Governance versus shareholder capitalism

3 APRIL 2010

The US had, in the early 80s, when it was threatened by the economic success of Japan and Germany, founded on stakeholder capitalism, countered by promoting shareholder capitalism. Under the former, the interests of all stakeholders in a company are given weightage. Employees in Japan were given lifetime job guarantees. Select suppliers were chosen, supported both financially and with large orders, and in return, gave companies 'just in time' inventory, freeing up their capital. Financiers (banks) had special relationships and were given equity holding; alongwith trading houses they formed a mutually beneficial triumvirate.

------------------ Listen to the sound of money...big money ------------------
If you missed out on The Equitymaster Investment Summit 2010, don't lose heart, or your sleep! We're bringing it to you in a special Limited Edition Investment Summit twin CD pack.

To listen to investment strategies and insights by Ajit Dayal and Bill Bonner on the world economy, India and the biggest risk it faces, the 'must-haves' in your portfolio, ' the 5 categories of investment to build your wealth'....and so much more, click here

Under shareholder capitalism, the interests of providers of capital (equity and debt) are given primacy, with interests of other stakeholders subordinated and assumed to fall into place. This was promoted through the 'institutionalisation' of money by promoting the growth of the fund industry. Mutual funds, hedge funds, pension funds et al have grown in size to more than the banking industry in the US. They now own over 2/3rds of corporate equity, through which they exercise enough clout over company management to affect governance. The pressure by institutional shareholders to produce improved quarterly (short term earnings) was what led financial institutions take stupid risks which caused the global financial crisis. Corporate management also cannot sometimes weigh the balance between governance and the 'short term profit' mantra of shareholder capitalism.

Bloomberg magazine had, in an investigative article, reported on how, under shareholder pressure for returns, companies as well known as Cargill and Alcoa were plundering the Amazon. They cleared a 56 km corridor in the Amazon forest to build a railway track to carry out bauxite, a raw material used in manufacture of Aluminium, made by Alcoa. The environmental damage caused by burning the trees to clear the tract is nothing short of criminally insane. This is what the authors say: "The fires men set to clear land for ranches and farms create 6 percent of the carbon dioxide spewed into the air worldwide, according to the Cambridge, Massachusetts-based Union of Concerned Scientists. That equates to half of all the emissions from cars, trucks, planes, trains and ships in the world."

The large investors of firms such Cargill and Alcoa would be more willing to oppose this with their feet, selling the stock if they felt strongly enough, rather than with their voice, staying on to improve governance. But there are other investors who would buy the stock, so their leaving does not result in pressure for good governance. Witness what happened when the Church of England sold, on ethical grounds, its stake in Vedanta, objecting to the group's treatment of tribals in Orissa.

In Mint (April 1) a columnist, Sudeep Chakravarti, has written about the objections of the local community of Meghalaya, to the transportation of ore by Lafarge Umiam Mining P Ltd, a subsidiary of cement maker Lafarge, to a cement plant in Bangladesh. It has, apparently, mortgaged leased lands in Meghalaya, to raise funds to set up the Bangladesh factory and the local community, together with environmentalists, have used viral marketing networks to apply pressure. The mining activities of the Reddy brothers in Andhra Pradesh are also being investigated.

Poor governance is not the preserve of companies and short term profits are not the sole motivation. It also manifests itself in Government, with vote bank politics as the driver. Today one of the concerns of investors is the rising food inflation. A column by Himanshu (Mint, April 1) explains this. In 2009, the Government, wanting votes of farmers, went on an overdrive in wheat and rice procurement. The result? Stocks of rice at 26.6 million tonnes are twice the estimated buffer stock requirement, and of wheat, at 18.1 m. tonnes, 4 ½ times buffer stock requirement. Yet the release of this stock is poor, resulting in food price inflation, with the attendant interest rate hikes. Now this stock of foodgrains is largely stored in the open; there are not enough silos. So it either rots or is eaten by rats. The Indian Government should be lauded for its animal welfare; we probably have the healthies, subsidised rat population in the world! The procurement of foodgrains is added go GDP figures, but if these are ultimately junked or eaten by rats, that paints an incorrect picture of GDP growth. Its like paying 1 million people money to dig a hole and then to fill it up. The GDP would grow, but without anything to show for it.

In corporate news of interest, Civil Aviation Minister Praful Patel, has asked Cabinet permission to sell 49% of NACIL, which runs Air India. Air India faced flak for allowing Standard Chartered to make a quick profit by selling part of the 10 year bonds it had taken from Air India when the latter wanted to pay for aircraft it had bought. Standard Chartered had bought the 9.13% coupon bonds, and sold a part of them to pension funds, on an 8.7% yield basis. But this was because the bank had assumed a risk; when it had bought the bonds they were not backed by Government guarantee, which came later, and so bore a higher rate. Having said that, it would be better if the Government were to sell off more than a majority holding in Nacil; it has been making huge losses which have been funded by the Government.

The Essar group is seeking to list a holding company, Essar Global, in London, and raise upto $ 3b.

The markets were steady last week, with the BSE-Sensex ending the week at 17692, up 48 and the NSE-Nifty closing at 5290, up 8. Investor nerves seem to be calmer after Greece was bailed out by the EU and on encouraging data such as the 162,000 new, non-farm jobs created in March in the US, and the 34% increase in February exports by India.

Investors ought to look at the chart to appreciate the context of the new job data. Since the job losses during the current meltdown compared to previous ones was sharper, the recovery, whilst very welcome, is the start of a long process of recovery. Remember, Japan's Nikkei is nowhere near the peak of 40,000 it hit in Dec 89. In order to pare down its debt, US households would have to up their savings rate, which they are doing, and reduce consumption. So its GDP growth would be sluggish, probably for years.

Now there are red flags being raised by Edward Chancellor on China as well India, with its largely domestic consumption driven economy which is less dependent on exports for growth (unlike China) is a far better story. Our weakness is poor governance; one has only to look at Bihar and Gujarat, where governance has improved, to see how well they have performed economically.

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

Equitymaster requests your view! Post a comment on "Governance versus shareholder capitalism". Click here!

5 Responses to "Governance versus shareholder capitalism"

r j

Apr 7, 2010

Less said about food procurement in India the better.

Food Corporation of India is the biggest most corrupt and wasteful enterprise supported by the govt of India.No blunder committed by it would surprise me.

As for shareholder capitalism in the United Statesthe 401k schemes have ended up being an aid to the corporations whereby the public is invested in the stock market whether they like it or not most of the time and the cream is swallowed by the Wall St fatties.

When there is a problem it is the public that loses.


Kapil Kekre

Apr 6, 2010

It's unfortunate but true, over the years while people showed little interest inchoosing political leaders, all political parties have become tools of goons who were earlier in minority. To day they not only control politics but have succeded in getting beauracracy also well penetrated and under control with people who wish to serve politicians first and then people. Till the system is purged to remove this cancer we will have to bear and suffer. It will take a lot of time, may be a genration but the process must go on even if we do not see immediate results. Good luck forearly recovery!



Apr 5, 2010




Apr 3, 2010

So they procured twice the amount of rice required and 4.5 times the wheat required and created artificial shortage of food grains and caused unbearable food inflation. Who was responsible for this? What will happen to them? Nothing - may be they will all make a lot of money at the expense of the people. Unless the corrupt politicians and the Bureaucrats are kicked out, nothing good will happen to this country.


sunilkumar tejwani

Apr 3, 2010

as you mentioned exit of church of England from Vedanta (parent company of Indian listed Sterlite Industries) has not deterred others from buying the stock. Ever since the price has appreciated from 730 to 855 of Sterlite Industries on the Indian Bourses. In short, ethical & environmental issues no longer have place in the marketplace, only wads of money & speculative profits count.

Equitymaster requests your view! Post a comment on "Governance versus shareholder capitalism". Click here!