Willing to strike, but afraid to wound

It usually takes a lot to get institutional investors in India all hot and bothered about a governance issue. That’s why it is surprising to see the barrage of protests against Suzuki Motor Corporation’s plans to execute its proposed Gujarat plant under a wholly owned arm. For some reason, even usually quiescent insurance companies and independent directors have joined voices with mutual funds to oppose this move.

While there is no doubt that opaque transactions of this kind need to be put through the wringer, as governance issues go, related party deals are hardly the worst infractions in the Indian context. In fact, the furore over the Maruti issue does make one wonder why institutional investors in India should be so selective in their activism and why their bark often proves worse than their bite.

To start with, why do Indian institutions get all worked up about governance practices of multinational companies, but let Indian promoters off the hook lightly? Running through the 2012-13 financials of listed companies, it is Indian companies which have put through some of the largest related party transactions. UB Holdings extended guarantees and collaterals worth ₹8,800 crore to associate firms. Reliance Infrastructure earned ₹5,900 crore in revenues from EPC contracts from group entities. JSW Steel bought goods and services worth ₹2,800 crore from associates.

Infrastructure companies that operate through a web of holdings routinely route sizeable business to group firms. Real estate firms such as DLF and Unitech, for long transacted in property and land banks with unlisted promoter companies. All such related party transactions create conflict of interest situations between the promoter group and minority shareholders. They become detrimental to investors if the transaction values are out of sync with the market. But given that related party information is confined to the annual report, it is hard to get to the bottom of such deals.

Now, most institutional investors are aware of these deals, but prefer to deal with them by building it into their valuation models. Therefore, we have a situation where firms with a good record stir up a hornet’s nest when they make a contentious move. But those with a dodgy record get away because everyone is aware of their governance issues.

Then there is the fact that shareholder activism in India is triggered only by one-off events. A multinational parent hiking royalty payments, an index company proposing a merger with a group firm, a large-cap company transferring big assets at a throwaway price — transactions such as these attract the institutions’ ire. What of the scores of companies that have decimated shareholder value by routinely and systematically mismanaging their day-to-day business?

Over the last 20 years, over a third of the listed stocks have simply vanished from the bourses — they have been suspended, delisted or simply turned illiquid. The last three years have thrown up many instances where companies have exceeded prudent borrowing limits, raised irresponsible amounts of foreign currency loans or generally pursued strategies that run their business to the ground. Yet, how many of these cases have been flagged by institutional investors?

Or for that matter, how many instances of activism have we seen in cases where promoters diverted IPO proceeds to projects which they never disclosed?

Our institutions also like to take the path of least resistance while fighting governance issues. Compare the Maruti episode with the Herbalife case now being fought in the US.

For some time now, activist investor Bill Ackman has been accusing direct selling company Herbalife of running an illegal pyramid scheme. Last year, Ackman made a fire-and-brimstone presentation to the public and initiated a $1 billion short position in his own hedge fund on the stock. Since then, declaring that he will pursue this case “to the ends of the earth”, he has lobbied Washington and investigative agencies from the UK to China to look into the firm’s operations. Ackman may or may not win his crusade, but there can certainly be no doubt about his conviction.

Contrast this with how activism plays out in India. In the Maruti case, mutual funds and insurance companies have been bickering with the management in closed-door conferences, writing long letters and complaining to the Securities Exchange Board of India (SEBI). But given that related party transactions are not illegal and are practised by a vast number of listed companies, it isn’t clear what the regulator can do.

This raises the question — if domestic institutions are really annoyed with the Maruti management, why don’t they vote with their feet by shorting the stock à la Ackman? And why don’t they join forces to actively vote out the deal?

To the first question, fund managers privately admit that they really wouldn’t like to sell the Maruti stock, if they can help it. After all, very few good automobile companies are listed in the Indian market. And if one wants to invest only in companies with spotless governance records, one would have to rule out much of the listed universe.

A survey by proxy advisory firm Institutional Investor Advisory Services reinforces the view that Indian institutions prefer to take a non-confrontational approach to governance issues. Asked what they would do if they disagreed with a company’s decision, a whopping 59 per cent of the surveyed institutions said that they would “engage with the management to reach a consensus”. Only 28 per cent said they would exit the stock.

Separate studies by proxy firms have found that leading mutual fund houses often abstain from voting or throw in their lot with the management. Insurance companies, who manage much more money than mutual funds, are an even more quiescent lot and don’t even disclose their voting polices. The defence could be that the stakes that domestic institutions hold in listed companies are dwarfed by the FIIs and promoters. Why make a hue and cry when you can’t really make a difference?

However, this situation is likely to change very soon, with the new Company Law allowing only non-interested parties to vote on key corporate decisions. This will move promoters out of the equation. Then we will really know if domestic institutions are willing to use their newly acquired teeth.

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