Why Investors Are Holding Infosys Guilty Until Proven Innocent

For Infosys Ltd, it is more a case of being guilty until proven innocent, rather than innocent until proven guilty. A whistleblower complaint against the company, alleging unethical practices to boost short-term revenue, has led to a massive sell-off in the company’s American depositary receipts (ADRs). On the New York Stock Exchange, Infosys ADRs fell 15% to $8.95 in early trading on Monday.

News reports say the whistleblower complaint was sent to the company’s board on 20 September. Still, the board has no adequate response yet for investors after a month has passed. All the company said in a statement to the stock exchanges is that the complaint has been placed before the audit committee and will be dealt with in accordance with its whistleblower policy.

“The lack of a detailed response from the company is a concern, especially since it’s been a month since the complaint was filed,” said an analyst at a multinational brokerage, requesting anonymity. With the Infosys board shying away from instilling confidence, it’s natural that investors feel jittery.

Another big worry is that the complaint states the company’s top management asked some employees to hide certain information from directors and auditors. The complainant also claims to have emails and voice recordings to substantiate the claims.

“If there is some element of truth to this claim about withholding information from the company’s board, it will create a huge wall of mistrust between the top management and the board,” said another analyst from a multinational brokerage.

This can be a huge negative, as a smooth relationship between the board and its management is critical to the smooth functioning of a company. Regardless of whether there were unethical practices at the company, the aspect of withholding information itself creates a lack of trust within the organization that can be counterproductive.

The charges pertain largely to aggressive accounting norms allegedly used by the company to mask zero profitability in some recent large deals, which were signed with the sole purpose of boosting revenue.

Some large investors may give Infosys the benefit of doubt, and brush off the allegations of a low-margin or a no-margin deal with a client as purely a business decision.

“If the company management is comfortable kick-starting revenue growth through an aggressively priced deal, that is purely a business decision, and can’t be seen as malfeasance,” said an analyst at a local brokerage, also requesting anonymity.

As the chart shows, Infosys’s valuations have caught up with that of Tata Consultancy Services Ltd in the past year and a half. Apart from TCS, Infosys is the only other IT services stock that trades at valuations of over 20 times earnings. One reason for this is that Infosys’s growth rates have picked up this year. The second reason is the fair degree of comfort investors have about the company’s corporate governance policies and practices.

In order to ensure the whistleblower complaint doesn’t deal a major blow to this perception, the company’s board should act quickly in addressing investors’ concerns.

―Livemint