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9
May 2017
 |
India's NPA (The
Total Investment & Insurance Solutions)
India's
NPA problem has a flip side to it: the issue of rising corporate debts.
The
IMF, in its latest Global Financial Stability Report, warned that rising
corporate debts were a risk to growth in emerging markets and pointed out that
India's debt is one of the highest among these economies. In fact, in 2016-17,
trading in corporate debt securities at BSE and NSE shot up by 44 percent.
There is a deep underlying problem within the system that is causing this issue
of rising debt, which is so commonplace in corporate practices that it is often
overlooked: The goal of "maximising shareholder value". The Total Investment & Insurance Solutions
In
a recent speech at the University of Virginia, Infosys co-founder N.R. Narayana
Murthy said that "good governance is all about maximising shareholder
value". The statement was not always passed around as truism till a few
decades ago. The phenomenon first arose in the developed world and India merely
imported these corporate practices.
In
the immediate post-War era, the role of shareholders was restricted and the
managers of large corporations enjoyed relative autonomy. The financial sector
was strictly regulated and limits were imposed on the movement of capital.
Corporations tended to retain the profit they earned and the people they
employed -- and they reinvested this profit in accumulating physical and human
capital. The Total Investment & Insurance
Solutions
In
the 1960s and 1970s, this strategy of "retain and reinvest" hit a
roadblock due to a massive growth of corporations. Through mergers and
acquisitions, corporations grew too big with too many divisions in different
kinds of businesses. Following this, there occurred two institutional changes
that aligned the management's interests with that of the shareholders:
Development of new financial instruments like junk bonds and tender offers that
allowed hostile takeovers and changes in compensation of managers who were
offered performance-related pay schemes and stock options. The Total Investment & Insurance Solutions
The
1970s also witnessed the financial and banking deregulation of the American
economy, which would help hostile takeovers in the next decade by allowing the
risky trade in junk bonds -- a corporate or government bond that the
bond-rating agencies consider being below "investment grade". The Total Investment & Insurance Solutions
Managers
responded to the "shareholder revolution" by a marked shift in their
strategy. William Lazonick and Mary O'Sullivan famously wrote in 2000: "In
the name of creating 'shareholder value', the period following the hostile takeover
movement witnessed a marked shift in the strategic orientation of top corporate
managers in the allocation of corporate resources and returns away from 'retain
and reinvest' and towards 'downsize and distribute'."
Under
the new regime, top managers downsize the corporations they control, with a
particular emphasis on cutting the size of the labour forces they employ, in an
attempt to increase the return on equity. It has been empirically shown that
"reduction in force" announcements have a positive effect on share
prices. Rational pursuit of these managers led them to do whatever they could
to keep the stock prices up and the shareholders happy. There was a rise in
dividends paid out to shareholders and repeated stock buy-backs to reduce the
supply of shares in the market and artificially prop up their prices. The Total Investment & Insurance Solutions
The
shift towards shareholder value orientation of firms has resulted in a
short-term strategy of boosting share prices rather than a focus on long-term
growth of the firm with real investment for non-financial firms. Indian firms
also began pursuing this self-destructive strategy, which ties to the corporate
debt problem that they are currently facing and eventually to the country's
ever-widening NPA crisis. The Total
Investment & Insurance Solutions
During
the boom years of 2004-08, India's corporate profit as a percentage of GDP rose
from 4.5 percent to 7.1 percent, as per RBI data. Post-crisis, profits
immediately started falling, eventually reaching 4.5 percent in 2014. However,
between 2004 and 2014, corporate debt-to-equity ratio consistently rose from
0.68 to 1.1. In value terms, corporate debt rose by 8.1 times while net profit
had merely climbed 3.2 times.
It
is quite clear that the debt was not being taken for productive purposes. On
the contrary, despite troubling times, Indian corporates were generously
handing out dividends. Between 2011 and 2016, the country's top listed
companies had tripled their dividend payments while their profits rose by
merely 50 per cent. They were quite honourably sticking to Narayana Murthy's
idea of good governance. The Total Investment
& Insurance Solutions
This
is not to argue that shareholders are not an important constituent of a firm,
but the obsession with such a metric creates the wrong incentives for managers.
They are forced to focus on boosting quarterly results rather than enhancing
long-term growth; and satisfying shareholder needs rather than those of its
customers and employees. Today, Indian firms are burdened with unmanageable
corporate debt due to such misaligned goals. Firefighting the NPA issue will
not help the economy in the long-run if inherent corporate practices maintain status
quo.The Total Investment & Insurance
Solutions
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