Pledging Shares and the Mirage of Prosperity

This article was first published in Business Standard on June 24, 2019. Co-author: Prof. Kavil Ramachandran.
https://www.business-standard.com/article/opinion/pledging-shares-the-mirage-of-prosperity-119062300819_1.html

Pledging shares has become an easy option to raise funds, even for many well-known business families. Unfortunately, they do not seem to visualize scenarios where the optimistic assumptions about future performance may not always materialize. As of May 2019, 62% of all listed companies in India had pledged at least some (in a few cases all) of their promoters holding. As many as 193 companies’ promoters had pledged 75% or more of their shares and 327 companies’ promoters had pledged at least 50% of their stake. The scenario of lenders liquidating the pledged shares of defaulted borrower is very scary.

Background to Pledging of Shares

Pledging of shares where promoters use their shares as collateral to raise money is not a new phenomenon but has become popular amongst promoters in recent years. It was after the scam involving Satyam Computers in 2009 that SEBI made it mandatory for promoters to disclose to the stock exchanges of any pledging of shares.  It is often understood as pawning the “family jewel” as a last resort to tide over difficult times. Stock market sees it as a sign of weak financial position of the promoter. Promoters often pledge shares for personal use like investment in another venture or buying more shares of the company. Pledging shares in a “cash cow” company to fund a risky untested startup or a fledging business may spook the investors.

Similarly, when the promoters pledge their shares to buy more shares of their own company, on the one hand it signifies that the promoters think the share is undervalued and/or have confidence in the prospects of the company. It therefore should send a positive signal to the market. However, promoters are not only putting more of their eggs in the same basket but also taking on leverage to do so. Adding to this, the increase in control in the company is based on information asymmetry that exists between the promoters and the minority shareholders. This gives rise to insider trading and governance concerns. In a recent amendment to insider trading regulations, to promote fair market conduct, SEBI has plugged this gap by closing the trading and pledging of shares window for the promoters starting from the end of a quarter to 48 hours after the declaration of quarterly results by the company.

Dangers of Pledging

Trouble begins when the value of the pledged shares falls below the agreed level with the lenders.   Many promoters get into the trap of pledging more shares to fill the drop in value in the hope that they will soon be able to revoke the shares by repaying the amount to the lenders.

When stock prices fall or go in a downward spiral and the promoters are no longer able to either pay the money or pledge more shares, the lenders invoke the shares, and sell them in the open market. The promoters may even end up losing control, as has happened with a few companies recently.

The implications for business families are grave, particularly with a lot of their family wealth blocked up in the business. Family splits, loss of reputation and bleak career possibilities for the next generation do happen in such cases, resulting in formation of entirely new trajectories of life for everyone.

Way Forward

In a rapidly growing economy, entrepreneurial promoters naturally tend to assume that the rising graph of growth and prosperity will never fall. This is a myth. Pledging beyond small quantities is very dangerous, like over leveraging. Shares are virtual collaterals with very high potential for volatility, due to known as well as many unknowns, including news or events that are totally not related to the company, its performance or management. There is a huge possibility of share prices falling anytime.

Most bankers and lenders fail to learn from history that in a crisis, most assets become illiquid. Most of the risk models do not account for illiquidity. They assume that markets are perfectly liquid. However, that is not the case. Lenders often invoke the pledge and dump shares in the market at very low prices, translating the already downward spiral into a shock. Financial Institutions need to have built-in mechanisms and standards to ensure that investments are made in assets that can be liquidated at the lowest possible cost.

SEBI must also put in place a limitation to the percentage of shares that can be pledged, including the cumulative pledged shares after margin calls. Having pledged most of the shares and yet maintaining the voting rights may seem like a good situation to the promoters when in reality their fate is hanging by a day’s movement on the stock exchange. Or, pledging should also suspend voting rights till the pledge is not revoked. If the promoters need to raise more money, they should take a conscious decision to sell their stake in a phased manner or through a strategic sale.

The board of directors must also assert and prevent promoters from taking this treacherous road to the mirage of prosperity. As the custodian of the wealth of all stake holders, the board has a vantage view of the things to happen. It has to exercise its rights instead of being a rubber stamp.

(Bang is Associate Director and Ramachandran Professor and Executive Director at the Thomas Schmidheiny Centre for Family Enterprise at the Indian School of Business).

Goals of Workplace Inclusion Remain Elusive

This article was first published in GARP, Risk Intelligence on June 14, 2019. Co-author: Sai Nitya Bodavala;

https://www.garp.org/#!/risk-intelligence/culture-governance/conduct-ethics/a1Z1W0000054wahUAA

Data supporting gender diversity, though hard to refute, doesn’t automatically change behavior

It is well within the reach of companies to make the effort to ensure that there are more women in leadership positions, and that those who are receive sufficient support to flourish at their jobs. It costs little when compared to the profit that will come as a result of being more gender-inclusive.

Numerous studies indicate a positive correlation between profitability and the presence of women in leadership, but in practice it appears that many are unconvinced.

For example, in a 2016 paper based on a survey of 21,980 firms in 91 countries, the Peterson Institute for International Economics concluded that “for profitable firms, a move from no female leaders to 30% representation is associated with a 15% increase in the net revenue margin.”

McKinsey and Co.'s Delivering through Diversity  found that companies in the top quartile for gender equality not only had a greater likelihood of earning higher profits, but also outperformed companies in the bottom quartile by 27% in long-term value creation.

Recruitment firm Phaidon International, surveying its employees in 2018, found that six out of 10 felt that management did little to promote the benefits of gender diversity in the workplace. Seven out of 10 employees believed that whenever the issue of gender diversity came up, it was presented as a matter pertaining to human resources, rather than its potential contribution to the goal of diversity.

Employees' lack of awareness of the benefits that women can bring to the table, as well as managements' apathy with regard to educating them about it, paints a dismal picture. This is because in many cases, the management is itself unconvinced of this fact.

In a survey that IBM conducted of 2,300 executives and professionals worldwide, 43% could not definitively answer yes or no when asked if they thought gender-inclusive companies were more successful financially. Two-thirds believed that women weren't in leadership positions because they were more likely than men to prioritize their families over their careers.

It seems counterintuitive to think that executives of companies that primarily chase profit would be unaware of evidence linking gender diversity to profit. It may be more of an issue of prejudice than lack of awareness.

Preconceived Notions

Certain ideas have become deeply rooted regarding what a woman can and cannot, or must and must not, do. In India, where gender roles are rigid, women who are in the workforce face a double-edged sword. On the one hand, being assertive and being go-getters leads to them being perceived as “bossy” or “insufferable.” On the other hand, being quiet and conforming to what is asked of them reinforces the general idea that women are subservient and unsuitable for positions of power.

Those who make hiring and firing decisions seem to have skewed ideas of what women are supposed to be like. This idealized perception does not allow them to see the reality. When these two versions are presented as diametric opposites, companies are discouraged from hiring women.

According to a study by LeanIn.org and McKinsey and Co., participants (employees) “rated mothers as the least desirable job candidates and deemed them as less competent and committed than women without children or men.” Companies subscribe to the notion that motherhood makes the quality of work suffer. What is often overlooked, however, is the boost in productivity that could occur if companies chose to accept the reality of motherhood and to support women instead. If working mothers were assured of a conducive work environment and policies that facilitate their growth, it could greatly decrease turnover rates as well as the cost that companies incur when hiring and training replacements for those who leave.

Not an Immediate Issue

Gender equality isn't considered to be an immediate concern. Although the benefits of having more women in leadership positions are undeniable, less-inclusive organizations aren't necessarily suffering huge losses. So long as profit-making doesn't seem to be affected, companies just push the problem to tomorrow. It is far easier to blame the societal perception of women than to try to create and implement inclusive policies.

Not recognizing and addressing the issue of gender inequality means that fewer steps are being taken to bring women into leadership positions. The lack of women at the decision-making level means that there aren't enough people invested in the problem to bring it up and address it, which perpetuates this vicious cycle.

Investment in Inclusion

Effective inclusion takes time, research, money, collaboration and constantly evolving ideas.  Companies lack incentive to invest when the pay-off could take a while. Further, a bias training program or a policy borrowed from another organization does not amount to inclusion.

Inclusive policies must begin by keeping in mind the employees currently working with the company and those that it wishes to hire. It is fairly easy to label as corporate policy a checklist that contributes little to employees' well-being. For a policy to work, it has to be well-researched and thoroughly thought out.

Organizational support is crucial for implementing and sustaining inclusive policies. Over time, the idea of inclusion must be built into the very culture of the organization. As a result, when issues come up, there are mechanisms in place to handle them. On the other hand, dealing with problems as and when they come up is not very efficient. It also does not allow for the company to come up with new and innovative ways of inclusion, instead being far too busy putting out small fires.

Misled Men

IBM's study brings out the misconceptions that men have about working women. Sixty-five percent of the male respondents said that they would have been just as likely to be promoted if they were women; 68% said that they would have received the same compensation had they been women.

That just indicates how far society still has to go in making gender equality a reality. Men are not bystanders, but rather active participants who play a pivotal role in ensuring the closing of the gap between genders.

Excluding men from the conversation about equality only serves to alienate those who currently hold most of the decision-making power. IBM found that 75% of the male executives were willing to commit to certain measurable outcomes that would bring about greater equality over the next five years.

Conclusion

The reasons for companies holding back from implementing inclusive policies are many. It is naïve to think that mindsets and norms that have developed over decades will change overnight. However, it is undeniable that change is not around the corner, but here and now, and soon older attitudes will lose their sway. Every woman who has managed to reach a leadership position that allows her to change conventional ideas, every company that helps women grow and come into their own, and every woman who has just entered the job market, ready to take on all of the challenges that it poses, is proof of that.

The Secret Sauce

This review was first published in Business Today, June 30, 2019

https://www.businesstoday.in/magazine/the-break-out-zone/the-secret-sauce/story/354889.html

The Made in India Manager- R. Gopalakrishnan and Ranjan Banerjee

Hachette Book Publishing India Pvt. Ltd.

4^th and 5^th Floors, Corporate Centre,

Plot Np. 94, Sector 44, Gurugram, India

First edition (2018)

Rs 499/-

A look at the factors that work in favour of global managers who have grown up and had their foundational education in a chaotic India

Buying a gas connection, bargaining with vendors, living in a joint family, navigating traffic, getting admission to a good school/college or securing a job - the Generation X who grew up in India had experienced them all and also witnessed their parents struggling with the same. Chaos and contradictions, competition and perseverance often rule people's lives in this country, and they mostly manage to deal with those. This is the environment that the authors, R. Gopalakrishnan and Ranjan Banerjee, have written about, weaving a meaningful narrative to explain why India-made managers succeed globally.

Terabytes have been published about India's English-speaking population (leading to a multicultural mindset), jugaad economy (read resourcefulness in a challenging environment), crushingly competitive environment (for top-rung education and good jobs) and the steady supply of highly innovative alumni from genius factories - the IITs and the IIMs. But the writers, both of them business experts, think a concoction of all these factors could help explain the unique capabilities of India-made managers who have been elevated to top positions in global corporations such as Google, Microsoft, Adobe and NIO over the past decade or so.

Sundar Pichai, Satya Nadella, Shantanu Narayen, Padmasree Warrior and their ilk "have received their foundational education and degrees in India till the age of eighteen and a little later. They have had prolonged exposure to Indian institutions... They have experienced the collage of strengths, contradictions and anomalies that make up India on a daily basis. After this foundational exposure, these managers may have studied or embarked on a career abroad. Over the course of their professional lives, they have most likely travelled internationally and been through a process of cultural adjustment and adaptation,..." the book elaborates. And the authors attribute their success to this very factor, highlighting how this environment impacted their decision-making and crisis-preparedness - most critical qualities of a successful manager.

Understandably, the theory of emergence is in play here. Simply put, it is the synergy of many factors, but the combined effect could be distinctive and produce unexpected results. "Poverty and living in cramped spaces occur in San Salvador and Egypt as well. Family values and the pursuit of a better standard of living is a recurrent theme in every society. But the combination of challenges in India is quite distinctive. Navigating those challenges while growing up endows distinctive capabilities in made-in-Indian managers," the authors explain. The outcome: Single-minded focus and soft power that these managers seem to be exerting over the global corporations where they work.

Next comes the evolution of their thoughts, practices and future trajectory. The book chronicles how managers of yesteryears in companies like HLL, Metal Box and ITC have metamorphosed and led from the front in organisations such as Sun Microsystems, Berkshire Hathaway and Google. It can be argued, though, that they are the outliers who left India at the right time and were good at tapping opportunities. It will be interesting to know the ratio of successful made-in-India managers to other made-in-India Indians settled abroad or the corresponding ratio of Chinese or European or American managers. And what about the Indians who failed? They too have grown up here before moving (the book does not include Indian-origin people born and brought up overseas). So, how do we explain their failures?

This is where the problem lies. According to the authors, the book is based on their experience and that of their acquaintances and the anecdotes shared with them. So, I am assuming that the samples will be too few and skewed for a vast country like India. It cannot be generalised. The Satya Nadellas and the Sundar Pichais are a minuscule percentage of our population, and the book requires more research to rise above personal experiences. But then, everyone needs role models, and good stories must be shared. To that extent, the authors have succeeded in "offering a sense of possibility".