Satyam and Governance

Posted by Jeff Lipshaw

Once again, our mouths are agape as a putative paragon of “good governance” – the Indian outsourcing firm, Satyam – turns out to be rife with out-and-out fraud.  Larry Cunningham has a nice post on this over at Concurring Opinions.

Two quick reactions.

One.  It really is a mystery how somebody who is audited by PWC gins up a billion dollars in fake cash.  My wife has been an inactive CPA since about 1983, and her comment this morning was:  “I haven’t been on an audit in over 25 years, but I’d still know how to audit cash!”

Two.  Back in October, I did a sarcastic little post on whether having good governance somehow insulated firms from the consequences of the financial tsunami.  One of the exemplar firms in my little survey was none other than Satyam.  I took the list from a group I had never heard of, but unless it also is lying, it seems to have the endorsement of outfits like Bloomberg, NYSE Euronext, Arnold & Porter, KPMG, etc. (A sidebar WSJ article refers to another London good governance rating outfit that also extolled Satyam, but intimated that the rating outfit itself was a little corrupt.  My point is that Satyam seemed to have fooled everybody, even those who were on the up and up.) I have suggested many times that attempts to legislate good governance by things like independence rules are based on tenuous cause/effect relationships.  Since that post, I tried to reconcile this with my own intuition that, indeed, something does stink if the board consists of a bunch of people who receive financial benefits (other than their fees) from the institution they purport to govern. 

What I realized is that the relationship between rules (“entrenched generalizations” in Fred Schauer’s coinage) and consequences is not symmetrical.  We may reasonably generalize that when a director’s public relations firm, for example, receives $500,000 a year in business from the company on whose board the director sits, there is a plausible enough connection between the conflict of interest and bad judgment to institute a financial independence rule (this is good ol’ rule utilitarianism).  The fallacy is in thinking that similar rules will by themselves create good judgment.  That, of course, is the problem with much of governance reform.  The rules will probably inoculate the board against one kind of disease, but it’s otherwise no assurance of good health.