Truth or Dare

“Sunlight is the best disinfectant,” a well-known quote from the US Supreme Court Justice, Louis Brandeis, refers to the benefits of openness and transparency. The more things come in open, the better it is for all stakeholders. Most credible and transparent organisations operate in an environment of avowed openness, wherein they share information right from annual statements to the remuneration to the directors with their shareholders. No one can better explain ‘Corporate Governance’ than the billionaire and CEO of Berkshire Hathaway, Warren Buffet himself, “I think of our shareholders as owner-partners, and ourselves as managing partners. We do not view the company itself as the ultimate owner of our business assets, but instead, view the company as a conduit through which our shareholders own the assets.” One of the foremost principles of corporate governance is that ownership and management should be in the hands of two different entities. Let’s consider Warren Buffet & his company Berkshire Hathaway and analyse the ownership and the management structure. Warren Buffet has 99% of its ‘personal net worth’ invested entirely in the shares of Berkshire and the same goes with Buffet’s close relatives and his directors. But what about the stake? Warren Buffet has a 38% stake in the company.

It’s no brainier a thought that Buffet runs the show; he is not the owner. In fact, he is first an investor in Berkshire, then an owner. Warren earns and loses money only when his partners (other shareholders) do and in the same proportion. This is an ideal form of management of a business, but is an exception, not a rule even in the US and other European countries. The recent case of Options Backdating Scandal, wherein executives of as many as 140 companies, were found guilty of choosing a past date when the market price was particularly low, thereby, inflating the value of the options. The situation is not so different in Europe. Recently, the proposed appointment of Mervyn Davies as Chairman of Standard Chartered Bank runs counter to the findings of a government-commissioned review of corporate governance, which discourages companies from naming their CEOs as chairmen.

The situation in India too has been disappointing. Firstly, there are a handful of Indian companies which are listed on the bourses, and have less than 50% promoters’ stake (though it is not a figure that we should aspire for). In the Indian scenario, the ownership and management are in the hands of only one entity, to a large extent. Unfortunately, Indian stock exchanges prescribe a minimum of 25% non-promoters’ stake, which urgently needs to be upgraded. Sadly, in India, what would one expect out of companies when even the exchange on which they are listed is not demutualised! According to the Global Transparency and Disclosure study by Standard & Poor’s of 2006, over a period of two years and studying as many as 1600 world’s most liquid stocks, Asian companies were found to be far behind their US and European counterparts.

The survey highlights ‘block ownership’ or ‘family-owned structure’ in Indian companies as the key impediment. According to the study, closely held companies still do not find any incentive in tapping equity markets to raise money and get listed. As a result, their incentives for clearer disclosure or more robust governance policies remained subdued. As per the research, non-financial disclosure such as details on ownership structures, operational issues, backgrounds of key executive, the description of key shareholder rights et al, are the key susceptible areas in corporate governance. While accounting disclosures are heavily regulated and monitored, it is the non-financial disclosure that gives India companies bigger room to manoeuvre. Interestingly, globally, real estate firms are the ones which have outperformed others in terms of corporate governance. According to the 2006 ranking of Institutional Shareholder Services, the real estate industry (REIT) for the second year ranked second only to the utilities industry.

On the contrary, in India, real estate firms have just begun the marathon by getting themselves listed on the bourses. Voting rights entitled to shareholders is another critical element which needs attention. According to Asian Corporate Governance Association’s Asian proxy Voting Survey 2006, India was ranked 4th out of 11 countries in voting system and has been judged as the one with ‘antiquated voting system’. Though the evolution of capital markets has been slow in India, but it’s steady. Exposure of Indian companies to global markets has resulted in giving a major push to corporate governance standards and transparency levels. Compulsory filing of financial statements form a part of mandatory requirements of stock market regulations in all the countries. And the results are instant; though it’s true that transparency in real estate sector in India is still low, but facts indicate that things are improving.

As per Jones Lang LaSalle’s 2006 Real Estate Transparency Index, India along with Japan is the biggest gainer in terms of the transparency. As Manisha Grover, Head, Strategic Consulting & Research, Jones Lang LaSalle (India), points out, “India’s legal regulatory framework, professional standards and transaction processes continue to evolve and set the pace for an even greater improvement in overall transparency in the immediate term.” But, it’s not only the stock market requirements, which forces a company to adopt ‘best possible management practices’. “Companies choose to be lead adopter of such practices because of several other reasons, such as, a signal of its high quality or to benefit indirectly from positive externalities that its adoption decision had on other firms in India,” opines Tarun Khanna of Harvard Business School. Many private companies are voluntarily adopting the latest governance codes. Cargill world’s largest privately held corporation is the best example of such ongoing transformation. The $75 billion trading giant, discloses material details of its off -balance-sheet dealings to outsiders.

Even business families too, in the US & Europe have started inducting professionals (outside their families) on their boards, realising the importance of a demutualised entity. Appointments of Allen Mullally as Ford’s CEO & William Perez as Wrigley’s CEO have been some of the recent high-profile entry into the boards of the companies that were guarded heavily by their families at one point in time. Corporate governance in India needs a shot in the arm, be it a professionally managed or family-owned. A recent issue that has made it to the headlines is the implementation of clause 49, which advocates for induction of independent directors on boards and many other provisions, which are in line with ethical practices accepted worldwide. Unfortunately, the enactment has been facing persistent delays and the deadline is being extended since April 2005; the first time when listed companies were asked to comply with. At the core of proper corporate governance lies the identification and correction of inefficiencies in the running of businesses. Creation of sustainable wealth can only be done by dhering to fair business practices & sharing it with all stakeholders.

The corporate conquerors

After surfing through the histories of some of the great Indian business families, it’s crystal clear that these business houses have ventured into almost all possible businesses, harnessed the potential of almost all sectors and left no stone unturned. Considering this, it needs no explanation that these business houses have in some way or the other contributed, however small or big it may be, to the growth & development of this country. On this backdrop it’s quite imperative to draw a parallel between these business empires & the amount of stake they currently hold in our country’s business arena. And more importantly, it would answers the question – whether the face of the Indian economy that’s visible to the outer world is actually the face of these business families. To be more precise, is the Indian economy being run by these business families? Researches claim, data substantiate and history is a witness that be it any part of the world, family-run businesses have always been more successful than their counterparts. Well, it’s no different out here.

Historically, Indian business families too have proved the same, but only till they operated in pre-1990’s closed economy. With liberalisation hitting the country, all the track records started collapsing; many giants of the ‘License Raj’ era like Thappers, Modis, Srirams were gasping for breath. The control of family business over Indian stock indices lost its grip. It can be well imagined from the fact that in the year 1996 alone, 12 family-controlled companies were dropped from the list of Sensex constituents as against just five inclusions. Interestingly, 2 out of 5 that were picked up in 1996 were again dropped from the list in 1998. The major family-owned companies that came down from centre stage were Arvind Mills, Bharat Forge, Ballarpur Industries, Bombay Dyeing, Kirloskar Cummins and Pemier Auto.

However, the zest for fighting in few like the Tatas, AV Birla Group and the Ambanis ensured their survival. And the proactiveness of the little known business families like the Ruias, O.P. Jindal Group and GMR Group saw them rise much faster. Well, with 15 years gone past the year which spelled problems for business families, the tug-of-war seems to be poised slightly favouring the family-owned businesses. While this article was being written, more than half the number of companies in major Indian indices were family controlled. While the 30 scrip benchmark index of Bombay Stock Exchange, Sensex, had 17 family-owned businesses in the list representing 57% of the pie, the 50 scrip NSE Nifty carried 26 of them. And not surprisingly, these family-controlled businesses’ share of the total index activity is quite substantial (almost half).

For this purpose, let’s take into consideration the Nifty – one of the most comprehensive stock indices. The 50 stocks present in the Nifty boasts of a market capitalization of Rs.18.6 trillion, and if we calculate the market capitalisation of the family-controlled companies that are a part of Nifty, then this strata forms a whopping 49.82% of the total market capitalisation of the index, that is, Rs.9.2 trillion. In terms of trading volumes also, the pattern is maintained. While the total trading volume of Nifty is 14,169.74 trillion, family-owned companies in Nifty have a cumulative market capitalisation of Rs.6,563.40 trillion, which is as much as 46.32% of the total trading volume of Nifty. And finally, the most important factor – returns! Current calculations show that the past one year (as of end October, 2006) return of Nifty is 57.92%. Now, if one compares this with the 365-day simple returns (difference in share price over one year) of the family-controlled companies in Nifty, then one would find that out of the 26 family-controlled companies 12 have actually outperformed the index.

Again, considering the 365-day simple return for all the fifty constituents individually, Grasim Industries, a family-controlled business, is the outperformer with a return of 134.99%. Furthermore, out of the top ten performers in terms of 365-day (ending November 1, 2006) simple returns, no less than eight companies are family-controlled. A comparison of the financial performance between the two groups shows that the accumulated gross sales of the family-owned businesses (in Nifty) for the four quarters ending September, 2006 stands at Rs.3,024 billion as compared to the combined top line figures of Rs.7,034 billion for the Nifty constituents, which represents a healthy 43% of the total pie. The bottom-line figures too show a similar trend as family-owned constituents in the index, with a total figure of Rs.911 billion, form 44% of the total net profits of all Nifty companies.

Interestingly, public sector companies account for 40% of market capitalisation. And these are family-run businesses that snap the up usually when they are privatised. Sterlite Industries run by Anil Agarwal snapped up BALCO while IPCL was picked up by the Ambanis. Families are also increasing their stakes in their group companies. For example, promoters of Grasim Industries Ltd. have increased their holdings in the company to 25.07% by second quarter of the current financial year from 20.38% in second quarter of the FY2001-02. The same holds true for Mahindra & Mahindra also, whose promoters holding have gone up to 23.06% from 22% during the same period. Quite clearly, the Indian business family is holding firm in the era of intense globalisation.