Thursday, May 7, 2009

Satyam vs. Siemens Corruption: The Difference is in Ponzinomics

The financial crisis exposes emperors with no clothes.  Witness Madoff.  But naked truths are not only emerging for those dealings with obscure financial instruments.  Dramatic exposure in the corporate business sector is also taking place. 

Last month we discussed the corruption scandal surrounding Siemens, the multinational giant, which has agreed to pay billions in fines and fees.  With the holiday came a short truce.  New Year had not even taken place and we are hit by the enormity of the Satyam’s corporate fraud, labelled as India's Enron.

Bribery and fraud by business corporations is not new, of course.  And in fact the Siemens bribery case is a longstanding one, preceding the financial crisis.  Corporate fraud and corruption are not unique to developing or to industrialized countries, obviously.  They can take place anywhere.  They do.

The magnitude and timing proximity between the Siemens and Satyam corporate scandals may tempt some to rush and generalize, lumping such corporate scandals together as belonging to the same kilt.  That would be unfortunate.  There is a fundamental difference between those two cases.  It relates to “Ponzinomics.”  While Satyam shows clear features of a Ponzi scheme, the Siemens case doesn’t.  This difference matters.

For starters, Satyam’s bribery to obtain some contracts –including evidently improper benefits years ago to a former high official of the World Bank– appears to have been just one sideshow within a wholly fraudulent ‘house of cards’ company.  A venture with largely fictitious assets and inflated revenues and profits over the years, but with a facade of a major and respected IT company.  

Virtually the entire company was based on a Ponzi-like scheme, in which unsuspecting investors, shareholders and even many of their own staff continued to unwittingly support a bubble created through a fraudulent web of financial accounting lies and a careful misinformation strategy.  In such large and publicly listed company (in multiple jurisdictions) this fraud at Satyam could have hardly taken place through the sole actions of their Chairman, Ramalinga Raju -- in spite of what he claimed in his resignation letter (why would he suddendly tell the truth in that venue?...).  Complicity by some other in the company is being investigated, as is the role of their external international auditor, PwC.

Now onto the German conglomerate Siemens, a company that produces and actually deliversmany sophisticated real products, such as electronics and electrical engineering solutions for the industry, energy and healthcare sectors.  It is very different than Satyam.  Siemens does have real assets, backed by such production of real goods and services.  Siemens, in order to ‘compete’, and to pad its bottom line and gain market share, had engaged in wholesale bribery as a corporate strategy, so to obtain contracts fraudelently rather than through level-field competition.  Under this type of corruption, a welfare loss to society takes place because contracts are not awarded due to to real cost and productivity advantage, but according to having illegally paid government officials under the table.  Further, there is the serious societal and ethical cost of corrupting senior government officials in (often poorer) investment-recipient countries and in undermining public institutions.

At the same time, in the case of Siemens, a real product is produced and delivered, and the assets of the multinational company are largely real, and reflected (more or less) accurately in its own balance sheet.  In fact, until no long ago, corporate bribery was not only legal under German law, but such 'necessary expenses' were tax deductible.  Talking about financial transparency: even the bribes themselves would have been reflected in their financial statements!  Quite a difference with Satyam... 

Not that one evil is more or less damaging than the other.  We are simply pointing out that there are crucial differences.  Satyam joins the group of collapsed companies due to Ponzi-scheme-like-behaviour, akin to Enron, WorldComm and Parmalat.  Conversely, Siemens joins the group of bribers as a corporate strategy, akin to Lockheed (of the 1970s, which spurred US foreign anti-bribery legislation),  or more recentlyHalliburton, and VW…  Siemens’ stock price has not been battered in recent months.   Satyam's has.

A Satyam-type of Ponzian company tends to crash when hovering needles poke their fragile bubble.  This is more prone to take place in a financial crisis or a downturn.  Thus we now witness the Ponzi-like collapse of the house of cards.  This has loud consequences, often beyond the company itself, due to loss of trust in other companies in their industry, and even country-wide.  Satyam’s scandal has been associated with massive overall losses in the Indian stock market, not to mention the dire effects on the battered stock price of Satyam itself and of other giants in the Indian IT industry. 

By construction, Ponzi mechanisms cannot go on forever.  A self-correcting process eventually takes place when the bubble has grown too large and too feeble for any further web of lies to lure additional funds.   Obviously, if external oversight, transparency and auditing would have worked, detecting such Ponzi schemes much earlier may have taken place, which would have reduced the damage.  

But even when such due diligence fails, the storm eventually exposes (or imply the wind blows away...) the house of cards.  With that, the game is over.  Satyam’s chairman Raju, in his resignation letter, famously said: “it was like riding a tiger, not knowing how to get off without being eaten.”  He should have known that if you do mount a wild tiger, and are afraid to dismount, then it will be a longer ride, until the tiger will eventually dismount and eat you anyway...

In the Siemens type of corruption, the massive firm does not collapse due to corruption, even if the reputational cost (and fines) are far from negligible.  A few days after it was mightily fined, Siemens won a billion-plus contract for a Iraqi power plant.  And despite settling and paying huge  fines, Siemens was not banned from bidding for US public sector projects.  

In a non-Ponzian case like Siemens, If the whole intricate web of bribery is not externally detected and exposed, it can continue unabated for a very long time, without putting the whole company in jeopardy.  This is why the Siemens' type of corporate bribery requires particular mechanisms of external monitoring and oversight, plus serious whistleblower protection.  Once corruption is detected,very high financial penalties, and, at least as important, transparent disclosure of such sanctions and misdeeds, need to be applied. 

All International organizations, such as the UN, EU, the World Bank, Regional Development Banks, as well as bilateral donor agencies, and, more broadly, all governments, need to have fully transparent sanction mechanisms in place.  Firms found to have engaged in bribery should be debarred from contracts with such organizations or governments.  Such debarment should be public.  Such transparent disclosure is a major deterrent to such corrupt practices, as it significantly raises the (reputational) cost of engaging in such practices. 

In such international organizations and governments that award contracts to such firms, full and detailed disclosure of the sanction and of the extent of the misdeed should be timely and not be limited to small companies or mere individuals.  Mighty multinationals, regardless of how 'politically untouchable' they may have been in the past, ought not get special dispensation any longer from governments or international organization when they have been engaged in bribery. 

Timely public debarment is not only important for non-Ponzian companies like Siemens, of course.  Earlier public debarment of Satyam (their bribery was known for many years, even if it was only the tip of the Ponzian iceberg) would have lowered the cost to India's IT industry.  Clearly, while Siemens and Satyam corruption scandals are very different, this recommendation applies to both cases. 

Similarly, the case for revisiting the whole politically correct mantra on CSR and voluntary corporate codes of conduct is also a common corollary of both scandals.  We already touched on this issue in a previous entry on Siemens.   For the case of Satyam, let us only note that they had been awarded prestigious corporate governance prizes and had been used as amodel case study of CSR (and CDD)...  

Nonetheless, whether Ponzinomics applies or not to a particular corporate corruption case does have implications for the diagnosis, and for some of the practical implications and recommendations.  More in future entries...

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