Exit Policy for Inefficient Businessmen

I welcome the coming era of hostile takeovers of companies. By the end of this year, new takeover guidelines, based on the Bhagwati Committee’s recommendations will be in place, ending the cosy security of inefficient and crooked businessmen who have long controlled companies with a modest shareholding.

In many cases, the original promoters of a company were dynamic, but their scions are second-rates, and quarrels between the scions have hurt companies that were once top-class (look at the mess in the Modi group). Henceforth, inefficient businessmen will face the threat of takeover by more talented ones. That will be good for shareholders, workers, creditors, and the whole economy.

Indian businessmen have long pleaded for and exit policy for surplus labour. They have, of course, remained silent on the need for an exit policy for inefficient businessmen. Even when their companies fell sick, the promoters remained prosperous, and in control. Now, at last, hostile takeovers will enforce accountability among business families. Talented one will thrive, while second-raters will have to exit.

Critics fear that the takeover rules will allow big businessmen to swallow small ones; that crooked raiders will gut companies instead of running them well; that ‘green mailers’ will demand protection money from small businessmen to withdraw takeover attempts.

I am far more optimistic. I think the threat of takeover will force sleepy managements to wake up and improve their efficiency. The worse a management, the more likely it is to be taken over, since its intrinsic value. In many cases, companies should be saved from sickness by takeover, and that will be a clear benefit for the economy.

The new guidelines make takeover possible but by no means easy. In other countries, banks happily lend money to potential raiders and green mailers. Even a small operator can raid a big company since banks abroad will lend to him against the shares of the company he proposes to take over. But in India not even the biggest companies can get bank finance for takeovers or against shares as collateral. So only serious bidders with large cash reserves can attempt takeovers.

Legal delays in takeover constitute another hurdle. Serious bidders will have the stamina to persist, but frivolous bidders, greenmail airs and asset-strippers will be stripping a company’s real estate is difficult because the Urban Land ceiling Act makes sales of real estate difficult. Moreover, any raider attempting to strip a company will see its share price crash, and so become a takeover target himself.

For decades, government financial institutions have controlled the bulk of equity in many companies, and could in theory change poor managements. But this would have led to charges of political favouritism, so in practice the promoters remained in charge no matter how badly they ran a company.

Often the shareholders, workers and institutions were helpless spectators to companies being run to the ground. The promoter was simply not accountable.

Even if the company fell sick, creditors were not allowed to seize the assets and liquidate the company. The promoter would tell politicians that they must save the company to protect his poor workers. And so the government banks and financial institutions would be told to make sacrifices to keep the company afloat, by writing off their loans.

The promoter, of course, made no sacrifice. On the contrary, he obtained fresh doses of working capital from the long-suffering banks. Of the new money, the biggest chunk would go to pay workers’ wages, some would be given as a kickback to the politicians, and the promoter would pocket the rest. Thus the banks were fleeced to promote the unholy alliance between promoters, trade unions and politicians.

This, then, explains the phenomenon of profitable sickness that we have witnessed from decades. It stems from the lack of accountability of even the worst businessmen. The takeover provisions need to be strengthened to enable creditors (banks, financial institutions) to throw out promoters who default on loans.

Of course, this must not be overdone in a competitive economy any company is liable to run into lean patches, and must be given a fair chance to revive. But if a company fails to service its loans for over a year, the creditors should be able to convert their loans into equity.

This will give the promoter immediate relief on interest payments and help him turn round the company, but at a price-the financial institutions will, after conversion, be majority shareholders. If the company revives, the institutions will share in its new prosperity.

If the company does not revive, the institutions can auction their majority stake and bring in a new management. Either way we will see accountability for the promoter.

The Bhagwati Committee wants to ensure that takeovers are fair and transparent, and that minority shareholders are given and opportunity to benefit too. Its guidelines provide that no raider can buy shares on the quite, or strike a deal to buy out the controlling family.

A raider acquiring 10 percent of a company’s shares, alone or in concert with others, must make a public offer to buy at least 20 per cent of the company’s equity from minority shareholders.

This makes a takeover very expensive, and should discourage fly-by-night operators. These will even more discouraged by the rule that bidders must make and advance deposit of one-tenth of their bids.

So takeover bids will usually be genuine, and raise share prices. And rival raiders can chip in with still higher bids.

This will benefit small shareholders. Today, small investors are too unorganised to come together to force a change in a bad management. They simply suffer in silence. Now, takeovers will force changes. In some cases, the small investor may fear the new management more than the old. No problem: he can exit from the company by taking advantage of the public purchase offer at a high price.

Many small shareholders are dismayed by the recent slump in the stock market. Companies complain that the capital market is dead as mutton. However, the markets should revive because of the new takeover possibilities. Raiders will make fresh purchases, and vulnerable prompters will also buy shares to protect themselves.

In this manner, share prices should rise closer to the intrinsic worth of companies. So don’t look to the finance minister to revive the capital market with tax concessions (such concessions have failed in the Past). If we simply enforce accountability through an exit policy for businessmen, that will do the trick.

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