Thursday, September 21, 2017

Politics and the family plot

This article was first published in the New Indian Express on September 21, 2017; Co-author- S. Subramanian

Can political parties in India and abroad find their own Jorgen Vig Knudstorp (Lego), Sergio Marchionne (Fiat Chrysler Automobiles) or Oh-Hyun Kwon (Samsung Electronics)? These people are all successful non-dynast professional CEOs of family-run businesses. Do political parties pick candidates keeping in mind what is best for the party, its growth and purpose?

Typically, communist parties in countries such as China, Vietnam, North Korea and Cuba are run as family affairs. Party leaders pass the baton from one family member to the other and one generation to the next. The descendants of the communist party elites, or ‘princelings’ as they are called, are usually chosen to lead the party, and are given important portfolios in the government and the country when the earlier generation retires or passes away.

It is almost impossible for anybody to rise to the top of the party (and hence the government machinery) unless they have strong family influence in the communist party. In China, four of the seven members in the all-powerful Politburo Standing Committee of Communist Party of China (CPC) are princelings. Similarly, in the Communist Party of Vietnam (CPV), of the 19 members in the Politburo, 11 are princelings. In North Korea, the ‘Kim’ family is in power for the third generation. And in Cuba, after Fidel Castro, his brother Raul Castro came to power.

The above scenario is similar to many family-run businesses all over the world. Closer home, in India, most of the businesses are owned and managed by founders and their family members. The reasons for this phenomenon of family-based succession are culture and the ‘correct fit’.

Asian countries are known for their collectivist family-oriented culture, unlike Western individualist culture. The elders want to pass on what they have earned to the next generation family members. This is reflected in the literature on succession in family-run businesses. The business is passed on from one generation to the next for the family to retain control, even if there are better candidates outside the family for continued shareholder wealth creation.

The founders of the party earned power when they set up the party and they want to pass on that power to the next generation family members. The thought process is that ‘the founders of the party set up the political establishment in the country and even though the government is for the people, the founders and their family members are best suited to enjoy the outcomes and take the mission of the party forward’.

This thought process is more or less explicit in the succession planning in Vietnam. The Communist party’s informal rule set by Ho Chi Minh, the founding father of the CPV, states that priority should be given to the children of the senior comrades, i.e. party elites.

Even if the incumbent leadership of the family business genuinely wants to consider outsiders for succession planning, it does not work in many situations. The outgoing leadership typically has a vision for the company and wants to choose someone who understands and shares that vision.

When they search for a successor, they find it difficult to find an outsider who fits their expectations. On the other hand, they find that their own family member, who has been brought up under their supervision, is entrenched in the same values and shares the same vision. Hence they prefer to pass on the baton to someone inside the family rather than an outsider.

The communist party elites feel the same. It is up to the non-communist parties in democracies like India to decide if they would like to follow this method of selecting successors. It must be emphasised that if the next generation of the founding family is well qualified, as passionate as the founder or incumbent and as suitable to lead the company as an outsider, the family member may be given a preference over the professional as the family member would be well entrenched in the values of the company. But, if the next generation is not well suited for the top job, the shirt sleeve to shirt sleeve in three generations saying may prove to be right!

A look into the various Birla Groups proves an important point. The Aditya Vikram Birla group which appointed professional CEOs with strategic freedom at the business level for most of its companies continued its success story in the liberalised environment, whereas the other Birla Groups which continued with family leadership did not perform as well.


The political parties would do well to realise that the adage will apply to them as well if they don’t learn from the experiences of family-run businesses and make course corrections. Parties that subscribe to dynastic politics can learn from family businesses that choose ‘outsiders’. Family-run businesses are realising the need for change. So should the political parties!

Thursday, September 7, 2017

Will Family Businesses Jump on the e-commerce Bandwagon?

This article was first published in www.entrepreneur.com on September 6, 2017; Co-author: S. Subramanian; https://www.entrepreneur.com/article/299866

The family businesses quickly entered the IT industry in the 1990s and today represent 14.31% of Nifty in Market Capitalization

It is interesting to note that out of the 13 different sectors represented by the Nifty stocks, sunshine industries like Pharma, Telecom and IT are totally dominated by family businesses. Though most of the older family business groups like the Bajaj, Birla, Godrej, Reliance and TATA started with traditional manufacturing, metals and energy sectors, almost all of them forayed into the emerging services sector with aplomb and success.

Family Businesses Rule
Out of the 50 companies in Nifty, 32 are family businesses and 11 of those 32 are less than 25 years of age, accounting for 47 per cent of the market capitalization of Family businesses in Nifty. This points towards the swiftness with which families have responded to the emerging opportunities and embraced them.

Entrepreneur Ruling the Scene
The family businesses quickly entered the IT industry in the 1990s and today represent 14.31% of Nifty in Market Capitalization and 74% of the market capitalization of all IT industry stocks in Nifty. To draw a parallel, e-commerce in India is at a nascent stage and start-ups, all entrepreneurs, are ruling the scene in this space. However, what intrigues us is that none of the large family businesses have forayed into it in a major way so far. While they do have a presence in the B2B space, they have so far stayed away from the B2C sector, with the exception of the recent foray of TATAs with CLIQ.

E-commerce Business Boost
With government initiative like Digital India, the internet penetration in the country is set to rise further. The growth rate is already one of the highest at 51 per cent per annum.  This will provide a further boost to the e-commerce business. According to estimates by the Associated Chambers of Commerce & Industry of India (Assocham) and Forrester, revenues from e-commerce market in India is expected to grow to $120billion by the year 2020.

How a Young Team Helps
Typically the ecommerce start-ups are headed by youngsters of less than 35 years age and the employee teams are also usually fresh engineers and MBAs.  This may be essential for a B2C e-commerce venture as the buyers in online stores are predominantly the youngsters. Their behavioural pattern as consumers is very different from that of the traditional buyers.

For example, they rely a lot on social media communication to develop an opinion about the product. And hence having a young team, led by a youngster, is important to understand the consumer mindset and set the right strategic direction for the ecommerce firm. But the traditional family owned businesses tend to have experienced personnel at the very top level. Having very young people lead a venture is new for them and may take some time to culturally accept.

VC-funded Start-ups
Let us assume that a business group does promote an e-commerce business and lets a team of youngsters, led by a young CEO, manage it.  Will that guarantee success? Probably no, as the team may not still get the strategic freedom similar to that of their standalone competitors. Most of the existing ecommerce start-ups are almost fully funded by the venture capitalists (VC), whose expectation as investors are completely different from that of a business family. The VCs’ expectation of success in the start-up that they invest is just about 10 percent or so. Hence they allow the team to take risks, even if it means going to an uncharted territory. The families do not and probably cannot allow such risky moves in their own ventures, there by effectively curtailing the strategic freedom of the top management.

High-risk Strategies
Further, such high-risk strategies have created expectations of high returns from the e-commerce ventures. This, in turn, resulted in the valuations skyrocketing, essentially creating a bubble, and some analysts went to the extent of calling them as Ponzi schemes. The business families, while willing to enter into the sunshine sector, are generally cautious about their reputation.


The entry of Tata Group into e-commerce sector with CliQ, the first such venture by a major family business group, may indicate that the moment has come. What is to be seen is if CliQ is not too late to take on the Flipkarts and the Amazons of the industry which have already established themselves in the market. Would CliQ set the precedence for the other family businesses to foray into the ecommerce bandwagon? And, we would be happy to do a similar analysis 20 years from now to see how many ecommerce companies form a part of Nifty and how many of them will be family businesses!

Monday, August 28, 2017

India Confronts Its Non-Performing-Asset Crisis

The article was first published in GARP Risk Intelligence, August 22, 2017; Co-author: Anisha Sircar


Central bank deputy governor Viral Acharya is latest to sound the alarm, advocating “tough love” with defaulters

The June 2017 Financial Stability Report of the Reserve Bank of India (RBI) (https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/0FSR_30061794092D8D036447928A4B45880863B33E.PDF), highlighting the outcomes of stress tests on Indian banks’ balance sheets, concluded that India’s financial system is healthy overall, but there are rising concerns about the banks’ non-performing assets (NPAs).

They are the No. 1 priority of the RBI, the central bank’s deputy governor, Viral Acharya, said at the Delhi Economics Conclave on July 22.

The business of banking inherently involves risk-taking. A loan is by definition exposed to the risk that the borrower will not ultimately return the principal and/or interest, as per the loan agreement. In its definition of a NPA, the RBI says that “an asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank . . .”

It is axiomatic that NPAs are undesirable, and when at high levels, they constrict banks’ ability to extend credit. The ratio of non-performing to total loans is often used as an indicator of the health of a banking system and the broader economy.

For the first two decades after liberalization of the Indian economy, non-performing loans were managed well, falling from 14% in the early 1990s to 3% 2004, attributed to policies implemented by the RBI to curb the post-reforms NPA crisis.

However, since late 2011, bad loans have been rising sharply and have evolved into a major threat for the banking sector and the economy at large.

Figure 1


“Credit Shock” Concern
The RBI report predicted a further rise in the Gross NPAs of Scheduled Commercial Banks (the dominant players of the financial system, under which public sector banks, private banks, foreign banks and regional rural banks are classified) from 9.6% in March 2017 to 10.2% in March 2018.
Even more telling was the prediction that “a severe credit shock is likely to impact capital adequacy and profitability of a significant number of banks” by the same year.

The solvency of a bank – the ability to meet its long-term fiscal obligations – when extended to the potential of disrupted asset quality of banks at a macroeconomic level, can lead to impaired credit growth in the entire economy. In the long term, this can also hamper macroeconomic factors such as GDP growth.

Furthermore, bailing out banks with high NPAs would require infusion of capital by the government, potentially becoming a burden on taxpayers.

Banks with higher retail portfolios (that is, more consumer-oriented) and lower “legacy loan” clients (whose assets have been on the books for long periods of time) usually have better NPA ratios.
Public-sector banks are more exposed to NPAs because their portfolios tend toward infrastructure, real estate and telecom, which are significantly hampered during economic downturns. Private-sector banks are often more vigilant and prudent in their credit appraisal, risk management and loan recovery.

In this light, India’s NPAs are concentrated and growing fastest in public-sector banks. The trend in other banks has also been upwards, but at a lower rate than the public banks. (See: Galloping Non-Performing Assets Bringing a Stress on India's Banking Sector; https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2947557).

Government and Central Bank Actions
Capital infusion, setting up Debt Recovery Tribunals (DRTs) and Debt Recovery Appellate Tribunals (DRATs) in 1993, and the SARFAESI (Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest) Act of 2002 did not help banks and financial institutions recover NPAs.

Over the decades, the RBI has also come up with schemes such as Corporate Debt Restructuring, Strategic Debt Restructuring, 5/25 Scheme, Sustainable Structuring of Stressed Assets (S4A), and the Joint Lenders’ Forum (JLF).

The “Indradhanush” road map was laid out by the government in 2015 to recapitalize banks by asking them to officially recognize top defaulters as non-performing accounts, and make provisions for them, as well as to inject Rs. 700 billion into state-run banks. However, the challenges kept mounting until it reached proportions that threaten the stability of the entire banking system.
In recognition of the escalating nature of the NPA issue, the Banks Board Bureau was set up in February 2016 to improve the governance of public-sector banks. In August 2016, the Indian government issued the Insolvency and Bankruptcy Code 2016 (IBC), which empowered the RBI to speed up the recovery of NPAs in the banking system.

Significant Defaulters
In October 2016, the Insolvency and Bankruptcy Board of India was set up, consisting of the National Company Law Tribunal (NCLT) and Debt Recovery Tribunal to oversee proceedings – the former for companies and limited liability partnership firms, and the latter for individuals and partnerships.

Within a month, the RBI came out with a list of “willful defaulters” responsible for the preponderance of problem loans. As it turned out, 12 companies accounted for around 25% of the entire banking sector’s NPAs.

However, after several banks (particularly State Bank of India) published personal details and photographs of willful defaulters and their guarantors, the RBI cracked down on them, surmising that the banks were not limiting their disclosures to the worst cases. In April 2016, then-RBI governor Raghuram Rajan contended, “Sometimes you default on your credit card bill. Would you like that default to be put up in public? If every time you defaulted, it was put up in public for your neighbors and relatives to see and no reason was given, you might have some concerns.”

In a landmark move announced in May 2017, the government issued an ordinance to amend Section 35 A of the Banking Regulation Act – allowing the RBI to oversee individual cases and directly pressure borrowers into repaying their loans.

Finger Pointing
The NPA crisis has been plagued by a blame game. The center has been blaming the banks for not doing enough to tackle the NPA issue; and the reluctance from the banks’ side seems to stem from an incentive to under-report: Classifying loans as “sub-standard assets” would entail provisioning, which hampers the banks’ ability to lend.

Banks are also wary of creating a negative or aggressive public image, particularly with respect to large corporate loans. Lenders are wary of enquiries by vigilance committees later on, who look into the writing-off of loans on the earliest signs of frailty. This is when the onus is shifted to the RBI – to prevent the under-reporting of bad loans, more thorough and regular inspections into banks’ classified loan categories seems like a plausible preventive measure.

Even though the central bank has been instructing other banks and setting up committees to resolve the NPA crisis, inadequacies and flexibilities in the implementation of regulations have so far not yielded any substantive outcomes.

A July 2017 release by CRISIL suggests that banks may have to take a loss amounting to Rs 2,400 billion, in order to account for 50 massive bad loans to the tune of Rs 4,000 billion. The 50 loans to the metal, construction and power sectors account for half of the NPAs recorded in March this year.
Such haircuts are usually invoked when other resolution strategies don’t work and there is minimal hope of recovering the loans. The intensity of this haircut reflects the challenges faced by India’s banking sector – in many senses, the veritable backbone of the economy.

No Quick Fix 
Recent steps taken by the RBI will take time to show results. The institutional changes may indeed bring about faster outcomes than other restructuring mechanisms so far, but recoveries will still entail taking losses from loans that have not seen the light of day, until now. It is important to note that this is no ordinary crisis: this is a large and complex multi-billion-rupee debt bankruptcy, and requires well-thought-out solutions from the political economy.

Acharya, who is on leave from New York University’s Stern School of Business and has been studying global banking crises for years, has been warning that failure to take decisive action will lead to the kind of financial stagnation that Japan suffered in the 1990s “lost decade,” which has had lasting after-effects.

Italy is currently confronting a banking crisis that is seen as cautionary for India. The establishment of “bad banks” to work out non-performing assets helped Ireland and Spain, and now Italy is looking to the European Central Bank for guidance along those lines.

Acharya’s approach involves establishment of bad banks and taking a hard line with defaulters, which he characterises as “tough love,” to prevent NPAs from becoming unmanageable.

In the final analysis, transactions between honest borrowers and lenders can lead to NPAs. It becomes calamitous when problems are allowed to grow and fester for years and inflict significant pain on bank balance sheets. The resulting macroeconomic credit crunch can then affect money circulation, investments, development and overall economic growth, as India has experienced since 2011. The roots of the NPA problem are widespread, and only time will determine whether the new strategic tools are equipped to solve the crisis at hand.

Thursday, August 24, 2017

If Infosys Is India's Apple, Nandan Nilekani is Our Steve Jobs

This article was first published in www.news18.com on August 23, 2017

The Institutional Investor Advisory Services (IiAS) and the institutional investors have written to the board of Infosys to bring back co-founder Nandan Nilekani to stabilize Infosys and calm the nerves of investors.

Promoters returning to head the companies they founded is not a new phenomenon. Steve Jobs returned to Apple when the company was floundering, Howard Schultz returned to Starbucks when recession hit the company hard, and closer home, Narayana Murthy was brought back to Infosys in 2013 to restore its “bellwether status”.

It is therefore not surprising that the Institutional Investor Advisory Services (IiAS) and the institutional investors have written to the board of Infosys to bring back co-founder Nandan Nilekani to stabilize Infosys and calm the nerves of investors.

The sudden but impending resignation of Vishal Sikka due to the alleged “false, baseless, malicious and increasingly personal attacks” on him by Murthy (representing the founders) brought back the Infosys board back to square one, and their search for a new CEO began immediately. Chief operating officer UB Pravin, an Infosys veteran, was made the interim CEO and MD. Search for a CEO of a company as large as Infosys is always challenging.

Outside candidate: Any outsider with the right credentials to head the company will need to tick the right boxes so that the sword of Murthy does not hang on his head, like it did in the case of Sikka. If the potential CEO is from the US, he would have to compromise on salary. He would be expected to be “a compassionate capitalist”. He would be expected to uphold the standards of governance that meet Murthy’s approval, board approval won’t be enough. He would have to spend time and energy on replying to allegations made through press meets and open letters. And then he must perform as well. Can we imagine a Satya Nadella or a Sundar Pichai operating thus?

Internal candidate: T V Mohandas Pai, a former board member, CFO and head of human resources, education and research at Infosys, had said in an interview in 2013, when Murthy was brought back in an attempt to stabilize the company, that many good senior people left the company because of the succession of founder-CEOs. Good people were discriminated against because founders took turns to become the CEOs even if they were not the best suited for the role. Many others left the company after Sikka became the CEO, probably due to a change in culture under Sikka, as also better opportunities outside Infosys. Executive like Pravin (the current interim CEO), Ranganath D Mavinakere (CFO), Ravi Kumar S, Rajesh Krishnamurthy, etc. were around even in 2014 when the search for a CEO was on and they were not selected to lead the company. Appointing one of them now will be a ‘compromise’. It may calm the nerves of the founders and the investors for the time being, but may not be the best decision to take the company into the next orbit of competitiveness.

That leaves us with the founders themselves.

Founders: Murthy has already had two stints at running the company. Why not a third? Given the acrimony between the board and him, in the current scenario, it is impossible. Except, Nandan Nilekani, who was the CEO of Infosys from 2002-2007 and co-chairman from 2007-2009, none of the other founder CEOs have had an excellent track record. To be fair to Kris Gopalakrishnan, he tided over the recession of 2008-09. He could be an option, but it seems unlikely that he will be called back. That leaves us with Nilekani.

With the domestic institutional investors clamoring for him, his personal equation with Murthy, his stint at Unique Identification Authority of India (UIDAI) and a man who has kept up with technology and played a major role in digitizing India, he does seem like someone who could work.

At this juncture, in the best interest of the company, debates like founders versus outsiders, old guard versus new blood, could be kept aside. Nilekani, if he accepts to come back to the company, must do it for the long term though. It should not be a stop gap arrangement, like it was when Murthy was called back in 2013. Nilekani has age at his side. He is just 62. He should steer the company to the next orbit in the next 7-8 years while grooming a couple of people to take over the mantle when he finally retires.


The founders faltered in succession planning in their first stint at Infosys. They should not repeat the mistake when they get the chance to do it in the second stint. With this, we hope that Nilekani does accept to come back to Infosys!

Wednesday, August 23, 2017

Infosys and Its ‘Shareholder-Activist’ Founders

The article was first published in GARP Risk Intelligence, August 23, 2017

A clash over the Indian IT giant’s corporate governance plays out in public – and a CEO departs.
“. . . the distractions that we have seen, the constant drumbeat of the same issues over and over again, while ignoring and undermining the good work that has been done, take the excitement and passion out of this amazing journey. Over the last many months and quarters, we have all been besieged by false, baseless, malicious and increasingly personal attacks. Allegations that have been repeatedly proven false and baseless by multiple, independent investigations. But despite this, the attacks continue, and worse still, amplified by the very people from whom we all expected the most steadfast support in this great transformation.”
Thus wrote Vishal Sikka, the ex-CEO of Infosys Ltd., in his August 18 resignation letter to the company’s board. He further asserted that such distractions were damaging to the company and inhibit value creation.
Earlier, in June, Infosys, the NYSE-listed Indian company that was the quintessential dream of information-technology job seekers in the 1990s and early 2000s, had made a veiled reference in SEC filings to its seven founders as a risk:
“Negative media coverage and public scrutiny may divert the time and attention of our board and management and adversely affect the prices of our equity shares and ADSs”.
“Actions of activist shareholders may adversely affect our ability to execute our strategic priorities, and could impact the trading value of our securities”.
R. Narayana Murthy, Infosys founder and CEO from 1981 to 2002, chairman and chief mentor from 1981 to 2011, and chairman emeritus from 2011 to 2013, was, and still is, one of the most admired entrepreneurs of his generation – not just for what he achieved with Infosys, but also for the values that he stood for and an attitude that inspired millions who dreamt of a better India with economic liberalization in 1991.
Activist shareholders” in the SEC filings is an obvious reference to the seven founders of Infosys, now collectively holding about 13% of its shares (including shares of their family members), who are no longer associated with the company in any executive or non-executive position.
This article looks at the history of Infosys and the reasons that compelled the company to list the actions of its founders as a risk. The experience suggests that for the well-being of the company, the “founder’s mentality” must be retained, but the founders themselves must let go.
The Journey
Seven friends, with a personal capital of $250, started what is now the second-largest IT company in India, with revenues exceeding $10 billion, a market capitalization of more than $36 billion, and more than 200,000 employees.
Infosys ushered in an era of global IT services outsourcing, giving India the tag of “back office for the world,” in turn inspiring other entrepreneurs to start similar ventures and put money in the pockets of the country’s educated, English-speaking youth.
Apart from its significant contribution to the Indian IT industry, Infosys stood out from most others in its corporate governance practices. Under Murthy’s leadership, Infosys established itself as one of India’s best-governed and most transparent enterprises. It was one of the first in India to adopt the U.S. generally accepted accounting principles (GAAP). It received one or more governance and other corporate excellence awards in most of the years since it listed on the Indian bourses in 1993.
Management Succession
In a country where more than 90% of listed companies are family businesses and it is taken for granted that succeeding generations will join the firms when they are ready, Infosys was an exception. The founders had made it clear at a very early stage that their relatives would not follow in succession. Infosys was not run as a family business, even though Murthy often referred to the company as his child.
After Murthy stepped down as CEO in 2002, other founders followed in that role until 2014. Their taking turns did not match the highest of governance standards set by the founders in other aspects of running the company. Despite holding senior positions, they were not necessarily the best people to run the company.
T. V. Mohandas Pai, a former board member, CFO and head of human resources, education and research at Infosys, said in a 2011 interview, when he resigned after 17 years at the company, “What goes against me? Seniority. You are discriminated against because the founders have spent longer years.”
Pai added: “I don't agree . . . you have to go by the person best suited for leadership over the next five years.”
Aside from going against meritocracy in appointing founders as CEO, Murthy was brought back in 2013 in an attempt to stabilize the company. Infosys was criticized for not finding a suitable leader from within or outside, and for not looking beyond the founders. Pai said that many good senior people left the company because of the succession of founder-CEOs.
When the last of the founder-CEOs, S.D. Shibulal, expressed his desire to retire, the search for a non-founder began. The board’ s Nominations and Governance committee selected Vishal Sikka, a member of the executive board and chief technology officer of SAP and a Stanford University Ph.D. in computer science, as CEO, effective August 1, 2014.
The remaining founders, including Murthy, voluntarily stepped down from all Infosys positions by October 14, 2014, and are no longer on the board of directors.
Alleged Governance Lapses
Reports of the founders’ dissatisfaction with the board and management began surfacing in April 2016, when a majority of the founders abstained from voting for an extension of Sikka’s term as CEO. Just a couple of months before, Sikka was given a 55% raise in compensation, to $11 million (including both fixed and variable components) for the 2016-’17 financial year. Perhaps this did not go down well with the founders. Murthy has said that he is “a capitalist in mind, a socialist at heart – a compassionate capitalist.”
There was further reaction in May 2016 when Infosys disclosed in its annual report a severance package of Rs 174 million ($2.7 million) – considered well above industry norms – for former CFO Rajiv Bansal, who quit in October 2015. The founders were reportedly unhappy with the delay in disclosure was well as the amount. There were also reports that the founders objected to the $868,250 severance paid to former chief compliance officer and executive vice president David Kennedy, who resigned January 2, 2017.
Murthy Speaks Out
A series of media interviews with Murthy in February 2017 brought the founders’ displeasure into the open: They were unhappy with governance standards, timeliness of disclosures, due diligence at the board level, the role of independent directors, and a perceived straying from the core corporate values.
“Overall, the issue is whether the remuneration and nominations committee and the board is actually spending adequate time on these issues,” Murthy said. “Are they asking questions like, is this what happens normally in India, or what will the world think of us if we pay such huge sums? Third, are we going to pay such huge sums to future key people that leave the company? What is the financial implication on the company, financial liability for the company?
“There are lots of questions that need to be asked before you come to a conclusion to change the policy from one of three-month severance to such a large sum.”
In a February 10 interview with the Economic Times, Corporate Governance Badly Down at Infosys . . .,  Murthy said, “We strove hard right from the day Infosys was founded till the day we left the company voluntarily on October 14, 2014, to make Infosys the best-governed company in India . . . However, since June 1, 2015, we have seen a concerning drop in governance standards at Infosys.”
Figure 1

In an April 2017 letter to the media, Murthy raised questions about the compensation hike of chief operating officer U.B. Pravin. The heart of the matter was “striving towards reducing differences in compensation and equity in a corporation,” Murthy wrote.
The Company Responds
Infosys denied any wrongdoing, said the salary increases of both Pravin and Sikka were justified, and acknowledged misjudgment in the severance package to Bansal.
R. Seshasayee, independent director and current chairman of Infosys’ board, said, “It is a challenging transition [from being promoter-managed to professionally managed] and we have to deal with it in a sensitive fashion. This does not mean that the board and the founders have divergence. I passionately believe that this model of professional board and management is the right model for the country.”
Murthy, by airing his grievances through the media, forced the company to go on the defensive and counter the negative publicity – no doubt at some expense and explaining why “activist shareholders” represented a risk to be cited in SEC filings.
On August 10, the Economic Times   reported  that the Infosys board, while fully supporting CEO Sikka, was open to giving Murthy “a formal role if [he] wishes it.
The following week, on August 18, Sikka resigned as CEO and managing director of Infosys. Pravin was made interim CEO and MD, and a CEO search began yet again.
Founders’ Qualities
Research reveals that companies that consistently grow and perform well retain their founders’ mentality; an insurgent’s mission, an owner’s mindset, and obsession with the front line. (See: Chris Zook and James Allen, “The Founder’s Mentality: How to Overcome the Predictable Crises of Growth,” Harvard Business Review Press, 2016). The ones that don’t tend to face problems of bureaucracy, loss of accountability, lack of clarity of roles, etc. A founder’s mentality can overcome these, and it can be leveraged by effective leadership, not necessarily that of a founder.
From the beginning, Infosys’ founders had the qualities necessary for creating a great company. But that did not mean that Sikka was not capable to carry out the mission.
While the values of “compassionate capitalism” are appreciable, why would an executive who might be able to earn much more elsewhere agree to work at Infosys? While founders might be in a position to sacrifice high salaries because they own shares that appreciate and pay dividends, non-founders do not have comparable equity stakes.
Letting Go
The Infosys board members  are people of eminence and extremely well qualified. There is no reason to believe that they will not act in the best interests of the company and its shareholders. There can be mistakes of judgment, to which they must be held accountable, but there does not have to be a sword hanging on their heads.
The founders, meanwhile, must have faith in their decision to hand over the company to a non-founder, non-family professional. And they must let go. Now Sikka has resigned; tomorrow it will be somebody else if they don’t allow the executive to function.
They can, as shareholders, question policies and seek answers. But founders are not ordinary shareholders. Their words have greater impact; they must keep their position in mind and choose the right platform to raise any issues. Inviting unwelcome public attention in a “trial by media” is not the best course for corporate governance.


Tuesday, August 22, 2017

Murthy is a hero. Yet, he faltered.

This article was first published in www.forbesindia.com on August 22, 2017; Co-author- S. Subramanian

The founders may be right in fighting tooth and nail to uphold the standards of governance at Infosys, but the approach is at fault

When in doubt, disclose
Infosys came out with its Initial Public Offering and raised around Rs 90 crores in the year 1993.  As the company waited for the government approvals for capital investments, the board decided to invest part of the funds raised in the stock market. Unfortunately, those investments suffered losses due to weak market conditions. The laws and regulations at that time did not require Infosys to reveal it to the shareholders. However, Infosys leadership decided to disclose it in the annual report, arguing that the funds belonged to the public and hence they were ethically bound to disclose the stock market misadventure. They refused to be merely legally complaint. They ignored the warnings by experts that Infosys being a new company, disclosing such misadventure would result in severe shareholders’ backlash. Thankfully the shareholders were appreciative of the transparency and supported the leadership. Mr. Narayana Murthy famously said at that time “When in doubt, disclose”.

Something dubious?
In February 2017, two anonymous whistle-blower letters alleged that the USD 200 million Panaya acquisition by Infosys in 2015 was overvalued. Similar allegations were made against the acquisition of Kallidus Inc. (d.b.a Skava).  The complaints to SEBI indicated that the unusually high severance package to the former chief financial officer, Rajiv Bansal, was to cover up the wrongdoings in Panaya and Skava deals. Bansal resigned in October 2015. His annual compensation in the financial year 2014-15 was Rs 4.72 crores. On his resignation, Infosys agreed to pay him Rs 23.02 crores that included a severance package, accumulated bonuses and salary. However, this high severance package was not disclosed immediately and was revealed only when the company published its annual report in May 2016. After the shareholders’ backlash, in September 2016, the company announced that it had stopped the remaining tranches of payments to Bansal.  The whistle-blower also questioned the high severance package to general legal counsel David Kennedy who quit in January 2017. It was alleged that Kennedy wrote an email to the CEO, Vishal Sikka, that he could no longer hide the reasons behind Bansal's high severance package.

The Issues

Disclosure: The company set up an independent probe by international law firm ‘Gibson Dunn & Crutcher’ and risk investigation firm ‘Control Risks’ after Murthy went public in February 2017 with his displeasure over the alleged wrongdoings and non-disclosure/non-timely disclosures by the board and leadership. The probe submitted its report in June 2017 clearing the company of any wrongdoing in Panaya and Skava Deals. However, the company refused to make the report public. This precisely is the problem that the founders have with the top management of Infosys- their refusal to disclose the report is against the motto that founders followed at Infosys, “When in doubt, disclose”. Under the founders, Infosys always set the standards in Corporate Governance whether it was disclosure or board practices or top management compensation. However, it is those corporate governance standards that the board and Sikka were compromising on while running Infosys, feared Murthy.

Independence of the Board: Murthy also indicated that the appointment of Punita Kumar Sinha, wife of Union Minister Jayant Sinha as an Independent Director in January 2016 was a violation of Infosys principles, despite the credentials of Sinha.  He argued that Infosys competes with its peers for Government contracts and having a highly politically connected person on the board creates a conflict of interest situation.  This is against the board standards set by Infosys, which had constituted committees like the Audit Committee in the late 1990s, well before they became a regulatory requirement.

Compensation: Similar was the case with top management compensation. Despite the fact that Infosys market capitalization had been growing at CAGR of more than 50 percent between 1993 when the company listed and 2014 when the founders quit the company, the founders were never known to take high salaries. However, Sikka’s compensation was Rs 48.73 crore for the financial year 2015-16 and the compensation of Mr N. Chandrasekaran, then CEO of TCS, the bigger peer of Infosys was Rs 25.66 crore. Murthy argued that such high salaries were against Infosys's 'compassionate capitalism' philosophy.

Infosys was a bellwether company that always set the standards, against the tide. There are many instances in the 1980s and 1990s, to indicate the ethical practices of Infosys, well before the stakeholders accepted that Infosys is an ethical company. The founders refused to bribe the customs officials to get duty exemption in the 1980s when Infosys imported its first computer. The founders did not accept that paying a bribe was the reality and fought against it. That became the culture of Infosys. This is exactly what Murthy is concerned about in Infosys and not the strategies adopted by the professional CEO.

Founders faltered in succession planning
While Murthy’s concern’s on the corporate governance issues in Infosys may be valid, the fact is that the founders are also responsible for the issues in Infosys.  They failed in succession planning. Did the founders, who took turns to become CEO of Infosys, whether or not they were best suited to run the company, nurture a successor who would be entrenched in Infosys’s value? Did the founders spend enough time working alongside Sikka to hand hold him and nurture him? The founders voluntarily stepped out just a couple of months after Sikka took over as the CEO. Why did they do it? They could have ensured continuity by spending some more time with the new leadership, as has been the case in many companies with ‘legacy’ in India.

The changing times
In 2013, Sikka’s compensation at SAP was Euro4.2 million. When he joined Infosys, his compensation was set at $5.08 million and stock options worth $2million- not a major hike from his compensation at SAP- and lower than peers globally. While Infosys founders may believe in ‘compassionate capitalism’, Sikka or any other professional CEO, would expect to be compensated for the opportunity cost. Besides, the professional CEO does not have the benefit of high shareholdings that the founders have. 

Long-term sustenance of the company
In the entire battle between the Board and the founders, the loser is brand ‘Infosys’. The founders must realize that taking their battle to the media would not go down well with the external stakeholders. While the founders may be right in fighting tooth and nail to uphold the standards of governance at Infosys, the approach is at fault. So much so, that Murthy who was a ‘Hero’, is now being seen as the ‘villain’. Even the other shareholders had shown overwhelming support to the board at the 36th annual general meeting of the company held in June this year.


The founders started this public spat, and they must end it too for the future of the company. It is time that they truly move on, especially since they are the ones who voluntarily stepped down and did not do enough to groom their successor!

Professional CEOs Successful in Legacy Companies when Promoters Move Beyond ‘I, Me, Myself’

This article was first published in www.news18.com on August 21, 2017; Co-author- Kavil Ramachandran

Founder shareholders have the right to question the CEO if the performance is not up to the mark. But they must realize their special status as the “founders” and choose the forum wisely.

Unceremonious exits of Cyrus Mistry and Vishal Sikka have sparked the debate on whether it is difficult for the professional CEOs of firms with ‘legacy’ to perform and work.

There are ample examples against it: AM Naik to SN Subrahmanyan at L&T, YC Deveshwar to Sanjiv Puri at ITC, KV Kamath to Chanda Kochhar at ICICI Bank and S Ramadorai to N Chandrasekaran at Tata Consultancy Services are just a few examples of CEOs who served/are serving companies with ‘legacy’ with aplomb. It cannot be generalized. Even in mid-sized firms like Jyothy Laboratories, professionals like Ullas Kamath have made their own identity aside from the founder M P Ramachandran.

The CEO is usually appointed after a lot of due diligence and search. Compatibility of the CEO with the values and culture of the company is an important aspect. So is the ability to take the organization to the next level. There may be many decisions that need different approach than what were taken earlier. In pursuit of long-term performance and transformation of the company there may be a path that was not trodden by the predecessor that is needed to be taken now. Different does not mean wrong. To question the decision of the CEO at each step and not allowing him to work without a sword hanging on his head is unfair and undermines the very selection process.

Passing the baton
Promoters of family businesses often find it difficult to pass on the baton to their successors, especially if the successor happens to be a non-family professional. As a result, transition in leadership is one of the biggest challenges faced by family businesses. While finding the right successor is one part of the challenge, the preparedness of the founder to retire and letting go is the other part. Continuation of the legacy and respect for what has been achieved in the past is healthy. But continued need of the founder to feel acknowledged, useful and important is not.

Succession planning
Infosys was one of the first companies in the country to follow the highest standards in corporate Governance. They faltered in succession planning though. Founders took turns to become the CEO of the company irrespective of whether they were best suited for the job or not. Many good senior executives left Infosys due to meritocracy being overlooked in favour of founders. That was perhaps one of the reasons that when the last of the founder CEO, SD Shibulal, expressed his desire to retire, the Nominations and Governance Committee of Infosys could not find anyone within Infosys to lead the company.

Even if it is assumed that Mr. Murthy has valid concerns about the governance standards at Infosys stooping after the founders stepped down voluntarily in 2014, even if it is assumed that the current board at Infosys is not upholding the core values of governance and transparency set by the founders, what cannot be denied is that the founders did not nurture a successor while at the helm of affairs. The entire Infosys and Tata saga points to the importance of succession in organizations and that the incumbent CEO or the founder do not spend enough time to tackle the issue.

I, me, myself
One of the most important life lessons that the founders and the CEOs should learn is to let go of ‘I, me, myself’ syndrome. The moment one starts taking credit for everything they start alienating people. That is perhaps what is happening with Murthy as well. In his latest letter to the media as well, there are numerous references to how things were great when the founders were at the helm of affairs. While many of his concerns may have merit, the tone of the letter alienates him from the readers and generates sympathy for Sikka.

Right forum
The founder shareholders have the right to question the CEO if the performance is not up to the mark. But they must realize their special status as the “founders” and choose the forum wisely. Else it becomes a case of ‘trial by media’ for the CEO and as Sikka said in his resignation letter to the Infosys board, “This continuous drumbeat of distractions and negativity over the last several months/quarters, inhibits our ability to make positive change and stay focused on value creation”.

Non-founder shareholders with significant shareholdings
Deutsche Bank Trust Company Americas and the LIC of India are the largest shareholders in Infosys as individual entities. Qualified Foreign Investor together hold about 38 percent shares, Insurance companies hold 12 percent and Mutual Funds hold more than 8 percent shares. Institutions collectively own about 59 percent shares. Assuming that most of these institutions have invested for the long-term, they are expected to have an in-depth knowledge of the company and seek clarifications from the board from time to time. It is difficult to believe that these institutions would blindly continue to be invested if there were governance lapses at the company.


In conclusion, the problem is not with companies with “legacy”. The problem is with people with an extended sense of “legacy”. When people start to consider that the company is an extension of their own identity and refuse to let go even after they decide to bring in a professional CEO, difficult situations arise.

Thursday, July 20, 2017

India’s Economy No Longer the Fastest Growing

As the impact of demonetization is debated, the World Bank projects a return to 7%-plus GDP growth.
  
The article was first published in GARP Risk Intelligence, July 14, 2017; Co-Author- Anisha Sircar

India’s gross domestic product growth rate fell to 6.1% in the March quarter, the final quarter of the 2016-17 fiscal year. The slowdown was not unexpected; it was merely a matter of how much. GDP growth was 7.3% in the first half of the fiscal year (April to September 2016) and 7.0% in the October-December period.

All of these numbers are below the 7.9% GDP growth of the previous, 2015-16 fiscal year, when India was the fastest growing economy in the world, according to the World Bank’s May 2017 India Development Update.

In a country where about half the population is dependent upon agriculture, and where agriculture is, in turn, largely dependent on the monsoon rains for irrigation, the economy seemed to be poised for even better growth, with heavy monsoons this year resulting in higher consumption-driven demand.

Therefore, the fourth quarter GDP data did not sit well with most economists and critics of the Narendra Modi-led government. It had demonetized high-value Rs500 and Rs1000 currency notes in November 2016, in an attempt to root out black money in India. Eighty-six percent of the country’s currency was demonetized at one go.

Critics claimed that the demonetization was a vain exercise that resulted in significant inconveniences, delivered a massive blow to the unorganized sector that is largely cash-driven, caused jobs losses, and regressed the overall economy.

Weighing the Impact

Government agencies maintained that the impact of demonetization on growth would be temporary, as GDP data does not encompass the entire health of the economy, or the total effects of demonetization. This is particularly significant because demonetization is estimated to have affected the informal sector of the economy – that which is neither taxed nor regulated – more than the formal sector. The 7% GDP figure for the third quarter suggested that the economy was almost unaffected by the demonetization experiment.

Prof. Arun Kumar, an expert on India’s black economy, writes in his recently published book, “Understanding the Black Economy and Black Money in India: An Enquiry into Causes, Consequences and Remedies,” that demonetization “created great economic hardships for many millions, and disrupted the economic momentum the country had hitherto succeeded in building up . . . The black money the government was targeting is only 1% of the black wealth held in the country, and even if the government managed to suck out all the black cash in circulation, it would not have much effect on the black economy which involves various activities in which black incomes are generated. It does not stop these activities from continuing.

“Moreover, 80% of the Rs500 and Rs1000 notes was not black money, but rather white money used by businesses and citizens. The biggest fish were able to quickly convert whatever black cash they had into white . . . [Also] it was not explained why, when high currency notes were being demonetized, currency of even higher denomination, i.e. Rs2000 notes, were being introduced – as this would be even easier to hoard.”

Can we therefore conclude that demonetization is to be blamed for the slowdown in the GDP growth rate? A closer look suggests that the economic slowdown began before the demonetization. GDP growth in the second quarter was lower than GDP growth in the first quarter, and other indicators such as the gross value added (GVA) were also revealing.

GVA is the value of goods and services produced in terms of output, minus intermediate consumption, that is, GVA = GDP + subsidies – taxes. In simple terms, it is output, as measured from the supply side of an economy.

Tax and Inflation Factors

The increased sales tax collection translates into higher net indirect taxes (NIT), accounting for a significant gap between GDP and the lower GVA. The recent growth in tax receipts, particularly from fuel and metal, was a factor in the difference. Even when global oil prices were on the rise throughout the year, India did not cut excise duties on petroleum products, and customs duty receipts on imported metals increased because of higher commodity prices.

With the rise in commodity prices, and latent demand becoming rendered after the currency was re-monetized, another factor that came into play was inflation. Its rise contributed to lowering GDP and GVA even more in the fourth quarter.

When demonetization was at its peak, the wholesale price index (WPI) inflation rate stood at 1.8% and 2.1% in November and December 2016, respectively. WPI inflation rose dramatically following re-monetization, from 5.25% in January 2017, to 6.55% in February 2017 – its highest recorded figure in two and a half years. This increase was attributed mineral and fuel prices.

Consumer price index (CPI) inflation went from 3.17% in January, two months after demonetization was announced and just as food prices began picking up, to 3.65% in February. (Re-monetisation, it seems, picked up the pace for consumption-driven demand as well.)

The sudden surge in inflation accentuated worries of a latent, untapped nexus of demand caused by demonetization. However, more recent inflation figures reveal that notwithstanding the slight optimism in GDP numbers, inflation rates began falling to multi-month lows in May, due mainly to a rarely seen drop in food prices. In April, CPI reached a historic, multi-year low of 2.99%, compared to 5.47% in April 2016, due to the deflation in food prices; and WPI dropped to 3.85%, a four-month low.

Macro Indicators Slump

While GDP growth slowed to 6.1% in January-March 2017, from 9.2% a year earlier, the GVA rate went from 8.7% to 5.6%.

The index of industrial production (IIP), used to approximate activity in informal manufacturing, showed healthy growth in the first fiscal quarter (April-June 2016) and then began tapering off. Even investments took a significant hit during the fourth quarter: fixed investment lowered to 25.5%, the lowest in 13 years; and real fixed investment dropped 2% year-on-year. High expectations for foreign direct investment this fiscal year did not revive the private sector; declines in private investment have been setting back employment generation for many years, but the repercussions of demonetization on private investments seem to have worsened this problem.

Overall, in contrast to earlier optimism, the fiscal fourth quarter was harrowing for the Indian economy, uplifted only by government expenditure and, to a lesser extent, agriculture, without which GDP growth would have accounted for only an estimated 4%.

Long-Term Rebound?

Economists such as Arun Kumar are not so optimistic – they say that not only has demonetization failed to effectively tackle the black-economy problem; it has also hurt the overall economy and the livelihoods of the poor and small traders who depend overwhelmingly on cash.

Aside from the decline in demand across the economy, better-off sectors have also been facing uncertainty, cutting back discretionary expenditure on even “white” goods. All of this, as the figures reveal, has impacted agriculture, services and industry, and will only serve to exacerbate the problem of non-performing assets in banks as industrial profits continue to decline. Since demonetization was announced, unemployment is believed to have risen, investments fallen, and banks and agriculture facing growing crises – all in spite of a good spate of monsoons. Many believe that this could turn the economy toward.

According to the World Bank, India’s fundamentals remain strong and a re-acceleration of GDP growth, to 7.2%, is anticipated in fiscal year 2018. A growth rate of 7.7% is projected for fiscal 2020, attributed to efforts to encourage the recovery of private investment through infrastructure spending and less crowding of the private sector.


The World Bank assessment concludes that in order to heighten the potential for growth, productivity enhancements, larger investments, and increasing the number of women in the labor force of India would need to be implemented.