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The Crusaders

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Wipro’s announcement last November of its plan to hive off its non-IT businesses into a separate company was widely cheered by Dalal Street. The company’s stock surged 3 per cent that day. Several brokerages soon upgraded the stock setting higher price targets, saying that the demerger would allow for better decision-making in the more profitable IT business. The firm gave its shareholders three options to choose from: equity in the new entity, Wipro Enterprises; preference shares in it; or shares of equivalent value in the IT business. Everybody was happy, it seemed. That is, everybody but a small clutch of firms that saw red.

J.N. Gupta, a former executive director at capital markets regulator Securities and Exchange Board of India (Sebi), had made a habit of sifting through corporate announcements since setting up his advisory firm Stakeholders Empowerment Services (SES) in June, with son Arjun and friend Amarendra Singh. His eyes caught a seemingly innocuous line in the press release about the Wipro brand being jointly shared by the two demerged entities. For the lack of any other details, he assumed that the brand would be shared equally. Not a fair prospect, he thought, considering that the IT business accounted for 85 per cent of the firm’s revenues. And since Wipro Enterprises was not listed, shareholders were most likely to take shares in the IT business. Could this the management’s way of removing value out of the IT business, he wondered. After a letter to the management elicited no response, Gupta came out with a report advising Wipro’s minority shareholders to vote against the restructuring.

Elsewhere, Amit Tandon, former managing director at Fitch Ratings and co-founder of Institutional Investor Advisory Services India (IiAS), was drafting another report questioning Wipro’s decision not to list its demerged entity. How would shareholders who buy shares in the demerged entity get to exit unless it was listed? He advised shareholders to question the management about future plans for Wipro Enterprises, and recommended that they vote against the proposed demerger.

As it turned out, not even 1 per cent of Wipro’s shareholders voted against the proposal (just 400 out of the 250,000-odd shareholders attended the meeting in Bangalore). Wipro, in an email to BW, highlighted the approvals received from regulators and creditors, saying,  “The positive response received so far from the investors, financial analysts and media reflect an appreciation for the rationale and fairness of the scheme.”

The vigilantes, however, are not deterred. In the past two years, proxy advisory firms operating in the country have issued around 1,500 advisories on voting. Gupta says that proxy advisory is an idea whose time has come.

An Uphill Task
In the 2000s, Shriram Subramanian was head of wealth and asset management consulting at Infosys Consulting. He noticed how in the US asset management firms were clear about the amount of transparency expected from their investee firms by scrutinising annual reports and other filings, and had detailed guidelines on how to vote on all issues. In 2010, a Sebi circular required mutual funds (MF) to publicly disclose their voting records. Sensing an opportunity, he quit Infosys to set up InGovern, a proxy advisory firm, with the aim of helping investors take better decisions on company resolutions.

Proxy advisory firms are based on the concept of “proxy voting”, where a shareholder — unable to attend a meeting — authorises another person to vote on his behalf. These firms recommend how an investor should vote on resolutions. In the US, where the practice is pretty much entrenched, it is estimated that MFs pay around 0.1 per cent of their assets under management (AUM) as fees for such advice. With an estimated AUM of just over Rs 7 lakh crore in India, the growth potential for proxy advisory firms can be enormous.

But Subramanian admits that promoting shareholder activism is an uphill task. “Awareness is still growing,” he says. In fact, there is a lot of indifference. InGovern analysed the voting patterns of 39 MFs during 2011-12, and their findings told a sorry tale. During 2011-12, for instance, just four Indian MFs voted against a proposal 1 per cent of the time, six always abstained, while two voted in favour of the management each time. Even top MF firms such as HDFC MF and ICICI Prudential, when they voted, hardly opposed the management. For instance, of 480 resolutions, HDFC voted ‘against’ only one. MFs owned by multinational firms, such as Fidelity MF and ING MF, fared marginally better — their ‘against’ votes were in double-digits. In comparison, a survey of voting trends by MFs in the US showed that they disagreed with the management 5-20 per cent of the times.

Of course, it is quite possible that Indian MFs that voted ‘for’ actually agreed with the management. But proxy advisory firms attribute the trend of ‘acquiescence’ to indifference, which is, perhaps, the biggest stumbling block for the growth of investor activism in India.

Investor indifference was evident during the recast of Vedanta group’s Indian operations last year, entailing consolidation of its holdings under a new entity, Sesa-Sterlite. As part of the exercise, Sesa Goa acquired the loss-making Vedanta Aluminium (with about Rs 25,000 crore in debt) from Vedanta Resources in the UK. This had the effect of making the minority shareholders of Sesa Goa and Sterlite share the debt without any direct benefit, points out an analyst. Franklin Templeton (which held 12 per cent in Sesa Goa) opposed the move, but fellow investors did not fall in line, and the MF could not garner the little over 25 per cent of votes needed to block the proposal. 

Similarly, paint maker AkzoNobel had a run in with IiAS and InGovern last year when its Indian arm floated a proposal to merge its three unlisted subsidiaries with itself. Both proxy advisors came out strongly against the resolution saying the valuations were tilted against minority shareholders. Though Azko defended the move saying it had recommended the merger after due diligence, the proxy firms campaigned heavily against it. But when the votes were finally counted, only 23.2 per cent out of the requisite 25 per cent opposed the resolution. Two mutual funds, ICICI Prudential Life Insurance and UTI MF (which held 6.5 per cent between them) abstained from voting. As they say, you can only lead a horse to the water but you cannot make it drink.
 
Challenging the Master

It is perhaps this feature that makes corporate governance activism akin to David fighting Goliath. Not only does the promoter have a sizeable chunk of votes to bulldoze any resolution through, but the scramble for dissenting votes almost always hits nought. Subramanian says that in the US, MFs usually vote according to the recommendations of proxy advisors. So much so that major players like Institutional Shareholder Services (ISS) hold considerable sway in corporate decisions, acting as an effective check on self-serving decisions by the management. In India, though, most investors go with the attitude that as long as any decisions do not immediately harm their interests, they’d rather not upset the company. And if things get really bad, they’d just sell and find another investment, an indifference that hurts the efforts by activists.
 
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There are probably reasons for that too. Managements in India can be really vindictive; they can bar access to analysts who challenge the firm, thus impairing their equity research capability.

Nevertheless, corporate governance watchdogs have been growling loudly over the past year — from MFs like Franklin Templeton to analysts at investment banks like Espirito Santos and Macquarie, which came out with scathing reports on accounting practices at Biocon and HDFC Bank, respectively, among others. Nick Paulson-Ellis, India head of Espirito Santos Securities, says that high-governance stocks tend to outperform in difficult markets like India, hence the focus on governance quality. But he warns that after a while people tend to forget. The silver lining is that there are a few firms that care enough to take corrective measures. Paulson-Ellis cites HDFC Bank as an example, saying that after the reports came out, it began reporting consolidated numbers even in its quarterly filing, and disclosing the interest it was charging to the balance sheet.

Saurabh Mukherjea, head, institutional equities, at Ambit Capital, says that just like politicians, corporates now want to be at least perceived as clean. Hence, rather than bullying minority shareholders, they are now willing to discuss corporate governance-related issues.

Of course, the trouble is that majority of the companies don’t care. As Gupta says, corporate governance for them is more like a modern-Indian façade — beautiful to behold, but step in to inspect and “you will find stains of betel spit at every corner”. And then there are those who would rather not go through the hassle of getting investors together. Arun Agarwal, a Bangalore-based lawyer who has taken on bigwigs like Reliance Industries, Hindustan Unilever (HUL) and Vedanta, says that in a promoter-dominated corporation, there’s no democracy. Activism should be through courts, not via shareholding.

Take, for instance, related-party transactions in a firm. While the accounting standards require that all transactions with related parties be disclosed, shareholders can hardly make anything out from annual reports. But the law also gives other checks like independent directors to question the board of directors — such as when SES raised a hue and cry about Naveen Jindal’s Rs 73 crore pay packet at Jindal Steel and Power, where he was MD. Without a remuneration committee, he was free to decide his own salary, says Gupta. “Independent directors are meant to question the rationale behind board decisions. Unfortunately, in India, many independent directors see themselves as informal advisers to the board,” says Marti Subrahmanyam, a former independent director at Infosys as well as at ICICI Bank.



Another point of contention is royalty payments. Indian subsidiaries of MNCs pay hefty amounts as royalty to their parent for the ‘right’ to use their global branding. IiAS recently juxtaposed sales growth in firms that paid royalty against the rest of the BSE 100 universe. The findings were telling: The BSE 100 firms on average beat the top 25 royalty-paying companies squarely, both in terms of share performance as well as earnings growth. Thus negating the claim that the foreign branding helps the domestic subsidiary. In only one case — Ambuja Cements — was the royalty decision partly rolled back after a backlash from proxy advisors. Recently, HUL decided to increase its royalty payout to 3.15 per cent. It’s anyone’s guess whether parent Unilever has anything to do with the massive sales of some of its bestselling soaps and detergents, or if the Wadia branding helps Britannia.

Vote of Confidence
But if getting institutional investors to vote for corporate governance is a gigantic task, then getting them to pay for proxy advisory services will be Herculean. InGovern’s Subramanian rues that the general attitude in India is that research should be free, even if affordability is not really a problem. Mukherjea says the challenge is to be create a sustainable revenue model, but with investors reluctant to pay, these firms may be acquired by MNC proxy giants or become part of independent brokerages in the long run.

So the question is: will the proxy firms be able to find a sustainable revenue model? Gupta, having set up his firm as a non-profit to keep out conflicts of interest allegations, was hard pressed to find even a single investor before he decided to fund himself. With a few institutions showing interest, he hopes the organisation can soon start meeting its operational costs from revenues. InGovern was lucky to find sympathisers early on — such as former Infosys HR head T.V. Mohandas Pai — as investors. IiAS has been the most successful so far, with an investor list that includes BSE, Tata Group, and Fitch Ratings.

While the institutions themselves would prefer being recognised for their work, several global analysts who track corporate governance compliance argue that only a model where firms pay for being analysed, as in the case of credit rating agencies, is sustainable. That, of course, would be a boon to these companies, but even short of that, if the users of their research, such as investors, start taking their advice seriously, the entire corporate governance scenario in India could change. That is, if the companies don’t clean up their acts by themselves.

abraham(dot)mathews(at)abp(dot)in
matabrahamc(at)gmail(dot)com
(at)ebbruz

(This story was published in BW | Businessworld Issue Dated 17-06-2013)
 
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