Larger stake, greater involvement

D. Sampathkumar

WOULD William Tell's arrow have unerringly found its mark had the apple not been placed on his son's head, but on that of a boy from the local Swiss orphanage? Maybe not.

The legendary hero of the Canton of Uri in Switzerland might have been a wizard with the bow and arrow. But in the challenge that the Austrian bailiff threw at him, he would have merely staked his professional reputation as an archer if the boy on whose head the apple had been placed had been a total stranger.

It is possible that a combination of supreme skill and professional pride might have got him close enough to knock the apple off its perch, or perhaps nick the skin. But to get the arrow to go through the core of the apple, clean as a whistle, as the legend says he did, needed an extra something. It is a moot point if he would have been able to bring into play that extra focus or concentration had the victim not been his son.

This story has a moral in the corporate context. Would the quantum of ownership stake of the manager have a bearing on corporate performance far more than mere professional competence or a commitment to the best principles of corporate governance? There is reason to believe that while professional competence is needed, there is nothing quite like having one's own money at stake to extract superior corporate performance.

The average manager may swear by Kumaramangalam Birla Committee's report on corporate governance. He may possess credentials that would be the envy of the Dean of Harvard Business School. These attributes may translate into creditable performance of the enterprise managed by him. But that would still be inferior to a level of performance where the capital at stake in the venture belongs entirely to that of the promoter-manager.

It does seem reasonable to presume that the level of involvement in the management of an enterprise would be all the greater if it was capitalised entirely with the promoter's funds. There is nothing revolutionary in all this. This is merely stating, in a different way, what has long been considered an axiom of management science. Superior effort on the part of a professional manager follows the acquisition by him of a personal stake in the business.

In fact, the concept of employee stock option schemes is a direct fallout of this principle. Extending the logic further, one might say that larger the ownership stake greater is the involvement. From here, it is but a logical next step to the proposition that the acme of managerial excellence is reached when the stake in the enterprise is entirely made up of funds provided by the promoter-manager.

There is empirical evidence too to support this proposition. India's small and medium enterprises have scored over their bigger and publicly-traded corporations in the economy on performance. A recent analysis of the finances of the private corporate sector, brought out by the Reserve Bank of India, bears this out. They have exploited the opportunities better under a regulated economic environment that was prevalent until the 1980s. But, more significantly, they have withstood the adverse effects of liberalisation post-1991, far better than their better known professionally managed rivals in the country.

In 1983-84, the average return on net worth (a ratio of profits available to the shareholders relative to the quantum of share capital and retained profits invested in the business) in 1983-84 for this group (private limited companies) was a shade lower than that of public limited companies. In the seven years since then, smaller and more closely held companies became more profitable with the group recording a return on net worth of 17.1 per cent to the 13.9 per cent for the public limited companies, in 1990-91.

While the post-liberalisation years saw the profitability rate slip for both, the more nimble-footed small enterprises managed to restrict it to 10.4 per cent in 1997-98, the latest year for which the RBI data is available. Their more fancied rivals, however, slipped to 7.6 per cent -- in short, back to where they started 15 years ago.

It is no coincidence that smaller companies are also those where the promoter-manager's stake is far higher than those listed on the stock exchanges. It is in the very nature of their organisational charter that they do not access public funds. The financial performance over such an extended period and that too covering a reasonably large sample suggests that managerial efficiency is enhanced under small nuclear organisations where managers are also those with near-total ownership stake in the company.

It is not that smaller and more closely-held companies have significant cost advantages over publicly-owned companies. Nor is it that their output commands a premium in the market place. It is just that private companies have not allowed their resources to be frittered away in a large number of unviable and below par projects. As the owner-manager's own capital is at stake, an element of conservatism has tended to dictate the choice of projects.

As investments have been undertaken only in those ventures where there is a greater certainty of returns, the overall return on shareholder funds has been good. But managers of large, publicly-owned corporations have no such limitations. Since the risk is assumed, in a large measure, by the general public and the public financial institutions, a tendency to chase the pot of gold at the end of the rainbow characterises the investment behaviour of the promoter-manager.