Will this deter companies from raising equity? - Views on News from Equitymaster

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Will this deter companies from raising equity?

Dec 21, 2011

Greed is one of the seven deadly sins that can hurt people. Unfortunately it is also one of the most common sins that people commit. And most promoters of companies are no exception to it. It is what prevails in their minds that prevents them from sharing their company's good fortunes with the minority shareholders.

It is the same greed that supersedes logical thinking when it comes to utilizing the funds raised through public offers. There are umpteen cases where the promoters of a company have taken the minority shareholders for a ride due to their own vested interests. There are many examples where promoters have not utilized the Initial Public Offering (IPO) or Follow on Public Offering (FPO) proceeds for the same purpose it was raised for.

Not only have that, many times the management takes decisions with which the minority shareholders may not be in agreement. For example when the company uses its existing cash reserves to venture into unrelated business lines or some acquisitions. Like what happened in the case of Piramal Healthcare when it sold its domestic formulations business and decided to venture into the financial services business. The management's move made many investors uncomfortable but they could not do much about it. Why? Because minority shareholders lack any proper say in the management's decisions. This in turn puts them at the mercy of the management and they cannot help but get duped in the process.

The new Company Bill, 2011 aims to change all this. The bill which is going to replace the 55-year-old Companies Act of 1956, addresses these concerns of the minority shareholders. It mandates the companies to provide an exit option to minority shareholders. This way those who disagree with decisions of the management with regards to acquisition, corporate or debt restructuring or getting into unrelated business areas, have an option to sell their stake and leave the company. This move is aimed at giving the minority, who have been ignored so far, a strong voice. The new bill also provides an option to the investors to go for a class action suit against the company, if they are not happy with the conduct of the management and think that the actions of the management are prejudicial to the interest of the company. This step stems from the case of erstwhile Satyam where small investors could not get any compensation for the damage suffered by them.

So the interests of the minority shareholders appear to be taken care of in this bill. But there is always another side to every story. In this case, the other side is the corporate world.

No matter how good the intent of the Bill, it is going to complicate the decision process of the companies. Now the management not only needs to think about taking permission for shareholders for its various business decisions but they also need to prepare adequately for the dissenting shareholders. They would need to think about the latter's exit options as well. This in itself is a complicated process. Besides being an extra burden on them, exit options may lead to promoter's shareholdings exceeding the norm of 75%. In India, we have a rule that states that promoters cannot hold more than 75% of the total outstanding shares. If the companies are forced to buy back the shares of the exiting minority stakeholders, then this limit may get breached. In addition to this, the company would need to maintain the required cash for the exit option given to dissatisfied shareholders.

Besides complicating the decision making process of the management, the new bill can also be misused by a group of shareholders. It gives them a chance to blackmail the company's management into serving their own vested interests. Because they know that they can always put a roadblock in the smooth functioning of the company which would result into delay and cost implications. And what about all the frivolous lawsuits and ill-intended roadblocks! This would create unnecessary nuisance as well.

All this may discourage the private companies from going public. If the companies feel that their decision making is going to be hindered by this new law, they would think twice before raising money from the public.

No wonder that the corporate world is not happy with this new move. What they want is that their interests are also taken care of in the new bill. While they are right in cribbing about the complications to decision making as well as the increased legal burden, however, it is important that there must be a system to question the management from time to time. And this can only be done by the minority shareholders. What the government needs to do is to remove all loopholes to prevent exploitation of the bill by either of the parties - management or minority investors. If this is taken care of then the bill would increase corporate governance standards in the country. Something that we all hope would happen soon.

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