While investing in stocks, investors need to consider various factors including the company’s performance, market trends, macroeconomic factors and the like. But an important variable which is often overlooked is promoters’ holding in their own firms. Promoter holding is an important part of corporate governance that can affect a company’s success or failure to a greater extent.

Of late, promoters selling their stake has been led by automobile and auto ancillaries, capital goods, electric utilities, IT services, and transportation sectors. Let us look at the recent trends in promoter dilution in the Indian firms and its importance to investors.

Promoters are the founders who conceive the idea of the business and bring it into existence and generally have a controlling interest in the business. The term promoter is defined in the Companies Act 2013 and in SEBI under it’s Issue of Capital and Disclosure Requirements (ICDR). Accordingly, a promoter should hold 20 per cent or more of the equity share capital of the company. SEBI also defines the term promoter group, which essentially means a person who is controlled by or related to the promoter.

The impact of dilution

Promoter dilution is the process of reducing the ownership stake of promoters in a company, and it has been observed that this is a growing trend in India in recent years. This trend has been driven by a number of factors such as the need to raise capital for expansion and growth, the desire to increase public float and improve liquidity, and the implementation of SEBI’s minimum public shareholding norms, and the like. Promoters with a significant stake in the firm demonstrate their belief in the company’s future prospects.

It is natural for a company’s founders to have a thorough understanding of its operations, business strategy, and long-term vision. As a result, their decision to retain a substantial ownership in the firm they built is a clear vote of confidence in the company’s capacity to produce value over time. As a result, their decision to retain a substantial ownership in the firm they built is a clear vote of confidence in the company’s capacity to produce value over time. When promoters sell their shares in a firm, however, it could indicate that they have lost faith in the company or that they need to liquidate their interests for other reasons.

Promoter dilution can have both positive and negative implications for investors. For instance, on the positive side promoter dilution could lead to improved corporate governance and better transparency, increased institutional investor interest and liquidity, and reduced risk of promoter manipulation. However, promoter dilution can also have some negative impact on investors. For instance, dilution of promoter control could lead to reduced alignment of interests between promoters and minority shareholders (which is popularly known as agency problem), potential for increased instability and volatility in the company’s stock price and less bargaining power for minority shareholders.

In recent months, there has been a growing concern among investors about the potential negative effects of promoter dilution in India. This concern has been fuelled by a number of high-profile cases where promoter dilution is significant.

There are few things that investors can do to mitigate the potential risks of promoter dilution. First, they need to conduct thorough due diligence on the company’s promoters and their track record. Second, understand the company’s plans for future growth and capital raising mechanism. This would help the investors in getting the bigger picture about the company’s long-term plan and prospects. This will help investors to protect themselves from the potential risks of promoter dilution.

Saravanan is a professor of finance and accounting at IIM Tiruchirappalli and Williams is an analyst at Sernova Financial