If America Inc faults, shall India be far behind? (1 July 2002)
If corporate America is reeling from a long string of accounting scandals that have blown the reputation of several corporate icons, can India be far behind in accounting jugglery? Almost every trick employed by US scamsters has been in vogue in India for decades. Cooking of accounts, inflating projects costs, diverting company funds to private companies belonging to the promoter, bill discounting frauds, over-invoicing/under-invoicing sales/purchases and faking exports in order to exploit duty-drawback schemes or subsidies — haven’t we seen them all? One investor, reacting to the WorldCom revelations wrote to say how a very large Indian company used to prepare as many as six draft balance sheets every quarter before it chose the one it would declare to its investors. Global Data Services, a subsidiary of the credit rating agency CRISIL has now produced analytical evidence of such manipulation, albeit on a small sample.
Based on a study of 639 companies it announced that large number of companies (139) had overstated their profits in the year 2000-2001 some to the tune of over 1000 per cent over Crisil norms. Also, 87 companies had understated profits—one by as much as 100 per cent. Since most Indian companies are family owned, CEO compensations are rarely linked to company profits; the manipulation of accounts is usually connected with another aspect of the corporate scam saga. That is the personal enrichment of the managing family at the cost of other stakeholders. Cooking the books allows them to indulge in insider trading and stock price manipulation in collusion with stock brokers. Otherwise, it helps prepare the grounds for fresh borrowing from banks and financial institutions to fund large expansion and diversification projects. Continuous expansion and asset growth is almost mandatory for siphoning out large sums of money. Several first generation industrialists have built up large diversified business empires using a combination of these tricks to raise thousands of crores of rupees from Indian banks, financial institutions and the capital market. The difference between the US situation and India is that until the monolithic UTI threatened to go down like a pack of cards, we have not had a single bankruptcy the size of Enron or acknowledged a fraud the size of WorldCom.
In fact, our largest collapse in recent times is that of the Rs 1,000 crore CRB Group and sundry finance companies. This is partly because Indian laws protect companies from bankruptcy. Moreover large scale corruption and the political clout of companies allows them to keep borrowing from banks and lending institution, until it is the latter that are bled dry and on the verge of collapse. But even without a single spectacular failure, the deadening impact of frequent scams, and the near collapse of trusted institutions such as UTI and IFCI have taken their toll on investor psyche.
The moribund market for Initial public offerings (IPOs) and the lack lustre growth of the mutual fund industry bear testimony to the destruction of investor confidence. Only weeks ago, corporate India was gung-ho about raising over Rs 30,000 crore through IPOs. But the very mediocre showing by the much awaited I-flex Solutions issue(no doubt affected by its very public battle with Saraswat Bank) indicates that companies planning IPOs will have to scale down both, the size of their offering and price expectations in order to attract investors.
If the government wants to revive the primary market and restore vibrancy to the capital market it needs to learn some important lessons from the spate of American corporate scandals. Firstly, that a mere code of corporate governance does not make for honest corporate behaviour. In fact, all these accounting scandals have coincided with the increased obsession over good corporate governance. One almost begins to wonder if the rhetoric was only a cover for the most brazen accounting fiddles. The incessant discussion also hid, what the noted economist Paul Krugman calls “regulatory black holes” in which shady practices could flourish. In India we have systemic black holes which not only allow shady practices to flourish, but enable regulators to turn a blind eye. These are the lack of coordination among regulators, long-winding investigations, the whining about lack of powers, corruption in the investigation agencies, an extremely slow judicial system and finally the reluctance to hand out exemplary punishments and damages. Yet, the American scandal seems to have had a tiny impact on members of the Joint Parliamentary Committee (JPC) investigating the Scam of 2000-01.
The manner in which the biggest and most powerful corporate houses, such as Enron have been forced to face the music or to fold up in the US, has probably woken up Indian politicians, who are otherwise beholden to corporate houses. Maybe there is a creeping realisation that campaign funding and corruption are common to both democracies – India as well as the USA. But companies who finance politicians are not allowed to get away with destroy public trust and the financial system. A sign of this realisation is the latest briefing by the JPC chairman. He said that the JPC was unhappy over the tardy progress of investigations by the Sebi as well as the Department of Company Affairs into the role of corporate houses. He also said that the regulators had been told to hasten their investigations and initiate action against companies who colluded with the scamsters.
If the JPC pursues this line to its logical conclusion, it would be a major departure from the damp squib of a report produced by the JPC of 1992, which let off banks with a slap on the wrist and did not dare touch corporate houses. The nefarious activities of companies are at the crux of all financial scandals in India, and if the JPC members are willing to rise above personal considerations and tackle these, then they stand a good chance of recommending systemic changes to protect investors. These would include, better accountability on the part of auditors and corporate CEOs, truly independent boards, checks on the brazen siphoning of funds from companies, increased privatisation of lending institutions and banks and making regulators responsible for poor supervision and failing to initiate timely action. -- Sucheta Dalal