»5 Minute Wrap Up by Equitymaster

On This Day - 31 MARCH 2014
Time to discipline the dominant shareholder?

In this issue:
» How will rupee appreciation impact exports?
» Could issuing new banking licenses be a retrograde move?
» Will a new Government boost fresh equity sales?
» Japanese economy likely to face crisis
» ...and more!

India has often been criticized for poor corporate Governance and lack of enough regulations to protect minority shareholders' interest. On the extreme side, there have been cases when promoters' greed has broken all boundaries leading to a scam big enough to set an example and inspire new codes in place.

But mostly, the promoters follow their whims with least regard to interests of minority shareholders. The root of the problem in such cases is lack of enough shareholder activism. In this context, the firmness and cooperation of fund managers that blocked the controversial production deal between India's leading auto manufacturer Maruti Suzuki with Japanese parent Suzuki deserves an applaud. The same has eased concerns of many of the minority shareholders who did not have platform to voice their concerns regarding the actions of the management. However, as suggested in an article in Livemint, it is a rare event in the history of Indian corporate governance. In many similar cases in the past, while the promoters' decision has been criticized, it has not been blocked due to lack of enough shareholder activism.

While a high promoter stake increases confidence in a company, many a times the promoter has taken the rights of minority shareholders for granted in the name of shareholder democracy. This event just highlights the need of a formal procedure to make sure that no decisions by the majority stakeholders are in conflict with that of the minority.

There are two entities that need to work together to achieve this - the regulator and market participants. The latter includes investors, both retail and institutional. While enough has been covered on the role and loopholes on the part of regulator, it is time for financial institutions, fund managers and retail investors to wake up to their responsibilities and power.

Unfortunately, investors wake up and question only when the stock price or financials start suffering as a result of poor management decisions. By that time, the damage is done and it is too late to make amends. Ideally, investors should give enough weightage to the transparency and management quality and track record. Before investing in a company, they should apply 'management discount' wherever the management falls short on the required parameters. This will also ensure some self discipline among the management.

There is further lapse on the part of fund houses. For e.g., the fund houses, having significant stake in the companies, have the power to vote against a board decision. However, this often comes with a conflict of interest for them. This is because these very companies contribute to bulk of the former's funds or assets. Hence, they abstain from voting or questioning management on controversial decisions for the fear of losing business from them. One way shareholders can make a difference here is by considering voting records and activism of fund houses while selecting mutual funds.

Meanwhile, the regulator should focus on making markets more efficient. It is time we understand that regulator can not be solely blamed for everything that goes wrong with corporate governance. It is only when market participants work along with regulator in disciplining the dominant shareholder that we can hope for better corporate governance in India.

In what ways do you think market participants can improve corporate governance in India? Let us know in the Equitymaster Club or share your comments below.

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 Chart of the day
In July-August 2013, we saw the Indian rupee crumble to new-lows against the US dollar. While bad for the overall economy, the depreciating rupee came as a boon to exporters who saw their fortunes improve after dismal growth in the April-June quarter of 2013-14. Exports grew by double digits during each month from July to October 2013.

But in recent weeks, the rupee has been witnessing a recovery on the back of strong FII inflows. And for the first time in the last eight months the USD-INR rate closed below the Rs 60 mark on Friday. While investors are hopeful of change in leadership at the Centre, the appreciating rupee is proving to be a dampener for exporters.

As the chart of the day shows, the export growth has turned tepid in recent months. In fact, in February 2014, exports declined by 3.7% YoY. Of course, rupee is not the only factor that determines export growth. As an article in Business Standard rightly points out, factors such as global demand, crude oil prices, the government's curbs on gold imports and the resultant impact on gold exports, as well as the regulatory issues engulfing Indian drug players in developed countries are some important factors that have impacted exports.

Will rupee recovery mean a decline in exports?

Nearly 24 corporate groups have been waiting for months in the hope of getting banking licenses from the Reserve Bank of India (RBI) to start their own banks. However, as we wrote earlier, most of them may remain disappointed. The RBI is paying a lot of attention to warnings about issuing bank licenses to corporate houses. Economists and global financial regulators have cautioned that the risks of offering banking licenses to corporate outweigh the benefits. Thus taking cues from these, industrial houses like Aditya Birla Nuvo, Bajaj group, Videocon and Reliance Capital may find it rather difficult to pass the RBI's test. Ones like the Tata group and Mahindra Finance have already withdrawn their applications. Moreover, when bank licenses were issued in 1993 and 2004 business houses were not considered. To add to that the All India Bank Employees' Association (AIBEA) has also raised objections. It has claimed that allowing private sector to open banks would lead to 'profiteering'. Moreover there were chances of public money being diverted by the corporate houses to run their ventures without any hindrance. At a time when the banking sector is facing huge NPA problems from even large corporates, this could be a retrograde move. We believe that the RBI will be adequately mindful of such risks.

We can talk all we can about how fundamentals determine share prices. But what cannot be denied is the role that sentiments play in the entire activity. This is true at least in the short term. Is it any wonder then that companies in India that are capital starved, could be rubbing their hands in anticipation of a more investor friendly government at the centre. This is because such an outcome could help them list their shares on the bourses and give their capital structure the much needed boost. Please note that fresh equity sales in India slowed to a crawl in 2013. Indian firms raised a total of just US$ 9.4 bn in that year as opposed to US$ 31 bn raised in the peak in 2007. Even 2012 saw a much higher figure of US$ 15 bn. All of this could change though once the new Government comes to power feel a few capital market experts. And they could well be right. A huge line up of companies wanting to list themselves on the bourses shall become available post elections. However, long term investors will do well not to take them at face value and take their decision only after a thorough analysis of long term fundamentals, management strength and the valuations embedded in the listing price.

The Japanese recovery driven by the large fiscal stimulus and aggressive monetary easing since Prime Minister Shinzo Abe took office in December 2012 appears to be losing steam. Japan's industrial production fell 2.3% in February, the steepest drop in eight months. And to make matters worse, from April 1, 2014, Japanese consumption tax is set to rise, from 5% to 8%. The consumption tax hike will erode badly the real purchasing power of household income which will further slowdown the economy. Abe is expected to unveil further pro-growth measures in June, amid scepticism over the pace and direction of his government's third arrow structural reforms. The last time a Japanese leader raised the consumption tax, the economy tanked and he was forced out of office by an angry electorate. Will history repeat itself, or can Prime Minister Shinzo Abe manage to continue the nation's revival with Abenomics, as his economic program is called?

In the meanwhile, the Indian stock markets have drifted into the red after opening firm. At the time of writing, the benchmark BSE-Sensex was down 27 points (-0.1%). Auto and Metal stocks were leading the gainers while Banking and FMCG stocks were leading the losses. Most of the Asian stock markets were trading in the green led by Japan and Hong Kong. Only the Shanghai market was trading in the red. Major European indices have opened the day on a positive note.

 Today's investing mantra
"Go for a business that any idiot can run - because sooner or later, any idiot probably is going to run it." - Peter Lynch

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