Flip side of huge promoter's stake

D. Sampathkumar

IS A huge promoter's stake an advantage or a drawback to the other minority shareholders?

Wipro thinks it could be a drawback. It has gone on record to that effect in a declaration filed before the regulatory authority for the US capital market. The company thinks there is a risk of the market price of its American Depository Receipt (ADR) staying depressed because of the promoter's concentrated ownership of capital. As the offer document spelt out, the promoter, Mr. Azim Premji, is the beneficial owner of close to 85 per cent of the total stake in the company.

The notion that concentrated ownership bodes ill for a company's share price must seem astonishing to those who are by now accustomed to seeing Wipro, along with a few chosen software stocks, scale one valuation high after another in the domestic market. The scrip recorded a more than five-fold price increase in the last two years. What is more, it looks set to ride the crest of a wave of euphoria created for software stocks, particularly those with some impressive calling cards for clients in the US, as Wipro undoubtedly has.

So why, then, is Wipro so conservative in its claim? The company has perhaps done so more out of a sense of caution than any fundamental belief in some esoteric aspect of corporate finance theory. It is cautious because a class-action suit seeking damages for real or imaginary non-disclosure of vital information is an ever-present threat for corporations going public in the US. And so, one cannot really fault the company for erring on the side of caution. But it must also be noted that there is very little downside to such an act of self-deprecation.

The ADR, after all, can count on solid investor support when it hits the market. The US is going through a phase where India is the flavour of the month. The American public can no more help lapping up everything from curry powder to corporate paper with a `Made in India' tag than Mr. Bill Clinton could restrain himself from dancing a jig with village women from Nayala in Rajasthan. And so, when a company claims for its business an impressive list of clients drawn from the Fortune 500 list, as Wipro seems to do, the path must be doubly smooth, proclamations to the contrary notwithstanding.

The perception that for the company it is a more a matter of form than any innate belief in the adverse linkage between ownership concentration and share price performance is reinforced when one looks at the company's arguments in this context. The company says such a high concentration of ownership in the hands of the promoter would mean that minority shareholders might not be able to influence the decisions of the company. But from the point view of wealth maximisation, this should hardly matter.

If the decisions of the promoter are such that the company benefits, then minority shareholders could hardly have any objection. As a matter of fact, traditional finance theory holds the exact opposite. When a management holds a minuscule stake in a company's capital, as can be expected when it is drawn purely from the professional ranks or when it is a case of the promoter family controlling the affairs of the company with a marginal stake, finance theory holds that there could be divergence of goals between those at the helm of affairs and the community of shareholders.

A management with minimal stake might pursue a policy of growth and commit the company into projects that are unviable merely because it enhances its prestige. The consequent destruction in shareholder wealth can easily be imagined. In contrast, a management with a substantial ownership stake has been viewed as traditionally more inclined to adopt conservative policies on the strategic direction for the company.

The Indian corporate sector is also replete with instances of management pursuing ambitious projects of expansion/diversification with disastrous results. Take IFB Industries. The company is battling to survive in the market place. It has run up a Rs 77-crore loss in the 15-month period ending March 2000. When the managing director was asked what went wrong, he is reported to have said the company pursued projects that were outside its core area of competence. The result: The company's share, which traded at Rs 120 at the start of 1996, now trades at Rs 5.

It may be a coincidence but the company's shares are widely held among financial institutions and the public, with the promoters controlling only about a quarter of the total stake. Now, it is a moot point if the promoter-management would have had the same enthusiasm for undertaking non-core areas of diversification, if its stake had been on the lines of Wipro's Mr. Premji.

Another example is Raymond. The company now claims that its core competence is in textiles. This realisation seems to have dawned much after its foray into newspaper publishing some years ago, which cost it close to Rs 10 crores.

But having said that, an ownership structure skewed in favour of the promoter's management too is not without its downside. Companies have been known to adopt overly conservative policies with adverse consequences to shareholder wealth. An area where managements with strong ownership stake have adopted excessive conservatism is in regard to debt. They have invariably forced companies under their control to shun or minimise recourse to debt.

While studies in the Indian context are either non-existent or unavailable, analysis of corporate performance in the West clearly points to the existence of such a phenomenon among family-owned enterprises. They tend to avoid potential diversification opportunities, as it would result in increasing financial risk, or in a loss of management control from an infusion of outside capital. The losers, of course, are the minority shareholders.

Of course, in the Indian stock market, the degree of ownership concentration is really irrelevant, at least so far as the software stocks are concerned. The volume of stocks that are actually traded in a day in some of these stocks are so huge that they render the entire outstanding capital of the company a fraction of such turnover.

It would, therefore, not matter in the least, even if Mr. Premji were to control the entire outstanding stock in the company. For better or worse, the market has chosen to place value on the piece of paper representing an edifice of secondary market transactions built around it. That is the rule by which the market plays the game.