Column: Maruti lessons

Updated: Mar 22 2014, 08:44am hrs
The recent attempt by Maruti Suzuki India Ltd (MSIL) to subcontract manufacturing to a 100% subsidiary of Suzuki made headlines, with several investorsincluding mutual fundsalleging that investors stand to lose several thousand crore of rupees as a result of this action as it will hollow out potential profit streams of the parent company, Maruti Suzuki. Demonstrating unusual aggression, these investors approached the MSIL board and warned of invoking the minority oppression regulations of Companies Act. Reacting to these actions, the board agreed to seek the approval of minority shareholders and to ensure that no extra profit would be made by the Suzuki subsidiary.

Such shareholder activism is a relatively recent trend. With increasing market efficiency, it is no longer easy to obtain bumper profits, leading investors to use more direct means to influence companies to act on their behalf. Instead of speculating about future performance of the company they have invested in, these activists are trying to change future performance. The financial services sector-led crisis of the recent years has created a sense among the investors that company (and bank) managements are not always right. Simultaneously, we seem to be reaching an inflection point in society with citizens beginning to ask more of people in public life. Activism among investors is just one manifestation of these trends.

A new ecosystem nurturing this kind of activism is also being created. The United Nations Environment Programme has established the so-called Principles for Responsible Investing. Over $35 trillion, under management of pension funds, insurance companies and mutual funds, has been signed up to honour principles which include disclosure of how these bodies will vote on shareholder resolutions, their commitment to investing only in companies that believe in sustainability and agreements to force their investees to increase disclosures in areas like water utilisation, hazardous chemicals control, etc. A similar forum has been created by Experts In Responsible Investing, who now routinely publish reports which comment on the long-term sustainability performance of the top-2000 companies in the world. It will come as quite a surprise to many that the otherwise forward-looking companies, Apple and Google, have scored fairly poorly in these ratings. It is a matter of only a few years before such ratings become common in the larger public domain, including within annual reports, equity research reports, etc, with concomitant consequences on company reputation.

The kind of activism displayed in the Maruti case has been evident in other countries for the past decade. Last year, over 400 sustainability-focused shareholder resolutions were filed in the US, according to the Sustainable

Investments Institute. In many cases, the target company agreed to negotiate with the investors proposing the resolutions. In others, the resolutions received well over 20% support, something unthinkable just a few years ago. The proposals filed include one by the New Yorks public employees pension-fund asking Dunkin Donuts to reconsider its use of palm oil, which is contributing to deforestation in Indonesia. The company has now agreed to limit its purchases to only from members of the Round Table on Sustainable Palm Oil. Similarly, the Investor Environmental Health Network, a partnership of investment managers, presents shareholder resolutions to encourage companies to eliminate toxic chemicals in their products. Based on their actions, Apple announced an expedited schedule for phasing out PVC and Whole Foods pulled out baby bottles and cups containing bisphenol-A. The Walt Disney Company and IBM were requested to phase out the use of toxic materials and lead acid batteries, respectively, undertook the same in a phased manner. Coca-Cola, however, put one such proposal (for phasing out bisphenols in its cans) to vote, but the proposal lost. But, it garnered 22% of the votes.

In addition to the creation of an ecosystem of agencies measuring the relative performance of companies, proxy advisory firms have also done their bit to bring shareholder issues to the fore. These firms have begun to sway how investors vote. The Institutional Shareholders Service (ISS), a major proxy advisor, had indicated that beginning 2014, it will recommend against the reappointment of individual directors and committee members of the board if they fail to act on a shareholder proposal that received the support of a majority. Such activism puts pressure on companies to actively engage with shareholders well in advance of taking decisions. The activist-investors scene in India is quite different, though. Despite the focus on corporate governance in the new Companies Act, there are very few instances of shareholders or institutional investors exercising their rights. An analysis of mutual fund voting patterns, by advisory firm In Govern, shows that, of the proposals that came their way in FY13, mutual fund houses abstained from voting in 52% of the cases and actually opposed only 1% of the proposals. The Securities and Exchange Board of India (Sebi) had asked mutual funds to make a more concerted push to vote. More recently, Sebi asked them to publish details of how they voted. The few notable exceptions of active investors include LIC and GIC, which chose to vote against the merger of Ambuja with Holcim. The pressure on the Vedanta group, with regards to its Niyamgiri project, is quite well-known. These instances show that the inertia of the investor is, perhaps, in retreat.

In response to these challenges, companies must remain alert to their environment and take steps to detect issues before they spin out of control. They need to analyse the register of shareholders and understand what issues might concern them. Companies need to understand how their major shareholders make their voting decisions. Do they strictly adhere to the advice of proxy advisory firms and, if so, which firms influence them Companies should set up a group of managers for investor engagement. This team should make periodic review of trends in investor-activism and identify potential challenges to the company.

The board of directors needs to discharge its fiduciary duties whenever it undertakes major corporate actions. Ideally, a company should have a lead director and few other directors meeting the shareholders. Companies like Goldman Sachs and J P Morgan frequently request their directors to meet with large institutional investors. Companies would be well-advised to engage with passive investors, who could vote with them in case an activist investor chooses to take a particularly belligerent approach. Of course, adherence to the straight path of governance and the articulation of a clearly though-out long-term strategy are the best bulwark against shareholder activism having any negative impact.

Increasing inequality and levels of unemployment can lead to a culture of greater challenge to authority. The many tentacles of social media now provide a platform for the escalation of issues. The spirit of the age has changed from acceptance to questioning and further still to activism. In this corporate milieu, calls for a capitalism shorn of its starkest angularities will only get louder. The Maruti episode is only the first of many such. Companies have no option but to be far more responsive to investors than ever before.

The author is chief financial officer and chief operating officer Corporate Affairs, Tata Capital Financial Services Ltd. Views are personal

Govind SankaraNarayanAn