BANGALORE, India — They introduced employee stock options, flattened a top-down corporate hierarchy and provided jobs to millions of young college graduates. They were managed by smart, articulate leaders and bolstered India’s image as a rising global economic power.

Much of urban India’s hopes rested on these new economy companies.

So when the chairman of one such firm, Satyam Computer Services, confessed earlier this month that he had trumped up the company balance sheet to show non-existent cash profits of over a billion dollars, it sent shock ripples through India.

And if that was not enough, Ramalinga Raju, who resigned as chairman, was arrested and jailed, the company’s chief financial officer attempted suicide — and survived — and early investigations suggested that Raju had been skimming off company cash and inflating employee numbers.

As Western customers and investors pulled out, employees were hit with the news that Satyam did not have the reserves to pay their January salaries.

“The truth as we know it now is shocking,” said Samartha Chandrashekhar , 21, who will graduate in computer science in May from Bangalore’s leading RV Engineering College. “Satyam was a respected, professionally-run company and we did not expect this in our wildest dreams,” he related, describing the feeling amongst his friends and peers.

Chandrashekar’s cousin, a Satyam employee, worried how long he would have a job and how Satyam would stay afloat.

The world’s top corporations farm a variety of work to Indian outsourcing firms, from the humdrum payroll processing to answering companies’1-800 customer helplines to high-end R&D and product design work involving intellectual property and sensitive data.

Satyam, India’s fourth largest outsourcing company, had customers such as General Electric, Coca-Cola, Nestle and Ford Motor.

“The Satyam episode represents a setback for India’s image,” said Ashok Divakaran, a Chicago-based principal at consulting firm Booz & Co adding that foreign investors and customers consider it a significant failure of corporate governance. “In the incestuous, relationship-driven Indian business environment, there is a good chance that additional failures could occur,” Divakaran said.

Like many of its outsourcing peers, Satyam’s story is an Indian dream. Its founder Ramalinga Raju was the son of a farmer who grew up in an Indian village, graduated from the University of Ohio and returned home to launch Satyam in a small way.

At its peak, Satyam had a swanky headquarters in the southern Indian city of Hyderabad, was a coveted employer with over 50,000 employees, had a roster full of Fortune 100 clients, and had a respectable board of directors including a Harvard Business School professor.

In the end, however, neither the high-flier board members nor high profile audit firm Pricewaterhouse was enough.

Opaque governance and poor corporate ethics have typified India’s traditional, family-run companies. The country has a poor track record in corruption and, last year, ranked 85th out of 180 countries in Transparency International’s Corruption Perception Index.

The fear is that disastrous corporate governance standards could converge with corruption and repulse much-needed foreign investment.

However, the Satyam incident is an isolated one and cannot be perceived as a black eye for corporate India, said Anil Gupta, professor of strategy and organization at the University of Maryland’s Smith School of Business. But Satyam has illustrated that India’s new economy companies are far from perfect, said Gupta, co-author of a new book Getting China and India Right.

The Satyam scandal has colored the outsourcing industry, said Bernard Mathaisel, chief operating officer of San Ramon, California-based outsourcing firm, Achievo Corporation. The privately-held, 2300-employee Achievo, which executes the bulk of its work in China, said its customers are demanding that it demonstrate its competency, integrity and staying power.

“We are getting asked more frequently for our audited financial statements, to perform pilot projects as a precursor to bigger, long-term relationships, and to provide references,” Mathaisel said.

Satyam has been likened by some with Enron and Ramalinga Raju to the Wall Street scammer Bernard Madoff. But the comparisons are not justified, said Gupta, the professor of strategy. Unlike Enron whose business model was based on trading in exotic financial instruments, Satyam’s business services outsourcing model is a more tangible business proposition. The global economic meltdown would make it more attractive to American businesses, he said.

In Bangalore, India’s technology hub, the Satyam scandal has brought many career dreams crashing down. With the Wall Street meltdown and the recession, outsourcing firms were already in a lay-off or hiring freeze mode.

“Satyam further impacted the already-tough job scenario ,” said Chandrashekar, the engineering student, who says he is lucky to have been hired by IBM’s India unit.

When Satyam arrived this time last year for campus recruitment at Chandrashekar’s college, there was jublilation. This year, however, many students said they had a “narrow escape” – the scandal broke just before Satyam was due on campus.

In India, both the government and outsourcing companies have moved quickly to contain damage. The government has appointed a new board. Many top outsourcing companies are baring their corporate governance and business practices to investor and customer scrutiny. “While one Satyam won't cripple the industry, it likely can't afford a second one,” said Divakaran, the industry expert.

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