Why minority investors lose out against corporates

Asish K Bhattacharyya thinks minority shareholder interest can be protected by tightening the regulations and ensuring that its strictly followed. He believes that the proposed new Companies Act will go a long way in improving corporate governance.

Who protects the minority (non-controlling) shareholders? Although many institutions have been created to protect minority interest none of them are effective in companies where there is concentration of ownership (e.g. family businesses and public sector enterprises).

Globally, the protection of law is minimum to equity shareholders because they are deemed owners of the company. The court of law intervenes only when there is mismanagement or fraud. The protection is even lower for shareholders in companies where there is ownership concentration.

Let us take the case of The Children's Investment Fund Management LLP(TCI), a UK hedge fund that holds 1.01 per cent stake in Coal India Ltd (CIL). It has filed a lawsuit against the directors alleging that they have failed to 'perform their functions with adequate care and skill.'

It has also named the Indian government, which owns 90 per cent of the company, in its suit "for improperly exerting pressure on CIL directors" on key policies.

TCI is seeking cancellation of a coal ministry directive that led to a revocation of a 12.5 per cent increase in coal prices in January. It argues that the local regulation allows prices to be set independently by coal companies, and therefore, the government's directive was illegal and has cost CIL a lot of money.

In a panel discussion someone argued that TCI has no case as the Red Herring prospectus filed by CIL mentions government intervention as one of many risks.

Item number 17 under Internal Risks, among other things, discloses that CIL sells coal at a price lower than the market price and it consults the Government of India in determining the price of coal.

TCI has no case if the court of law applies the principle of 'caveat emptor' (let the buyer beware), which is usually applied in contracts for sale of goods.

A clause that usually appears in Red Herring Prospectus of private sector companies that are promoted by business groups discloses that promoter's decisions might not be in the best interest of minority shareholders. An example is Clause 40 (section II) of the Red Herring Prospectus of Godrej Properties Limited.

It clearly states that the promoters may take or block actions with respect to the company's business, which may conflict with the company's interests or the interests of the minority shareholders.

It further states that the management cannot assure minority shareholders that promoters will always act in their best interests.

Perhaps such clauses are included in Red Herring Prospectus to protect the management from any legal proceedings against the company, which some shareholder may file on some trivial issue.

However, such a clause weakens the legal protection to shareholders if the court of law applies the principle of 'caveat emptor'. The outcome of the TCI case will be of interest to us.

Institutional investors can play an important role in protecting minority interest. Therefore, SEBI has made it mandatory (effective from 2010-11) for AMCs to disclose in their website the proxy-voting policy and how they actually voted in annual general meeting (AGM) or extra-ordinary general meetings (EGM) of shareholders.

However, an analysis for the year 2011-12 by 'ingovern', a proxy advisory firm, shows a dismal picture. Mutual funds abstained from voting in 48 per cent of resolutions, voted for 51 per cent of resolutions and voted against one per cent of resolutions.

In most cases, where they voted against a resolution, they failed to block the resolution. However, one positive aspect of the new regulation is the emergence of proxy advisory service firms, which advises institutional investors to take a view on different resolutions proposed to be placed in AGM/EGM.

They are able to draw attention of investors to decisions that might hurt minority interest by asking uncomfortable questions. This exposes companies to reputation risks.

In India family business dominates the corporate sector and therefore, investment decisions are significantly influenced by the reputation of the management. Therefore, it is a way forward in improving corporate governance.

Research has established that independent directors are not effective in influencing strategies and policies of companies, which are managed by the promoter group, including the public sector enterprises.

Although it is an exaggeration, it might not be totally incorrect to say that minority interest is not protected in India. The only way out is to improve the average level of corporate governance.

This can be achieved by tightening the regulations and strict enforcement of the same. The proposed new Companies Act will go a long way in improving corporate governance.

Let us hope that the Parliament will approve the same in this winter sessions. After all we live in hope.

Email: asish.bhattacharyya@gmail.com

Affiliation: Professor and Head, School of Corporate Governance and Public Policy, Indian Institute of Corporate Affairs, Manesar, Haryana