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Home > India > Business > Columnists > Guest Column > R Ravimohan

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Satyam loses, but markets triumph

January 12, 2009

The Satyam [Get Quote] episode is an unfortunate instance of fraud of grave proportions, coming at a time when the investment world appears to be recovering from the economic shocks. But financial scandals, first the Madoff scandal last month and now the disclosure of accounting fraud by Satyam, continue to challenge the market recovery process.

However, the markets have begun to function again and appear to have emerged from the year-end break with a new approach to investment, which is predominantly bottom up, meaning that markets will choose to invest in specific companies, as opposed to thematic or top-down strategies, where sectors, countries or themes determine the broad investment strategies.

In the equity market, this is manifesting as wider spreads between those stocks that are in favour as compared to others and involving greater scrutiny and diligent efforts. This was witnessed in the Indian equity markets which hammered Satyam and stocks that were deemed questionable, while some stocks that were considered good actually went up.

Emerging markets around the world had a muted effect of the Satyam imbroglio, as opposed to the widespread contagion that used to sweep in the past. Clearly, the market is saying that they would continue to invest in stocks that are considered good, do more due diligence, but not sit out a big market like India.

The bond markets and banking system also seem to have taken the Satyam fraud in their stride. The credit premium spreads on Indian papers have remained largely intact, with some widening in a few papers which could reflect markets' unease in those particular cases, but there is no systemic adverse reaction.

Of course, it has to be recognised that these are early days and some impact could be felt when Indian borrowers actually negotiate deals, especially with respect to diligence and covenants.

It is also definitely too early to make a call on the fallout, if any, on the market for Indian products and services. It is to be expected that potential clients are likely to dig deeper and seek greater reassurances before doing business.

Thanks to the IT industry, Brand India enjoys a good reputation for quality, dependability and competitiveness.  However, it is worthwhile to keep in mind that this brand image is relatively new and fragile.

Conscious efforts must be made to safeguard and strengthen it. Industry associations would do well to conduct well-presented global road shows to convey Indian industry's seriousness in engaging with the global markets and its competitive ability to do so, with appropriate government patronage. For specific companies, a good endorsement from the financial markets will help.

So for all these reasons, companies must engage pro-actively and voluntarily with the market. The yardstick used by the market in discriminating between good and bad companies will run along the lines of management capabilities and behaviour expectations, governance and accounting standards, in addition to the business prospects and their financial strengths.

It is therefore imperative that companies do take all action they can to make all relevant facts and figures available to the market's scrutiny, which is definitely likely to intensify across board.

The government, regulators and exchanges can and should also help in restoring confidence in the market. They should of course punish the guilty expeditiously with the aim of recovering any ill-gotten gains, remedying the damages caused and to serve as a serious deterrent to potential future fraudsters.

But, they should, after being satisfied, come out strongly endorsing good governance and accounting standards followed by the system as a whole, despite their past shyness in doing this. The regulatory and the governmental system should also take steps to strengthen the system to minimise recurrence of this type of episodes.

These measures should also aim to streamline the legal and regulatory systems to enhance their ability to become more pervasive in their ability to detect fraud and more importantly respond much faster than they are able to act now.

In times of such market turbulence, the faster the authorities are able to intervene, the lesser the damage is and easier the recovery. There is a set of very good recommendations in the Raghuram Rajan Committee Report aimed at better coordination amongst the regulatory systems. It will be good to expedite implementation of the same. These measures will aid confidence building.

In fact some regulators are already setting very high standards of governance and transparency themselves. Sebi set a stellar example when it put the agenda and minutes of its Board meeting on its website last month. I am not aware of any other regulator doing this, except in the US. That in itself is unique.

But what makes it extraordinary is that Sebi has done it voluntarily. It is a very powerful development because, it signals the security regulator's intention to strive for maximum transparency in these markets, which augurs well for the Satyam episode as well.

When considering regulatory-strengthening measures at a firm level, it is important to distinguish between fraud and misgovernance.

Fraud is a hard criminal activity and its prevention through structural measures will not yield any results. Only early detection and strong deterrence are counter measures to minimise fraud occurrences. Governance also cannot be ensured by structural prescription. Satyam is a good example of how putting in place the right structure alone does not work. Beyond manning these structures such as independent directorship, audit committee, reputed auditors with the right people, there need to be good incentives for them to perform and strong disincentives for either committing fraud or not discharging their responsibilities with effectiveness.

Solutions that sharpen these incentives for good behaviour will be mostly market-based, in terms of valuation and financial returns. Disincentives also need to be equally punishing both from the market and from the regulators which will need to revolve around strict enforcement, punishment and deterrence.

However, despite the slow system response and uneven governance standards, it is my sense that enough market-based corrective mechanisms exist today. The aborted proposal by Satyam to acquire its associated companies for exaggerated value is a good case in point. Despite failure of corporate governance in that instance, swift, vociferous and active shareholders' protest supported by marketwide protest against the deal ensured its demise. Going forward, I would expect sharper risk premium differentiations to be attached to companies considered to be well-managed and governed, and those companies that are not able to pass muster are likely to face tough time raising funds in the market.

While system responses are being prepared, it is really up to each company to strengthen its appeal to the investors, financiers and customers to ensure they are considered good investments and credits.

The author is the Managing Director & Regional Head of Standard & Poor's, South Asia.

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