Infosys: By No Means A “Boring” Company!
Infosys is no ordinary company. And uneasy lies the head which wears the crown.
There are three defining companies which epitomize the Indian financial markets – all of which with their unique characteristics have created enormous wealth through clinical execution : Reliance for its innovative ability to create wealth by leveraging itself through creative financial instruments; HDFC group for its consistent prudence in the demanding area of financial sector lending and risk management ; and Infosys for corporate governance.
The whistleblower allegations strike at the root of what Infosys stands for. In a country where large sections of the Government itself do not believe their own figures of late, Infosys has stood out as a beacon – now if investors cannot trust its financials then who do you trust in India ? Valuation ultimately is a factor of trust and management quality, and thus it is not surprising that it lost $ 8 B in market cap in one day. The question though is : will this derate the Indian markets too ? Not at the moment : but if these facts are proven at a later stage it would accelerate the process of rising risk premiums in India - for more reasons than one.
Given the enormity of these implications a thoughtful dissection of the whistleblowers’ letter is necessary, and this leads to multiple levels of issues – both operational and strategic. First, the integrity of accounting practices and financial statements. Here two issues have been raised : one, policy deviations / changes on internal controls ( large bid reviews ) and risk profile of investments (treasury operations) for short term profitability considerations ; second, improper recognition of costs and revenues. Whlist the first is purely an internal matter of the company which has implications on interaction protocols between the board and executive management, and the judiciousness with which the business is presently being run, the second issue is to do with law. There is some leeway within the interpretative aspects of the accounting standards though, and the seriousness will depend on the facts of the particular case. Also the difference between ‘understatement’ of costs and ‘deferment’ of costs is vital as the first implies criminality ( which is highly unlikely ) and the latter, though serious, could be justified given particular circumstances. This distinction has not yet been established. Before closing this point on accounting, I must point out that there are certain managerial behaviours linked to faulty incentivisation policies which precipitate management quest for short term profitability. This needs to be examined in depth.
The second category relates to withholding information from the Board. Whilst this too is purely an internal matter which infringes on the agreed terms of engagement of the executive management with the Board, the implications can be far reaching if specific information is withheld from the Audit Committee ( and the auditors ) on matters impacting integrity of financial statements. This would generally cover issues of revenue recognition of large, multiple quarter contracts, booking of costs, capitalization of expenses, etc.
The third aspect is to do with materiality of the alleged misdemeanors. Since the specifics of the whilstleblowers is unknown ( business unit level, large bids team, corporate finance ,etc.? ), it is not possible to estimate the pervasiveness of the malpractices within the company as the visibility of the whistleblowers themselves would be circumscribed based on their organizational position. And lastly, taking orders at zero margins is purely a business decision and cannot be questioned from the prism of legality. However, we do need to remember that such orders do finally reflect in the financials of the company at some point in the future ( depending on materiality ) and this is where Satyam ultimately blew up.
Irrespective of the operational flavor above, the couple of larger strategic issues cannot be ignored by Nandan. It is apparent that there is a potential breach of corporate culture within Infosys which was nurtured painstakingly by Narayana Murthy, Nandan himself and Mohan Das Pai amongst others. A breach of this nature almost always starts with nibbles and, over time, becomes an accepted norm within the organization. The “sab chalta hai” attitude so prevalent all around ! Like I argued repeatedly during the Chanda Kochar controversy, the tone for corporate governance is set from the top and can disintegrate quite quickly ( ala ICICI Bank post N Vaghul ) if not nurtured with an eagle’s eye by the company’s custodians. Also, the ostensible comments about the three directors were simply racist and sexist, and need to be handled with uncompromising sternness.
During the last controversy Nandan displayed a statesmanlike approach that comes only with a culture of character and competence; this was appreciated by most who still value balance, character and grace in public life.....though, I must admit, it is a fast diminishing breed.
He will need it yet once again. The markets may have provided an instant reaction yesterday to the news without a thoughtful analysis, but, if this is not properly handled, it could be more unforgiving than the last time. The approach of reaching compromise settlements with regulators, and limited disclosures like the Panaya investigation report, must not be repeated. In this battle of perceptions a transparent closure must also be “seen” to have been done….more so in repeated cases of deja vu.
Though he has succeeded in all that he chose to do in life, it would seem that Nandan has been singularly unsuccessful in “making Infosys a boring company” !
