ESG and Stakeholder Capitalism: Seeking Value for All

This article was first published in Outlook India on May 09, 2023. Co-authors: Moksh Garg, Sougata Ray; https://www.outlookindia.com/business/esg-and-stakeholder-capitalism-seeking-value-for-all-news-284879

Nobel Laureate Milton Friedman, in his famous essay "The Social Responsibility of Business is to Increase its Profits," published in the New York Times magazine in 1970, famously wrote, "There is one and only one social responsibility of business--to use its resources and engage in activities designed to increase its profits..."

Compare this with the Statement on the Purpose of a Corporation adopted by 181 CEOs of America's largest companies in 2019. The Statement declared, "…companies should deliver long-term value to all of their stakeholders – customers, employees, suppliers, the communities in which they operate, and shareholders."

Post the Covid19 pandemic, calls for "stakeholder capitalism" has further picked up the pace. Gone are the days when economic profits alone determined a firm's success. The for-profit entities are being held responsible not only for the bottom line but also for the activities through which they create shareholder value and the value they create for other stakeholders. As a result, it is no longer surprising to see them getting mired in controversies or even attacked by their shareholders over broad-ranging social issues. This has led shareholders and the wider investor community to take stock of businesses beyond traditional metrics.

Measure accurately and improve

The method to measure economic profits has been established and standardised for long. However, measuring stakeholders' value creation is still in its infancy. And, what cannot be measured, cannot be improved, managed, or controlled. Therefore, combined with changing social dynamics and the issue's salience, many rating agencies and data providers started providing ESG ratings for companies.

At the most basic level, ESG ratings aid investors in comprehensively evaluating a firm by analysing it across its three major dimensions: environmental, social, and governance actions and impact. While ESG, in spirit, is a step in the right direction, it has been wrestling to drive a commensurate impact worldwide. There are significant roadblocks impairing its overall uptake and effectiveness. Two major hurdles are the lack of standardized disclosures by corporate and inconsistent measurement criteria employed by the ESG rating providers (ERPs).

Disclosure: Our research at the Thomas Schmidheiny Centre for Family Enterprise, Indian School of Business, suggests that less than 4% of the total publicly listed Indian firms have been assigned ESG ratings between 2014 to 2021. We arrived at this figure by consolidating three different ERPs, i.e., WRDS Sustainalytics, Thomson Reuters, and CRISIL. The reason for the low coverage of companies by ERPs is that ERPs rely on publicly available data to make assessments. However, most companies – especially the medium and small-sized ones – do not track their ESG activities, let alone disclose them publicly. Even companies that make complete disclosures do not follow any standard procedure, making their interpretation subjective and comparisons across companies challenging.

Measurement: While comparisons across companies are difficult due to a lack of standardised disclosures, how information for the same company is compiled, measured, and converted into an aggregate score differs quite a bit from ERP to ERP. A study conducted by researchers from MIT, published in the Review of Finance, reported steep inconsistencies in the ESG ratings assigned to a business by different agencies (Berg, Koelbel, & Rigobon, 2022). In many cases, firms are assigned highly inconsistent ratings by different ERPs owing to differences in methodology, scope, or weights (importance) assigned to attributes. The divergent estimates about the same underlying entity add to the confusion and defeat the very purpose of these ratings.

Sample: The number of firms assigned an ESG rating in India (by the three ERPs cumulatively) is a minuscule percent of all listed firms (4%). Further, because we cannot compare the ratings across ERPs, research must be done using the data from just one ERP, reducing the number of companies that can be studied even further. Additionally, the number of years of data available for each ERP varies. In such a scenario, the reliability and generalization of research become questionable.

ESG ratings and their effectiveness are subject to substantial political debate in the West. The opposition has openly attacked ESG for its overly ambitious vision but deeply flawed implementation. Some critics have even questioned the morality of ESG by calling it a fabricated tool to legitimize greenwashing. However, in our opinion, although ESG is undoubtedly far from perfect, it remains one of the most potent ways to reimagine businesses in a society fraught with grand challenges.

In line with the old saying "do not throw the baby out with the bathwater," we expect that in the Indian context, SEBI's mandate for BSE Top 1000 companies to report their ESG activities as part of the Business Responsibility and Sustainability Reporting (BRSR) shall alleviate some of these concerns. However, it is time that companies understand the spirit of ESG, and even those companies that do not fall under the purview of BRSR voluntarily disclose the steps taken toward a more sustainable future. Let us actively work towards addressing the pitfalls, bringing more standardisation to disclosures and objectivity to measurement.

What Family and Non-Family Businesses Can Learn from Each Other

This article was first published in the Economic Times on April 05, 2023, Co-authors: Navneet Bhatnagar, Sougata Ray; https://economictimes.indiatimes.com/news/company/corporate-trends/what-family-and-non-family-businesses-can-learn-from-each-other/articleshow/99276293.cms

Indian economy comprises business organisations belonging to diverse ownership categories. On one hand, these include the traditional family-owned firms, such as those owned by the Tatas, Godrejs, or Birlas. While on the other hand, there are non-family businesses that are owned by the state (ONGC or SAIL), or multi-national corporations (HUL or BATA), or have diversified set of owners (L&T or Infosys). Both the family and non-family businesses have had a track record of successes and failures. There are significant learnings that each of these categories of businesses can share with each other and benefit from.

Family-owned business is the dominant form of business organisation in India. Ranging from large industrial houses to medium and small enterprises, family businesses form the backbone of the Indian economy. Over 90% of all listed firms in India are family-owned businesses. There are several lessons that non-family businesses can learn from their family-owned peers:

1. Long-Term Orientation and Patient Capitalism: Known for their resilience, many Indian family businesses such as, the Tatas, Birlas, Burmans, and Murugappas, have survived for five generations or beyond. Their long-term orientation and patient capitalism helps them assign greater significance to long-term gains compared to short-term returns. Long-term orientation of family business facilitates radical innovations which require longer time horizons to fructify and earn profits. Globally, this phenomenon is observed in some of the most innovative family firms in the pharmaceutical industry like, Merck of Germany or the Swiss, Roche group. Patient capital investment provides for longer gestation periods and enables a family business to outperform competition in the long run, thereby helping it sustain longer. Businesses operating with a short-term perspective react to the emerging trends to earn a fast buck, often at the cost of long-term gains. On the other hand, research has shown that a family business with long-term orientation in its vision and strategy conducts extensive environmental scanning to anticipate long-term trends and prepares itself to take quick actions when opportunities emerge.

2. Strong Stakeholder Relationships: A set of strong stakeholder relationships is another characteristic that sets family businesses apart from their non-family peers. On account of personal engagement of family owners, family firms often have long-standing relationships with their suppliers, distributors, customers, and employees. Family businesses are also known for their community embeddedness and family identity. There is mutual trust and dependence on each of their stakeholder communities, which helps family businesses overcome challenges caused due to uncertainties in business environment. This strong stakeholder cooperation was amply visible during the pandemic times when many family businesses witnessed a quicker rebound to business operations and profits.

3. Family Values in Practice: Most important lesson that family businesses offer to their non-family peers is their strong roots in family values of custodianship. Being firmly rooted in family values helps family businesses develop shared vision and goals, define clear and cohesive purpose for being in the business, and values drive the policies and practices in the family business. Values provide a moral compass, inspire exceptional performance, and help family businesses achieve stability and maintain consistent behaviour. It helps them overcome adversities and guides them through ethical dilemmas in a constantly evolving business environment. For instance, in our qualitative research on ‘family values in practice,’ the house of Tatas and the Godrej group were found to command respect and committed stakeholders mainly due to their conduct rooted in a strong value system, which was passed on from one generation to another.

Family businesses can also learn several things from effectively managed non-family businesses:

1. Professionalism: Professionalism has two dimensions: organisational professionalism and occupational professionalism. Effectively managed and organised non-family businesses exhibit high levels of organisational professionalism, which entails clear hierarchy of authority and decision-making, standardised procedures, clear roles and responsibilities and assessment of executive performance. Occupational professionalism entails managerial conduct that adheres to principles, values, and ethics. While practicing occupational professionalism, managers of non-family firms exhibit self-discipline and gain collegial authority. Professionalism is intricately attached to an organisational culture of excellence and merit. Thus, family firms can enhance routines, managerial outcomes, control, and productivity if they imbibe professionalism.

2. Capability and Resource Orchestration: Another aspect that family businesses can learn from non-family peers is ‘capability orchestration for scalability.’ A firm's ability to orchestrate appropriate capabilities and resources required to achieve certain strategic objectives is critical to its success. Non-family firms are known to have effective capability orchestration because of a diverse and qualified workforce comprising professionals that come from different backgrounds. They can quickly garner resources and tap capabilities to create value for the customers and owners. Owing to their capabilities and resource orchestration skills, non-family firms can also quickly scale-up their operations. Family businesses that aim for growth can learn these from their non-family peers.

3. Decisiveness and Accountability: Well structured decision-making process, high quality of professional employees, clear evaluation rubric for key business problems and professional approach to dealing with management situations enhance the decisiveness of non-family businesses. They also have high levels of accountability for the targeted outcomes of executive decisions. If the desired outcomes are not achieved, they immediately adopt corrective measures. This ensures that they stay on course to achieve their strategic objectives. Family firms are often blamed for being indecisive and for poor accountability norms and practice. They can considerably benefit from adopting the decisiveness and accountability norms followed by non-family businesses.

Thus, both the family and non-family businesses can enhance their performance outcomes through their constant effort towards mutual learning. 

Leveraging the power of an independent board

This article was first published in the Financial Express on March 14, 2023, Co-authors: Navneet Bhatnagar, Sougata Ray; https://www.financialexpress.com/industry/leveraging-the-power-of-an-independent-board/3008998/

Governance failures often jeopardise businesses, including family-owned firms. Family businesses are often blamed for poor corporate governance and oversight. In India, well known and established family firms have come under the regulatory scanner for opacity in financial dealings, related party transactions, and appropriation of minority shareholders’ wealth.

For corporate governance and monitoring issues, the buck stops at the apex governing body of the company, that is, its board of directors. The board of directors of a company determines its purpose, broad policies, and oversight mechanisms. An effective board ensures that executive decisions are made in the company's best interest. It is critical for the board oversight mechanism to assess the impact of executive decisions on shareholders and other stakeholders.

Aimed at improving corporate governance, the Companies Act 2013 stipulates the appointment of Independent Directors as non-executive members who can objectively scrutinise executive decisions and management performance. While monitoring the firm's reporting mechanism, independent directors are expected to evaluate and check the robustness of financial controls and risk management systems. They must uphold high ethical standards, integrity, and probity. Independent directors are not supposed to receive any monetary benefits except their fees. They are appointed for a five-year term and can not hold more than two consecutive terms.

Corporate governance standards were expected to be elevated through these legal provisions. However, various corporate governance debacles continue to hit the headlines in India. In 2015, Diageo alleged misappropriation of funds at United Spirits, which they had acquired from Vijay Mallya. Malvinder and Shivender Singh's fraudulent loan transactions at Religare and loan fraud at Gitanjali Gems were the other cases that poorly reflected the governance in Indian family businesses. So was the case of the Dhoot family-owned Videocon's loans obtained from ICICI Bank by questionable means and alleged kickbacks. In all these cases, the role that independent directors played as the custodians of stakeholder interest was wanting.

Our research on these cases of corporate governance failures of independent directors reveals some key insights.

Proximity to Promoters: One of the reasons why independent directors fail to discharge their fiduciary duties is their proximity to the promoters. Due to this, they often do not hold management to account and avoid asking tough questions. Independent directors who continue to serve the companies for a long time develop an affinity with key management personnel, making oversight difficult as the emotional costs of a negative exchange escalate. Hence, independent directors impose self-restraint.

Power equation: In several cases, we observed that the aura and assertiveness of the promoter family's leader kept the independent directors constrained to voice concerns. Board selections were made so that the independent directors could not seriously challenge executive decisions.

Incentives: Another reason for this oversight was the lure of the incentives attached to the board position. Independent directors follow what pleases the management or postpone raising their concerns due to the significant monetary/non-monetary incentives they gain from the company.

Overworked: In some other cases, we observed that the independent directors were so occupied with multiple responsibilities across different companies that they failed to devote sufficient time and attention to their oversight responsibilities.

As a result of the above factors, independent directors are rendered “rubber stamps”, corporate governance falters, and the respective businesses suffer a significant loss of monetary and brand value.

The need of our times is to make independent directors “truly independent.” Several measures can be adopted to empower independent directors with the authority to intervene through more effective checks and control mechanisms.

Selection: First and foremost, it is vital to improve the independent directors' selection process. They must be chosen on merit and have an impeccable value system.

Induction: They must be appropriately inducted and familiarized with the business and its key challenges. They must be eager to learn and update their knowledge and skills. They must be able to assess the internal and external environments in which the business operates and be vigilant of the motives that drive executive decisions.

Promoters' Buy-In: The most crucial factor that may make the role of independent directors more effective is the promoters' realization of the genuine need to raise the corporate governance standards of their company. If promoter families embrace good corporate governance in its true spirit, they will see the value in fostering vocal, expert, empowered, and truly independent directors.

Family firms and promoters must realise that when boards fail to exercise effective oversight, deviations from governance norms go unchecked. Ineffective governance eventually results in bigger violations and the destruction of value. Therefore, the boards must be diligent in objectively assessing executive decisions and providing timely advice when remedial measures are required, and they must be 'allowed' to do it. 

Managing Differences in the Family to Prevent Destruction of Business and Wealth

This article was first published in the Economic Times on March 08, 2023, Co-authors: Navneet Bhatnagar, Sougata Ray; https://economictimes.indiatimes.com/news/company/corporate-trends/managing-differences-in-the-family-to-prevent-destruction-of-business-and-wealth/articleshow/98481901.cms?from=mdr 

Recently, the Hinduja brothers decided to put an end to their long-standing dispute over family wealth. The Singhanias, owners of Raymond, have also shown signs of a reconciliation after a bitter dispute between the father and son. Managing a family business is often more challenging than steering a non-family enterprise. This is because family businesses are an amalgam of two inherently distinct subsystems. While business is an economic system, the family is a social system. In the initial phase both the family and business are simple systems. As time passes by both grow to become complex and complicated. While businesses expand in size and enter new segments and markets, families increase in size, extend into branches, or forge new relationships (in-laws). New generations emerge, often with distinct ways of thinking and analysing than the previous generations. Therefore, it is very natural for differences to emerge within the family. If these differences are not addressed properly, they turn into deep discontent and surface later as full-blown conflicts. Repeatedly, Indian family businesses have seen bitter feuds in the past, which has ruined large business groups and their legacy- the Modis, the Mafatlals, and the Singhs of Ranbaxy group- to name a few.

Many a times, the roots of such differences lie in the family sub-system. The socialist nature of the family accords equal rights and status to all its members. However, business, rooted in capitalism, rewards the more meritorious members. Differences arise when some family members feel that they are not being equally rewarded, or their opinions are not valued, or their needs remain unmet. Differences emerge when the roles, rights, and responsibilities are not clearly understood by the members. This happens due to lack of clear policies, that leads to decisions being made in an ad-hoc and inconsistent manner. When left unaddressed, these differences turn into a deep sense of ‘perceived’ injustice and bitterness. Often, these pent-up emotions get triggered into outbursts at a tipping point that ‘breaks the camel’s back’, leading to a cascading effect of deviations in action, poor decisions, and destruction of wealth and family legacy.

Is there a way to avoid this ‘differences to destruction’ trap? The answer lies in robust governance and clear communication mechanisms. It is important to create effective governance structures and mechanisms both for the business and family. Governance mechanisms must be embraced in true spirit and not just to meet regulatory requirements. High quality governance based on strong values can resolve most issues right at their emergence. Some measures that could help family businesses minimize the impact of family differences include: adopting the policy of fair treatment to all family members, clear and transparent communication within family and with all stakeholders, decoupling critical business and family issues, establishing fora for communication and raising concerns (such as a family council or forum), adhering to policy-based family governance rooted in a family agreement, charter or constitution and developing shared-clarity on ownership rights. A well-defined conflict resolution mechanism can ensure that the differences are resolved before they turn into a major problem and the business interest is not affected.  

Two examples that may be cited here are: the structured succession planning initiated by Mukesh Ambani-led Reliance group and the recent amicable restructuring of the TVS group. Reliance is adopting a holding entity model that will own and control the family's businesses-refining and petrochemicals, retail and e-commerce, telecom, and green energy. The family members will own stakes in this entity and serve on its board. However, operations will be managed by non-family professionals. This planned shift from operations to ownership and governance will keep the next-gen family members focused on strategic issues. This decision will minimise differences that may emerge in the family due to operational issues of the business.

In the TVS case, the four family branches decided amicably to re-align the ownership of their group companies. Earlier all the TVS group firms were grouped under three holding firms and there were lot of cross holdings among the four family branches. The family decided to merge all three holding firms and then demerge into four holding companies, one for each family branch. Each resultant holding firm will own the businesses managed by that branch. Besides this, the agreement also envisaged to included clear terms of the use of TVS brand, and non-compete agreements among the family members.

In the Indian context, which continues to witness fierce battles for rights over control of business and family wealth, the proactive planning and implementation of structured mechanisms adopted by both Reliance and TVS groups are inspiring examples of ringfencing the business from potential family disputes.

Bridging the generational divide in family businesses through communication

This article was first published in Outlook India on January 05, 2023, Co-author: Simran Senani; https://www.outlookindia.com/business/bridging-generational-divide-in-family-businesses-through-communication-news-251014 

It was a life of struggles for the family when my grandfather died unexpectedly at a young age, my 85-year-old grandmother recalls. “Suddenly, we had nothing. However, we never spoke about it outside. We did not ask anyone for anything. Our lifestyle did not change when we had nothing. And, it has not changed now when we have everything again.”

Those words, spoken casually while I watched The Crown season 5 on Netflix and she went about her daily routine, subconsciously made me feel connected to our lineage and family values. My mind wandered to the challenge many family businesses face in the 21st century. Myriad options, gadgets in the palm, shorter attention spans and intolerance for listening to anything that may not seem of direct interest have caused a divide between the younger and the older generation that seems insurmountable.

Many parents in family businesses pay little attention to interaction with children in their formative years due to their busy schedules and the business demands on their time. Soon, as the children reach their teenage years, in many cases, they feel an emotional void and disconnect from their parents. The older generation also finds it hard to cope with the children’s needs, thoughts and desires. They realise there is little to talk about except coordinating with them for their basic needs. In addition, the widening gap between shared generational experiences also leads to weakening intergenerational bonds.

A second-generation family business leader rued, “The way my brother and I see our business, the emotional connection that we have with it, the desire to uphold the legacy of the business that our father left for us, is simply lacking in our children. They see the business as a money-making machine without wanting to nurture it adequately. We do not know how and from where to start bridging the gap!”

How can the intergenerational gaps be bridged? Here are a few practical solutions that may be considered.

Shared Spaces: This should be the first step towards understanding each other and communicating more. The senior generation can make rules that evolve into traditions over time, such as having dinner together, having a single television at home, eating breakfast together on Sundays with extended family members and celebrating important days together. Sharing space, time and experiences with each other results in better bonding and communication.

Creating opportunities to share: Whether a family lives in the same house or not, communication opportunities need to be created if they do not happen organically. The family must establish formal mechanisms to facilitate dialogue among members on family and business issues in an environment of non-judgement, trust and openness. Starting with a few planned meetings, the family can eventually form a family council (FC). All members of the family become members of the family council, including the children, as they reach their teenage years.

Some families go a step ahead and form the next-generation members’ young council (YC) to facilitate communication among the next-generation members. They have monthly scheduled video calls where they all connect informally and share their challenges and learnings in work and personal life.

Championing communication: When communication between family members is not great, there is often a fear of saying something that might alienate others further. Someone from the family needs to take the lead in understanding how relationships between generations play a crucial role in building legacy, harmony and business growth. A person with empathy, who is willing and able to take everyone along, can champion the engagement and, if needed, engage an advisor (or coach).

Communication is not what is said or intended but what the other person receives. We often underestimate the effort that must be put into learning how to communicate effectively. Families sometimes engage with a coach to learn and practise communicating effectively with the help of communication tools. These sessions also allow the family members to connect deeply.

Conclusion

The unconscious opportunities to interact, bond and build a legacy gradually disappear. Bridging gaps between generations, even intra-generational, is vital to perpetuating family businesses. Family business guru John L. Ward writes in his book Perpetuating the Family Business: 50 Lessons Learned From Long Lasting, Successful Families in Business: When one firm was sold to a large conglomerate amid a great deal of family turmoil, its CEO was asked by a reporter why the family had failed to carry on with its business, “Three reasons,” he answered, “Communication. Communication. Communication.” What he meant, of course, was “Lack of communication. Lack of communication. Lack of communication”.

Therefore, business families, do not take communication for granted, or ignore it at your own peril. And, if you (business families) have to take one resolution for the New Year, let it be to communicate more! On that note, here’s wishing all the readers a very Happy and Prosperous New Year.

Tricks to ensure the next generation becomes capable to take over the family business

This article was first published by the Economic Times, on November 15, 2022, Co-Authors: Sougata Ray, Navneet Bhatnagar

https://economictimes.indiatimes.com/news/company/corporate-trends/the-tricks-to-ensure-the-next-generation-become-capable-to-take-over-the-family-business/articleshow/95529582.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

Leadership succession is a critical transition for family-controlled businesses. Successor selection is a crucial decision that determines the future strategic direction of both the business and promoter family. In practice, family businesses often do not realize the need and importance to plan for succession. Some that do recognize it, continue to postpone that decision. This happens primarily due to three reasons. First, often the incumbent leaders are engrossed in operational aspects of the business and do not feel an urgent need to plan for succession. Another reason, especially with large promoter families, is that the complexity of family dynamics and tangled interface with the business, render succession, a tough decision to make. Third, and most critical, is the lack of preparedness of the next generation leadership, which makes the incumbent leader hesitant to pass on the baton. This is often reflected in our interactions with senior generation participants of our executive education programmes for family business leaders. Senior family business leaders express their reluctance to transfer leadership charge as they lack confidence in the capabilities of their next generation members.

It is important to note that succession is not an event but a process which needs to be planned for years in advance. Promoters of a few large family businesses in India have experimented with non-family successors. However, successor choice for most family firms is often restricted to the family talent pool, which is limited to the family size. While non-family businesses can quickly replace a non-performing leader, for a family business this is not so easy because of kinship ties and lack of alternatives. For a next-generation family business successor, failure costs the survival of both the business and family. Hence, given the high cost of a failure, an incumbent family business leader must not only plan early for succession but also take effective measures to groom the next generation members. This is the biggest succession challenge family businesses face today.

Next generation leadership building takes time and careful planning. It requires diligent cultivation of mentee-mentor relationship between the senior and younger generation leaders. Our research studied 19 successful cases of inter-generational leadership transitions since 2004 in large Indian family businesses. We traced these transformational journeys to identify crucial leadership building measures adopted by these family businesses. The study found that these next generation members followed a systematic development pathway, which equipped them for the leadership role. These leaders were exposed to the family business and its operational challenges at an early age. After their graduation, they joined the family business at middle management level. They gained experience in business operations and developed an understanding of ground-level challenges. They also learnt manpower management and interpersonal skills. In the subsequent phase, they went to world-class institutions to obtain a business management degree, which equipped them with knowledge of strategic frameworks and leadership capabilities.

A critical part of this journey was the work experience they gained in large international organisations after obtaining their business degrees. Working outside the comfort-zone of their family business made these next-gen members independent business decision-makers. It built their leadership strength as they had to prove their capabilities and bear the consequences of their decisions. After 2-3 years of working outside, they joined the family business at senior leadership level. During this phase, they worked closely with family and non-family mentors. They understood the strategic and leadership challenges of the business. They became effective change agents, improved legacy systems and practices, and led their business to the next level of growth. Proving their leadership mantle within and outside the family business, with diverse work experience in India and abroad, these next-gen members earned respect and acceptance from internal and external stakeholders. In a span of 5-8 years, they took complete leadership charge. The senior generation leader stepped out of the executive role and continued to provide strategic guidance.

For succession to be effective the next-gen members must have the ability and willingness to take on leadership responsibility. This can only happen when they are equipped with a wide range of knowledge, experiences and capabilities. Structured training and outside work experience play a very important role in leadership development. Business families that plan early and take timely measures to groom their next-gen members, can implement effective intergenerational leadership succession. 

Why the Rs 4.6 lakh crore pledged promoter shares matter for India Inc.,?

This article was first published in the Financial Express, on November 14, 2022, Co-author: Sougata Ray; https://www.financialexpress.com/industry/pledged-shares-valued-at-rs-4-6-trillion-the-good-and-the-bad/2812080/

Gautam Adani, hailed as the richest Asian and the third richest person in the world in October 2022, acquired 63.15% stake in Ambuja Cements and 56.69% in ACC in September 2022. Part of the acquisition was funded through pledging the entire acquired stake in both the companies, worth $13 billion. It once again highlights the popularity and importance of pledging as a financing tool for the Indian family business owners who usually have the dominant or controlling stakes in the companies.

Pledging at a varied degree is quite widely prevalent around the world. However, in countries where diversified ownership is more common, such as the United States, pledging is generally done by owners, directors, and executives to hedge and diversify their personal wealth or to meet personal needs. However, in India, pledging by family promoters often serves as a mechanism to generate financial capital for the firm or other affiliate firms belonging to the same business group. 

Promoters of almost a quarter of all companies listed on the National Stock Exchange (NSE) of India have pledged their shares to some degree. The average being a staggering 44 percent of the holdings of promoters in these companies. In the last quarter of financial year 2022 (January-March 2022), the value of shares pledged by promoters of NSE listed companies stood at Rs 4.6 Trillion. In a country like India, where more than 90% of the listed firms are family firms and concentrated shareholding is the norm, the exposure of investors and financial institutions to pledging can result in a systemic risk. It may not be so in many other countries where diversified firm is more of a norm when compared to concentrated ownership.

During the last couple of years, there have been many instances where promoters have lost ownership control in well-known large family firms. Of course, this outcome happened due to a combination of over-ambitious or bad decisions. But in many of them, the promoters had pledged their shares to financial institutions and when the share prices started to fall, the institutions sold the pledged shares in the open market. This resulted in the promoters losing ownership in their family firms. The situation was exacerbated due to the pandemic when the share prices of most companies took a hit. 

Just like the mark-to-market concept in the case of financial derivatives, when the share prices fall and the asset cover falls below a predetermined value, the financial institution raises a margin call to the pledging shareholder. Consequently, the shareholder is required to either top-up the loan with more shares or pay off a portion of the loan’s principal to increase the existing asset cover back to the pre-determined value. If the shareholder answers the margin call in the stipulated time, they will continue to own the shares. If the shareholder is unable to answer the margin call, the financial institution has the right to sell the shares in the market. The news of a margin call is generally perceived negatively by investors and the sale of a block of shares of a company in the open market accentuates the negative sentiment associated with the stock. Investors may indulge in panic selling of the stock. The increased supply of shares puts downward pressure on the stock price, thereby warranting further sale of shares by the lending financial institutions. 

In research conducted by the Thomas Schmidheiny Centre for Family Enterprise, Indian School of Business, the authors found increased crash risk, lower return on assets, increase risk aversion, and negative investor reaction to the news of pledging. We observe that the potential loss of ownership control faced by many firms that have pledged their shares is overwhelming and would have significant impact on the promoting families and the other stakeholders of those companies if the promoters were to lose the pledged shares due to an unforeseen circumstance.

However, we also find many instances of family business promoters that have effectively used pledging as a tool to finance strategic initiatives for expansion, new venture creation, acquisition, etc., and to buy back shares in their own firms. Such promoters have not only used pledging for growth, liquidity, market performance, and ownership consolidation, but also reduced pledging thereafter in a systematic way. Examples include firms such as Asian Paints, Apollo Hospitals, and Granules India. Therefore, pledging per se is not bad – it is a legitimate, legal, and effective tool to raise funds by the promoters. When access to capital is limited either due to tight liquidity in the overall economy or stretched bank limits and high debt-equity ratio of the firm, the environment may not be conducive to raise equity or the promoters may not want to dilute their stake, in all these situations, pledging comes in handy.

Pledging has been around for decades in India. However, its impact has become more accentuated now due to the VUCA world that we live in. Awareness about its possible negative consequences has also gone up. It is amply clear that the promoters need to be prudent and strategic in using pledging as a financing tool. A decision to pledge must be associated with a clear plan for usage of funds, returns from them, and a path to de-pledge the shares. The promoters should avoid getting into a trap of excessive pledging, being overconfident about the prospects of the firm and under preparing and underestimating the external risks. The family business leaders taking the decision to pledge the shares must consult the family members and keep them updated. The funds from pledging should be used responsibly, with immense accountability and transparency. The Board and particularly the independent directors have an important role to play in this regard. Timely disclosures and effective communication will help calm the nerves of the other investors. Financial institutions should closely monitor the pledging situation in a firm, as well as that of the companies affiliated with the same business group, when deciding to buy, hold or sell their investments in a firm.

Resetting of Conscience, Priorities, and Emotions

Book: To Hell and Back: Humans of COVID

Author: Barkha Dutt

Price: 699/-

Pages: 288

Year: 2022

Publisher: Juggernaut Books, India

Usually, I have a wisecrack to crack on every occasion. Today, I have none. Even my posts post getting Covid in the second wave in May 2021, were full of humour [Post 1 Post 2]. I was able to laugh at myself. Not today. My pain, my experiences, seem too small today.

Sometime in April 2022, I ordered and got Barkha Dutt’s book, To Hell and Back: Humans of COVID. I was reluctant to start reading it, even though I wanted to. I didn’t want to refresh the memories of what I went through. But finally, I did start reading it last week [3^rd week of July, 2022].

There were a lot of things I reminisced while reading the book. Like wondering, during the period that I was hospitalized, that how would someone who doesn’t know someone get a bed like I had? What if the oxygen supply ran out? What if I was taken to the hospital a couple of hours later? And many such questions.

During that period, I knew of a junior, who had a two-year-old kid, not reaching the hospital on time, and then not even getting a proper funeral. I knew of an uncle who was brilliant and taught me accounts but did not get the right treatment. My thoughts lingered on an aunt who was never diagnosed with Covid but had all the symptoms and passed away soon after. I remember questioning that why did I deserve to live when they could not be saved?

Post Covid, suffering from Long Covid- chronic insomnia, anxiety, hair loss, pain in the bones, palpitations- I constantly battled my symptoms and tried to be normal and move on. Barkha Dutt describes my conversation with her on the Mojo Story on page 255 of her book. She calls me Nutan Banga. When I started reading the book, I realized that I had really moved on.

Barkha Dutt’s book is a solemn reminder of what the pandemic was and gives us a view that none of us could have had individually. The experience of a migrant labourer was very different from the experiences of a cow herder from that of a funeral service provider, to a doctor, and to a well-connected upper-class person, like she herself is. The inequalities that she has presented in her book, even in the way one faced death, are unimaginable to people like us who live in urban bubbles, disconnected from the grassroots, disconnected from our roots, and disconnected from how people outside such bubbles live.

I went to Kundli once and enjoyed the Murthal parathas with white butter and daal makhana. But did I know about the toxic yellow water that the people of this village got? No. The water that caused serious skin diseases, how would they drink that water when even buying drinking water became difficult? 

Or consider the corpses of 20 tribal migrant workers who were so exhausted from all the walking that they went to sleep on the railway tracks where “they thought they would not be noticed or disturbed by the police. A goods train ran over them an hour later.” [Pg38] A chill went up my spine.

Most of us were helpless in the case of covid deaths to a large extent. Whether it was the availability of beds in the hospitals, medicines, oxygen, testing, what could most of us do? How could I help the migrants or those who lost their jobs? Sonu Sood did it. Many others did. But let’s just say that I am a more ordinary person. At least it was a good excuse to console myself. But I could not stop my tears for a long time when I read about Aishwarya.

The girl from Shadnagar, 50kms from Hyderabad, Aishwarya, committed suicide. She committed suicide because her parents could not afford to buy her a laptop or a smart phone to continue her education. “If I can’t study, I can’t live”, she wrote in her suicide note [pg 233-234]. Probably because of the geographical proximity, probably because she got an admission at the Lady Shri Ram College despite the poverty and circumstances, probably because I feel strongly for the cause of girl education, my tears would just not stop. Could I have helped if I knew what she was going through? Would I have helped? The fact is that I did nothing. Not for her. Not for anyone.

I would gladly give away all my hair if I could save Aishwarya.

The pandemic was sudden, but not improbable. Bill Gates warned against “the next outbreak” in 2014. National Geographic warned of how deforestation was causing bats to have “no other option than to fly elsewhere in search of food, carrying with them a deadly disease” in a 2019 article. But the world at large was not prepared for the Covid19. Some events need to be prepared for due to the severity of their impact. The governments must build their Afsluitdijks to prepare for such events. The quantum of impact, the number of people impacted, the physical, emotional, economic, and societal disruption is of catastrophic scale. Life cannot go back to normal.

To understand the severity of the catastrophe that Covid19 unleashed on humanity, each one of us should read the book. It will make us realise that there is life beyond our bubbles. While everyone’s sorrow and difficulties are exactly that- sorrows and difficulties- and thus, cannot be undermined, different situations have very different impact on the different strata of society. And in some cases, survival itself becomes a challenge.

Some books move you. Leave an indelible mark on you. And this is one such book. I am not going to comment on the writing style, what the government did or did not do, the organization of the chapters, etc. Sometimes, the message is far too important, the story is so powerful and compelling that how it is delivered doesn’t matter.

I cried many a times while reading the book, choked many times, sometimes just happy to be alive, while at the other times questioning why I was alive? What was I doing? And what am I going to do now? These questions are haunting me. Something in me changed after Covid. Something in me has changed again after reading this book.

Efficiency is the name of the game

This book review was first published in the Financial Express on June 27, 2022, https://www.financialexpress.com/lifestyle/book-review-the-ambuja-story-how-a-group-of-ordinary-men-created-an-extraordinary-company-by-narotam-sekhsaria/2573658/

Book: The Ambuja Story: How a Group of Ordinary Men Created an Extraordinary Company

Author: Narotam Sekhsaria

Price: 699/-

Pages: 368

Year: 2022

Publisher: Harper Business, India

Once upon a time, there was a boy, named Narotam. He was born in a Marwari family in Chirawa, Rajasthan. His family took him to Bombay (now Mumbai) when he was three. There, he was adopted by his grandfather’s younger brother who did not have a son of his own. This practice was a way to ensure the continuity of lineage in a patrilineal society. Destiny had plans for him. This is his story and the story of the company that he built.

Ordinary is relative

Narotam and his family were ordinary. Ordinary compared to the Bajaj’s who were their neighbors. But living in the same building as the Bajajs, who owned and managed one of the biggest business houses in the country then and now, cannot be ordinary for sure. Similarly, Narotam had an ordinary upbringing. A boy next door. He struggled at school yet finished at the top of the class. Was aimless and non-ambitious yet went on to study at some of the top colleges in Bombay.

Joining the civil services or getting a job in a bank or a multinational company was the dream career for those joining the workforce in the India of 1960s and 1970s. Not so for a lad growing up in a Marwari household. Working for someone else was unthinkable. So, he joined his family’s typical cotton trading business. He proved his mettle in various ways. Whether it was getting orders from Finlay, having the foresight to buy extra for his customer when prices started to rise and the customer was holidaying, being fair even when he could have made much more money, and making, maintaining, and tapping into social networks, were at display in the way he functioned.

Nothing that he did was extraordinary. Just ordinary things done well to achieve extraordinary results.

Bigger shores beckoned

Narotam’s “dil” wanted more. Forty years back, entrepreneurship was not a buzz word. Nor was ease of doing business. The Ambuja Story is not the usual start-up story that we are used to reading in the twenty first century.

Narotam grew up in a family of traders. The DNA needed to manufacture is very different from that for trading. After spending a decade being a trader himself, to set up a manufacturing unit for a commodity product about which he knew nothing, could not have been easy. And it was not.

The book brings out the vulnerabilities and the many uncertainties faced by the founder. It also shows how he adapted at each step of the way. He recruited the best, treated them with respect, and retained them. Did not compromise on quality of the plant, even though he placed his trust in newcomers, rather than well established players. Financial management, credit policy, and high ethical standards were all consciously made a part of setting up Ambuja. While there are many learnings from the story, the three that I would like to highlight here are efficiency, innovation, and brand building.

Efficiency: Cement is a commodity. There is little scope to differentiate the product itself. But there is ample scope to differentiate on efficiency. Efficiency in processes, tweaking the plants to enhance productivity, dust management systems, and each person doing their job well, are just a few examples. The company has efficiency written all over it.

Innovation: Innovation does not mean usage of artificial intelligence and machine learning to solve problems with digital solutions only. Innovating, doing things differently, to achieve better or cost-efficient solutions such as transporting cement through sea when no one else was doing it in India, and making small changes to the plants to achieve big impact, played a big role in making Ambuja profitable from the very beginning.

Branding: In a product where it was difficult to charge a premium, the investment in brand building from the very beginning, like it was a consumer product, helped Ambuja establish itself even in the presence of existing giants. Ambuja kept building and improvising on its branding as they grew. The results were all too visible.

Values and responsibility

Being born in a Marwari family, I have often heard about and witnessed philanthropy without anyone knowing about it. Left hand should not know if the right hand is giving. Such beliefs leave an indelible mark on everyone around. It was no different for Narotam. He writes of how the values and spirituality kept him “calm and centred even in the most turbulent of times. The values of ethics and compassion that he [his father] taught me steered me in everything that I did in my career” (Pg. 134). The Ambuja Cement Foundation has been way ahead of its times in adopting impactful corporate social responsibility projects and transforming the lives of communities around which they operate and going beyond those communities.

Resilience

An entrepreneur starts when he spots an opportunity. But the time at which he/she should exit is also important. Exit does not only mean selling the business. It could also mean redefining the role of the founder to ensure continuity beyond him/her. The confidence that the company would survive beyond the founder is what makes them long-lasting. Even without planning for it, Narotam had built a company that did not need him on a day-to-day basis when he had cancer.

Conclusion

There are many books on industrialists and entrepreneurs. Not many of them go into so much detailing regarding the thought process on each aspect of setting up and running of the business. This book is focused on the building of Ambuja, easy to read, comprehensive, and depicts the trials, turbulations, and triumphs at each step.

Shareholder capitalism to stakeholder capitalism: Are Indian family firms prepared?

This article was first published in moneycontrol.com, April 18, 2022, Co-authors: Sougata Ray & Navneet Bhatnagar; https://www.moneycontrol.com/news/business/shareholder-capitalism-to-stakeholder-capitalism-are-indian-family-firms-prepared-8371801.html

The debate whether companies should be governed with the sole objective of maximising shareholder value (shareholder capitalism as reflected in the shareholder primacy model advocated by Prof. Milton Friedman) or balancing the interests of multiple stakeholders (stakeholder capitalism as reflected in stakeholder primacy model advocated by Prof. R. Edward Freeman), including shareholders, has been raging for several decades.

Climate disasters, rapidly rising inequalities and COVID-19 have perhaps put to rest the shareholder vs. stakeholder primacy debate and tilted the balance firmly in favour of the latter. Modern corporations, irrespective of ownership, have an obligation to act in the interests of multiple constituents -- viz., ecology, environment, society, and shareholders.

It has been argued in literature, with some empirical validation across country contexts, that family firms are generally more influenced by the ideals of stakeholder capitalism and less by the idea of shareholder capitalism.

Anecdotal evidence in India suggests so. Many times in the past, when there has been the need, family firms in India have risen to the occasion and swiftly aided government and people, be it during the Independence movement, wars, floods, famine or pandemics.

How family firms fare

To measure how family firms fare with various stakeholders, we analysed them on various parameters and found interesting results.

Using a sample of over 6,000 firms, over the last 30 years, we found that family firms underperformed non-family firms in terms of return on assets. This indicates that family firms are, in fact, not very focused on returns. This is congruent with the socio-emotional wealth theory of family firms which suggests that they, at times, compromise on economic gains for non-economic goals of the family. This may not be something non-family shareholders want.

Pledging of shares by family owners is an example. Here, the goals of the family and non-family shareholders may deviate. Pledging of shares enables the family to raise funds against shares as collateral. The funds can be used for the same firm whose shares are pledged or for personal use. This results in a limited downside risk for family shareholders as they have already got the funds, but the minority shareholders risk losing a significant amount of their investments, if margin calls are not met.

Such situations are detrimental to minority shareholders. The behaviour of the dominant shareholders may lead to loss of wealth for other shareholders, and ultimately loss of wealth and control of the firm for dominant shareholders, too.

In the recent past, there has been a significant loss of wealth for all shareholders due to the misguided ambitions and decisions, clubbed with the pledging of shares, by promoters of family firms.

Low scores on social, environment fronts

It is, therefore, not surprising that the governance scores of family firms in the ESG (Environment, Social and Governance) rating, as per Reuters and Sustainalytics data, were found to be lower than those of other firms.

Family firms were also found to have relatively low scores on environment and social categories as well as consolidated ESG parameters. The low social score is somewhat puzzling as family firms in India are known to care for the community in which they operate.

In fact, among a larger sample of firms from a different database, we observed that the CSR spends of family firms are higher than those of non-family firms, suggesting that family firms are more compliant to CSR regulations.

It is important to note that the debate around primacy to shareholders vs stakeholders is not about the reaction of corporations to exigencies or CSR spends. It is not the primacy of other stakeholders over shareholders, but about achieving balance on sustainability principles.

It is not about one heroic act catching media attention, but their every action, every day. It is also not about one bottom line – profit. It is about the triple bottom line – people, planet, profit -- and generating and sharing value for all constituents in a fair and equitable manner.

It is about being purposive without losing focus on profit in day-to-day activities. Therefore, to be a multi-stakeholder-friendly and sustainable organisation, family firms need to adopt the principles of triple bottom line and make ESG their strategic ally. It is no longer an option. It is needed for the long-term sustainability of the firms as well as the business families in order to create and pass on the wealth to the next generation and build and sustain the family legacy.

The authors are from the Thomas Schmidheiny Centre for Family Enterprise, Indian School of Business.

Family Firms in India: Performance and Relevance

This article was first published in moneycontrol.com, April 05, 2022, Co-authors: Sougata Ray & Navneet Bhatnagar; https://www.moneycontrol.com/news/business/family-firms-in-india-performance-and-relevance-8320491.html/amp?ajaxcall=yes

Concentrated ownership of a firm in the hands of a family presents unique opportunities and challenges that impact its performance.

In India, family firms are a dominant force in the economy, contributing significantly to nation-building, the exchequer, creation of jobs and asset creation. Their footprints on the Indian economy are indelible. It is imperative for family firms to perform well, grow profitably, create value and contribute to economic progress if India has to realise its full potential.

Researchers have argued that family firms have better monitoring and lower agency costs than non-family firms, have incentives to take long-term views of maximising firm value, and are value-driven organisations. Yet, many of them are found to be plagued by rent-seeking behaviour, succession issues, lack of transparency and governance, lack of professionalisation, and family conflicts. Understandably, therefore, there is mixed evidence globally on whether family firms perform better than non-family firms.

Using a unique proprietary database of scientifically classified listed family and non-family firms, the team at the Thomas Schmidheiny Centre for Family Enterprise conducted a study on all listed firms in India over the past three decades. The analyses overwhelmingly reveal that on an average, family firms underperform non-family firms.

What are the reasons? Lapses in overall strategic planning by family firms, conflicting intrinsic motivations of family members, lack of professionalisation and governance, and opposing utility functions of management (non-family professionals) and the promoting family could be responsible. Many a time, maintaining control and influence over the firm also pushes the family to take decisions independent of financial considerations. These idiosyncratic strategies and irrational choices, mainly due to the emotional ties that the family has with the firm, may overpower the advantages of being a family firm. The analysis also reveals a negative impact of family leadership on performance among family firms.

While the average trend is negative, there are family firms across industries that have performed exceedingly well. They have withstood the licence raj as well as the winds of change that swept the nation during the economic liberalisation in 1991. There had been widespread apprehensions about the capabilities of family businesses to withstand the pressure of the newly created “freedom” that made them vulnerable to competition for resources, markets and capital. However, many family businesses transformed themselves by taking stock, restructuring their operations, taking advantage of new opportunities, putting the right governance systems in place, and professionalising.

There is much to learn from these businesses.

90% of the listed world 

Despite the underperformance of family firms on an average, their dominance in India continues. Ninety-one percent of all listed firms in India are family firms. Large family firms and business groups have consolidated their positions even more in recent years. As these business families and the firms owned by them are firmly embedded in the society and institutional context and develop patterns of trust and confidence among stakeholders, they have better access to social and financial capital and are willing to embark on enterprises involving considerable risk with a reasonable chance of success. This reinforces the continued cultural, political and social importance of family firms in India, which is not going to diminish any time soon.

However, a vast majority of family firms in India does not possess these constructive characteristics exhibited by the more successful ones. These underperforming family firms must be open to learning from the select others who have been performing well, put in place family as well as business governance systems, professionalise as they grow, delegate management and operating responsibilities to the right persons outside the family, and change with time to adapt and modernise. They need to be made aware of the enormous opportunities and be nudged to overcome their challenges building on their inherent strengths.

Policymakers must be open to framing targeted interventions that are required to create favourable conditions for improving the performance of family firms. Given the importance and significance of family firms in an economy like India, more family firms across industries have to undergo a transformation and start pulling their punches to make India Aatmanirbhar.