iGate’s Failures in Risk Management

phaneeshiGate fired its CEO Phaneesh Murthy for sexual misconduct after Araceli Roiz; an American employee accused him of sexual harassment. As per media reports she has claimed that the relationship started soon after she joined the organization in 2010 and is pregnant with his child.

Mr Phaneesh Murthy has the dubious honor of facing two similar charges while working as a senior manager in Infosys in 2002. Reka Maximovitch and Jennifer Griffith had both received huge out of court settlements previously. Now he faces the similar charges from Araceli Roiz. Mr Murthy has acknowledged that he had sexual relationships with Ms Roiz. However, it was with her consent. He has alleged he is being defamed and this is an attempt at extortion.

With the limited information available in the media, one cannot comment on the details of the personal relationship.

However, this disaster teaches a few lessons. iGate could have prevented this reputation damage and legal risks if it would have taken a few timely steps.  iGate board and senior managers failed to take due care of the following risks.

1.     Pre-employment Background Screening

Mr Murthy has an excellent academic and professional achievement record. He was credited for taking Infosys turnover from $ 2 million to $ 700 million. However, when he was hired by iGate in 2003 he was in the news for all the wrong reasons. The sexual harassment cases were all over the media.

iGate needed a CEO who could deliver results. My guess is the board looked the other way or considered Mr Murthy’s infidelities small or insignificant. However, if a junior or middle manager had the same reputation, his career would have been over. No organization would have hired him.

Hence, when generally senior managers background screening is more stringent  than junior or middle managers, iGate board took the opposite stance.  It appears that the same yardstick isn’t being applied for background screening or it is being given lip service.

2.     Failure to Monitor & Control CEO Behavioural Risks

iGate board and senior managers chose to ignore the CEO behavior  As per media reports, the relationship was known to the staff. However, it appears no action was taken to guide or coach Mr Murthy.

Read these statements of Mr Murthy from prior interviews at the time of Patni takeover.

The National – “Everyone says that M&As are about ego. I’ve been a salesperson for 10 years. For every 100 doors that you knock on, 98 get shut in your face. That has knocked away most of my ego. I have two teenage boys who whip my butt in every game. They have gone from wanting to be on my team to not wanting to be on the loser’s team. Because of that, I have no ego left.”

Livemint – “Not at all. I am basically a conservative, middle-class south Indian Brahmin. As it is, we don’t like debt, and I am very uncomfortable with a $700 million (around Rs 3,180 crore) debt.”

Ms Araceli Roiz is 31 years old and Mr Phaneesh Murthy is 53 years old. In conservative South-Indian Brahmin families “divorce” is taboo. With two teen aged boys at home, he started an affair, if Mr Roiz version is true, when she was in her late twenties.

From a psychological perspective, it is a classic case of a talented man unable to deal with his own fallibility and mortality. Mr Murthy is a competitive man and the yearly success in his career may have made him feel invincible and powerful.  He is raised on Indian middle class values that look down on promiscuous behavior  He competes with his own children in games. He was heading an Indian IT organization where the average age of employees is 25-26 years. Does it look like he was suffering from mid-life crises?

The board members and other senior managers could have identified the emotional baggage he was carrying around and addressed the issue. The question arises, when the board knew about his weakness and character problem, was he provided any coaching or mentoring? Or did the board take the view, that as long as he is delivering the numbers, everything will be tolerated.

3.     Lack of attention to work culture

The board and management knew that Mr Murthy had a marked reputation in respect to female employees. Secondly, it appears that is relationship with Ms Roiz was an open secret. From his own words, it doesn’t seem that he took sexual harassment or company policies seriously. In the interview, he stated:

“It was a personal relationship. The company policy states that any two employees having a relationship have to inform the superiors. It is a small note in an employee handbook. I did inform the company about the relationship. Though it was a question of timing from my side as I disclosed this only a few weeks ago, only after the relationship was over.”

According to him, “it is a small note” in the company handbook.  He didn’t believe in walking the talk in personal ethics or corporate code of conduct. Hence, the question arises, what attention iGate paid to maintain the corporate culture.

With previous cases of sexual harassment against the CEO and an on-going affair, did iGate management ensure that the sexual harassment policies were implemented in spirit? If a woman, as per Roiz’s claim, was forced into a sexual relationship by the CEO, what effect did it have on other female employees and work culture? Did it not set the stage for the hostile work culture where women would feel insecure to report cases of sexual harassment? Let us say, another female employee was harassed by a male senior manager, what options does she have when she knows that the CEO is doing something similar? How seriously was sexually offensive behavior taken by the management?

 The organizations pay a heavy price in respect to sexually harassing culture. The direct costs are of course legal penalties and cases, however, the indirect costs are absenteeism, disengagement, high turnover and lower productivity. The iGate management appears to have ignored these aspects while hiring Mr Murthy and during his tenure.

4.     Ineffective Crises Management

iGate public relations team issued the statement – “The investigation, which is on-going, has reached the finding that Murthy’s failure to report this relationship violated iGATE’s policy, as well as Murthy’s employment contract. The investigation has not uncovered any violation of iGATE’s harassment policy.”

It gave information on the interim CEO and search for the new CEO, to rest fears of the investors.

This appears more of an attempt to limit legal risks. According to US laws the company is responsible for sexual misconduct by its employees. Subsequent to the above news, the company has not made any statement or explanation on what it did to prevent such incidents.

According to media reports, the Indian employees received an explanation from the senior managers on the incident and were instructed not to talk to people outside and within the organization. An instruction not to communicate with the media or put comments in social media is sound. However, not to communicate with fellow employees sounds like an attempt to silence. Can management stop the discussion outside office hours between the employees?

In such instances, various stakeholder expectations need to be addressed. It is a sensitive issue that gets the attention of public, bloggers, activists, women lobbies etc. Even the employees psychological stress levels increase and they need to be managed. However, from the information available in the media, there isn’t much effort being done to manage the crises.

Closing Thoughts

Sexual harassment cases cause huge reputation damage and legal risks. I am not sure whether after Mr Murthy’s previous cases, iGate got proper insurance coverage for directors and senior manager liabilities. Implementing sexual harassment policies and holding everyone to high standards of conduct is something organizations need to concentrate on. The issue was taken lightly previously, but now women workforce is increasing and so are the cases of harassment. Unless companies wish to have their name tarnished, they need to take the right steps.

References:

  1. Read more: http://www.thenational.ae/business/technology/rise-and-fall-and-rise-again-of-it-star-phaneesh-murthy#ixzz2UBKIGikk
  2. http://www.financialexpress.com/news/phaneesh-murthy-i-will-fight-sexual-harassment-charges-vigorously/1118857/1
  3. http://timesofindia.indiatimes.com/tech/careers/job-trends/Murthy-scandal-iGate-staff-gets-social-media-code/articleshow/20222185.cms

Leadership of Dead Bodies, Stones and Flowers

leadership imprint1

In April, two Air India pilots handed over the controls in auto-pilot mode to two female cabin attendants to take a short nap. They decided that their sleep was more important at 33,000 feet while flying the 160-passenger flight from Bangkok to Delhi. They returned to the cockpit after 40 minutes when one of the cabin attendants accidently knocked off the auto-pilot mode.

The angry Twitterate asked for pilot’s license suspension, removal from job and legal charges for culpable homicide. Everyone questioned their work ethics and shock at their irresponsible behavior. Air India investigated the incident, suspended the pilots and sated that passengers’ safety was never compromised. Unbelievable, how can passengers be safe without any pilots at the helm?

1.     Double Standards in Evaluating Corporate Leaders

 The pilots were crucified for risking the lives of passengers. However, surprisingly the pilots of the corporate world do not suffer the same fate. The wizards and titans of the banking industry crash landed the world economy, but they didn’t lose their CXO seats.

Look from another lens. Did any senior in Supplier Company or the multinationals lose their job in the Bangladesh factory fire? In Foxconn, the Apple contractor, 11 employees committed suicide, four died in an accident and one collapsed after continuously working for 36 hours. However, Steve Jobs was rated as the second most popular leader by the CEOs in a survey conducted by Price Waterhouse Coopers. The first and third were Winston Churchill and Mahatma Gandhi respectively.

Now this is going to rattle my readers but let me say it. Steve Jobs was a great inventor, designer, strategist and marketer. However, when it came to people, his employees considered him rude and manipulative, and his competitors found him uncivil. Though Apple achieved great heights, he paid low salaries to the employees in the Apple stores, paid no dividends to the shareholders, pushed down suppliers to manufacture at lowest possible rate and didn’t believe in charity or corporate social responsibility. His behavior and actions weren’t people centric or humanity oriented. So my question is – do we consider him a great leader because he managed to put Apple on top? That makes him a great CEO, not necessarily a great leader.

2.     Misconceptions of Leadership

 The problem arises due to the definition of leadership. Read the dictionary meaning:

Leadership is “organizing a group of people to achieve a common goal”.

- We don’t focus on how the group of people were gathered; by inspiring them or arm-twisting them.

-  We don’t focus on the nobility of the goal; was it to exploit others or liberate them.

-  We don’t focus on the method adopted to achieve the goal; was it by breaking the rules or a journey of virtue.

In the present world we see leaders leaving dead bodies in their path, walking over people as if they were stones and sucking the life out of them. Great leaders create leaders not followers, they make others blossom like flowers.

Be it a corporate leader or political leader, we don’t wish to question the leadership methods. Our thinking is, how it matters to us, we have nothing to lose. We have everything to lose, and Martin-Niemöller-Foundation words at Hitler’s time still resonate:  

“First they came for the communists,
and I didn’t speak out because I wasn’t a communist.

Then they came for the socialists,
and I didn’t speak out because I wasn’t a socialist.

Then they came for the trade unionists,
and I didn’t speak out because I wasn’t a trade unionist.

Then they came for me,
and there was no one left to speak for me.”

Our own silence will kill us and the society we live in. When humanity is at stake, can we close our eyes and say nothing is at stake.

3.     Leadership Training

The Institute of Strategic Change reported that – “the stock price of ‘well-led‘ companies grew by over 900% over 10 years, compared with 74% for poorly led companies”. Warren Bennis in 1998 said – “The Truth is that no one factor makes a company admirable. But if you were forced to pick the one that makes the most difference, you’d pick leadership.” However, how many companies train on leadership or do a performance evaluation on leadership qualities?

Quite a few would be saying we do it. So let me clarify. In organizations bosses tell the juniors what to do and how to do it. They give rave reviews to the employee who completes the task as they had stated. They promote that employee and now he becomes a boss. At best, he will be a good manager, not a leader.

Corporate world determines success rate by title and salary.  Neither guarantees leadership skills. Employees aim to become a boss, not a leader. The terms are not synonyms.

According to Malcolm Gladwell,  all outliers practiced their talent for over 10,000 hours to achieve greatness.  In the corporate world, how many hours are dedicated by each employee to learn leadership? Learning leadership is a by-product of the main job, till CEO level. Then isn’t it surprising that we do not have many great leaders in the corporate world.

 Closing Thoughts

Maximum damage in the world was caused by people who got powerful positions without good leadership qualities, be it Hitler, Jeff Skilling, Bernie Madoff or Lance Armstrong. The biggest risks in the corporate world are leadership risks. It is the leaders who make the decisions, so unless we have a system of putting the right people in leadership positions we will continue to have these disasters. Hence, our job is to develop good leaders, select good leaders and continuously monitor the leaders.

 Wishing my readers a Happy Mother’s Day. Being parents is the toughest job in the world,. They are responsible for raising the next generation of leaders.

References:

  1. Air India Pilots Story  
  2. Deaths in Foxconn
  3. Price Waterhouse Coopers report on best leaders

 

US Presidential Race – A Learning Board

A yearlong battle with approximately US $3 billion spent on it and the verdict is the  same. President Obama got re-elected; Republicans have majority in the house and Democrats in the senate. On the face, nothing changed. Even to maintain status quo, it is a case of survival of the fittest. So here are some lessons risk managers can learn from the US Presidential race.

1.      Don’t rest on your laurels

President Obama was leading the race, and then he was complacent in the first debate. Romney gained advantage and in the last few weeks, the race was neck-to-neck. Once we achieve something, we tend to take it for granted. Over time from peak status, we gradually unnoticeably start slipping until the gap is huge. Then we are shocked on discovering we are not as good as we thought. As risk managers, we need to continuously manage risks and upgrade skills. We cannot take it for granted that risks will remain the same and everyone will see things in the same light.

2.      Use disasters to demonstrate skills

President Obama in 2008 used the financial crises to demonstrate his leadership skills. In this election, he exhibited presidential capabilities during hurricane Sandy. The message was clear to the public, in crises he leads with calmness and control. He is on top of the things. Risk managers must lead from the front to build trust and confidence in the business teams. They must not start the blame game when risk disasters occur.

3.      Cover the whole organization

President Obama won the elections due to his people centric approach. He was the favorite among women, minority communities and middle class. The Republican party upper echelons are white dominated and Romney sounded pro-rich. He failed to address specific issues of the masses except the jobs shortfall. Risk managers to build a risk culture and make risk management successful, you must spread the word at all levels of the organization. Communicating just with the top management is insufficient and ineffective.

4.      Negative messages work

This election saw the highest number of negative messages from both parties. Democrats and Republicans ran down their competitors. Pointing out problems with others strategies benefitted their game. Risk managers need to incorporate negative messages in their communication strategy. Sometimes giving strong messages of what can go wrong helps in changing minds. Secondly, communication has to be continuous, not periodical. To build the right culture, communicate daily.

5.      Define starting point clearly

Most of the problems President Obama faced during first term were from President George Bush’s era. He took over an economy and country in distress. However, he made that clear to the public and did not take the blame for Bush’s bad decisions. In risk management too, on taking a new role clearly highlight the current status and previous problems. Define the starting point first before laying down the road map for progress. Don’t take blame or responsibility for predecessors problems.

Closing thoughts

President Obama’s first task is to address the fiscal deficit and that will lay the foundation of his second term. In his book – Audacity of Hope – he had inspired many to think beyond the present limitations and lead change. This term will define whether he will be remembered successfully as a President. With his personal achievements, he has shown the world that most barriers can be broken. Risk managers can take that lesson from his life and work towards changing the organizations risk climate.

Re-branding Risk Management and Audit Functions

There is an old joke on power of branding. When a man goes to a woman and says – “I am great in bed, how about it?”, it is sales. When an attractive woman goes over to a guy at a party and says – “Hi, I hear you’re great in bed, how about it?”, it is branding.  Seriously speaking, how many times have the business teams come over to the risk management or audit department and said – “You are great at this, we need your help and advice”. If the business teams aren’t approaching, then we have poor brand image. Our customers are in two minds whether they should involve us or not. Quite often the business teams think they are better off without us. So shouldn’t we be delving deeper to find out that why in the competition between various departments in an organization, we generally are at the bottom on the popularity chart?

1.     Auditors are Watchdogs

Seriously, why do we use this term? It negates the very premise of being of service to others. Think of it for a second. We say, men are dogs, women are bitches, and auditors are watchdogs. Does it connect to negative or positive emotions?

With it we wish to sell the image of trusted partners, advisers and mentors. When we use the word watchdog, do we think –as trustworthy as a dog?

Have you ever felt the urge to pet a strange German Shepard or a Doberman? We see a couple of them coming towards us, and the bravest of us feel a tinge of fear and anxiety. Why do we expect any person interacting with an auditor to feel any different then?  Doesn’t the term watchdog, makes auditing sound like a blood sport? Why get stuck with an age old expression?

2.     The Coolness Quotient

We associate with brands because of their coolness quotient. It feels good to be part of the tribe, now whether it is Facebook site, Intel machines, Apple iPhone or Harvard degree. We desire it because it makes us feel or look good. When does audit or risk management makes the customer feel or look good?

I came across David Brier (@davidbrier), a branding expert on Twitter. In his short book titled “The Lucky Brand Book”, I was stunned by the last point. It said – give a reason to celebrate the brand.

I questioned him – how does one celebrate risk management? He gave me two answers –

a)     “Choreographed spontaneity” – all the fun and with a safety net

b)     All the gain without the pain

Both these answers send out positive messages. It definitely shatters the mind-set that risk management applies to negative aspects of business. Why not give it a try?

3.     The Independence Clause

We profess to maintain independence, and to do so we state quite a few things are management responsibility. At one point we express a desire to sit on the board table; at another we disassociate ourselves from management. I understand the technicalities of requirement to maintain independence. The question is – are we using it to escape responsibility?

As part of an internal audit role we undertake to issue an audit report. In risk management we either assist or conduct a risk assessment. As risk managers we provide the second line of defense and as auditors the third line of defense.

Though we desire a more active role, we don’t wish to match the responsibility with it. For instance, we submit a report with recommendations, and leave the business teams to implement the solutions, as it not part of our job. Doesn’t that appear like sailing a person in  middle of a deep-sea and leaving them there, on their own? As giving a return ride back to the shore isn’t part of the deal.  Is it going to generate trust and respect to build healthy relationships? Next time round, are the business teams going to welcome us back?

Closing Thoughts

I definitely don’t have the answers to this one. Though it is clear, we need to re-brand. Maintaining the status quo isn’t helping us. At the logical level we are doing our job. At the sub-conscious level the business teams receive numerous negative messages, which dissuade them from emotionally connecting with the functions and its members. Risk managers and auditors need to figure out how to brand themselves externally and internally.

While you do so, listen to one of the everlasting brands – Elvis singing Suspicious Mind

References:

The Lucky Brand Book by David Brier

Auditor’s Communication With Audit Committee

Finally, the US audit committees will be getting the full picture of the financial statements from the auditors. The Public Company Accounting Oversight Board (“PCAOB” or the “Board”) of US  is adopting Auditing Standard No. 16 – Communications with Audit Committees. It is aimed at improving dialogue between auditors and audit committees to enable better oversight and financial reporting.

The scope of communications has increased from the previous practice of discussing – accounting policies, procedures and estimates, quality of financial reporting, unusual transactions and significant auditing and accounting matters. It covers a  more matters that will increase clarity.

Previously the status of communication was aptly described by George Bernard Shaw’s quote – “The single biggest problem in communication is the illusion that it has taken place.” Audit committees in my view lacked critical information . Secondly, as there is a shortage of financial experts (just one is mandatory) they were in no position to analyse the details of the financial statements. It was easy to hide artistic accounting from them. This standard will reduce communication gap between the auditors and audit committee.

In India, though the roles and responsibilities of the auditor and audit committee are defined in the Listing Agreement of SEBI and New Companies Bill, the nature, content and quality of communication is not specified. It mandates audit committee should meet at least four times a year, however doesn’t shed light on the quality of discussion to take place. The audit committees in India, are required to look into loan transactions, related party transactions and a couple of other things. These requirements are not mentioned in the list below.

In brief, as per Auditing Standard No. 16 the auditor would be required to communicate the following to the audit committee:

a.  The terms of appointment and engagement, objective of the audit, and responsibilities of management and auditor.

b. An overview of the overall audit strategy, including timing of the audit, significant risks the auditor identified including risk assessment procedures, and significant changes to the planned audit strategy or identified risks;

c. Information about the nature and extent of specialized skill or knowledge needed in the audit, the extent of the planned use of internal auditors, company personnel or other third parties, and other independent public accounting firms, or other persons not employed by the auditor that are involved in the audit;

d. The basis for the auditor’s determination that he or she can serve as principal auditor, if significant parts of the audit will be performed by other auditors;

e. Significant accounting policies and practices including changes. Reasons certain policies and procedures were considered critical and the effect on them in respect to current and future events. Effect of policies and disclosures in controversial area and where there is lack of authoritative guidance.

f. Situations in which the auditor identified a concern regarding management’s anticipated application of accounting pronouncements that have been issued but are not yet effective and might have a significant effect on future financial reporting;

g. Description of process for developing critical accounting estimates including the significant assumptions. If any significant changes are made in the process or estimates.

h. Significant unusual transactions with policy and procedures used by management for accounting unusual transaction;

i. Quality of financial reporting including whether auditor identified bias in management’s judgement about the amounts and disclosures in financial statements. Assessment and conclusion of critical accounting policies. Auditor’s understanding of the business rationale for significant unusual transactions.

j. The results of auditor’s evaluation about financial statement presentation. Whether the reporting including form, content and arrangement are in conformity to standards.

k. Difficult or contentious matters for which auditors consulted external consultants

l. Auditor is aware management consulted external sources, the auditors should also give their opinion;

m. The auditor’s evaluation of going concern;

n. Uncorrected and corrected mis-statements including those discussed with management;

o. Material written communication with management

p. Disagreements with the management

q. Departure from the auditor’s standard report;

r. Difficulties encountered in performing the audit, and

s. Other matters arising from the audit that are significant to the oversight of the company¡¦s financial reporting process, including complaints or concerns regarding accounting or auditing matters.

Closing thoughts

The various auditing and accounting standards in India cover most of the points mentioned above. The auditor is required to ensure conformity to the standards and comment on the same if there are variances. However, there is no specific guideline for communication between auditor and audit committee. As the US standard just defines minimum communication requirements it would be beneficial to formulate and adopt a similar one in India and other countries. It will ensure a specific level of interaction with auditor and audit committee is maintained and the audit committee makes informed decisions.

What do you say? Should there be a global standard for communication with audit committees? What other steps can be taken to reduce barriers to communication between the auditor and audit committees?

References:

PCAOB Adopts Auditing Standard No. 16, Communications with Audit Committees, and Amendments to other PCAOB Standards

 

Lessons from Rajat Gupta’s Downfall

When I started my career, Rajat Gupta was an icon. Indian Gen X wanted to achieve his heights. He made us realize that Indian professionals can compete in the global arena and win. Now with his name tarnished with insider trading charges, every professional would be thinking – we don’t want to follow his path. The fall is always the hardest from the top floor of the building, not the ground floor. Whatever he built in his lifetime, today lies in shambles. His family is going to pay a heavy price for his wrong-doing. He has from being a case study on “what to do to fulfill your career dream” has become a study for “what not to do in your career”. I feel sad to say this, but here are some lessons all of us can learn from his downfall.

1. Poverty is in the mind and not in the bank balance - JP Morgan Chase estimated Gupta’s net-worth as US $ 130 million but as Rajaratnam joked – “Gupta wanted to be in the billionaires club“. Gupta’s greed got him down as he was unable to draw the line for his wants.

2. Don’t break the rules to get ahead - Gupta as ex-head of McKinsey knew he was duty bound to maintain confidentiality of boardroom information. He traded confidential information to meet his own personal targets. A McKinsey executive said – “It is mind-blowing that the guy who ran the firm for so many years could be going to jail for violating that principle.”

3. Choose friends carefully – That’s what parents say to kids but we forget it in our adult life. Gupta befriended  Rajaratnam, and though one cannot say he lacked judgment, he did manage to rationalize wrong-doing to keep the friendship alive. He got enamored by the Rajaratnam’s lifestyle. Relationship with  Rajaratnam, who had a dubious reputation, led him astray.

4. Keep feet firmly on the groundIdeas of invincibility and grandiosity lead to delusional thinking. Rajat Gupta was fined by SEC for insider trading. Instead of paying the fine, he chose to pursue the case legally. With the indictment, he is facing over 10 years of prison sentence. He took the decision to challenge SEC due to over-confidence and arrogance.

5.  Correct wrong-doing immediately – A person walking an unethical path rationalizes that s/he will get away with it, if they aren’t caught the first time. Gupta after doing insider trading for a few times got comfortable in his role. Mr. Naftalis said -“Having lived a lifetime of honesty and integrity, he didn’t turn into a criminal in the seventh decade of an otherwise praiseworthy life.” Gupta lost his principles over a time. He didn’t stop when he should have and didn’t take any corrective actions.

6. No one is above law – With the well-known figures in India and international arena facing trails and convictions, it is apparent that no one can escape the hands of justice. Sooner or later, the path will lead to a prison sentence. Being ethical pays in the long-run by keeping a person safe.

7. Protect your legacy – Rajat Gupta had an impeccable reputation of a world-class professional and a great humanitarian. His list of good deeds is long and was known as an exemplary citizen of the world. With these charges, he leaves a legacy of a criminal. A journey from  the boardrooms to a prison cell. There can’t be a greater tragedy on the professional field.

Closing thoughts

It is heartbreaking to find that our heroes have feet of clay. Gupta traded a comfortable old age with a prison cell for satisfying his insatiable hunger for power and money. An extremely intelligent man, an alumni of IIT and Harvard, failed to make the right ethical choices.  In the end, Robert Gilbert’s quote comes to mind -

“Conquer your bad habits or they will conquer you.” 

References:

Rajat Gupta Convicted of Insider Trading

Performance of Indian Boards

The board of directors have the responsibility for steering the organization in the right direction and guiding the CEO and senior management. However, worldwide they are lambasted for catering to the manifested interest of CEO and senior management at the expense of shareholder interest. The criticism is that boards’ failure to maintain independence results in  under-performance.

A prime example is the decision of Satyam board to acquire Matyas. The board approved a deal of USD 1.6 billion to acquire Maytas Infra for USD 300 million and Maytas Properties for USD 1.3 billion. Ramilanga Raju after admitting the Satyam fraud stated that deal was to fill Satyam with real assets instead of fictitious assets. The scandal came out as shareholders refused to approve the deal and Raju didn’t have a way to cover the fraud. The recent case of  Kingfisher Airlines debacle clearly shows that the board was not asking the right questions.

Mr. N. R. Narayan Murthy, founder of Infosys, in his book “A Better India, a Better World” succinctly describes the prevailing trends. He wrote – “A a result, the 1990s was the era of the stock-option-fattened, superman-superwoman CEOs who could do no wrong in the eyes of their admiration-heavy boards, and who were seen as demigods. Lax oversight by the boards made these CEOS more or less omnipotent.” He has lead corporate governance in India by walking the talk and his scathing comments are right on target. He has given a number of suggestions to improve corporate governance and board performance.

Let us see, whether Indian boards are up to the task. To analyse the performance of the boards, I have taken the best practices of the board from the report of Trinity Group and Mr. Narayan Murthy’s book. The statistics are from  India Board Governance report 2011 and the relevant laws are from the New Companies Bill 2011.

1. Constitution of the board

Corporate governance practices mention ideal board size of 8-12 members with around one-third to half the members being non-executive and independent directors.  Indian boards on an average had 9.6 directors of which 5.2 were independent directors in 2010 and 60% of the boards have separate roles for CEO and Chairpersons. On the whole, this sounds good, however, in light of the additional information given below, the perspective changes.

a)    In 2010 in India, board chairpersons were members of 9.5 external boards though majority of the memberships were of private companies. According to the survey “the maximum public board memberships held by an individual was 12, and the maximum private board memberships a whopping 37″.

b)   The CEOs & managing directors were on an average board members of 7 external boards. “The highest number of public company board memberships held by a CEO was 10, whereas it was 32 for private company boards.”

c) Non-executive directors, on an average held a total of 6.7 total board memberships, with 2.1 public and 4.6 private memberships.

d) 56% of the directors surveyed identified the limited talent pool as an impediment, with 38% perceiving it as a major hindrance. Yet, less than 10% used search firms or other 3rd party sources to locate suitable talent.


The lack of experienced and trained directors is the key reason for a few directors available in the talent pool holding multiple memberships. When most independent directors are selected from the social circle of the CEO or Chairperson, there are very few who would not toe the line stated by the CEO. With the multiple holdings, a conflict in one board may impact the relationship in another board. Hence, instead of independence, diplomacy and self-interest prevails.

Mr. Murthy candidly mentions that “board independence from management continues to be affected by directors who have limited accountability to shareholders and are ill-equipped in exercising management oversight.” He stated that in Infosys, directors are given training and a job charter to ensure that they fulfill there responsibilities appropriately.

2) Strategy review by the board

According to the best practices given in the Trinity report, “the board’s primary responsibilities include : (a) reaching agreement on a strategy and risk appetite with management, (b) choosing a CEO capable of  executing the strategy, (c) ensuring a high-quality leadership team is in place, (d) obtaining reasonable assurance of compliance with regulatory, legal, and ethical rules and guidelines and that appropriate and necessary risk control processes are in place, (e) ensuring all stakeholder interests are appropriately represented and considered, and (f) providing advice and support to management based on experience, expertise, and relationships.”

On the other hand, the Companies Bill mentions the board’s power as: “ (a) to make calls on shareholders in respect of money unpaid on their shares; (b) to authorise buy-back of securities under section 68; (c) to issue securities, including debentures, whether in or outside India; (d) to borrow monies; (e) to invest the funds of the company; (f) to grant loans or give guarantee or provide security in respect of loans; (g) to approve financial statement and the Board’s report; (h) to diversify the business of the company; (i) to approve amalgamation, merger or reconstruction; (j) to take over a company or acquire a controlling or substantial stake in another company; (k) any other matter which may be prescribed

The theoretical legal powers given are quite different from the actual working of an effective board. On an average in India in 2010, board members met 6.5 times during the year. The minimum number of meetings were four, that is a statutory requirement and maximum were 19 board meetings by a company. The boards met on an average three times during the year for strategic and business review.

Considering the number of meetings conducted by the board, with the legal responsibilities and practical requirements, it is not feasible for the boards to do a constructive strategic review of the business or provide regulatory oversight. Too big a mandate has been given, while the time spent on it is relatively small. It is not surprising that most boards are acting as rubber stamps to the senior management plans. It is a case of imbalance between power, responsibility and time commitment.

3. Focus on risks

After the Satyam scandal and financial crises, the board focus on risk management has increased. The boards ideally need to determine the risk appetite, review internal audit reports and external auditors reports, understand various strategic, financial and operational risks, and maintain compliance oversight.  In India, the Company Bill mandates an audit committee for listed companies, with majority being financially literate independent directors.

In 2010, in India, 69% of the board members respondents stated that boards are considering risks as top priority. However, 31% mentioned that boards are not involved in systematically addressing corporate risk management.

My view is that the focus on Indian boards is more on risk of misreporting financial statements rather than others. Risk management field as such is still in young stage in India, and board members are ill-geared or untrained on the various aspects.

4. Information availability

The decision-making of the board is subject to the information available with it. As per law, board members are ideally required to receive all relevant information about board resolutions and decisions, seven days before the meeting. However, board members responded that most of the documents are given prior to the meeting or just a couple of days in advance.

Moreover, “a vast majority of boards depend largely on management reports (90%) and informal management discussions (79%) for business information. Third party reports and stakeholder views are used as tools only by 23% of the companies.”

With such limited information, and high dependability on company sources, the directors may not be in a position to make informed decisions. The directors don’t even have sufficient time to study the presented information to make independent decisions and cross question the senior managers. Hence, this could be a key reason for poor performance.

5. Performance Review of CEO & senior management

The compensation committees recommend the CEO and other senior managers. In India, around 80% the respondent companies had a compensation or remuneration committee. The issue of CEO compensation isn’t as big as the western world, however, it is fast gaining prominence. Some high earning CEOs in the top 100 list are being evaluated on the basis of returns to investors.

The board as such has to evaluate  CEOs performance. In the west, the “star” CEOs are in the limelight and are paid high salaries in relationship long-term company performance. However, India scenario is different. Most of the critical positions in family organizations are held by family members and relatives. In such a scenario, the board or compensation committee are hardly in a position to evaluate the performance or recommend salary.

6. Performance review of board

As per law, the nomination committee reviews directors performance , and recommends removal. However, two-thirds of the independent directors stated the roles and responsibilities of non-executive directors are not defined clearly. Hence, without the clarity in role, the evaluations can hardly be constructive.

As such, the boards in India have the following three priorities: “ensuring overall corporate and statutory compliance (90%), monitoring business and operating performance (87%), and establishing and monitoring financial standards and internal controls (82%). Leadership development, succession planning, CSR and risk management continue to be low on the board priority list.”

The professionally run organization do claim for independent evaluation. For instance, Tata  and Infosys succession, the nomination committees were said to be doing independent evaluation. However, in both cases, questions were raised on the final selection. Though Mr. Murthy in his book mentioned that – “At Infosys, the chairman of the board sits with each board member, discusses his/her evaluation, and suggests remedies and course-corrections. The chairman’s performance review is handled by the lead independent director.

In my opinion, the practice of evaluating board performance only exists in some companies in India.

Closing thoughts

Unless the mindset changes to compassionate capitalism where business is done with integrity, decency and in a principled manner, boards will continue to be tutorial heads without much power and say. To ensure boards perform better, shareholders and investors need to become more active. The regulators need to ensure governance codes are followed in spirit and not just tick box mentality. A more elaborate role can be defined by regulators with mandatory requirement of time commitment and reporting requirements.

References:


Can Compensation Committees in India Decide Executive Pay?

With great power comes great responsibility. However, with the recent protests in US and UK by investors on banks CEO’s pay (RBS, Citi, Barclays), this dictum can be altered to “with great power comes a great salary”. This debate again raised the discussion on role of compensation committees. Are the compensation committees empowered to decide salary of CEOs or is it just a theoretical eye-wash? Let us delve on this topic from an Indian perspective, as till now the investors haven’t raised a hue and cry about it.

1. A Look at the Highest Paid CEOs

Business Today jointly with INSEAD-HBR did a study to identify India’s best CEOs by evaluating their performance from 1995-2011. As per the study Mr. Naveen Jindal, CEO of Jindal Steel & Power ranked first, followed by Mr. A.M.Naik, CEO of Larsen & Turbo and Mr. Y.C. Deveshwar, CEO of ITC. By another study Mr. Jindal is also the highest paid CEO in India with a salary of Rs 69.7 crores. (USD 12.75 million ).

However, the other two CEOs do not come in the top ten list of highest paid CEOs in India, as both are professional CEOs. Mr. Deveshwar’s salary plus perks excluding bonus was Rs 5.52 crores (USD 1.01 million) and he was entitled to a bonus limited to Rs.6.24 crore (USD 1.42 million) for 2011-2012 financial year. Mr. A.M.Naik’s salary including stock options was Rs 14.18 crores (USD 2.59 million) for the same period. Though market capitalization, net profits and growth have been on similar graphs for all the three companies.

Mr. Mukesh Ambai, CEO of Reliance Industries is ranked seventh on the list of best CEOs’. After being on the highest paid CEO list in 2008, he voluntarily decided to restrict his salary to Rs 15 crores ( USD 2.74 million) though he had shareholder approval for Rs 38.82 crores ( USD 7.10 million). However, the amount is peanuts considering his wealth. He is the richest man in India with a net-worth of USD 22.3 billion  and he along with his family are entitled to dividends of Rs 1244.33 crores ( USD 227.73 million) in 2011-12 financial year from Reliance Industries alone.

Most of the highest paid CEOs in India, consist of promoter-owner CEOs, and not professional CEOs. There is a huge disparities in the pay structures.

2. Disparities in Pay Structure of Chairman, Managing Directors and Directors

Looking from the regulatory angle, as per the Companies Bill, a managing director ( CEO in American terms) pay cannot exceed 5% of the net profits of the company. The total remuneration to directors cannot exceed 11% of net profits of the company. However, if approval of higher salary is taken from the shareholders in a general meeting, the limit can be exceeded with the approval of Central Government. Now the question is,  as the CEOs get the highest pay packet and promoter-owner CEOs have controlling stake, can the other directors really have much say, monitor the activities and decide on remuneration?

Coming back to Mr. Jindal’s case, he stated in the Business Today interview, that he spends 20-25% time on business, and most of his time is spent on his constituency as he is a Member of Parliament. Members of Parliament just earn around Rs 50,000/ per month. His mother, Savitri Jindal is the Chairperson of the Jindal group and 56th richest person in the world with the net-worth of USD 13.2 billion in 2011. Therefore, considering all this information, can the success of the company be attributed to him? Moreover, does he deserve this salary? Can the remuneration and compensation committee actually decide his salary independently and objectively?

Now let us look at the compensation of Chairman and Directors. Here are some details from  the India Board Report 2011: 

a) Non-executive director compensation ranged from Rs 1 to 10 lakhs (USD 18,000) in more than half of the companies surveyed. Average compensation rose 20% to Rs 9.9 lakhs in 2009-10 from Rs 8.2 lakhs in 2008-09.

b) The minimum compensation paid to non-executive directors was Rs 15,000 whereas the maximum
was Rs 54 lakhs (USD 100,000) for 2009-10 from among the companies surveyed.

c)  The average compensation paid to non-executive chairmen rose from Rs 15.7 lakhs in 2008-09 to Rs 21.7 lakhs (USD 38,000) in 2009-10, an increase of 38%.

d) Among the companies surveyed, the minimum compensation offered to the non-executive
chairman was Rs 16,000 and the maximum was Rs 13 crores (USD 2.37 million).

Hence, if you see the CEOs pay usually far exceeds Chairperson and Directors pays. There is no parity in their earning capacities and value for time.

3. Questionable Independence of Compensation Committees

In such a scenario, are boards capable of judging remuneration of CEO or other key personnel objectively? Generally, the Nomination and Remuneration Committees are charged with job. As per the Companies Bill in India, the committee should “consist of  three or more non-executive directors out of which not less than one half shall be independent directors.” Hence, the premise is that as there are independent directors, they will be fair. However, the question remains are these directors really independent ? Below are some information nuggets from the India Board Report 2011.

a) On an average in Indian boardrooms, 71% of directors are non-executive and 54% of the directors are independent. Just 16% of the directors are related to promoter or promoter’s spouse.

b) Just 10% of the board members were appointed through search firms. The rest were chosen through personal network of chairperson and managing director.

Therefore, in a way the independent directors appear superficially independent and there are deep relationships existing among them. More so, in family managed business. For instance, ITC has a diverse board room as public sector companies and banks have significant investments in the company. It is a 100 years old company and in last 15 years Mr. Deveshwar was the CEO. Therefore, the compensation committees can be transparent and objective only when they are not under the control of owner-promoter CEOs.

Closing Thoughts

In the western world, CEOs of banks and financial institutions are facing investment ire for unduly rewarding themselves at the expense of the shareholders. In India, the investors generally do not make any noise on pay structure of the owner-promoter CEOs as investors expect them to reward themselves. Although, the owner-promoter pay structures are 3-4 times higher than the professional CEOs. With such a mindset, can we really say corporate governance practices have a chance of succeeding in India? It is a controversial question, nonetheless, let me ask – What should the investors and regulators do to control promoter-owner CEO’s salaries?

References:

  1. Business Today – India’s Best CEOs
  2. India Board Report – Hunt Partners, PWC  and AZB & Partners
  3. Highest paid CEOs in India
  4. Mukesh Ambani’s salary and dividend
  5. Mukesh Ambani’s net-worth as per Forbes
  6. Savitri Jindal’s net-worth
  7. ITC chief Y C Deveshwar Pay Structure
  8. L &T chief A.M.Naik’s Pay Structure

Adidas India Euro 125 Million Fraud Story

The traders of good soles appear to have sold their souls. Adidas has filed a criminal complaint for euro 125 million irregularities reported in Indian operations in the first quarter results of 2012. The complaint mentions “commercial irregularities uncovered at Reebok India”. After Satyam, this is the biggest fraud reported in a private sector organization in India.

Briefly, Adidas acquired Reebok a few years back, however, the Indian operations were merged in 2011. Subhinder Prem Singh, head of Reebok India was appointed as the managing director of the merged entity. In March 2012, both Subhinder Prem Singh and the chief operating officer Vishnu Bhagat left the company. Very few details are available of the case till date, but the twists and turns are interesting. From the looks of it, this is going to be full-blown war and a lot of skeletons are coming out. Below are the events till date.

1. Adidas announcement on 30 April 2012

Following extract is from the Adidas press release. The statement states that commercial irregularities to the tune of euro 125 million ( Rs 870 crore, USD 161 million) have occurred prior to 2012 and prior year financial statements may require re-statement.

“In addition, Management also announces that commercial irregularities discovered at Reebok India Company, in India, will likely affect the consolidated financial statements of the adidas Group. The currently estimated maximum negative impact could be up to a pre-tax amount of € 125 million. Due to the sensitivity of the on-going investigation, specific details will be disclosed as appropriate in due course. As these irregularities have been deemed to have occurred prior to the 2012 financial year, the adidas Group might have to restate prior-year consolidated financial statements in line with the requirements of IAS 8. The financial statements of adidas AG will not be affected by this issue. Management assures its stakeholders that it has, and will continue to, vigorously pursue a course of action to protect the Group’s interests, which has already resulted in the appointment of a new local leadership team in India at the end of March.

Under this new leadership team, Management is further planning an accelerated restructuring of its business activities in India, including significant changes to its commercial business practices. This could lead to additional one-time charges in the remaining quarters of 2012 in an estimated amount of up to € 70 million.

2. Counter attack by Subhinder Prem Singh

After this announcement, Mr. Singh who initially reported that he left the organization on his own, clearly stated that he was terminated. He filed a case for damages of Rs 15 crore (USD 2.83 million, Euro 2.19 million) against Adidas. The Economic Times gave his version of the story. He says:

a) Adidas headquarters were “fully in the loop” on how Indian operations are run and it is not a one-man show. The finance chief of Indian operations was appointed by Adidas group last year.

b) He was called to Arizona, US on March 25, 2012 and after he presented the annual business plan, he was forced to leave and promised a severance package. Adidas did not give him a reason at the time of termination and he received a mail from Adidas subsequently that he was terminated due to “financial irregularities”. He denied any involvement in financial irregularities.

3) Further on he alleges that he exposed three major frauds in Adidas. He has given this statement on record – “The biggest scam was the scavenger deal (dumping rejects) running into Rs 200 crore, where about Rs 20 crore was illegally made by senior officials. However, the scam was brushed under the carpet because it related to Adidas and not Reebok, and the request to notify the fraud to the auditors at the year-end was turned down by the headquarters.” .

3. A few quick ones

a) Previous Frauds – While details are still not known, Mr. Singh’s statement about three previous frauds is definitely jaw dropping. He mentions Rs 200 crore (USD 37.36 million, Euro  28.15 million)) fraud in which senior officials made money. He doesn’t mention whether he terminated the senior officials or took legal action against them. As the managing director of the organization, he was required to investigate the frauds, take action and report the same to headquarters and auditors. He mentions that he sought permission from head office to report fraud to auditors. How can that nullify his responsibility as the head of the entity?

b) Dumping rejects – In Indian organizations sometimes, in rejects sales there is a percentage cut taken by the management. The modus operandi is that some good stuff is passed by the quality inspection team as sub-standard or rejects. These rejects are then sold at nominal values to previously selected vendors. The vendors unofficially give a percentage of the real value of the products to the management. This risk can be easily mitigated by frequently checking the quantum and quality of rejects and getting an independent valuation done of the products. Ideally, Mr Singh should have initiated these risk mitigation steps if he knew the problem. He doesn’t mention this, so can he escape liability?

c) Auditors Role – An Indian firm N. Narasimham & Co. is the auditor of Reebok India.  In this case, KPMG is the group auditor, and till now neither of the auditors have made any statements. However, KPMG has stated that they did not audit Adidas or Reebok India for the past several years. But, as per recent reports in 2010 KPMG was appointed as a forensic investigator for Reebok and gave a clean report. If so many frauds were occurring in the organization, how come they did not detect and report anything previously?

In India, sometimes auditors take kickbacks to hide frauds, or don’t report frauds because they wish to maintain client relationships. Hence, again the question of auditor independence, liability and involvement are likely to arise.  One has to wait and see whether this becomes another incident similar to Satyam PWC case.

d) Risk Management- The 2011 annual report of Adidas states that they upgraded the risk management IT solution in 2011. The Group Risk Management department maintains the risk and opportunity management system. The description of risk management process and techniques used is at par with the best-in-class. The supervisory board is responsible for monitoring the risk management system. According to the annual report, the audit committee in September 2011 checked group wide effectiveness of risk management, internal control system, internal audit and compliance organization. In November 2011, it discussed the internal audit report for the year and then also planned scope for 2012. The question is that if the frauds relate to previous years, then how come with all this narration in the annual report, the frauds remained undetected. Is the description risk management practices for the consumption of the investors, or do these practices actually function?

On May 2, 2012 Transworld Business reported that a former senior marketing manager of Adidas, Britney Obstar, was sentenced for master-minding a fraud scheme of USD 336,000. She got payments made to her husband’s company for services that were never rendered. She continued the fraud for over a year. This definitely shows that there are some loop holes in internal control systems for monitoring senior management activities and transactions.

Closing thoughts

This will be an interesting case to watch. It is apparent that global organizations face challenges in managing local subsidiaries. Without an efficient management and effective internal control and risk management systems, the corporate office will remain blissfully ignorant until it is too late. In India, the corporate governance practices applicable to public listed companies do not apply to private limited subsidiaries of international companies. Hence, the practices that are strictly followed at head offices may not be adhered to at local Indian offices, unless the organization is culturally and technologically integrated. This case will bring out a number of risk management lessons for global organizations. Hence, let us wait for the story to unfold further.

References:

  1. AD-HOC: adidas Group announces preliminary first quarter 2012 results
  2. Criminal complaint filed by Adidas
  3. Ex-MD Subhinder Singh sues Adidas over fraud charge, seeks Rs 15 crore in damages
  4. Former Adidas Marketing Manager Sentenced for Fraud. 

Reflections on New Companies Bill Auditor Rotation Clauses

The New Companies Bill 2011, tabled at the Parliament proposes a few clauses on auditor rotation. According to the new provisions, an auditor will be appointed in the first annual general meeting for a five-year term. Thereafter, the auditor will be changed as per the members’ decisions.

An additional clause for listed companies states that the same individual auditor cannot be appointed for a term exceeding five consecutive years. Secondly, an audit firm cannot be re-appointed for more than two five-year terms. For re-appointment purposes for the individual auditor or audit firm, there has to be a gap of five years. Moreover, for appointment or re-appointment purposes, there should be no common partners between the new firm and old audit firm.

Another interesting clause is that members can resolve to ask the audit firm to rotate the audit partner and team every year.

These clauses will ensure that auditors rotate every five years in the listed companies. As investor confidence is based on independent reporting of the auditors, the thought behind these clauses is that rotation of auditors will ensure independent reporting. The move is good, as economic growth is dependent on investor confidence in financial reporting. These clauses were incorporated in the draft after the Satyam fiasco. However, rotation isn’t a silver bullet that will resolve all auditor independence issues. A few concerns about the clauses are listed below:

1. Appointment of auditors for listed multinational companies.

Similar auditor rotation provision do not exist in other countries. In US, PCAOB recently held discussions on auditor rotation and independence. The general opinion of US auditors was that rotation does not ensure independence and comes with a huge financial cost. Hence, the question comes up whether multinational companies will be open to having different auditors in India, than in their headquarters. For large organizations, consolidation of accounts from different locations is a huge task, and with different auditors the information flow and audit practices may differ. Hence, the head office auditor may find it difficult to rely on the work of a local auditor.

Multinational companies are generally comfortable with big four, hence the audit will continue to rotate between big four. Very few Indian companies have the skill set and bandwidth to audit large multinationals. Therefore, this clause will put some practical challenges for multinational listed companies.

2. Audit firms’ partnerships

Indian audit firms scenario is unique in a way, as Institute of Chartered Accountants of India prohibits foreign audit firms to practice in their own name. Pricewaterhouse is the only one allowed, since it entered the market before these guidelines were passed. Others, for instance, Ernst & Young Indian member firm is S.R.Batliboi and company, and all audits are performed in Indian firm’s name, though partnerships are common. The provision of not having common partners applies in this scenario, as some audit firms are auditing under multiple names. PWC audits under the names of PW and Lovelock & Lewis.

The challenge in this clause is that audit partners move among the group companies. Some firms have organized the partnerships in a way to avoid common partnerships, however work under the same management. It will be a difficult task for companies to identify linkages between various audit firm partnerships. The onus should ideally rest with the audit firm to ensure that there are no common partners.

Another interesting aspect is  audit partners movement among big 4 and other companies. If an audit firm is pursuing an appointment, they now will have to be careful that another firms audit partner is not recruited in their partnership at the same time. This might again result in some fancy footwork to avoid the loss of a client.

3. Independence of the retiring auditor

According to the provisions, audit firm will mandatory be changed after two consecutive five-year terms. In simple words, ten years is maximum period an audit firm can audit a client on a single stretch. Hence, the audit firm knows that it is going to lose the audit client, however, the option to provide non-audit related services opens up. Law prohibits auditors from providing the following services to audit clients:

(a) accounting and book-keeping services;
(b) internal audit;
(c) design and implementation of any financial information system;
(d) actuarial services;
(e) investment advisory services;
(f) investment banking services;
(g) rendering of outsourced financial services;
(h) management services; and
(i) any other kind of services as may be prescribed

These services generally are more lucrative than the audit fees earned. Hence, a retiring auditor may wish to keep good client relationships to obtain future assignments. In such a scenario, one has to view rotation benefit skeptically, as the audit firm may not maintain independent reporting  as desired. Rotation of auditors in such a case may just result in adherence to legal requirement instead of contributing to auditor independence. As such, old Indian business houses have 2-3 audit firms that they use interchangeably in various subsidiaries for audit and other services. The work would just get shared among them.

4. Selection of new audit firm

As mentioned earlier, selecting a new audit firm will be difficult for large organizations. Reason being, besides big four there are just a handful of Indian audit firms who have the capability of conducting audits of multinational organizations. A few of these would already be providing some consulting services to the audit client, hence would not be eligible for appointment as auditors. If the potential of earning from consulting services is more, they might not drop those assignments in favor of audit.

Next aspect is that the provisions have additional clauses for barring a person from becoming an auditor. These relate to the usual clauses of individual, partner or his relative not having in holding or subsidiary companies – securities, directorships, loans, business relationships, managerial positions, or any other conflict of interest.

These clauses result in audit firms and client doing a lot of leg work to ensure that all legal requirements are met. All these aspects limit the choice of selection of new auditor to 3-4 audit firms. Since the audit business is going to circulate among the same set of audit firms, it is doubtful that mere auditor rotation would result in better financial reporting.

Closing thoughts

Auditor independence is a complex subject as it forms the bedrock of investor confidence in financial reporting.  Auditor rotation is a good step to ensure that auditors do not lose their professional skepticism and independence by doing the same audit for decades. However, additional quality monitoring procedures of audit firms and review procedures of financial reports need to be built in the regulatory system in India. India lacks a few aspects of US and other developed countries in this matter, however, that is a discussion for another post. On a positive note, the rotation clauses give an opportunity for medium-sized Indian audit firms to build skill sets to pitch in for business of large organizations.