- Company history
- Factors that precipitated fraud
- Satyam fraud
- Ways of preventing future fraud
The following is a research paper detailing fraud cases in Satyam Computer Services in India and it is one of the worst accounting scandals that happened in the year 2009. The research paper will analyze the fraud case, how it happened as well as the factors that facilitated it. The second part of the essay will look into the discovery of the fraud and the third part will describe the measure that would have prevented the fraud from occurring as well as the ways and means of preventing future fraud.
Satyam Computer Services was one of the most successful companies in India and it had received numerous awards prior to the discovery of the accounting fraud that existed in the company for many years. The IT Company that deals with the sale of computer software is now plummeting after shareholders withdrew their investments leading to a decrease in the value of shares. The company due to its impressive performance was at the New York stock Exchange until 2009 (Newesti, 2009).
Factors that precipitated fraud
The following are factors that precipitated the fraud in Satyam. The first reason is poor corporate governance, which refers to the procedures, and principles set to regulate the operations of a given institution. They dictate the relationship between the organization and the stakeholders in the company such as the shareholders, the employees, the government, and the customers. The loophole in corporate governance comes in when there is dominance by one individual to the extent that the individual makes most of the decisions. It is worth noting that in Satyam the chairperson of the board of directors was also the Chief Executive Officer of the company. This gives the chairperson a lot of power to control the company (Newesti, 2009).
The other issue that precipitated into this scandal is earnings management. This is an accounting practice where companies in an attempt to ensure positive and stable maintenance of their profits manipulate figures to project profit even if that may not be the real case. Companies do this to increase investor confidence as well as ensure that the company’s stock price goes up in the stock market as investors only invest in companies which make profit and are likely to make more profit in future. Satyam has since been involved in such practices by increasing their sales volume to levels that are not factual. Increased sales volume automatically leads to increased profits (Newesti, 2009).
The other factor which precipitated fraud in Satyam is that of performance based incentives where the management received bonuses because of good performance. This motivated the executives and the board to collude to increase the profits and receive bonus payments. In the case of Satyam the bonus were stock options where the managers received shares for the increase in profit. They sold the shares at an increased price because of rise in the share price from the increased profits. This precipitates fraud in form of earning to boost the profits, as it will lead to increased share price (Newsti, 2009).
The other factor that occasions fraud in a company is when the auditing measures are not stringent and they provide individuals with a chance to exploit this loophole. This is because they know that there are no means of holding them accountable. In the case of Satyam, the company that was responsible for auditing was Price Water House Coopers and it colluded with the managers of Satyam to manipulate figures thus defrauds the investors of their money. Although the auditing managers have denied involvement, there is no way such manipulations of figures would exist if the auditors were on the lookout. Collusion of managers with the auditors is a factor that precipitated this accounting fraud (Newesti, 2009).
The other factor that precipitates fraud in a company is when the managers of a company are working to cover up fraudulent activities or transactions within the company. The fraudulent activity occurred as the chief executive was informed of the fact that Satyam had thirteen thousand ghost workers. The actual workers in the company were forty thousand yet the company paid salaries to fifty three thousand workers. The surplus amount went into accounts controlled by the chief executive who would then withdrawal the $4million (Newesti, 2009).
Satyam account fraud involved classical manipulation of figures by the auditors and executives of the company such that the company had received many awards as one of the best IT companies in India. Satyam had for a period of five years been adding one billion USD on top of the profit they made. This is what the Company chief executive admitted that it happened and independent forensic auditors confirmed it. The company has thirteen thousand ghost workers and the actual employees were forty thousand yet the employees accounted for in the salary expenses were fifty three thousand. The surplus figure goes into the hands of the Company’s CEO (Newesti, 2009).
With such ghost profits and ghost workers, the company received many awards even in 2008 when the scandal was unearthed. The chief executive officer would receive bonus shares for the good performance together with other members of the board and senior management. They would then sell the shares and the stock option at higher prices thus raking a lot of money individually. To cover up the fraud the company would pay the investors with shares rather than dividends. This increased phantom money in the company, money not backed by real assets as touted by the managers. Though the company performance in the eye of the public was impressive, the revelation of this fraud was shocking and led to the removal of the company from the stock exchange in India as well as the United States. There was revoking of awards given to the company for its impressive performance, as the financial results used to gauge the company were fraudulent. The auditor of the company received a one-year ban for colluding with the company to engage in such fraud. This has seen PWC lose credibility in India after the scandal (Newesti, 2009).
The scandal came into the limelight after a whistle blower reported this matter to the government and investigations done to ratify whether the information was correct. Soon after there was arrest of the chief executive who later confessed that the reports were true. The company indeed magnified the profits by one billion through doctored sales volume figures. This caused an outrage among the various stakeholders of the company who have called for speedy prosecution of all those involved in the fraud (Newesti, 2009).
Ways of preventing future fraud
The following are ways of avoiding recurrence of fraud in Satyam. The first measure to prevent future occurrence of such fraud in Satyam is having proper corporate governance policies. Such policies should prevent managers from playing junior roles such of manipulating the pay roll to suit their own needs. When proper governance structures exist, they provide an oversight capability to the members of the board where they can pin point any misdeed happening in the organization. Lack of good corporate governance by having board members who lack integrity and of questionable character is one of the causes, which precipitate fraud (Crane, 2007). Lack of proper mechanisms to make the executives have accountability to the investors occasions fraud in many organizations. In the case of Satyam, it seems that the elected directors were part of the fraud or they were dormant and therefore ignored the day-to-day operations of Satyam (Crane, 2007).
Earning management or creative accounting practices require prohibition in the organization. This is because if such smoothening of figures, as it were informally known were illegal, manipulation of figures to project such huge sales would not take place. The earnings management is a major loophole for any organization because the temptation to have huge and more impressive figures always entice the managers and if not contained it wrecks companies, as the shareholders may not have the right information concerning the company. It is therefore necessary for organizations that hope to attain credibility to punish severely managers who come up with imaginary figures (Crane, 2007).
The other measure that if it was in place the fraud would not have occurred regards the compensation of the senior management through performance based measures. While many of the investors consider this as one of the best ways to ensure that managers perform exemplary resulting in huge dividends and more shares, the case does not apply always. The incentives make the senior executives provide figures with an intention of increasing the profits. The aim is to ensure that the profits made are brilliant. Removal of such incentives is critical in preventing fraud (Crane, 2007).
It is imperative for a company to have mechanisms of engaging different auditing companies to do an independent audit. The independent audit assists the company to asses its performance and the performance of the existing companies. If there were independent auditing in Satyam after every two years such a case where the managers provide false financial statements to the investors may not have occurred, as it would have early detection. The independent audit ensures that the company auditors do not engage in fraud because they know that their reports will go through an independent assessment from their competitors and they would strive to ensure that their auditing reports are factual (Crane, 2007).
Having a mechanism through which employees can report fraud without victimization is an important measure for containing accounting fraud. This is because it is through whistle blowing that fraudulent activities receive exposure and the culprits punished. However, the measures should be credible such that they are not used to witch-hunt anyone. Proper investigations are necessary after receiving information to establish facts and then to prosecute those who are involved in the fraudulent activities (Crane, 2007).
There is need for the management or the board of the company to have elected directors chairing key committees in the company. Such committees are the risk management, audit, and oversight committees because these are the committees where fraud prevails. If the individual investors have representation in such committees then cases of fraud intended to defraud the individual investor who is uninformed against conspiracy from the management are likely to reduce (Crane, 2007).
Finally, fraud in Satyam would not have prevailed if the auditing company reviews the stated human resource against the actual human resource. There is need for organization to conduct an audit on the human resources in the company to avert situation where senior managers include ghost workers as employees of the company. This would save the company expenses and attempts by managers to cover up fraud by false figures (Crane, 2007).
The case of fraud in Satyam was one of the revelations of how accounting fraud is prevalent in many organizations and takes long time without discovery if there are no proper mechanisms instituted to ensure that they do not occur. For a long period, the performance-based bonuses are the best way to motivate senior managers to drive performance in the organization. However, these measures have proved to be the greatest motivators of fraud that every major accounting scandal such as Enron and WorldCom results from the profit based incentives. The issue of earning management to project profits that are inexistent needs address as it may wreck many companies in an attempt to provide figures to impress the investors. It is necessary for companies with the need to exist in the long term to do away with this practice. Auditing companies need verification and reassessment as they can collude to defraud an organization through dubious practices. It is necessary for a company to have ways of reporting fraud cases to the investors so that early investigations may take place and avoid repercussions of prolonged fraud like this of Satyam.
Crane, A. (2007). Business ethics. New York: Oxford University Press.
Newesti, P. (2009). PwC India struggles to overcome Satyam Scandal. New York: New York Times.