Column : In the right zone

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: Good corporate governance involves ensuring that each share gets the same benefits. There are three zones of interest. In Zone-I, the promoter owns a lot. When the promoter owns 90%, he gets 90% of the true profit of the company anyway. He can only grab 10% more by stealing from the outside shareholders. For this reason, even in countries with weak institutions, corporate governance works out okay for such companies. This is an easy incremental step for family businesses or PSUs: a little outside capital is brought in but basically nothing changes.

The difficulties are worst in Zone-II, where a promoter who owns 51% can make a grab for (say) 80% of the cash produced by the business. Such theft presents acute problems because with 51% of shares, the promoter cannot be displaced. For this reason, outside shareholders are least willing to pay a good price for such companies.

In good countries, companies with a low promoter ownership—such as 5% to 15%—work the best. In this Zone-III, the low ownership of the CEO makes him vulnerable to being sacked, so the incidence of theft is low. This helps to attract large quantities of public equity capital; these companies grow big. At the same time, such companies avoid the inefficiencies which go with family run companies particularly over long horizons. In good countries, Zone-III companies have the best chance of becoming meritocracies. The DNA of a young employee does not disqualify him for the CEO’s job, which improves his drive.

By and large, India is doing okay in Zone-I and Zone-II. In Zone-I, not much needs to be done. In Zone-II, paying low valuations is really the only defence. Even in good countries, it is difficult to prevent theft by a promoter that can’t be sacked. The real story of corporate governance lies in Zone-III. In March 2001, the family had 25.5% of Satyam. This had dropped below 20% in September 2003 and below 10% in June 2006. The Satyam episode hence puts a spotlight on India’s difficulties with the critical Zone-III.