad cross-section of Indian industry. There are benefits to being family controlled: a lack of outside influence makes it easier to take a long-term view and to act quickly. That is one reason why Indian companies have been able to take advantage of the opportunities created by a fast growing and rapidly liberalising economy.

Problems underfoot

But family control also brings governance problems – not least of which are a lack of checks and balances over executive decision-making and behaviour, and a lack of transparent reporting to the outside world. “Although Indian corporate governance practices are improving, this largely reflects regulation of listed companies, particularly regarding ‘checks and balances’ such as composition of the board of directors and the operations of audit committees,” said Chetan Modi, co-author of the report. “The lack of board nomination sub-committees in many companies suggests that succession planning is not fully deliberated with independent directors. There is often insufficient transparency on ownership/control, related-party transactions and the group’s overall financial position. Also, the prospect remains of higher leverage as families try to maintain control while implementing their often aggressive growth plans,” said co-author Anjan Ghosh.

More regulation won’t necessarily do anything to help. Satyam – so far it seems – is a scandal of flawed leadership and human failure at the very top of the business. When the chairman himself is cooking the books, the best corporate governance in the world will do nothing to stop him. Having said that, Satyam’s supposedly independent directors – all of whom resigned just before the fraud was announced, but who claim no knowledge of it – could have done more. What questions, for example, did they ask about the quality of internal control over the company’s financial reporting (which, by Mr Raju’s admission, had been fraudulent for years) or about the scope and extent of the work done by its external auditors, who seem not to have spotted the fraud?

It’s hard to know what goes on inside a boardroom once the doors are closed. However, it’s often the case in India that the independent directors who are supposed to provide an objective voice are linked to the executives or their family. There is also an attitude in some Indian companies that the board members – executive and independent – work for the people who have brought them onto the board, and not for the interests of shareholders. This is wrong, but hard to fix in the short term.

How badly does Indian corporate governance need to improve? Here’s an interesting example. As Satyam fell apart, Puneet Kumar, a top manager at Wipro, India’s third-biggest IT business, said the company was “an aberration”. Mr Kumar told reporters: “After what happened there is bound to better self-regulation among Indian IT companies. The fact is that the IT industry thrives on good reputation and every major in the business lays great emphasis on maintaining global standards of corporate governance.” Sounds laudable, but within days the World Bank announced that, like Satyam, it had banned Wipro from providing it with IT services. The reason: corruption. Actually, the company was banned in July 2007 – for four years – a fact that, at the time, it didn’t bother to tell its shareholders.