Sub Heading : The regulation may help one kind of firms and work to the detriment of others
Author : Vijaya B Marisetty/DNA
Content :
Unequal footing
Business group-affiliated firms are almost co-insured through internal markets, while standalone firms have to depend on external liquidity
This may be why business group promoters are raising their stake in group companies while promoters of standalone firms decrease theirs
Therefore, the regulation should first aim at the private benefits of control of the business group promoters
There is a clear trade-off for the promoter of a firm in maintaining it as privately owned and publicly owned, research literature tells us. The trade-off is between the autonomy benefits of the promoter and the liquidity costs and corresponding cost of capital for the promoter, and also based on the underlying regulatory environment.
If the regulatory environment becomes tight and if the firm has public participation, the promoter will lose the autonomy of customising the contracts that can benefit him/her. Hence, the promoterís dilemma in a tightened corporate governance regulatory environment, is whether to increase his/ her equity (and retain the autonomy) or decrease the autonomy (in order to retain liquidity).
Clause 49 regulation, which was implemented in January 2006 for the majority of Indian companies, is a classical example of this dilemma. The Securities and Exchange Board of India asked companies to improve their disclosure requirements and empower the boards with compulsory independent directors. These changes will certainly affect the autonomy for the promoters. They will face more interventions and controls and in some cases disagreements to their decisions. In summary, the ìelbow roomî of the promoters will be squeezed.
And how did the promoters react?
My research indicates that promoters affiliated to large business groups have increased their ownership stake (post-regulatory changes, through buybacks and other means). However, promoters of standalone firms have decreased their ownership stake with the tightening of the regulatory environment. What could possibly explain this difference?
My theory goes like this: the cost of liquidity is not the same for business groups and standalone firms.
Business groups have alternative methods of securing liquidity. If the external market liquidity decreases, they can approach the internal markets, which are very deep and efficient for many business groups in India. Hence, if the regulation becomes tight, they can still retain their autonomy (by increasing equity) with no big loss in liquidity. However, for standalone firms, the life blood (if they want to remain public) is external liquidity. If they lose external liquidity, they canít survive as a public company.
Business group-affiliated firms are almost co-insured through internal markets and survival is not an issue for them. Hence, promoters of standalone firms pay the cost by decreasing their ownership to retain liquidity.
The lesson is very clear: A regulation that is uniform for all types of firms will not yield the desired effect, especially when different types of firms co-exist.
On the contrary, the regulation can harm one group of firms and benefit another group. In the case of Clause 49, it indirectly benefited large business groups: poor survival of standalone firms means less competition for business groups. I feel the regulation should first aim at the private benefits of control of the business group promoters that comes through internal capital markets and cross holdings.
The writer is a senior lecturer at Monash University, Australia and a visiting scholar at the National Institute of Securities Markets and the Indian School of Business in
Hyderabad. He can be reached at vijay.marisetty@buseco.monash.edu.au. Views are personal.
CAclubindia
