Lead Story

Why institutional investors duck governance issues

Corporates, especially in India, get away with just about anything because financial institutions look the other way

In December 16, 2008, B Ramalinga Raju stunned the market by announcing that Satyam Computer’s board had approved a decision to acquire Maytas Properties for $1.3 billion and a majority 51% stake in Maytas Infrastructure for $0.3 billion. The late evening announcement saw the ADRs listed on the US market tank 54.5% in a single session. In a conference call with institutional investors that same evening, Raju and his board came under fire from aggressive mutual funds and foreign institutional investors, who threatened to oppose the move. Jayesh Shroff, who was then with SBI Mutual Fund, was particularly scathing in his attack on Raju.

“No foreign investor in the country will track any Indian company after your move. Do you understand the implication of this move? …You had no business wasting money and paying back the promoters of Satyam and promoters of Maytas Properties,” Shroff said in the concall. The carnage continued on the Street when the local market opened the next day, with the stock tanking more than 33%. There was more trouble in store for Raju when, at the behest of Madhusudan Kela (who was then with Reliance Mutual Fund), some of India’s leading top-notch fund managers from ICICI, Templeton, Birla and a couple of FIIs got on a call with the promoter. The institutional investors informed him that they had taken a legal opinion about his proposal and threatened that they would take the case to the Company Law Board, if need be. Under immense pressure from investors, Raju and his board dropped the proposal and intimated the same to the exchanges.

A couple of days after the development and before Raju went public with the truth about Satyam’s cash position, Kela invited the country’s leading fund managers and FIIs for a meeting at the Reliance Mutual Fund office. The idea behind the meet was to discuss the possibility of creating a united forum comprising of fund houses and foreign institutional investors to oppose such instances of corporate misgovernance and malpractices. The meeting, as it turned out, saw just a handful of representatives in attendance and what emerged from the discussion was that there were too many conflicts of interest for the fund managers themselves, given that most of them were part of AMCs promoted by corporate houses and institutions.

Obviously, no fund manager would want to take on his own employer. It was pretty clear that none of us wanted to fight for a cause, but were more than happy to come together for a reason,” says a fund manager who was part of the discussion. Contrast this with the aggression of overseas fund managers, who dragged the promoters of Satyam to an international court over fraud and forced the new owner Tech Mahindra to settle the case with the Singapore-based Aberdeen Asset Management for $68 million. Back home, no fund manager or institution moved the local court and sought damages from the erstwhile promoters or the new promoters for the damages caused. While the laborious justice delivery system could be one of the reasons, the fact that domestic institutional investors have shown no gumption to fight, is a telling commentary on the state of corporate governance in the country. 

Back to the future

Fast forward to 2015. Vedanta proposes to merge Cairn India with itself. While there has not been a Satyam-like case since 2008, the Satyam-like audacity remains. Had the joint body of AMCs, that was discussed in the aftermath of Satyam come into existence, corporates may have been wary even before coming up with resolutions against the interests of minority shareholders. But corporates continue to be cocky and think they can breeze through all kinds of proposals — institutional investors’ voting rights don’t worry them.

Sample this: “The market has embraced the proposed merger and we are confident that the shareholders will approve the decision,” said Tom Albanese, CEO of Vedanta, on the sidelines of the company’s 50th annual general meeting. Though there have been stray instances where shareholders have managed to be heard, holistically speaking, domestic institutional investors have generally been a pliable lot. That lackadaisical approach is evident in the following statistics.

An analysis of the top-10 domestic asset management companies (AMCs) shows that of the total 30,012 proposals they voted on in FY15, their combined votes against management proposals were 3.5% of the total votes cast. Further, these AMCs abstained on 24.85% of the proposals. On the other hand, a worldwide asset management company such as Fidelity, which tracks companies across continents, actually abstained from less than 3% of proposals cast during the year ending June 2014. Of the 2,765 votes cast by the AMC during the period, 22.68% were against management proposals.

To be sure, e-voting has brought down the percentage of abstained votes in FY15, but at the same time, there has been a commensurate rise in the percentage of votes cast in favour of management. In FY15, abstained voting dropped by 16% and votes cast in favour of management rose by 14%.

Over the years, market regulator Sebi has made several changes to protect minority investors. But are these laws enough to ensure that corporates behave? JN Gupta, MD, Stakeholders’ Empowerment Services, doesn’t think so. “Regulatory changes alone cannot improve things. One has to ensure regulations are followed in spirit. One cannot get rid of wrongdoers by law unless someone points out the wrongdoer and the law takes over after that. A modified code of Albert Einstein would read as under, “The capital market is a dangerous place not because of people who do not follow laws relating to governance, but because of the failure or lack of interest of those who had a chance to notice this and correct it.” 

According to proxy advisory firms, the reason behind mutual funds’ relative lack of interest in corporate governance issues can be pinned down to their ownership and operating structures.

“The level of sophistication that is required is not there; nobody is taking a principled stand. Most of the institutional asset managers are seeking investments from corporates. A large portion of their AUMs is coming from corporates. So, if they start voting against corporates, then it will be counterproductive for them. Further, most AMCs are owned by corporate groups, who might have interests in maintaining good relations with other corporates. This may compromise the voting decisions of the AMCs,” says Shriram Subramanian, MD at the Bengaluru-based proxy advisory firm InGovern.

He contrasts Indian AMCs with the US industry, where shareholder activism is rather pronounced. “In the US, AMCs such as Fidelity and Vanguard are not dependent upon corporate money. They get money from pension funds and retail investors. Also, their ownership structures are different from those seen in India. They follow corporate governance principles and vote accordingly,” Subramanian adds. Curiously, UTI AMC, which is not part of any corporate group, has an appalling abstain vote of 88% in FY15. This period also overlaps with the first year of the two-year extended term of the current Sebi chairman UK Sinha.

Case in point 

The Ambuja-ACC rejig, which was put before shareholders for voting in 2013, sailed through. While the word on the Street is that foreign institutional investor (FII) backing pushed the merger through, data shows that of the top four AMCs that had a stake in Ambuja Cements, three abstained from voting on the controversial proposals. These included ICICI AMC, Reliance AMC and UTI AMC. This was the first proposal being put to the shareholders’ nod under the new ‘majority of the minority’ Sebi norms. At stake was ₹3,500 crore of Ambuja shareholders’ cash. Ambuja Cements first bought a 24% stake in HIL — the holding company of ACC — for a cash consideration of ₹3,500 crore, which would be paid to Holcim, the holding company of HIL.

It would then be merged into Ambuja Cements and Holcim would receive 584 million equity shares of Ambuja Cements as consideration. According to proxy advisory firm Stakeholders Empowerment Services (SES), the company could have opted for an alternate structure with equivalent results and without cash drain from Ambuja. Proxy advisory firms felt that a straight merger between ACC and Ambuja would have been a better option. 

However, the proposal still went through. Apart from domestic AMCs, LIC with its 5.57% stake was the largest institutional investor in Ambuja Cements. An emailed query sent to LIC about whether it voted on the deal, how it voted or if it abstained, remained unanswered. An LIC spokesperson confirmed that our query had been forwarded to LIC’s investment division but couldn’t assure us a response given the specific nature of our query.

Unlike domestic AMCs, which have now been asked to disclose their voting patterns by Sebi, insurance regulator IRDA has not yet made it binding on domestic insurers to give an account of how they are exercising their fiduciary responsibilities to their unit holders. Another case in point is Sterlite Industries’ merger with Sesa Goa, which was proposed in 2012. The deal was seen as Vedanta’s attempt to reduce debt from its books and transfer it on to the books of Sesa Goa.

The latter was forced to buy a 70.5% stake in the loss-making debt-laden Vedanta Aluminium (VAL) by coughing up 7.2 crore shares, which were worth ₹625 crore at the prevailing market price at the time of the proposal. The debt burden was another cause of concern. As per Vedanta Resources’ 2013 annual report, VAL had various borrowings through ECBs, NCDs and bank loans. A rough calculation showed interest costs of $348 million or ₹2,088 crore. Investment and interest costs put together, ₹2,713 crore was being risked.

However, three of the top five AMCs abstained from voting in court-convened meetings of both the companies. These were HDFC AMC, ICICI AMC and UTI AMC. Reliance AMC, one of the top five AMCs, in fact voted in favour of the deal. An email sent to Vedanta remained unanswered. An email sent to Reliance AMC on what made it vote in favour of the deal, too, remained unanswered. In an emailed response to Outlook Business, HDFC AMC said an official of the AMC attended the meeting of Sterlite Industries on June 21, 2012, at Madurai to cast a vote.

However, on account of a technical issue (depositing of proxy form), the AMC official was not allowed to cast his vote as a proxy. Consequently, the voting status was deemed as ‘abstained’. The HDFC AMC spokesperson added that the recently introduced e-voting facility is less time-consuming. “With the new Companies Act, companies have to mandatorily provide electronic voting (e-voting) facility. This has eased the investor’s administrative functions such as posting/mailing proxy forms/postal ballots, etc.” 

Escorts is another case where LIC was among the largest public shareholder with a 2.95% stake. The company proposed to merge itself with its unlisted group entities and an EGM was held on May 20, 2012. The proposal entailed merging of the unlisted subsidiary Escorts Construction Equipment (Ecel) and associate companies Escotrac Finance and Investments (Escotrac) and Escorts Finance Investments and Leasing (Efill) with Escorts. The matter drew flak from investor proxy advisory firms.

The restructuring would have increased the capital base of Escorts by 1.6 crore shares on account of the merger of the new Ecel shares. Ecel’s 1.6 crore shares would be added to an Escorts Benefit and Welfare Trust, which would also have Efill’s 0.6 crore shares and Escotrac’s 1.3 crore shares — a total of 3.7 crore shares. This trust would hold a 30.4% stake in Escorts. As the promoter also controlled the trust, the total promoter control on Escorts was rising to 41.1% from 31.8% on account of the transaction. 

The promoters were consolidating their stake in the company without spending any money to buy shares from public shareholders. At the average market price prevailing in February, when the proposal was made, the promoters would have needed to acquire a little over 3 crore shares for a consideration of ₹250 crore to take their shareholding to 41.1%. IIAS observed that Escotrac and Ecel were each being valued at ₹113 crore, given the merger ratio. Efill was being valued at ₹78 crore. Escorts’ market cap at that time stood at ₹760 crore. The proxy firms also raised the issue that Efill and Escotrac were wrongly being classified as ‘associate companies’ when they were actually subsidiaries.

As per law, subsidiaries were not allowed holding voting rights in the parent company. In a straight merger, promoters could have only raised their stake to 15.4% from 12.4%, as shares of the merged entities would get extinguished instead of being pooled into a trust. Although there was some resistance by institutional investors against this convoluted route taken by promoters to increase their stake, the proposal went through. 

All the institutional investors didn’t cast their votes. Reliance Capital Trustee Company — the Trustee for Reliance AMC — held a substantial 8.02% stake in the company and opposed the proposal. The second-largest domestic AMC in Escorts — Sundaram AMC (2.26%) — in its voting disclosures (a copy of which is with Outlook Business) showed both against and abstained votes for the same proposal. After Outlook Business questioned the AMC on the abstained vote, the spokesperson questioned the source of our information. When we revisited the AMC’s site, the abstained vote had disappeared.

An email query sent to the domestic house to explain the difference in the contents of the Sebi-mandated document was dealt with an ambiguous answer. “Sundaram AMC voted against the resolution in question. Sundaram AMC has been actively voting on corporate governance issues and protecting minority shareholders interest,” the response read. But the mystery of the abstained vote remains. An email query sent to LIC on how it voted on this proposal went unanswered.

In 2012, Akzo Nobel India’s proposal to merge its unlisted subsidiaries with itself was another controversial proposal that went through. The merger would dilute Akzo Nobel India’s public shareholders’ stake from 44% to 33%. Additionally, the public shareholders of the company would have to deal with the burden of unsecured loans to the tune of ₹113.74 crore. Proxy advisory firm InGovern had recommended shareholders to vote against this proposal on the grounds that the company had not made proper disclosures. The deal still went through. Of the two AMCs (in the more than 1% category) in the company, UTI AMC (2.17%) and SBI AMC (1.5%), the former chose to abstain from voting, while the latter voted against the proposal. Insurers together held 14.36% in the stock, with LIC holding a 3.88% stake in the quarter preceding the proposal announcement. 

Amit Tandon, MD, Institutional Investors Advisory Services (IIAS), believes that insurers still largely stay away from voting. “Their belief is that if the regulator asks them to do something, then they will vote. So, they need a regulatory push from the IRDA,” he says. Jayanth Varma, who is a professor on financial markets at IIM Ahmedabad, and also independent director on the boards of certain companies, speaks in a similar vein. He says that institutional investors’ rights are not limited to decisions that directly have a bearing on minority shareholders — they can even ask strategic questions to the companies on transactions such as acquisitions, they can ask whether the company is overpaying. But this is a relatively uncommon occurrence in India.

The right questions

Take the recent example of Eros International, which is listed on the NYSE and the domestic bourses. UK-based activist investor Knight Assets & Co, which holds a 3% stake, advised the company against making a foray into the TV business. As per reports, the Kishore Lulla-led Eros International had a $50-million plan to launch movie and music channels, with a possible buyout of the B4U network. The asset manager suggested that the company must focus on the ErosNow platform to improve shareholder value (ErosNow is a Netflix-style subscription platform). The promoters finally deferred the plan without getting into a face-off with the asset manager. 

Fund managers on their part argue that proxy advisory firms are not in touch with the ground reality. “They are making recommendations based on parameters that have been borrowed from the West. For instance, the idea of independent directors does not work in India. Proxy firms want independent directors to be rotated after every 10 years but a new independent director will take time to learn about the company, which would slow down the normal course of operations. It is practically impossible to follow their recommendations in India. They only draft their reports when there is a proposal on the table. Analysts are more in tune with the company as they meet the management on a regular basis,” says the CEO of a domestic fund house, requesting anonymity.

The same AMC has abstained from voting on 66% of proposals. In most cases, the AMC has given the reason that it abstained from voting because the scrip was part of a passive fund. When questioned, the CEO of the company said that as no analysts were actively tracking these companies, it was not fair that the AMC votes on the management’s decision. When questioned about the issue of abstaining from voting, the equities head of a top domestic fund house said that it was okay to abstain, as funds have the right to do so. “You can’t force a fund house on its voting decisions,” he says.

The fund manager added that his AMC doesn’t subscribe to proxy advisory firms but has its own internal committee on voting. The AMC’s FY14 annual report had no mention of voting on the Ambuja-ACC rejig, although the fund house held some stake in Ambuja. When the fund manager was asked why the AMC did not cast its vote, he said the AMC only considers voting on companies where it has invested at least 4% of its net assets. When the controversial Sesa Goa-Sterlite Industries merger was announced in the March 2012 quarter, data from Value Research shows that the AMC held a 0.46% stake in Sesa Goa through its Nifty ETF fund.

But when the proposal was up for voting in the June quarter, the AMC had exited the company. A top official of the same fund house admitted that there is a conflict of interest within asset management companies, as they are a part of larger financial services firms. 

The fund manager goes on to add, “Look at the scenario that is shaping up around the Cairn-Vedanta merger proposal. It is a sham. They are talking to LIC and the institution is saying no, this is not fair to shareholders. All this is drama — this is all predetermined. They will first come and make the announcement. Then the institution will say, we object. Then they will say we will sweeten the deal. Then they will say, see, we got it done.”

Incidentally, as per unconfirmed reports, the monitoring wing of LIC has recommended voting against the Cairn-Vedanta deal. LIC holds a little over 9% in Cairn India and has communicated to Vedanta to sweeten the deal for Cairn shareholders. Shareholders of the cash-rich Cairn India are getting one share of Vedanta for every share held and one redeemable preference share at face value of ₹10 in Vedanta. 

Private club?

In line with their non-confrontational approach, AMCs have preferred to make a silent exit by selling their shares without making public their stance against managements. A director with an AMC says, “Mutual funds need access to the management. If we are holding a stake in a company, we don’t necessarily vote against them. We take a consultative approach since an aggressive stance will ensure that you no longer have access to the management. No matter how many shares you hold, they will never give you an audience.” Besides, most asset management companies are part of bigger financial groups, which have merchant banking, commercial banking and investment banking interests. It probably doesn’t make a lot of sense for them to go and upset the applecart. The better option would be to just sell off the shares. 

For instance, in case of Sesa Goa, Kotak Mahindra AMC held 23,111 shares in the company at the end of the March 2012 quarter, when the merger was proposed. However, by the end of the June quarter, when the proposal was up for voting, the AMC had exited the company; its voting decision is not available. Reliance AMC held 15,727 shares in the March quarter but by June quarter, it had exited. Although the AMC had exited the company, it voted for the proposal at the shareholders’ meeting held on June 25, 2012.

An email query sent to the AMC on why it voted in favour of the deal did not elicit any response at the time of going to press. Motilal Oswal AMC, which held 1.86 lakh shares in Sesa Goa in the March quarter, had exited by June quarter. ICICI Prudential AMC’s stake of 40.25 lakh shares in the March quarter shrunk to 17,424 shares by the June quarter, even as the AMC cast an abstained vote on the proposal.

Tata AMC also cast an abstained vote on the deal, its stake falling from 1.61 lakh shares in the March quarter to 1,936 shares in the June quarter, data compiled from Ace Equity show. Interestingly, Tata AMC ‘refrained or abstained’ on all 231 proposals that came up for voting in FY13. The AMC mentions in its voting disclosure that “…it was felt that during the year, the management proposals put up for vote were not inadvertently affecting the interests of unit holders. Hence, Tata AMC has refrained or abstained from exercising the voting rights.”

In the case of the Akzo Nobel deal, SBI AMC held 8.27 lakh shares in the company at the end of the December 2011 quarter, when the proposal to merge itself with three unlisted group entities was made. However, in the March 2012 quarter, the AMC reduced its stake by 62% to 3.17 lakh shares and voted against the deal. In the following quarter, the AMC exited from the stock.

However, in the case of LIC, since data is not available on its voting pattern, the only other way is to look at whether there was a fall in its shareholding. In the case of Akzo Nobel, LIC’s holding in the March quarter — when the voting happened — and in the subsequent quarter was stable at 3.9%. It was only in the September 2012 quarter that the insurer pared its stake to 2.4%, around the time that the average share price was hovering around ₹879, an 8% gain over the average price of ₹813 in the March quarter. Putting the scenario in perspective, an equity fund manager with another leading domestic fund house points out that, in some instances, proponents of corporate governance are the ones twisting the laws.

“I have personally come across an instance where the head of a diversified financial services firm shifted votes, so what more can I say? He even admitted that left to them, we wouldn’t even want to get involved in the voting. If we don’t like a company, we’d prefer to sell the shares and go. But now Sebi is enforcing voting. We are not getting paid by investors to do activism. We are paid to make returns to investors. Somebody else can do [activism],” he says. 

Concurring with the view is Saurabh Mukherjea of Ambit Capital, who feels that opposing managements and taking them to task is not what governance vigilante is all about. “First and foremost, neither one has the time to get closely invested nor the appetite. It’s not like a PE who is taking a significant minority stake and has more say in how the management runs the show.”

Experts believe that while regulations are fine, a proactive approach is needed from institutional investors to make the system effective. “In terms of regulations, most of the things are now in place. The new Companies Act and the amended Clause 49 are in place.

Now, what is needed is that investors use their rights more effectively. This is what I think is more important. Having more and more regulations doesn’t really help. How much more draconian rules can you have? The focus should now be on enforcement by the regulator and a more proactive use by shareholders,” says Varma. Gupta of SES agrees.

“Forced regulations will not result in a conducive environment. At the most, they will create fear and tick-box compliance by both companies and investors. The belief that good governance is linked to long-term sustainable value will bring about change. Although things have started changing, as we saw in the United Spirits case,” he says.

At a special shareholder meeting in December 2014, public shareholders managed to block as many as nine related party transactions between United Spirits and entities controlled by
Vijay Mallya’s UB group.

Tandon of IIAS feels that India is still far away from seeing institutional investor activism. “Given the fact that you have people who own 40-50% of the companies they run, we are still very far from activism. It could happen in stray cases but it won’t be pervasive. In the foreseeable future, you won’t see it to the extent that you see it in Europe or America.”

The US-based proxy advisory firm Institutional Shareholders Services (ISS) echoes a similar view. “One of the biggest differences between India and the US is the concentration of ownership in companies. Many companies in India are substantially owned by promoters and their affiliates, whereas ownership is much more dispersed in the US and ownership by institutional investors is very high. This limits the influence institutions could have on listed companies,” says Jun Frank, head of Asia-Pacific Research, ISS.

What is helping corporates is an obliging government that is trying to keep business sentiment upbeat by easing governance standards. In the previous budget session, the government relaxed related party transaction (RPT) provisions in the Companies Act, 2013, through an amendment. This allows an ordinary resolution with over 50% approval from minority shareholders to be ratified. Under section 188 of the Act, it was mandatory for companies with a share capital of over ₹10 crore to get a special resolution with more than 75% minority shareholders.

The original provision was intended to protect the interest of minority shareholders but with the dilution, it is still not clear if their interest is being protected. “Earlier, you needed 75% of minority shareholders for an RPT but by watering down the rule, you have killed it. So we now have a law but it can’t bite,” adds the aforementioned fund manager. What queers the pitch further is the silence on the market regulator’s part on the issue, though it has said it will be realigning its proposed corporate governance norms and fully exempt state-owned firms from the regulations.

While the regulatory overhang continues, Nilesh Shah, managing director at Kotak Mahindra AMC, feels it should be fair to assume that the past performance of a promoter is a good indicator about his future behaviour. “On the one hand, we have promoters such as the Tatas, who pledged their personal assets to secure loans for a public company and on the other, we have promoters who have taken away everything from minority shareholders.”

He adds that institutional investors should encourage good governance by giving better valuation and their money to well-governed companies. “We should avoid investing in badly-governed companies so that their valuation remains low and this encourages others to behave. That’s the only way corporate governance can improve in this country.”

But that is where the hitch lies, believes Mukherjea of Ambit. “The problem with institutional investors is that they priortise return over governance. Till such a time that the financial targets are met, they have no qualms putting up with mediocre governance standards. Investors need to be more discerning about governance, regardless of financial performance.”

But given the NAV-driven world, that MFs operate in, and the nonchalant bunch of insurers all around, things are unlikely to change in a hurry on the governance front. While Aberdeen got its pound of flesh, no one is talking about the possible damage to domestic investors and whether they, too, need to be compensated for. “It’s not a one-man job. For governance to be administered, an effective ecosystem has to be in place, which includes strong regulations and an equally strong judicial mechanism,” points out Shah. Now, haven’t we heard this before?