The Forgotten Agenda

THE Finance Minister has recently allowed companies to issue non-voting shares (NVS), meeting a long-standing demand of local industrialists that Indian industry needs infusion of capital to grow, modernise and face the onslaught of transnationals, without facing the risk of hostile takeovers or incurring high-debt servicing. This reasoning appears dubious on two points: first, the floating stock of the average BSE-listed company is about 20 per cent and, second, the remaining bulk of private sector equity is owned by government-controlled financial institutions, notorious for their lack of oversight or shareholder activism of any kind. If anything, there's an  incestuous relationship between company promoters, financial institutions, commercial banks and politicians, allowing asset stripping and financial recklessness by management. There's, therefore, hardly any risk of large-scale corporate takeovers in India, hostile or benign, and the current pattern of corporate shareholding is already the non-voting kind.

Further, do we really need to protect Indian industrialists who for over 40 years have given us such shoddy products, indifferent treatment and terrible service? Doesn't the threat of takeovers force management to brush up their act, behave responsibly and become efficient? Why should Indian management have an implicit guarantee of tenure while foreign power companies are denied even the guarantee of payment of legitimate dues?

NVS may be a bad idea but excessive regulation by government could be worse. NVS should be allowed as long as there is transparency in the process, safeguards for existing shareholders and liquidity and mobility within both classes of shares.

Any public issue of equity is a voluntary con- tract between the company and shareholders, and if shareholders desire to authorise or subscribe to NVS with its attendant benefits and constraints, then so be it. The arguments against NVS can also be used in its favour. What's the big deal about voting rights when current shareholders hardly ever vote, or at least vote according to their intelligence or conscience?

Non-voting is really a non-issue, but it has opened up a wider debate on corporate governance. That's why in just a month, we've witnessed a new takeover code by SEBI, a major rethink by financial institutions on supporting ITC management embroiled in legal and financial problems, and the public disclosure of the RBI defaulters list. The Indian reform agenda has ignored corporate governance so far, despite its direct bearing on our economy. Corporate governance includes how to improve managerial efficiency and honesty, how to safeguard shareholder interests and how to ensure fiduciary oversight and trusteeship. Corporate governance increases efficiency of firms and financial markets, which optimises investments in areas with maximum positive impact on the national economy.

Bankruptcy, and how we deal with it, is an important issue within corporate governance because of its high incidence in India. Both shareholder and public money is locked up in sick assets, and unlike NVS which is a voluntary act by shareholders, industrial sickness is a fait accompli presented to investors. Bankruptcy in India, and its comparison with a country like Japan, is worth examining.

India did not have a separate corporate bankruptcy code till 1985, Then the Sick Industrial Companies Act was passed and the Board for Industrial and Financial Restructuring (BIFR) created as a fast-track mechanism for handling bankruptcy. BIFR has failed because it intercedes largely when companies have already become sick instead of identifying firms on their way to becoming sick. Intervention is thus too late for any turnaround and it often makes good sense to wind up the company and cut losses. But entrenched management, labour unions and politicians do not let this happen, and commercial banks are often forced to either reschedule, write off, or even extend their debts. Management, therefore, has no disincentive for poor  performance or penalty for acting against the interests of shareholders. That's why even large banks go bust, such as Indian Bank did recently.

Japan, on the other hand, has had far fewer corporate bankruptcies than other OECD nations. The only exception was the period between 1990 and 1994 when there was a spurt in bankruptcies in non-banking finance companies and real estate speculators which suffered with the bursting of the Japanese bubble economy and a 30 per cent drop in real estate prices. However, these bankruptcies had minimal impact on the manufacturing sector.

Why is the incidence so low, and how do they deal with it? First, the definition of bankruptcy is harsh and a company is considered bankrupt when it cannot meet its debt or promissory-note payments twice within six months. This triggers a two-year suspension of all banking transactions, including note treatment, tantamount to a two-year business closure. Second, the keiretsu structure of Japanese industry acts as a preventive mechanism since group firms, whether lenders, suppliers or customers, extend favourable credit and purchase terms to the distressed company. This is done to both avoid a loss of reputation for the group as a whole and to ensure stability of supplies. Group firms and banks also exercise a great deal of managerial oversight and control over companies, are able to detect signs of trouble early on, and often plant executives from the parent group to head the failing firm. In the famous Sumitomo Bank bailout of Mazda Motors in 1975, the senior-most vice-president of Sumitomo was made the new CEO of Mazda.

Bankruptcy in Japan is seen as a personal failure and has a high degree of shame associated with it. The element of shame can't be over emphasised, since personal and professional lives are intertwined for most Japanese executives. At the very least, their chances of promotion within the parent group are significantly diminished, and senior executives often have to resign at the time of bankruptcy. In cases involving an identifiable promoter, private assets of the promoters can also be used by courts during reorganisation.

What India needs is similarly strong managerial/financial disincentives against bankruptcy and poor performance. The disincetives will impact other shareholder issues, and both companies and financial institutions will be forced to take their responsibilities seriously. Now that Indian democracy has demonstrated its ability to facilitate the exit of politicians, it's time to produce an exit policy for corrupt management and apathetic board members.