Indian capital markets have progressed tremendously, on multiple dimensions, since 1991. This year is generally considered the watermark year with the beginning of a liberal and capital-attractive economy.
The public capital markets were opened up to foreign portfolio investors (FPIs) in 1992. This did lead to a significant amount of portfolio capital flows into the country and in turn, led to increased availability of funds to the economic agents, boosting of the foreign exchange reserves, and improvement in the trading volumes and liquidity on the stock exchanges.
Around the same time, in the early nineties, the mutual fund (MF) industry was opened up to the private sector. This helped in channelising a significant amount of savings of the household sector into the capital markets.
However, there has been another very significant impact of the opening up of the stock markets to FPIs and MFs. The firms listed on the stock exchanges have been subjected to a higher level of scrutiny and market discipline than earlier.
To be sure, our laws and institutional framework have also significantly strengthened over the years. As a result of these factors, the firms, in general, have been adopting an incrementally higher level of corporate governance standards.
Of course, the firms have moved over time through the phases of reluctance, hesitation, acquiescence, acceptance, and finally celebration of the idea of good corporate governance.
At the same time, there are still wide variations in the standards demonstrated by the firms across various promoter groups.
There are two key factors that could lead a firm to embrace the idea of a strong corporate governance framework.
The first, and more commonly observed reason, is the compulsion on account of various laws and regulations.
This leads to a compliance-driven attitude. The second factor is the realisation of the firm that adopting a higher standard would, in the long term, reward the management and the controlling shareholders far more than the cost of adoption for them. This leads to a happier embrace of the higher standards.
I am consciously talking, here, about the motivations of the management and the controlling shareholders (M&S), rather than of all stakeholders. It is because the former has the key control over the practices followed by the firm.
This relates, fundamentally, to the idea of incentives that drive the behaviour and performance of agents in real life.
The M&S have, traditionally, often gained at the cost of other stakeholders, using dubious methods benefitting the former.
However, the M&S are also increasingly realising that, in the longer term, the stock markets reward the firms with progressive corporate governance standards.
The rewards are actually significantly higher than what the M&S could gain through direct benefits, using dubious methods. Thus, the M&S who have discerning minds and eyes, have been shifting towards improved corporate governance practices. We must thank, for this, the high levels of disclosure, transparency, and efficiency brought into our stock markets.
It is interesting to note how the public sector units (PSUs) also often get pulled up for poor corporate governance practices. Their private sector counterparts are usually charged with the greed of the M&S driving their poor practices.
The PSUs are more institutionally driven and hence should not be prone to greed-driven malpractices. However, the key driver in the case of PSUs is the ignorance as well as the myopic approach adopted by their controlling shareholders, i.e., the government of the day.
The ignorance of the government officials with regard to the trade-offs involved in the areas of corporate finance and capital markets often leads to their poor decision-making outcomes.
There is pressure on PSUs to pay high dividends or invest in unprofitable projects, merely to serve the needs of boosting the government finances or short-term output growth.
The government fails to appreciate the long-term adverse impact on the concerned firms. Just as an example, Coal India could have done with far more investment, rather than paying dividends, and Air India should have received far less investment than it actually received over the years.
A recent example of the confusion in decision making was seen in the case of the Indian Rail Catering and Ticketing Corporation (IRCTC). The government decided to ask for a 50% share of the convenience fee revenue earned by IRCTC.
Within a day, it reversed its own decision. It is not clear how the government arrived at its initial decision. To be sure, the government has multiple relationships with IRCTC.
It is the licensor, the customer, and the majority shareholder in the latter. Many of the decisions by the government with regard to the PSUs can have conflicting impacts on the other stakeholders, and even on itself on account of its multiple relationships.
The planned increase in the revenues shared by IRCTC with the government would have increased the income of the government. Yet, on account of the sharp fall in the stock price of IRCTC, the government would have lost considerable wealth, which would have been far greater than the benefit accrued, in later years through rise in income.
The reversal of its decision showed that it did understand the adverse effect of its initial announcement, but had not thought of it carefully.
The bigger question is this. Do controlling shareholders, including the government, understand how to arrive at the decisions that maximise their benefits? Do they adopt logical frameworks, or just follow their instincts or adopt simplistic approaches to make significant decisions that impact the wider set of stakeholders of a firm?
There are frameworks available to help the M&S arrive at optimal decisions and they should use the same for their own benefit. These would also form a part of a good corporate governance framework.
In the absence of a carefully designed framework for decision making, firms and stakeholders will be often jolted by adverse outcomes, or even worse, an eventual threat to their own prosperity or existence.
(The author is Associate Professor, Finance at Bhavan's SPJIMR.)
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