Academic journal article Review of Business & Finance Studies

India's Satyam Scandal: Evidence the Too Large to Indict Mindset of Accounting Regulators Is a Global Phenomenon

Academic journal article Review of Business & Finance Studies

India's Satyam Scandal: Evidence the Too Large to Indict Mindset of Accounting Regulators Is a Global Phenomenon

Article excerpt

ABSTRACT

This paper examines the capture of government regulators using the case of Satyam Computer Services Ltd., one of India's largest software and services companies, which disclosed a $1.47 billion fraud on its balance sheet on January 7, 2009. The firm, which traded on the New York and Bombay Stock Exchanges, was required to file financial reports with the SEC. Price Waterhouse of India, the local member of PricewaterhouseCoopers (PWC), served as its auditor. After news of the scandal hit the airwaves, Price Waterhouse of India issued a press release and stated that its audit was conducted in accordance with applicable auditing standards and was supported by sufficient audit evidence. Because Satyam shares were quoted on Wall Street, SEC rules prohibited auditors from having business relations with their clients. U.S. regulators failed to take action against PWC. Is this lack of enforcement related to PWC's size and the impact that the failure of a Big 4 firm would have on the global financial marketplace? We question whether government regulators have been captured by the key market players in the auditing services market. One outcome of this "capture" is moral hazard, which implies that the Big 4 accounting firms, or their local affiliates, may place less emphasis on quality audits. Such an approach to the audit function places the self-interests of the audit firm above the public interest. We also question whether foreign companies that are listed on US Stock Exchanges fall under the purview of US Laws and if these companies and their auditors face the same regulatory scrutiny as publicly-traded US Corporations. In addition, the paper provides suggestions to protect the public interest while citing lessons learned from this scandal.

JEL: M42, M48, M41

KEYWORDS: Auditing, Capture Theory, Accounting Regulation

INTRODUCTION

Regulation of business has always been a topic of considerable debate. Regulatory proponents call for more regulation of the private sector in order to protect the public good, while regulatory opponents claim that additional regulation further damages a free-market economy by unduly constraining business. The theory of regulatory capture posits that regulators, including government bureaucrats who oversee the regulatory process and legislators who write the regulations, are routinely and predictably "captured" and manipulated to serve the interests of those who are supposed to be subject to them.

For public choice theorists, regulatory capture occurs because groups or individuals with a high-stakes interest in the outcome of policy or regulatory decisions can be expected to focus their resources and energies to gain their preferential policy. Meanwhile, members of the public, each with an insignificant individual stake in the regulatory outcome, will either ignore or pay scant attention to the regulatory process altogether. Regulatory capture results when this imbalance of focused resources devoted to a particular policy outcome is successful at "capturing" influence with elected officials or regulatory agency bureaucrats so that the preferred policy outcomes of the special interest(s) are implemented. A captured regulatory agency serving the interests of its invested patrons and wielding the power of the government behind its decisions is often worse than no regulation. Galbraith (1955) posited that captured regulators were part of the problem rather than the solution. He suggested that regulators were vigorous in their youth, moving to complacency in middle age, until they became in old age either senile or arms of the sector they are supposed to regulate.

Ample evidence suggests that regulatory capture is indeed widespread and takes a variety of forms. The Big 5 accounting firms were reduced to the Big 4 with the criminal indictment of Arthur Andersen in 2002 and the firm's ultimate collapse. The vacuum created by the demise of Arthur Andersen and, ironically, the constraints of the Sarbanes-Oxley Act of 2002 (SOX), i. …

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