Amit Tandon

Should shareholder democracy be at the expense of shareholder value? Recently, ACC and Ambuja Cements decided to increase royalty paid to their parent, Holcim. Both the companies will now pay a fixed royalty of 1% based on turnover. They also put this to vote.

A simple reading of the voting data shows that 69.3% of ACC shareholders and 78.6% of Ambuja Cements shareholders voted in favour of this resolution. This data distorts the fair picture as these percentages include the shares held by Holcim in these companies, of over 50%.

Dig deeper. Our analysis reveals that excluding Holcim?s vote, only 2.1% of ACC?s shareholders voted for the resolution. Similarly excluding Holcim, only 4.5% of Ambuja Cements shareholders supported the royalty increase. Conversely, excluding Holcim, 88.6% of those voting in ACC opposed the resolution. And in case of Ambuja Cements, this number is 83%.

What I find more noteworthy is that despite knowing that this resolution will be approved, given Holcim?s 50%-plus ownership in both companies, a fairly large number of shareholders have chosen to vote against and express their negative response to the move.

Over the last four years, operating margins for both companies have come down, and through this, Holcim is taking advantage of its controlling shareholding stakes to extract a disproportionate amount of cash flows of ACC and Ambuja Cements.

Let me give a few more instances, this time without naming names. The controlling shareholder sells a 30% stake in its subsidiary in 2009 to the ?promoter group’. In 2013, the controlling shareholder votes in favour of buying it back at 4.5 times the sale value. The controlling shareholder votes in favour of paying himself and his wife’s salary and commission of approximately R114 crore. The controlling shareholder votes in favour of appointing his 23 year old son on the board of a company. The controlling shareholder votes in favour of the merger with a 100% subsidiary and two companies in which they directly and through cross-holdings held 99.62%. The promoters hold 12.4% equity in the company, but can now exercise control on the resultant treasury stock, which gives them control over an additional 31.7% of the voting stock. Such examples, where the controlling shareholders use their dominant shareholding to vote something for themselves, can be repeated ad nauseum. The real weakness lies in the company?s decision-making process. How are these resolutions proposed in the first instance? The controlling shareholder, and often also the CEO, will decide that they will merge a family-controlled company with the listed entity. Or appoint his four daughters as executive directors on the board. At the behest of the CEO, the item will be put to the directors to deliberate. The board will then appoint the firm that will undertake the valuation. Based on which, the company secretary, who reports to the CEO, will then draft a resolution, which is then put to shareholders to vote. This inevitably results in a system in which controlling shareholders have an outsized influence on the outcome of the resolution.

One way to check undue promoter influence in sensitive matters like related party transactions is to ensure greater transparency in the decision-making process. Companies need to have stated policies for related party transactions. These need to spell out when a transaction will be done without any approval, when it will be pre-approved by the audit committee and when it will be put to shareholders to vote.

All these year, the controlling shareholders have wanted to have their cake and eat it too. They may fool themselves into believing that by pushing through these resolutions, they get something for nothing; but each time they do so, they eat into their company?s market cap.

The author is managing director, Institutional Investor Advisory Services India Limited

Sandeep Parekh

The Companies Bill, 2012, proposes a number of significant changes to corporate governance norms. Among the most debated is Clause 188, on related party transactions (RPTs). Under the current Companies Act, 1956, compulsory sanction of the board of directors is required for the company to enter into certain proposed transactions, where a director may have a personal interest which conflicts, or may possibly conflict with the interests of those to whom he owes a fiduciary duty.

The Bill broadens the scope of transactions covered with related parties and views RPTs as potential conflict of interest situations. It conveys the legislative intent that RPTs must not be detrimental to the company?s minority shareholders, and it seeks to strengthen the approval mechanism by requiring shareholder approval for the transaction, via special resolution, instead of just a sanction by the board. In addition, Clause 188 prohibits a member of the company, being a related party, from voting in the special resolution (though applicable to probably only larger companies). The lessons from the Satyam Computers scandal, where the acquisition of related entities?Maytas Properties and Maytas Infra?was opposed by the shareholders and approved by the board, seem to have been at the back of the Bill draftsman?s mind. The Bill further mandates that the requirement for a special resolution shall not operate for any RPTs that are entered into by the company in its ordinary course of business on an arm?s length basis, that is, a transaction conducted as if the entities are unrelated and is devoid of conflict of interest.

Sebi too has raised concerns regarding the abuse of RPTs by controlling shareholders in its Consultative Paper on Review of Corporate Governance Norms and has recommended the use of voting by non-interested shareholders and has implemented it in court-driven M&As with prior dis-interested shareholder vote by two-thirds majority. It has done so in several other instances as well.

The regulatory posturing on RPTs may have been motivated by the peculiarity of Indian corporate structures, where nearly half of shareholding on average is held by promoters and the ?group structure? with many related party transactions. It is not uncommon in Indian listed companies for the promoter to lease office space to the company or own the brand for which he charges an annual royalty to the company. By bringing in the requirement that the RPTs that are not undertaken in the course of ordinary business and not conducted at arm?s length must require approval of the ?majority of the minority or disinterested shareholders?, the move is aimed towards introducing a higher standard of corporate governance.

There may be a counter-argument on the grounds of loss of competitive advantage for the company due to the passage of time in seeking shareholder approval. The Bill has adequately provided that where an RPT, not being at an arm?s length or in the ordinary course of business, is entered into without seeking the board?s approval or winning the shareholders? mandate under a special resolution within 3 months from the date the contract was entered into, the contract may be declared voidable at the option of the board.

A negative fallout of this could be felt in situations where the company is locked in a takeover battle, where apart from the interested shareholder, shares are held by a hostile entity. This requirement would essentially pre-empt the possibility of any successful takeover defence being made by the controlling shareholder via an RPT. Additionally, even in cases where the balance shares are held by a competing entity, as opposed to the minority shareholders, some benign RPTs could be stalled and thus be an impediment to business. Finally, there may be rare cases of a large shareholder holding the majority shareholder to ransom. This situation would be rare because most RPTs are not desirable in any case. However, on the whole, the move would be good both for minority shareholders and hostile acquirers and thereby the corporate governance standards of India.

The author is the founder of Finsec Law Advisors