Cry freedom!

In February 2006, US billionaire Carl Icahn along with other investors made a bid to acquire Korean tobacco company KT&G. Icahn saw an opportunity, as the core tobacco business was trading at a significant discount to its peers. The acquirers were of the view that the value in KT&G could be realised if the company’s non-core holdings including the ginseng business and its real estate holdings were stripped, and the proceeds returned to shareholders in the form of an ongoing stock dividend and repurchase.

In August 2006, the KT&G management bowed to activist investor pressure. The company announced a buyback of 12 million shares (or 7.5 per cent of its outstanding stock) and a dividend increase of 40 per cent. Stock price subsequently shot up 31 per cent over eight months in 2006.

Clearly, active shareholders can be more effective in goading managements to create value rather than passive shareholders. In fact, such activism is seen as a good counter to boards that aren’t truly independent, and where ownership and management aren’t distinct.

Separating the two in India becomes difficult especially when you consider that most promoters by virtue of their chunky stakes are both owners and managers of their businesses.

Appointing independent directors on the board is of good cosmetic value but, as the Satyam episode reveals (see Satyam’s Six Deadly Sins), such directors are rarely potent enough to challenge inappropriate decision-making (also see The Myth of Corporate Governance).

Shareholder activism is still a nascent concept in India. The good news, however, is that the Satyam episode has succeeded in putting such institutional investors back in the spotlight. Institutional investors own 61.5 per cent in Satyam and were largely responsible in persuading the management to reverse two visibly wealth-destroying acquisitions. By mercilessly hammering the stock, these investors succeeded in doing something the independent directors couldn’t. “There is a thin line between the management and ownership of companies in India. Shareholder activism may not be easy in a situation where the promoters (owners) are also the managers of companies,” says Devesh Kumar, Managing Director, Centrum Broking. However, a fund manager who didn’t want to be named said: “Shareholder activism can be more effective than appointing independent directors in preventing mismanagement from eroding investor wealth.”

In the past, domestic financial institutions like Life Insurance Corp. of India (LIC), IDBI and IFCI would have their nominees on boards of companies. However, they weren’t effective in keeping management on their toes. Much has been expected from independent directors, but they’ve rarely risen to the occasion. “An independent director is a myth in India,” says Prithvi Haldea, Managing Director, Prime Database. Haldea himself is an independent director on the boards of several companies, so he knows what he is talking about.

Perhaps it makes more sense to encourage shareholder activists and hostile takeovers back home. That’s hardly the case, with banks reluctant to finance such raiders and policy-makers frowning on them. Perhaps this has to do with the danger of short-term traders posing as activists in the quest for a quick buck. Whatever the reasons, few investors are willing to go out on a limb and take on managements. The last time something like this happened successfully was in 2000, when Delhi-based investor Abhishek Dalmia made a hostile bid for Mahindra Lifespaces (earlier Gesco Corporation). This prompted the promoters Mahindra & Mahindra to make a counter offer at a higher price. Dalmia didn’t succeed in the acquisition but he succeeded at something else—in creating value for shareholders.

So much talk, so little action

1999: First ever Report on Corporate Governance by Kumar Mangalam Birla Committee
Recommendations:
• Disclosure of material and price-sensitive information at regular intervals
• Defined the scope and interpretation of “independent directors”
• Audit Committee should be independent

2002: Naresh Chandra Committee Report on Corporate Audit and Governance
Recommendations:
• CEO/CFO should certify the fairness of annual reports
• Redefined the interpretation of “independent directors”
• Statutory limit on the sitting fees of directors2003: Narayana Murthy Committee Report
Recommendations:
• Put more responsibility on the audit committee
• Utilisation of proceeds from IPO
• Whistleblower policy
• Formal code of conduct for the board

2004: Clause 49 of Sebi’s listing rules becomes mandatory
Recommendation:
• All listed companies have to comply with the clause which laid the definition of independent directors, and their constitution on the board.

Why independent directors are not effective . Many of them have full-time responsibilities and are on several boards. That makes it difficult to do justice to the role. . They have little at stake at the company on whose board they sit. . Are often ‘friends’ of the promoters. . Have little experience in the industry of the company on whose board they are.