A Case for Statutory Audit

of Rent Seeking Activities in

Corporate Entities Track 1 – Contemporary Issues & innovations in

Accounting & Finance

M.Ganeshan

B.Com; F.C.A

( Member of the Institute of Chartered Accountants of India)

Permanent Address: J/8, Pinnac Memories, Kothrud,

Pune 411 029, India.

Mobile no: +919922056419 / +919730649278

Tel nos: +91-20-25420392/41205584

E-mail: caganeshan@gmail.com

A case for statutory audit of

rent seeking activities in corporate entities

Abstract: In this paper we provide the Institute of Chartered Accountants of India (ICAI) an

opportunity to examine, reflect and modulate guidelines for members to introduce audit of rent

seeking in its scope due to the prevailing status of the developing Indian economy and its

growth. Rent seeking has become widespread and a system in itself. Hence corporate entities are

not an exception. Crony capitalism is the order of the day irrespective of the political party in

power. The Government of India and its regulatory authorities do want to address the issue but

only superficially due to political pressures. However, statutory auditors have no provisions in

the statute or in the accounting standards including IFRS to audit rent seeking practices prevalent

in corporate entities, which are visible directly or covertly. ICAI should conduct a survey of rent

seeking practices in corporate and collect empirical evidences. Based on the survey, evidences,

discussions and deliberations with the members by way of exposure draft, guidelines should be

issued to the members regarding the methodology by which rent seeking audit can be conducted

as part of the statutory audit and the opinion to be given based on any findings. It can help

shareholders and stake holders alike. This will help corporate entities to have confidence about

raising capital in the capital market due to ethical corporate governance and investors trust with

the company.

Key words: Rent seeking, statutory audit, ICAI, corruption, fraud, corporate entities

“Rent-seeking may, indeed, impose costs to the economy as high, if not higher, than those

arising from corruption”

Anthony Ogus

Introduction

Rent seeking, if not in the same term, is existing for many centuries around the world.

However, the genesis of rent seeking theory goes to Late Gordon Tullock, an economist

and retired professor of law and economics at the George Mason university school of

law, who developed the concept in 1967. Later on Ms. Anne Osborn Krueger, an

economist and a professor of international economics at the John Hopkins School of

advanced studies baptised the concept by giving the formal term of “Rent seeking” in

1974 in an article named “The political economy of rent seeking society”.

We have to understand that the word rent does not signify the meaning in normal

parlance of payment of rent on any lease or sublease. Here it means to gain undue

advantage to increase the wealth of the seeker and aspirant without actually creating

wealth as it is. It is not a legitimate profit seeking activity; hence precious resources are

dissipated for negative productivity or unproductive. The examples are corruption, fraud,

lobbying, subsidies, taxation, tariffs etc.

In India rent seeking is not exogenous but endogenous. Rent seeking is very popular in

India for many decades and is not only emanating from business circles but is prevalent

also due to extensive and complex Government rules, regulations and policies. Pre and

post independence has witnessed the dichotomy of rent seeking behaviour getting deeply

entrenched in one form or other affecting every stratum of the society and the willingness

of society to embrace it as a way of life as opposed to rejecting it. If we focus on

economic history, we come across several incidences of corruption driven mainly by the

connivance of civil servants, the political class, the bankers and entrepreneurs with

minimal actions or no actions against it. Fundamental economic theory of demand and

supply place its role in rent seeking. Hence, we don’t have social equality in the society.

History – Pre and post independence:

If we study the history of rent seeking since independence, various laws and regulations

promulgated gave rise to rent seeking due to a generally clumsy implementation, without

addressing the main purpose and objectives of these laws and regulations. Poor

regulatory and monitoring system and plenty of loop holes in laws and regulations led

bureaucracy and politicians to exploit it to the hilt. It is a mystery why it has not received

serious importance and public attention so far.

Prior to independence, between the period 1934 to 1940 there was a sugar cartel which

controlled the prices of sugar in the market with the blessings of the Government. A

consideration was paid for such favouritism by the sugar syndicate. Was it an example of

rent seeking? This was a form of lobbying and raises the pertinent question – Is lobbying

a form of rent seeking?

Even before independence, our great leaders like Mahatma Gandhi and Jawaharlal Nehru

were frustrated with corruption in the country. As a result, in 1947 the new Government

put into place the Prevention of corruption act to prevent people from encashment of post

independence reconstruction of the nation with corruption and lobbying.

In 1950, India adopted the constitution and proclaimed an economic model of socialist

welfare state by including it in the preamble. In the same year, the position of the

comptroller and auditor general of India was enshrined in the constitution of India though

it came in to existence in 1860. It has exhaustive duties and powers. Its reports are

considered seriously by the Government, parliament and state legislatures.

In 1951 the industries act was enacted which required all the industries establishments to

procure licences to operate their businesses. Thus, the licence raj became the breeding

ground for corruption for bureaucracy and politicians alike. It resulted in the waste of

precious social resources due to lack of meaningful social welfare programs. Food and

civil supplies was subject to rationing and Government had control over the supplies of

the same which effectively encouraged the black market. The concerned regulators for

e.g. inspectors were rent seeking as a matter of routine system to overlook the black

market.

The Government gave quota for the manufacturing industries in many areas and sectors.

All the heavy industries like coal mining, quarries, heavy machinery manufacturing

industries, infrastructures like railways, air transport came under direct control by

establishing public sector companies. More so, India suffers from red-tapism and to get

around it one has to pay bribes. This not only allowed briberies to thrive unabated but

also prevented investments from domestic players, non resident Indians and foreign

companies.

The Central bureau of investigation (CBI) was established in 1941 and it was renamed as

CBI on 1st, April 1963. It has wide range of power including investigation of economic

offenses. In 1987, it was divided in to two investigation division namely anti corruption

division and special crimes division.

Due to rampant corruption and rent seeking habits, the Government set up a central

vigilance commission on 11th

, Feb 1964 based on the report and recommendations of a

committee on prevention of corruption under the chairmanship of Shri.K.Santanam, a

member of the parliament. However, it had no or nil effect on the scale of corruption in

India. Indira Gandhi once proclaimed that corruption is a universal phenomenon and

showed a blind eye towards it.

The income tax 1961, have dedicated sections for prevention of rent seeking like

Prosecution section; abetment of false return; assessment of undisclosed income as a

result of search etc. However, the bureaucrats flourished with such provisions in the act

with unlimited rent seeking activities.

The prevention of corruption act 1988 which was applicable to all public servants had an

effect on curbing corruption but at a minuscule level. The Prevention of corruption

(Amendment) bill 2013 is under consideration now.

Laws and regulatory measures were in place but its implementation lacked will and

desire to eradicate rent seeking in India. This is due to political interference, nepotism,

corruption, bribery, tax evasion which was all circumventing the system effectively. In a

nutshell, license raj, quota system, issue of permits, subsidies, red-tapism, direct and

indirect taxes assessment are actively promoting rent seeking in our system and has

become a hobby of the political class and habits of the bureaucracy. Self enrichment was

above the common citizens’ social welfare. In India, rent seeking is prevalent at every

level and among every strata of the society. Not an exhaustive list but some examples of

this are issue of licence for driving by road transport authorities, allotment of petrol

dealership, issue of passport, Government recruitments and official postings, land

registration, awarding contracts by the Government, admission to the educational

institutions, tax authorities for direct and indirect tax assessments, custom and excise duty

and service tax authorities for evasions, stamp duty franking, police for traffic violations,

vote buying scandals, admissions in the hospitals, Government awards through lobbying

or due to political influence, procurement of defence materials etc. There are no areas

where it is not widespread. It is omnipresent and omnipotent.

Post reforms 1991:-

Post 1991 reforms in India, reforms were refreshing, economic progress is notable and

achievements are note worthy, but it also gave several rent seeking opportunities.

Emerging economy has given emerging rent seeking habits. Crony capitalism is the order

of the day irrespective of the political party in power. Several entrepreneurs, politicians

and bureaucrats have gained through rent seeking of different dimensions. Kickbacks of

several kinds are regularly paid by corporate entities for contracts to be awarded by the

Government or its related agencies. No doubt, of late corruption has gained prominence.

Government of India and the regulatory authorities do want to address the issue and set

up various committees at various periods to look in to the problems but with no

extraordinary positive results so far due to political pressures.

The measures commendable in this direction are Right to information act in 2002 and

The Lokpal and Lokayukta act 2013 – an anti corruption ombudsman. The prevention of

money laundry act 2002; Whistle blowers Protection act of 2011 and The Benami

transactions (prohibition) act 1988.

Many scams like Coal allocation, 2G spectrum, Commonwealth games scam, famous

fodder case of Bihar and disproportionate assets case of Tamil Nadu are few examples. In

India, statutory bodies like the Central Bureau of Investigation (CBI), the Central

Vigilance Commission (CVC) and Office of the Comptroller and Auditor General (CAG)

of India have become, to some extent, autonomous and are doing their job to large extent

in a professional and ethical basis. Also, our apex court has taken a tough stand against

corruption cases. Yet, corruption is still rampant and wide spread in India due to lack of

strict enforcement of law, no strict penalties and deterrent punishments. Political and

bureaucratic corruptions are percolating to Rural India and village Panchayat’s level in a

huge magnitude.

Satyam computer services, an IT company (called India’s Enron) was involved in a

breathtaking and amazing fraud. The magnitude of the fraud was Rs.7800 crores (US$

1.47 billion) through creative accounting of the promoters. It is a classic case of corporate

accounting fraud. The company was audited by a global auditing firm. They were

indicted by ICAI for being guilty of professional misconduct since the red flags were

clearly visible in the financial statements. We are aware that it was a clear case of rent

seeking since many were involved due to rent seeking activities carried out by the

fraudulent promoters. Corporate frauds are increasing day by day in quantity and quality

in India.

Another novel case was that of late Sunanda Pushkar’s case of sweat equity in the Kochi

IPL franchise. She had 19% stake as sweat equity for her so called efforts in Rendezvous

sports world limited. It was ruled that it was a clear violation of company law and later

she surrendered it after much publicised discussions in media. It was a clear case of rent

seeking.

Rent seeking by way of lobbying goes on in India though India does not recognise

lobbying and treat it as an offense. Lobbyists are regularly hired by corporate including

multinational companies to influence or persuade the Government’s decisions in many

ways. The famous Nira Radia’s Tape Controversy case, Indian coal allocation scam and

Wal-Mart’s case comes to our mind immediately. Lobbying has become synonymous

with corruption for long time though it is disputed and protested.

India ranks 85th

out of 175 countries as per Transparency internationals’ corruption

perception index in 2014. Total corruption and scams in India since independence till

2010 Rs.9 crore 10lakhs 60 thousand 323 crores 43 lakhs (without inflation adjustment)

i.e USD $20.23 trillion. (Source: www.mudraa.com)

Hence, Corporate entities in India are not an exception. Corporate entities are accused of

grabbing a bigger slice of pie rather than making the pie bigger. They have ambitions to

grow over night. This is the reason that rent seeking has increased tremendously in

various sizes and in all sectors of the industries. It is ultimately not good for the growth

and development of the country evenly and becomes an impediment to free market

mechanism.

Just to quote as to how it can happen, a holding or parent corporate can show huge profits

where as costs can be transferred to subsidiaries companies. A different scenario could be

that it can invest in unrelated assets to its core business directly or through subsidiaries

e.g. land and profit reflects the rent seeking/earning capacity of that asset in the parent

company or in its subsidiaries.

Reasons for Statutory audit of rent seeking in India:

Based on the past history observations and findings of various types of rent seeking

practices in India, a strong case arose to include audit of rent seeking along with the other

objectives while auditing corporate entities. Some of these important reasons are:

a) The Government is slowly withdrawing from managing the public sector

undertakings since it has realized that it has no business to be in business and

precious public resources are being wasted and misused with no productivity.

E.G. Air India

b) The Corporate entities of India (industry and services sectors) are contributing

nearly 85% of our GDP.

c) Auditors while doing regulatory and performance audit under statute are ethically

responsible to all the shareholders, stake holders and capital market. The

investors, shareholders, Government and banks have to trust the financial

statements signed by the auditors. Watering down audit reports is not desirable

anymore.

d) Corporate entities, through their management with an overzealous attitude, do

anything including rent seeking to have a greater share of the economy. There are

proven facts that they regularly cook their books in order to conceal the rent

seeking activities. The situation has become out of control and it is grave. Rent

seeking by corporate entities does have implications in its ethical corporate

governance particularly in an emerging market like India.

For e.g. is it a time to ponder? In 2013-14, aggregate of 10 highest paid top

executives of corporate were Rs.400 crores (Approx). Are they paid for their

value maximization and performance or for their ability and ingenuity with rent

seeking activities? Study showed that their remunerations were disproportionate

to their companies’ revenues, growth and profit after tax.

e) Reporting based on accountability and transparency of the corporate are the

probity of the auditors. The perception that auditors are watch dogs and not

bloodhounds has to change now. The companies Act 2013 has made it a

mandatory responsibility of auditors of corporate entities to find and reveal frauds

by reporting to the board and central Government. Hence, the standard model for

doing statutory audit has to be reviewed in order to improve its quality since the

onus falls on the statutory auditors now. The standard audit report has to undergo

revamping with a proper facelift so that auditors include reporting on all grey

areas too. The report has to state categorically that the audited financial

statements are rid of material rent seeking activities which will increase the

confidence of all stakeholders and the capital market.

f) Auditing firms themselves should not indulge in rent seeking or lobbying to get

audits. By including rent seeking in the scope of the audit, it may prevent

members from indulging in such unwarranted practices. Conflict of interest

should be kept in mind while undertaking the audit.

g) Under the current situation of the development phase of economy in India, it is

logical and incumbent for statutory auditors to begin the audit of rent seeking

since it is covertly known that corporate entities are in the business of active rent

seeking. Auditors can no longer remain passive. It is imperative and obligatory for

ICAI and its members to see that while financial reporting of corporate entities;

their report becomes reliable and transparent.

Is it possible to suspect rent seeking activities of a corporate - May be through

statistical trend analysis, important ratios, strategic growth rate over the years, its

investment patterns, fund flow analysis etc. A lot will be thrown in from such

analysis which is not time consuming.

h) Presently ICAI does not cover audit of rent seeking activities as one of their

objectives and duties and no accounting standard is issued for the purpose.

However, ICAI do meet and discuss the issue with various nodal agencies now

and then. ICAI even introduced a certificate course on Forensic accounting and

fraud detection. But, is this enough? IFRS also does not directly mention or talk

about rent seeking in its standards. Audit of rent seeking must become mandatory.

So, it is important that rent seeking activities should also be covered under a statutory

audit of corporate entities. An auditors’ role is central and pivotal. It is emerging as a

necessity to include audit of rent seeking. ICAI has the opportunity to take the

necessary steps and help raise the bar and ethical standards of this noble profession.

We need to institute proper checks and balances in our audit review to minimise rent

seeking activities if not totally eradicate it. If rent seeking activities are declared in

the report appropriately, concerned agencies can take further actions to take it to a

logical conclusion.

ICAI should conduct survey of rent seeking practices in corporate entities going on at

present as well as data collection of past reports on rent seeking and collect

comprehensive empirical evidences at micro and macro levels; though this will be a

challenging and daunting task. They should study the stock market also intensely for

any kind of manipulation to find incidences of rent seeking in addition to what SEBI

does by interfering in the market.

ICAI should start the subject with a discussion paper, after sufficient research and

inputs; introduce an exposure draft to seek opinion of the members and other stake

holders. After assessing the feasibility, a mandatory standard can be introduced with

constant post review and feedback.

Members are then equipped with the necessary skills and knowledge to confront the

issue of detection of rent seeking in corporate entities. It is no longer duty of the CAG

only to include under their scope.

Resources of any kind belong to the citizens of the country and when it is wasted or

abused or misused in a frivolous manner by corporate entities, it should be reported

impartially by the auditors. Otherwise, the youth in future will question the veracity

of audit reports. We should move away from issuing rigmarole reports and issue

reports which strengthen the faith of the society. So, a regulatory reform is required in

the scope of audit and audit opinion.

Let ICAI push for a change for the betterment of the nation and become a role model

for virtuousness.

M. Ganeshan

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