Prof. Jayanth R. Varma's Financial Markets Blog

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Open the books

I wrote a piece in the Financial Express today on the enhancements to corporate disclosure that are required in the aftermath of the Satyam fraud.

Ramalinga Raju was in jail two days after he confessed to a $1.5 billion fraud at Satyam and has remained there since then. By contrast, Bernie Madoff is still ensconced in his home more than a month after he confessed to a $50 billion fraud in the United States. Two days after the Raju confession, there was a new board of directors for Satyam taking charge of its assets and trying to preserve as much of shareholder value as possible. Meanwhile, Madoff has spent his time out on bail mailing a million dollars worth of jewellery as gifts to his friends and relatives, putting them beyond the reach of the investors whom he has defrauded.

On the whole then, the Indian government has done better than the low expectations that we have of our rulers, while the US has conformed to the images of crony capitalism that has characterised its bailout era.

But complacency would be a mistake on our part. Emerging markets are held to higher standards than developed markets, and it is essential to use Satyam as an opportunity to make a series of much-needed disclosure and governance reforms. The question to ask is not whether these reforms would have prevented Satyam; the relevant question is whether these reforms would help bolster investor confidence in the Indian corporate sector at a time when it has been badly shaken.

Much as the government might like to portray Satyam as an unfortunate exception, the fact is that most investors, both in India and abroad, think of it as symptomatic of the problems that could be lurking in many other leading Indian companies. Of course, companies will voluntarily increase their disclosure standards to signal that they have nothing to hide. But this by itself is not enough. Disclosure is most effective and useful to investors when it is carried out in a uniform way by many companies. This is where regulators have a role to play.

Increasing the quality of quarterly disclosures is very important. Satyam was, of course, subject to this requirement as a US listed company and it is conceivable that these disclosure requirements forced a confession in early January 2009 shortly before the results of the quarter ended December 2008 were to be unveiled. Absent the pressure of this disclosure requirement, it is not beyond the realm of possibility that the deception might have been kept up for another quarter till the year end in March 2009.

I have written in the past (FE, November 27, 2008) on the need to force companies to reveal the complete balance sheet and not just the income statement highlights on a quarterly basis. This needs to be pushed forward more rapidly. On the same lines, a more rapid move to international accounting standards is desirable. Certain key standards like AS 30 on financial instruments could be targeted for accelerated adoption and implementation.

Greater regulatory scrutiny of corporate disclosures is also essential. The Raghuram Rajan Committee on financial sector reforms (of which I was a member) has recommended that India should adopt a system of reviewing the accounting filings of companies on a selective or sample basis on the lines of what the SEC does in the US.

Equally important are measures to improve private sector scrutiny of corporate disclosures. In the US, the Edgar database of regulatory filings with its full text search capability and its XBRL based interactivity is a huge boon. It is difficult to see how private sector scrutiny of the kind carried out by could ever be done without Edgar. The dissemination of corporate disclosures by the exchanges and by Sebi on their websites does not come remotely close to what Edgar achieves in the US. We should make it a top priority to get our own Edgar style repository functional as quickly as possible.

I am also a proponent of combining regulatory review and private sector scrutiny in innovative ways. For example, a short seller who believes that there is something wrong with the accounts of a company should be able to demand a regulatory review by paying a fee to cover the regulator’s costs. Needless to say, the results of the review should be announced only publicly so that the short seller does not get any advance information. He would of course benefit from the price impact of the review findings on any pre-existing short positions.

I am invariably told that this scheme would be misused by people to embarrass their corporate rivals. My flippant response is that there is nothing wrong in harnessing corporate rivalry in such a constructive way to improve the credibility of corporate disclosures. More seriously, if a review leads to a clean chit, the public announcement of this would benefit the target company. This in itself would act as a disincentive against frivolous review requests by people endowed with deep pockets.

Posted at 7:03 am IST on Thu, 22 Jan 2009         permanent link