CIRCUIT BREAKER. What’s sacrosanct about promoters?

The recent move by Infosys promoters and their families to offload sizeable stakes in the company has triggered mostly adverse reactions from investors. Many seem to see this move as a dark foreboding that the business is in a terminal decline and have hastened to sell the stock.

This view is quite puzzling, for it is under the helmsmanship of the very same promoters that Infosys has lost its mojo in recent years. It was under its founder-CEOs that Infosys ceded its top slot in Indian software’s Big Four and fell behind rivals such as TCS and Cognizant in terms of growth and scale. Turnaround hopes for the company have in fact revived after the recent induction of a professional CEO.

Nor is the decision by Infosys promoters to reduce their stake in the firm they founded unique. Taking stock of the latest shareholding disclosures of the top 500 companies (September 2014), over 200 of them now feature promoter holdings below the critical 51 per cent mark; 27 firms have promoter holdings of less than 25 per cent. And nearly a dozen of these have no official ‘promoters’ at all. They are owned by institutions, run by a professional board and are none the worse for it.

This list features companies such as IDFC, L&T, ITC, HDFC, HDFC Bank and CARE. All are top wealth creators and some leaders in their respective business. Despite this evidence, shareholders in Indian companies seem to cling to the belief that a high promoter holding is the best guarantee of the company’s financial health and good governance.

But experience suggests that when an individual or a business family holds overarching control over a firm’s strategies and operations for a long time, they do often make decisions that aren’t quite rational or even in the company’s interests.

For one, haven’t we seen quite a few instances of perfectly sound companies turning value destroyers because of the promoter’s vaulting personal ambition? Often, a cash-rich flagship firm is used to bankroll unrelated and unwise forays into sectors that the promoters fancy. (Airlines, IPL teams and hotels seem to be the most popular choices.) Or in a mad race for size, it takes on an oversized acquisition which saddles it with unnecessary debt.

Political affiliations of promoters can deliver needless jolts to shareholders too. In the last two years, shareholders in firms belonging to business groups such as the Adanis, Ambanis, GMR and Marans have been on a rollercoaster ride irrespective of company fundamentals. This was thanks mainly to their perceived connections to the Congress and the BJP.

Far from being a guarantee of good behaviour, high promoter holdings in Indian companies often facilitate doubtful practices such as related party transactions. After all, quite a few listed Indian firms bail out ‘group’ firms in distress with generous low-interest loans, large corporate guarantees and inter-corporate deposits which would never be extended in the normal course of business. As a result, though their businesses may be very different, the problems of one company in a group often get visited upon other firms sharing the same promoter. Take United Spirits, which despite being in an unassailable position in the Indian liquor market, has seen its shareholders endure poor stock valuations and wild price swings, due to the highly visible debt troubles of Kingfisher Airlines.

In such cases, promoters selling their stake is obviously good news for the shareholders. The company’s board can be better constituted and its managers empowered to make objective decisions that are in the best interests of the business.

But isn’t it wrong to tar all of India Inc’s promoters with the same brush? What if the entrepreneur is committed, far-seeing and able to efficiently manage the business? Even such companies may benefit from a change of guard over time.

As any business grows in scale and complexity, there does come a time when a single individual no longer has the bandwidth to make all the decisions the enterprise demands. If steered by a team of specialists in diverse areas of operations, it may make even better use of its opportunities that it has hitherto done.

Having said this, in most cases, promoters or business families haven’t ceded their majority shareholding in listed companies out of choice. A good number of promoters have done it reluctantly, to comply with the Securities and Exchange Board of India’s minimum public shareholding rule. This rule, which required promoters to divest at least 25 per cent of their shares to the public by mid-2013, has been a primary driver of falling promoter holdings in India Inc.

The economic downturn of the past three years has expedited the trend too. The bad loan woes of banks and regulatory pressure to recover them have forced promoters of quite a few distressed companies to pledge or sell their equity stakes to settle the claims of their creditors.

However, from a regulatory standpoint, getting promoters to liquidate their shares in listed companies at gun-point is only half the battle won. To really allow the company’s board and top managers to function independently, regulators need to ensure that the promoter or his family members do not continue to exercise decision-making powers or rights that are disproportionate to their shareholding in the company. After stake sales, promoters should be required to relinquish their board seats, key managerial positions or assorted perks that they have hitherto enjoyed in listed companies.

But public shareholders must note that even this will not automatically guarantee good governance or great strategic decisions at the companies they invest in.

With the promoters no longer taking an active role, it is important that the institutional investors and public shareholders in listed companies take a more active part in corporate decisions by consciously exercising their voting rights.

Given that the shareholding in most Indian companies is dominated by foreign institutional investors, who may be short-term in their outlook, a disproportionate share of the burden for ensuring good governance falls to domestic institutional investors such as the LIC, private insurance companies and mutual funds.

Today, most of them participate only sporadically in key corporate decisions that are put to vote. Where they do, they often rubber stamp the decisions of the management. As for public shareholders, they usually stay completely away from company meetings, despite recently being armed with e-voting facilities.

If institutional and public shareholders in Indian companies fail to take control of decision-making at the firms they own, promoters, even after their recent stake sales, will get to enjoy the best of both the worlds.

They will continue to call all the shots on corporate decisions. But as majority owners, it is the public shareholders who will face the financial consequences of their bad decisions.