Following the US short-seller Hindenburg’s allegations against the Adani group, several commentators have reiterated the risks associated with concentrated ownership, especially when large family business groups are involved in ‘traditional’ markets (such as those in Asia and Latin America, among other places). Accordingly, prescriptions for dispersed shareholding and board independence have inevitably resurfaced.
But the social logic of family control has, nevertheless, remained a global norm, persisting across history and geographic boundaries. In addition, India’s regulatory tendency to superimpose Anglo-American standards onto a local reality far removed from dispersed ownership, may continue to prove a case of putting the cart before the horse.
For instance, instead of trying to strengthen independent directorships through statutory prescription alone — which is demonstrably susceptible to local workarounds, resignations, and other suboptimal outcomes — we could examine whether family conglomerates have historically served some invisible governance function. Is it possible, for example, that these conglomerates fill an institutional void by giving access to resources through informal private networks? Do such family-controlled firms always discriminate against outside shareholders, leading to worse performance?
Historical evidence suggests that concentrated ownership could even be beneficial when formal legal institutions are weak. As a matter of strategy, therefore, horizontally diversified structures may be better equipped to deal with market failure and labour scarcity. Further, when access to foreign capital is limited, family groups may seek to create an internal capital market, enabling firms to interally compete for funds.
On the other hand, where the promoter-owners can extract private benefits, concentration is obviously detrimental. The point is, prematurely transplanting foreign standards may produce limited results when the imported norms are incongruent with local customs.
How the US did it
While it may be tempting to tweak India’s governance framework further, statutory reform alone may not be the answer. Instead, we could look at how other countries managed to transition structurally from concentrated to dispersed shareholding despite regulatory arbitrage.
After all, legal developments with regard to governance tend to follow, rather than precede, economic change.
In the late 19th century, the US, for example, lacked meaningful laws to regulate its securities market. The private benefits of control were high, judicial corruption was rampant, and legal safeguards were scarce. Nevertheless, over a relatively brief period, dispersed ownership did emerge there. Given the circumstances, this transition seems remarkable in retrospect.
To begin with, on account of high infrastructural requirements (such as railways), the US needed more financing than what was locally available. Thus, between 1870 and 1900, foreign investment increased dramatically.
While large proportions of stock in US corporations were held by foreign investors, the latter’s decisions were coordinated by investment bankers. Such bankers became efficient at drawing capital from outside (such as Europe) and putting it to local use. Since US railway companies were highly leveraged, the demand for more capital made equity issuances necessary. As a result, public equity markets developed quickly.
In turn, the reliance on foreign investors produced innovations aimed at enhancing the reputation of US public offerings. These included a governance regime in which investment bankers, who originally sought to protect foreign investors alone, started seeking board positions to monitor management and protect public investors.
Having its own representative on a company’s board enabled investment banks to supervise major decisions. On the other hand, the presence of a major investment firm on the board offered advantages to minority investors too. After all, like in present-day India, the fundamental worry of public investors was not that a company’s managers would expropriate their wealth, but that controlling shareholders would. In turn, the company’s founders benefited because they did not have to retain a controlling block until the arrival of a majority buyer. Also, to the extent that such founders remained active in management, they gained additional protection from disruptive and/or hostile takeovers.
While investment firms held directorships across companies, the presence of an external board representative added value to a company’s stock. In addition, these firms specialised in underwriting large issuances and arranging merger and acquisition (M&A) deals. Indeed, a wave of horizontal mergers, in the late 19th century, among erstwhile rivals diluted existing block-holders.
Other than obvious differences across time and space, India’s present circumstances may be similar to those of the US from more than a hundred years ago — whether in terms of ‘great power’ ambitions or infrastructural priorities.
While earlier Indian companies depended little on international capital markets, over time they have emerged as globally prominent actors. Concomitantly, local shareholding patterns have started to change. For example, non-promoter institutional investors — including foreign ones — have made significant inroads into ownership.
In sum, India’s structural, circumstantial, and market dynamics may collectively provide the best antidote to continued concentration and/or governance lapses.
However, for financial intermediaries and other private actors to work things out — including via stock exchanges, industry bodies, and business associations, where India’s top companies remain represented, the state could restrain its paternalistic urges, especially as market regulator SEBI and the Ministry of Corporate Affairs feel the pressure to impose yet another foreign model that the country isn’t quite ready for.
(The writer is a lawyer with S&R Associates, a law firm)