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The two faces of business groups

india Updated: Jan 04, 2009 20:53 IST
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The misadventures of the Satyam Computer Services Chairman Ramalinga Raju and his board has brought into focus what is generally called corporate governance.

A few days ago there were some newspaper reports of what looked like another corporate governance issue, this one from the Chennai-based Muruguppa group. It was reported that the group’s finance company, DBS Chola Finance was being helped out with cash from listed group companies like EID Parry, Tube Investments, Carborundum Universal and Coromandel Fertilizers.

The group companies are to subscribe to preference shares that will be converted to equity later.

Apparently, some institutional investors don’t like this. But, as one report pointed out, what is happening with DBS Chola happens in most Indian business groups. This is not seen as unethical or an undesirable practice.

When money is needed for a new or struggling business, then the other group companies invest in that business. There are variations to the theme such as the role played by holding companies, but the basic idea remains that of cross-funding within a business group. The general line that critics take is that ‘if investors wanted to invest in the new business, then they would bought shares in some other company that already does that business.’ By itself, this is a neat argument that appears difficult to counter.

However, I believe there’s measure of hypocrisy in it. Given the economic history of India, many large businesses could not have come into existence without such cross-funding.

Investors buy a company’s shares in full knowledge that it belongs to a business group and this plays a role in their decision to buy into a company. This is much like buying a product from a trusted brand. If you recall what the first Indica was like, you should wonder how many people would have given that line of cars a second chance had it not been a Tata product.

An investor does take a call on promoters and managers like she does on business details.

Does this justify what Raju tried to do and many other promoters successfully do? Not at all. There is considerable pilferage of shareholders’ wealth in India. Many promoters think of themselves as sole owners and other shareholders as merely a source of financing. By instinct, they never consider shareholders to be co-owners — as it seemed to be clear in the Raju affair.

For investors, a company’s part in a given business group could be an advantage or a disadvantage. At the very least, it’s a useful information point. In the hard times that are coming, both the pros and cons will show up sharply.

(Dhirendra Kumar is the Managing director, Value Research)