The Cooked Book Raj

The growing clamour recently in favour of corporate ethics and against blatant corporate greed and malfeasance, both from outside and within the corporate sector, is of a piece with the push for transparency and against corruption. The angst is best exemplified in Gop­alkrishna Gandhi’s recent outpouring that “corporate greed has crossed all bounds as has corporate tastelessness”. The Satyam scam, followed by the 2G spectrum scam and the Coalgate scam, have blown the lid off the rot within the system. Much of the recent writing on this theme seems to attribute the roots of this malaise to the regulatory system of the lic­ence-permit raj, which was put in place post-Independence. But this misses the wood for the trees: the roots of unethical business practices well predate 1947.

The institutionalisation of corruption in business can be traced to the Raj, and beyond that, to the very nature of colonial mercantile trade under the aegis of the East India Company. It is best exemplified in the involvement of company officials in private trade in violation of the company charter and the enormous pecuniary benefits derived by them through graft as revealed in the cases involving Robert Clive and Warren Hastings.

I am inclined to attribute the strengthening and embedding of these unethical business practices in imperial India, with implications for developments in post-independence India, to two main factors: a) the absence of level playing field as bet­ween European capital and fractions of Indian  merchant capital over access to emerging investment opportunities,  and b) to the uniquely Indian experience of the rise of an Indian entrepreneurial class, in those times, from business communities with pronounced commercial  moorings. As a consequence, the commercial instinct of the traditional family firms—such as pedhis and sarafis—assumed overriding importance in their overall scheme of business and many of these business traits were carried over to the management of modern enterprises that came under their control. It was also reflected in the compelling need in a highly competitive and  imperfect market, characterised by uncertainties and risk, for quick turnover, irrespective of the means used for doing so. Satta, or speculative bids and deals, was integral to the opium and cotton trade, the initial source of wealth generation of many of the traditional Indian firms. This situation, as it were, created the basis for the growth of  what came to be perceived as unhealthy business practices. Legendary is the case of Premchand Roychand. His rise to riches and decline through speculative dealings in cotton trade and the Backbay Reclamation project during the 1860s was probably the first major scam in the financial history of India.

The third factor possibly could be cultural—or rather, to do with education. Most Indian businessmen, especially those of the first and second generation, with the possible exception of Parsis, did not have the privilege of being exposed to English education and to the Calvinistic ethos it brought along with it, and were therefore not able to internalise what were then the modern concepts of corporate behaviour.

The basic legal framework for the Indian corporate sector came in the form of the Indian Companies  Act, the first of which was enacted in 1850, with subsequent major amendments in 1882, 1913 and 1936. The two major institutional forms that emerged from these enactments and which were to play a crucial role in shaping the corporate sector were the joint stock limited companies and the managing agency firms. The law was  modelled entirely on the lines of the English law and most of the provisions were essentially conceived to enc­ourage the free flow of English capital into the emerging corporate sector. The British didn’t in their wildest dreams anticipate or imagine that the Indian merchants would break through the glass ceiling and enter this sphere in strength as they did in Bombay and Ahmedabad, which emerged as centres of industry, especially in the production of textiles.

The British Raj’s reaction to this was less than fair. Through an overt policy of discrimination against Indian commercial enterprise they stifled the possibility of  a level playing field emerging and ended up not only violating the spirit of the law but also indirectly encouraging Indians to adopt other means of  survival and growth.

The system of managing agency that came into the statute book under the Indian Companies Act was another classic example of the manner in which Indian family firms managed to thwart the basic spirit of this Act. It was intended to be a system which would provide for able and efficient management of the companies by a team of professionally qualified managers who would be acc­ountable to the shareholders. Both the British, and taking a cue, the Indians, managed to circumvent this law to their advantage. The managing agency firm was usually the family firm, which controlled the unit and also tightly controlled most of the shares of the firm. Indian business history is replete with examples of companies being milched by managing agency firms through a whole range of illegal commissions and diversion of funds to various activities of the family firms.

Given the imperfections of the capital market and the absence of a level playing field as well as the imperative need to hasten the process of wealth generation, the Indians utilised these institutions to serve their interests and in so doing chose to violate the basic principles of the Act. However, given the absence of effective machinery for enforcing the law, the Indians could not be prosecuted. The history of the Bombay textile mills industry powerfully illustrates  how managing agency firms were allowed to blatantly contravene the basic spirit of the company law, how capital was allowed to milch the industry dry with scant regard for sustaining it over time through reinvestment, especially for modernisation of machinery and production methods.

The skewed development of the basic architectural infrastructure for growth of modern capitalism lay at the root of unethical business practices which in course of time assumed legitimacy. The capital markets remained underdeveloped for most part of the period under British Raj. European banks, including the Imperial Bank of India, were unwilling to fin­ance Indian industry. However, in response, some of the larger Indian business houses created and promoted their own banks. These banks mopped public middle-class savings to meet the family firms’ capital requirements. There were complaints of funds of these public banks being used by the managing agents to serve their financial interests. Loans were often provided to special beneficiaries on easy terms.

The stock markets emerged relatively late and were initially controlled by European stock-broking firms, which dealt largely with blue-chip companies.  It was rather difficult for most average companies to raise capital through public issue in stock exchanges until very late in the colonial period, and therefore, they ended up raising capital through informal kin networks or from the informal financial market. This pushed up costs and encouraged entrepreneurs to make up for the loss through other means such as commission on sales and purchases. Forward trading in commodities, especially jute in eastern India, was another channel for illegal amassing of wealth by some of the Indian trading firms. Evasion of income tax by business firms through inappropriate auditing systems was another major complaint during the colonial period.

There was violation of the yarn control order during war time. Many leading Indian industrialists were found to be div­erting yarn into the open market in violation of this control order, intended to control fair distribution of scarce yarn to all stakeholders. Many of these industrialists were charged and prosecuted for violation of this Government of India order.

Noteworthy was the lobbying for industrial licenses and scarce foreign exchange. The nexus between bureaucracy and business houses and the skills of lobbying for securing the necessary  clearances  can be traced to the 1940s following the promulgation of the control over capital issues. This system becomes a fine art in the post-independence period during the infamous permit-control phase of contemporary Indian history.

The situation reached alarming proportions during the war and post-war period, when the incidence of malfeasance and deviation became a matter of concern, forcing the post-independence Indian government to step in and crack the whip in order to provide some checks and balances and ensure there was a semblance of order. This was reflected in the setting up of the company law committee, the regulation of the stock market committee and the income tax investigation commission, all of whom  expressed serious concern over  the problem of deviance in business behaviour and urged the need for  conformity with  accepted standard  norms. The prosecution of the Dalmia group over serious charges of misappropriation and  misconduct in the 1950s was also intended as a message to the business world at large of the sanctity of the red lines. However, these measures fell far short of addressing the core problem of probity. That the problem still dogs us clearly suggests that sections of corporate India have drawn  the  wrong lessons from its history.

(Raman Mahadevan is a Bangalore-based business historian.)