The Magnificent History Of Indian Family Businesses

This article was first published in Family Business United blog on June 22, 2020;  Co-author: Yashodhara Basuthakur; https://familybusinessunited.com/2020/06/22/the-magnificent-history-of-indian-family-businesses/
 
India has a rich and magnificent history of family businesses. The country’s rich history and culture have molded the edifice and character of family businesses over the years. The joint family system was the backbone of these businesses and provided the required resources and capital for the cohesion and growth of the firms. In the early eighteenth century, India was predominantly an agrarian economy, with a deep-rooted caste-based social system that defined the occupational choices of the communities. Agriculture was the primary source of income and livelihood. The manufacturing industries were few and mostly in textiles, handicrafts. But India was lagging in the development of the economic, political, and commercial infrastructure essential for trade pursuits.
 
The turn of the eighteenth century marked the transition from mercantile capitalism to industrial capitalism. The colonial rule led to the decline of the vibrant Indian merchant community. The Indian businesses faced discrimination in trade, policy and bank loans. During the Industrial Revolution in 1850, India became the supplier of raw materials and a market for the products of the British factories (cotton, iron and steel, chemicals, etc.). Some of the businessmen who emerged during this time were the Birlas, Kasturbhai Lalbhai, Walchands and the Tatas. They constantly criticized economic racism and created bodies of commerce and trade associations to lobby for the Indian companies. They invested in research and development and introduced new product lines. The Indian led business enterprises had expanded in scope and scale across the country by the end of the 1940s when India gained Independence.
 
The Indian family businesses also actively engaged in social causes and philanthropy through generous contributions to charitable trusts and other institutions driven by the cultural and religious traditions of “daan” (giving) as a sense of duty to the community. They played a pivotal role in institutional building by partaking philanthropic activities such as setting up premier educational institutes, research, and cultural centers for the progress of the country.
 
The post-independence period marked with communal unrest was not very conducive for business. Additionally, the new Industrial Policy (1948)[1] of free India was introduced which saw increased participation of the government in economic affairs. The large-scale nationalization and government monopoly of critical industries such as utilities, transportation, iron and steel, heavy industries, armaments, atomic energy, manufacturing curbed the freedom of operations of the private enterprises. The Monopolies and Restrictive Trade Practices Act, 1969, put severe bottlenecks with respect to the quantities and types of goods or services that could be produced by the private sector. The firms now had to obtain licenses or permits to expand or start new businesses. Because of the limited licenses and capacity constraints, firms focused on diversifying into areas wherever they could acquire the required licenses instead of building on their core competencies.
 
Some of the multigenerational business houses focused on restructuring by consolidation and expansion within the new framework by acquiring overseas companies and expatriate houses to enter new industries. Other business houses acquired a significant number of licenses to thwart competition and block other firms from entering the space. Also, there was a new genre of technology-savvy entrepreneurs who were well-educated with degrees from abroad and joined their family business or started new ventures. Some of the legacy business groups even lend their expertise in areas like engineering, iron and steel (Tatas) and shipping (Walchands) to the newly formed government enterprises. However, this period also witnessed some of the older business families already in their third generation going through splits due to waning family ties. The families had not yet adopted professionalization, and the dominant family coalition still controlled the ownership and management.
 
The economic liberalization in 1991 was a landmark decision which opened the economy and introduced several macroeconomic and structural reforms. These reforms brought in a gamut of opportunities and challenges for the family businesses. While the businesses now had to compete with foreign multinationals and new entrepreneurial organizations for capital and resources, but they could now enter sectors which were earlier exclusively reserved for the public sector. The family firms were quick to restructure and respond to environmental changes. Some of the multigenerational businesses were able to weather the turn and came out triumphant in the new economy, while others who couldn’t sustain disappeared from the thriving business scenario. This era also witnessed the dawn of a new set of stand-alone first-generation family firms who harnessed the information-led economy by investing in research and technology.
 
A study on Indian family firms by Bang, Ray and Ramachandran (2017) looks at the listed firms during the period from 1990 – 2015. The study categorizes the firms based on ownership and management into two categories, namely family business group firms (FBGF) and stand-alone family firms (SFF) [2]. According to the study, ninety-one percent of the listed firms are family-firms, which is a key driver of the Indian economy. A synopsis of the findings is tabulated in Table-1.
 
In the year 2015, the top 30 family firms contributed to almost 50 percent of the total revenue of all listed family firms, which translated to 13 percent contribution to the GDP of India. Overall, listed family firms contributed to 26 percent of the GDP (Total Income). Out of the listed family firms, the FBGFs contributed to 21 percent, and the SFFs contributed 5 percent to the nation’s GDP. The family firms contributed to 28 percent of indirect taxes and 18 percent of direct corporate taxes collected by the government exchequer.

The family-firms built more assets in the manufacturing sector, which has a long-standing impact across all industries. The SFFs were predominantly in the services industry, owned and managed by the founder (or first-generation). The SFFs played a critical role in the rapid development of the services sector and generated large-scale wealth and employment opportunities. During the post-liberalization period, there was increased participation in equity markets by the family firms to meet the financing needs for expansion and growth. Among the listed family firms, the firms incorporated before the 1980s were more likely to create business groups as a response to the macroeconomic conditions. The average age of the listed FBGFs in the sample is 38.44 years, whereas that of SFFs is 28.73 years.
 
The family firms have displayed resilience, character, and adaptability over their long history and played a pivotal role in India’s growth story. However, with the current shifts in the economy and society, there are major challenges that family businesses must surmount. The family firms at the crossroads of succession have to take the decision on either to transition to next-generation or professionalize by inducting non-family managers. The family firms have to adhere to stricter and transparent corporate governance guidelines, better leadership and connect with the community to continue to chart the success story in years to come and ensure the perpetuity of the business and family.

[1](Ministry of Micro, Small & Medium Enterprises, 1948)
Statement of Industrial Policy, 6th April 1948, No. – 1 (3) – 44 (13) / 48, Ministry of Small-Scale Industries, Government of India, New Delhi.
 
[2] (Bang, Ray, & Ramachandran, 2017)
Bang, N. P., Ray, S., & Ramachandran, K. (2017). Family Business The Emerging Landscape 1990 to 2015. Thomas Schmidheiny Centre for Family Enterprise, Indian School of Business.

The Impact of the Coronavirus on Investment Decisions

This article was first published by the Global Association of Risk Professionals, Risk Intelligence, on June 19, 2020; Co-author: Anisha Sircar; https://www.garp.org/#!/risk-intelligence/market/investment-management/a1Z1W000005VYeIUAW

As the world heads toward a global recession, with plunging equity markets and countries facing severe economic downturns, there are uncertainties and strong beliefs that have practically divided the world into the optimists and the pessimists. There are those, for example, who make rash, seemingly opportunistic investment decisions, and those who are more measured in their financial approach. Those who unwittingly indulge in herd behavior, and those who are less prone to such external influences.

What's more, there are those who are extremely cautious, favoring extended lockdowns and total isolation, versus those who have a more “que sera, sera” approach to COVID-19, supporting getting back to normal as early as possible.

It's easy for one group to feel that the other group is being unreasonable. The pandemic's unprecedented impact on our lives, both in the short and the long run, makes people highly susceptible to making decisions they would have otherwise avoided.

In this article, we reflect upon the financial and investment decisions being made by people in the backdrop of the pandemic, and the dichotomy facing risk managers and investors. What are the obstacles standing in the way of investors making rational decisions and avoiding unnecessary risks in a time of crisis?

Bias

When analysts, policymakers, “experts,” and/or news reports offer statements and opinions, it's sometimes assumed that they know what they are talking about. However, people find opinions credible as long as it confirms their own thoughts or anxieties, or as long as they seem like “educated” or even consensus-based guesses. This can involve a range of biases, from herding behavior, to action biases, to confirmation biases.

When COVID-19 hit markets, it resulted in phenomena such as dwindling risk appetite and investor interest and declines in the perceived values of stocks. That led to dramatic drops in stock prices, wiping out any potential investor gains.

Herding behavior is tricky with respect to risk appetite and investing. It drives markets toward excesses during market upturns and nose-dives during downturns. It's why stock indices in India, the U.S. and Europe plunged, especially between mid-February and mid-March this year, and why circuit-breakers were triggered several times in recent months.

In India, the major indices lost 40% in just two months. While it might be natural to get carried away with all the noise and the herd, turbulent times like these call for more reflection, rather than panic selling. Investors in countries like India have been used to more euphoric highs over the last few years, and the losses on investments therefore now seem particularly painful.

Markets in India spiraled almost immediately into a “bull phase” in a fortnight, recovering 20% from the bottom. However, it's important to keep in mind that, by and large, market indices have rebounded and hit new highs after every previous global financial crash. So, despite the noise, this may be the time for anxious decisions to hit pause.

Shortsightedness

In 1995, Shlomo Benartz and Richard Thaler conducted a study titled, “Myopic Loss Aversion and the Equity Premium Puzzle.” The researchers asked: How much will the equilibrium equity premium fall if the evaluation period (of a portfolio) increased? In other words, is checking and re-checking your portfolio beneficial or detrimental to how well it does?

Their research found that more frequent checkers show considerably lower portfolio performance over time. “In a sense,” they concluded, “5.1% is the price of excessive vigilance.” Long-term profits can be found where there is courage to move away from the crowd — and think long-term.

On the other hand, there are those who did bottom hunting when the markets crashed and are now raking in the moola.

In essence, investors who hit the pause button (the que sera, sera group) felt that those who were rebalancing their portfolios were being myopic; on the other hand, those who were actively trying to buy and sell thought that the other group was simply being “stupid.”

However, in the end, every investment decision needs to incorporate the risk appetites and the risk-taking capability of people. Someone may have a higher risk appetite – but if the capability to absorb a huge loss is low, then wait-and-watch is perhaps a better approach than investing in uncertain times.

Overconfidence

Psychologist Daniel Crosby believes that uncertainty often leads to two kinds of behaviors —compensatory over-confidence or worst-case scenario thinking, neither of which results in smart financial choices.

While the volatility in markets during the pandemic may be partly attributed to panic, investor overreaction (which led to excessive trade volume) was certainly another cause. This is reflected in how markets have periodically surged because of overconfidence about the worst of the virus having passed.

Shortly after these surges, indices are found plunging back down again. The phenomenon is also reflected in how “experts” have been making a variety of assertions in the recent weeks, guaranteeing that investors will be spared the pain that others may be experiencing.

Overconfident people, write researchers Mao Zhang and Yi-Ming Wang, “may perceive themselves more favorably than others perceive them, or they may perceive themselves more favorably than they perceive others. (…) It is common for most people to rank themselves as better than the median.” Moreover, they note that it's also “common” for men to trade more excessively than women, and for individual investors to show more confidence than institutional investors.

This plays a significant role in market volatilities, because overconfident investors are usually quick to buy on margin ahead of a stock market crash. In the run-up to the Great Depression, the “Roaring Twenties” saw a lot of overconfidence, and several investors used large margin positions to leverage their beliefs. But this caused an asset bubble, and when the depression hit, they lost everything they owned. Indeed, they even owed large sums of money, ultimately leading to banks having to declare bankruptcy — and everybody losing.

The takeaway? Avoid overconfidence: think long and hard before buying on margin in uncertain times if you don't have the appetite to stomach a huge loss.

Faulty Forecasts

“Experts” have made an array of predictions, ranging from global economic agencies projecting India's potential economic recovery to analysts saying the global economy will bounce back in the next financial year. These forecasts assume that central banks will cooperate and offer a way out, and that currently spooked investors will react to the rescue and re-enter the market. But as we have seen in the past, people can just as easily do the exact opposite, crisis or not.

In a pandemic, the seemingly opposite behaviors of people get amplified. Everything starts to seem black and white to people, but markets and behaviors actually remain grey and complex, interacting with each other in intricate ways.

Parting Thoughts

Turbulence and downturns have causes relating to behavioral and psychological factors that are difficult to control and explain. But what's certain is that not allowing investment decisions to be fueled by emotions and biases is a wise course of action. Now more than ever, people need to get back to the basics: minimize costs, be COVID-19-cautious, and resist the urge to time markets — and the virus.