Globally, similar corporate revelations occur periodically. They highlight the shortcomings of investment banks and credit agencies that give good marks and encourage massive investment in companies without sufficient scrutiny. The Hindenburg report is an indictment of global credit agencies and investment banks, and calls for better performance from them too.
Barely a month ago, surging share prices enabled Gautam Adani to become the third-richest man in the world. With an awesome reputation for political clout plus great business skills, he became India’s top infrastructure operator, diversifying massively into new areas such as airports, gas distribution, cement and renewable energy. His crowning achievement was supposed to be a whopping share issue of $2.5 billion by Adani Enterprises, his flagship company.
But revelations about his business practices by a small US investment firm, Hindenburg Research, caused his share prices to crash last week, wiping out almost $100 billion of their market value. Adani strongly denied the charges. He, however, had to cancel the share issue. He now faces a financial and reputational battle.
The Global Lens
Analysts and investors will debate the pros and cons of the Hindenburg report and Adani’s responses for months. In this column, let me make a separate point – that globalisation has little-appreciated virtues such as improving corporate governance by detailed scrutiny of the mightiest titans.
For years, market analysts asked why Adani company shares kept skyrocketing to unheard of price-earnings (P-E) ratios. The P-E ratio of the Nifty companies overall is around 20. But for Adani Green Energy, it touched over 600, and for Adani Enterprises over 300. No Indian research company was willing to lock horns with such an important, well-connected group. But Hindenburg declared that Adani had engaged in ‘decades of brazen stock manipulation’ and pulled off ‘the largest con in corporate history‘.
Time will tell how true these charges are. Adani may be exonerated, and Hindenburg discredited. But the clamour means that many institutions – investment banks, credit agencies, the Securities and Exchange Board of India (Sebi), think tanks, maybe the Indian Parliament – will conduct a hard-nosed scrutiny. Such scrutiny is good regardless of the final outcome.
Globally, similar corporate revelations occur periodically. They highlight the shortcomings of investment banks and credit agencies that give good marks and encourage massive investment in companies without sufficient scrutiny. The Hindenburg report is an indictment of global credit agencies and investment banks, and calls for better performance from them too.
India needs capable businessmen like Gautam Adani. But it also needs institutional mechanisms to ensure that businesses promote the national interest. Entities that become too powerful and influential can be tempted to cut corners. Hence, public scrutiny of business practices is always in the national interest. Sometimes, domestic scrutiny is not thorough enough, and international scrutiny can fill that breach. International scrutiny is also a must for attracting global capital. So, the globalisation of corporate scrutiny is a public good, informing the public and improving corporate governance.
This revelation is not new. Before the 1991 economic reforms, foreign investment in our stock markets was banned. The Bombay Stock Exchange (BSE) was a snake pit rife with dubious practices and manipulation. This culminated in the Harshad Mehta scandal of 1992.
The quality of corporate governance was also poor. Crooked businessmen shifted profits out of their listed companies into their private companies, gaining at the expense of minority shareholders. But once foreigners entered Indian markets, they focused not on dubious balance sheets but governance. They pushed up the price of well-governed companies and depressed the prices of poorly governed ones. Suddenly, Indian businessmen found it better to keep profits in company books and get high share prices than to shift profits out and suffer falling prices.
Spread of Scruples
Foreign investors prodded the authorities into stock market reforms to make foreign investment in India safer and more profitable. They aimed to maximise their profits, not morality. But they spurred reforms that ultimately gave India the best stock market in developing countries.
Indian drug companies came up in the 1960s catering to the domestic market. Fake and adulterated drugs were common, and Indian inspectors were too weak or corrupt to stop this. But once Indian companies accepted World Trade Organisation (WTO) norms for patents and began exporting drugs, they came under the scanner of foreign drug agencies. Indian companies had to hugely improve quality control, or face debacles like that of Ranbaxy. Here again, globalisation of scrutiny improved corporate morality and customer protection.
Most Indians are suspicious of trading in financial derivatives, which looks like pure speculation unrelated to the real economy. When trading in derivatives fuelled the global crash of 2008, many Indians felt vindicated. In fact, the problem was not derivatives per se, but lack of appropriate regulation.
Why did Hindenburg put two years of research effort into investigating Adani? Because it was a short seller, trading in derivatives like futures and options. Such derivatives enable short sellers to make a big profit if the targeted company’s share prices dive. So, they search for companies with practices that, when revealed, can send prices diving. This is a search for private profit. Yet, short sellers render a public service by highlighting issues that regulators and other institutions may have glossed over.
Short sellers are not angels. Critics call them vultures. But in line with Adam Smith’s invisible hand, they unwittingly serve a public purpose.
This article was originally published by The Economic Times on Feb 07, 2023
