Arvind Subramanian had once said that India has moved after 1991 from socialism without entry to capitalism without exit. The recent sight of some of the biggest Indian companies being put on the auction block by creditors thus constitutes nothing more than a revolution in Indian capitalism.
The first few months since the Insolvency and Bankruptcy Code (IBC) was put into place has also presented several conundrums. Should promoters of defaulting companies be allowed to bid for companies that they are losing control of? How should creditors treat bids that are generated outside the insolvency process? Are the voting procedures in the committee of creditors adequate? A committee appointed by the government has recently submitted its report on what changes should be made in the IBC.
A good starting point to examine these issues is by looking at the principles of market design that have been proposed by economists Alvin Roth and Lloyd Shapley, for which they were awarded the Nobel Prize in 2012. There are three core principles they identify: A market should have enough participants to aid price discovery, the market process should be able to deal with complex transactions without getting bogged down in delays, and the market should be safe so that participants with valuable information prefer it to alternatives. In an article published in the October 2007 issue of the Harvard Business Review, Roth also added that elements of market culture—or how offers are accepted or rejected—are also important.
Each market has its own peculiarities. The sale of defaulting companies is quite different from the sale of telecom spectrum. However, the three core principles of market design matter across various types of markets. And the issue of market culture is the key in the debate about the future of the IBC. As economist Ajay Shah has argued in a recent blog post, the insolvency process is the centrepiece of the new exit framework that is shaking up Indian capitalism. The rules governing the insolvency process can decide the success or failure of the new framework.
It thus makes sense to allow promoters of defaulting companies to put in bids to participate in the auction since this deepens the market for distressed corporate assets. The government committee has reached halfway house by suggesting that this freedom should only be given to promoters of small companies, since it is very likely that these companies could go into liquidation given the likelihood that there will be no bidders.
Small companies also account for a sizeable proportion of the organized sector workforce in the country. They also dominate the list of companies that are in the insolvency process, despite the public focus on the large cases. The special status that could be given to small companies could end up as yet another disincentive against gaining size.
The other controversial issue dominating the news is whether a company should be allowed to bid outside the insolvency process, as with the bid that UltraTech Cement has put in for Binani Cement. It is worth reiterating that the decision of the committee of creditors should be considered to be sacrosanct. This is the market culture issue that Roth wrote about. Encouraging bids outside the system—even through complex financing structures—essentially undercuts the insolvency process. The government needs to take a hard line on this.
Some of the other recommendations of the committee are welcome, such as recognizing home buyers as financial creditors or easing the requirements of interim finance during the insolvency process or redefining the definition of persons who are barred from bidding for an insolvent firm. The idea that only 66% of lenders (rather than the earlier 75%) need to agree on a decision in the committee of creditors could speed up the settlement but also lead to agenda setting by a few dominant lenders. What happens on this front is still ambiguous.
There is little public information about what price insolvent companies have been sold at. The unofficial market estimates are that lenders could get 73 paise to a rupee when Tata Steel takes over Bhushan Steel. This compares well with the average 27 paise that lenders got through the onerous process in place before the IBC, at least if one goes by World Bank estimates. But then there is the reported 94% haircut that lenders to Synergies Dooray had to accept. It is thus not yet clear how much lenders will be getting back after the sale of defaulting companies, and whether some of the current assets are seeing overambitious bidding, but there is little doubt that the early successes of the IBC need to be built on if India is to avoid its next great wave of corporate over-borrowing and bank mislending.
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