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Undue reverence for company founders harms Indian firms

Source | www.economist.com

THE chairman of Microsoft, John Thompson, occasionally reminds one of its directors, a fellow by the name of Bill Gates, that his vote in board meetings is no more or less important than that of other members. Contrast that with Infosys, an Indian technology firm, whose own retired founder succeeded in getting its boss to quit on August 18th, after a months-long whispering campaign (see article). The board was dismayed, but the outcome was all too predictable, given India’s penchant for treating corporate founders as latter-day maharajahs.

Indian companies come in all shapes and sizes, from clannish outfits whose tycoon bosses routinely stiff minority investors, to giants like Infosys whose corporate governance (usually) matches Western norms. What unites them is that they accord undue deference to “promoters”, as India dubs a firm’s founding shareholders. The exalted status bestowed on promoters is a pervasive feature of the Indian corporate landscape. Of the 500 largest listed Indian firms, according to IiAS, an advisory firm, 344 are controlled in practice not by boards answerable to all shareholders, but directly by promoters.

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Founders can exert unhealthy influence over Western firms, too, but they typically do so using their shareholdings. The sway exercised by Indian founders has its roots in a unique mix of moral suasion, regulatory advantage and the trickiness of doing business in India. In many industries, the promoter has relationships with people who matter. Only he knows which palms need to be greased to keep a power plant open, or which union boss has to be co-opted to avoid strikes. This knowledge makes the promoter central to the running of the firm, even if it belongs mostly to other shareholders.

Sometimes that leads to dominant promoters bilking the firms they run. They give family members juicy contracts, pay themselves excessively and get the firm to provide private yachts, London flats and much else besides. United Spirits, a booze firm promoted by Vijay Mallya but owned mainly by outsiders, used to pay for 13 properties for him and his family (he is now in Britain, trying to avoid extradition to India).

The promoter’s perch is bad for the companies themselves, and not just their shareholders. It is harder to recruit good managers when power lies elsewhere. Balance-sheets get stretched as investment is funded more by debt than equity—because debt is cheaper and promoters can thereby avoid being diluted to the point of losing certain privileges.

Promoter power is also bad for the economy. Inefficient firms that should be taken over by a rival stumble on, as promoters seek to preserve their perks. The promoter culture is partly to blame for the nearly one-fifth of all loans made by Indian banks thought unlikely to be repaid. When promoter-led firms cannot service their debts, dominant owner-bosses tend to skip repayments. They understand that banks cannot easily foreclose on them and later hope to sell the firm on, because any new owner would lack a promoter’s hold over the business. This has harmed the Indian banks and, in turn, the finances of the government that owns many of them.

Read On….

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