Keeping the management in check

Seeing the writing on the wall, state-owned institutions like IDBI, ICICI, IFCI and even LIC and GIC have been on the offensive. One way is to thwart the plans of promoters to enrich themselves by hiking their stakes in companies through preferential issue of shares. FIs had opposed promoters’ moves in at least six cases in the last three months.

However, institutions which hold sizeable equity in many companies had a mixed luck so far. While in the cases of FAG and Wimco, institutions were able to prevent the promoters from hiking their stakes through the preferential issue route, this strategy didn’t work out in Mather & Platt and Birla Yamaha as their equity holding was much lower than the promoters. “As a matter of policy, institutions have decided that they will not support preferential allotment as a method of raising stake by promoters where the promoters already own above 26 per cent of the equity capital.There is no question of allowing the promoters to enrich themselves at the cost of institutions and minority shareholders,” said an official with an institution.

On the other hand, institutions had asked several companies including Lok Housing & Construction, Apeego, Kiran Overseas and Kesar Enterprises to withdraw dividend payments as they had failed to repay loans taken from institutions. The contention of FIs is that before paying dividend to the shareholders, companies will have to repay loans defaulted by them.

These measures have already brought about a sea change in the approach of companies. It may be recalled that several companies especially multinational companies operating in India had allowed their foreign parent to hike their stake in domestic subsidiaries at throwaway prices using the preferential share route. Nearly 100 companies used this method and issued shares much below the market prices, thereby short-changing the investing public.

Institutions have now decided that promoters who hold more than 26 per cent stake in a company and want to increase this stake should go for a rights issue or purchase the shares from the open market. For example, Cementation Company of the UK which hold 51 per cent stake in Trafalgar House Construction India Limited has decided to subscribe to its full entitlement and apply for additional shares of the company’s proposed rights issue to hike the stake to 74 per cent. It’s not only in preferential issues, institutions have turned proactive even in subscribing public takeover offers also. A classic example is that of Torrent takeover of Ahmedabad Electricity Company (AEC). Even though Torrent made a good price in the open offer for AEC, FIs (UTI, LIC and GIC) which hold around 33 per cent stake in AEC refused to sell the stake as they felt their investment in AEC was sound and their presence was needed in the company.

There are cases where institutions have asked promoters to hike the stakes in some companies. Chambal Fertiliser, owned by the K K Birla group, is one example where institutions have asked the promoter to hike the stake (from 18 per cent to at least 26 per cent). The minimum equity stake required to block a special resolution at an extra-ordinary general meeting of a company is 26 per cent. Moreover, if the promoter holds an equity stake below 26 per cent in a company, it is considered as a potential takeover target.

“FIs are rarely pure creditors and, in fact, provide a package of assistance including underwriting and direct subscription to equity. Moreover, their stake in the form of debt and equity far outweigh the stake of promoters themselves in many cases. And in case the company falls sick, the burden of sacrifices fall mainly on the secured creditors (FIs),” said an official of IDBI.

The IDBI official is correct as in top Indian companies, institutions hold more stake than the promoters. This is the case with companies like Tisco, Telco, ITC, Shaw Wallace, Mahindra & Mahindra, ACC and so on. This also means that takeover of such companies is not possible without the help of institutions. Moreover, there are companies like BSES and Larsen & Toubro where institutions they hold sizeable stakes also are directly giving guidance to professional managements.

IDBI chairman S H Khan has already indicated that a new set of guidelines are being evolved for nominee directors of institutions on the boards of companies. Khan has indicated that the new guidelines will see the role and responsibilities of nominee directors outlined with greater clarity and a mechanism is being introduced within each FI to interact with and monitor the performance of nominee directors more effectively. This is being done to make institutional nominees more active in the functioning of a company. The ITC episode (where FI nominees have been served with show-cause notices by Enforcement Directorate on the FERA violation issue) has reinforced the need for such steps from FIs.

Institutions have also turned down the plea of the corporate sector (Confederation of Indian Industry has indeed made this request in its draft corporate governance code) that FIs desist from appointing nominee directors for credit-worthy companies where they (FIs) are only pure creditors. Going a step further, institutions now demand that the board must also be informed of intercorporate loans, guarantees, investments, transactions with group and associate companies, formation of subsidiary and desubsidiarisation activities. There is a growing feeling that FIs need to do much more on recovery of loans. There were cases where institutions extended loans and guarantees to companies which defaulted on earlier loans.

The bottomline is that financial institutions will have to take care of their investments closely by monitoring the performance of company managements. If needed, FIs should not restrict their role by forcing companies to cancel dividends and restructure issues, they should even consider a change in the management.