Beating A Retreat

There are a number of important issues connected with this strategic retreat of the institutions. I will focus on three of them in this article. The first issue is the immediate motivation of this proposed course of action, and the impact that this has on the nature of the action. The second issue is that of the potential impact of large-scale disinvestment on the equity markets. The third, following from the first two, is whether there is a better alternative available to achieve the same goal.

Regardless of when and how the committee was constituted, its recommendations gain enormous significance in the context of the ITC affair. Thus, the intended retreat of the institutions can essentially be viewed as a recognition of the fact that they are incapable, or unwilling to play the internal policemans role in some companies. Thus, the committees criteria for divestiture are, among others, companies which are sick or potentially sick, companies that have not been paying dividends, and those whose managements are being prosecuted. In other words, the institutions want to dissociate from companies which are bad buys from a portfolio management viewpoint.

 

There is, however, a contradiction of sorts here. The basic distinction between a portfolio investor (like a mutual fund) and a long-term investor (which, one presumes, the institutions see themselves as) is the degree of commitment each is willing to make in overseeing managements. It is precisely in situations where bad management is devaluing a companys assets that shareholders with long-term interests in the company can and should intervene to change the management. Instead, the committees criteria suggest that the institutions suddenly change from being long-term investors to being portfolio investors and then bailing out of bad companies. The problem here is that the market would already have devalued the equity of the company commensurate with its performance. Good portfolio management usually involves buying low and selling high. What this strategy amounts to is just the opposite. On the other hand, the optimal strategy for a long-term investor in this situation would be to buy up the undervalued shares, consolidate control and then try and make the necessary management changes.

The second issue concerns the procedure involved in divesting themselves of unwanted scrips. The recommendations apparently suggest a strong concern for minimising the impact of large-scale divestitures on the market prices of the scrip, particularly those which are thinly traded. Since the institutions are behaving as though they are portfolio investors, they should be rightly concerned about the impact of large volume sales on their realisations. So the approach suggested is the controlled-competitive bidding cum-negotiated-sales, under which buyers interested in and capable of managing the company would be invited, provided they had the resources. This is a formula straight out of mainstream privatisation manuals. But, remember, we are talking about the private sector here! As portfolio investors, the institutions should be concerned only with getting the best price for their stake, and not with what happens to the company once they have dissociated from it.

The best way to meet this objective is a leveraged buy-out (LBO) by the management. Companies with good collateral assets would be prime candidates for this type of arrangements, and the buy-out would be at a price negotiated with the promoters or family who run the company. What comes in the way of this is the restriction against companies buying up their own shares; however, this constraint has to go anyway because this facility is the most effective defence mechanism against takeover threats, and all managements must have recourse to it. Even if LBOs are not an attractive proposition, promoters/families should still be given the right of first refusal on the institutions stake. What right do the latter have to predetermine that the incumbent management must go unless they intend to maintain their stake?

What has emerged from the discussion above is that the institutions appear to have a contrarian perception of the way in which they would withdraw from corporate equity ownership. In terms of the choice of companies, when they should be behaving like long-term investors, they are inclined to behave like portfolio investors. In terms of method, when they should be acting like portfolio investors, they take the position of long-term investors to exercising control over who should manage the company. In light of this, can one design an institutional mechanism which would optimally manage the retreat, balancing the potential conflicts between portfolio interests and long-term interests?

A possible solution is to privatise the institutions themselves. This may sound too simplistic to be overacceptable, but I dont believe it is. Look at the heterogeneity of public sector institutions that have substantial corporate equity holding. There is the Unit Trust of India, the two insurance companies, LIC and GIC, and the three term-lending institutions IDBI, ICICI and IPCI. Of these, the UTI is potentially closest in structure to a private entity since all unitholders can be given the status of shareholders; there are several ways in which the monolith can be divested into a number of viable portfolio management service companies. The economics of the insurance business worldwide requires large portfolio investment by these companies, so they are always going to be major players in the market, public or private. In any event, this issue is tied with the opening up of the insurance senior; if and when that is done, the domestic giants will have to start managing their insurance and portfolio activities like any private business in order to survive without budgetary support.

As for the term lending institutions, even if for some reason the government wanted to retain social control over their leading activities (I dont really see any reason), the portfolio activities of these companies could be hived off into separate companies to which public subscriptions could be solicited. These portfolios would thus be sold at their going market values without impinging on the market valuations of individual scrips.

It is indeed a good sign that we are talking about privatising our private sector. However, in doing so, public institutions withdrawing from the scene should not determine the order that they would leave behind. This is best left to the interplay between the private interests that would replace them.

(The author is associate professor at the Indira Gandhi Institute of Development Research, (IGIDR) Mumbai)