Lessons from the battle in Bombay House
Complex ownership structures give promoters far more control over listed companies than their actual shareholding would suggest
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Jamsetji Tata set up the Empress Mill in 1874. The business historian Dwijendra Tripathi has written about how the pioneering businessman tried to run the new textile mill through a managing director answerable to a board of directors. It was a stunning innovation at a time when most Indian business enterprises were tightly controlled by mercantile families or managing agencies. Jamsetji had to eventually abandon his experiment.
Good corporate governance has been a central feature of the Tata group almost since its inception. The ongoing battle within the conglomerate sullies the reputation of the Tata group as a paragon of corporate governance. The exact details of why Cyrus Mistry was suddenly toppled in a boardroom coup at Tata Sons are not clear, but the manner in which he was replaced seems problematic. The subsequent leaked email written by Mistry raises lots of questions about the way individual companies in the Tata group have been managed, and some of his own decisions will likely be questioned in the coming days.
The Tata imbroglio is a timely reminder of a deeper structural problem in Indian business. Too many large companies are controlled through a complex web of holding firms, investment vehicles, subsidiaries and inter-group investments. The control mechanisms in such corporate pyramids are opaque. They give promoters far more control over listed companies than their actual shareholding would suggest.
There was a time when Indian promoter groups controlled companies while owning a tenth of the equity. Matters have improved since then, thanks in large part to a more robust market for corporate acquisitions, but even now owning a third of a company is deemed enough to run it with an iron grip.
Complicated ownership structures are not unknown in other parts of the world, but they are not as common as in India. Even a new-age online retail operation such as Flipkart is controlled through a holding company based in Singapore. Berkshire Hathaway and General Electric are classic cases of listed firms that own stakes in other businesses. Tata Sons is the exact opposite. It is an unlisted holding company that has significant stakes in 14 listed firms and 144 unlisted ones. The holding company not only acts as a central allocator of capital across the group but also provides strategic direction. So, for example, the free cash flow of Tata Consultancy Services is reallocated via dividends to other ventures in the Tata group. Bombay House also has an important say in the way individual companies in the group are run.
The holding company is just one part of the interlocking organization. There are two other features. Some Tata companies have their own subsidiaries, as in the case of Tata Global Beverages having control over Tata Coffee or Tata Chemicals having control over Rallis. Then there are the cases of one Tata company owning a large stake in another—the Tata Steel investment in Tata Motors is a case in point. The result is that the promoter group has immense organizational leverage.
The Tatas are not unique in this. Most large Indian business groups have some variant of these complex methods of corporate control. The reasons stem from a combination of history and tax laws. Management gurus Tarun Khanna and Krishna Palepu have also famously argued that countries such as India have complex conglomerates because robust private markets for capital and talent are rare in emerging markets. The absence of such markets creates the need for complex corporate organizations to allocate capital and maximize organizational talent.
The ongoing battle in the Tata group shows that decisions in the private holding company (or a network of shell companies in other cases) have immense implications for shareholders in the listed companies of the group. Something similar was seen in the tussle within the Ambani family a few years ago: Some of the decisions taken by companies listed on the stock exchanges were inextricably linked to private agreements within the promoter group.
The question worth asking right now is: What should the boards of the listed Tata companies now do to protect the interests of other shareholders? That is their main fiduciary responsibility in case the internal battle in the Tata group deepens. Three other influential players—large institutional investors, credit rating agencies and capital market regulators—will also be tested in the coming weeks. There are thus wider challenges for the Indian corporate governance system as a whole—far beyond the confines of Bombay House.
Can complex conglomerates and good corporate governance go together? Tell us at firstname.lastname@example.org