The coming wave of shareholder activism
With investors beginning to ask the right questions, markets are set to change for the better
One recent trend in Indian equity markets has been the rise in shareholder activism. Large shareholders — be they banks, funds or institutions— are flexing their voting muscle and bringing about governance changes. Over the past week alone, we have seen a large Indian private sector bank (owning almost 25 per cent of the equity) ask for an extraordinary general meeting (EGM) to replace the entire board of a satellite direct-to-home company.
This was then followed by a large foreign fund owning almost 18 per cent of the company asking for an EGM to replace the promoter and certain directors of a large media company. While these two instances have garnered the spotlight, this is not the first time institutional shareholders have used their votes to bring about change. Last year, we saw the lenders to CG Power invoke their share pledges, take control of the company, demonstrate clear fraud on the part of the previous promoter and then manage to bring in a strategic shareholder. Something similar happened in Fortis. A large foreign fund managed to appoint a new board, unaffiliated to the erstwhile promoters, who then ran a process to bring in a new strategic shareholder to take a significant stake and run the company. Various firms bid for the hospital assets, but the board and the shareholders eventually decided who they wished to partner with.
In each of these instances, share prices have surged on the news of potential management/board change. In each instance, we had a large institutional shareholder willing to make the effort to improve governance, around which other shareholders could rally. In each instance, valuations seemed to imply that the markets had lost faith in the existing governance structures. There was thus tremendous incentive to bring about change, as institutional shareholders tried to protect their investments and realise fair value. The surge in share prices indicates the governance discount the market had assigned to these assets. The closing of this discount, as action was taken, shows that activism can work in India.
Why is this happening now? Has something changed? First of all, the shareholding of institutional investors has been rising. Over the last 15 years, their shareholding has risen from 25 per cent to 35 per cent of the equity of the BSE 500 companies (both foreign portfolio investors and domestic institutional investors). They now account for almost the same percentage share as private promoters, who are at 42 per cent. There are numerous companies where the institutional shareholding is greater than the promoters’.
There have also been numerous regulatory interventions that have empowered minority shareholders. All related party transactions have to now be approved by a majority of the minority investors. Independent directors can be appointed via a special resolution, requiring 75 per cent of the votes compared to 51 per cent in the past, and greater independence has been ensured in the composition of the board audit and nominations committees.
The Securities and Exchange Board of India has made it mandatory for mutual funds to vote on all governance and related party issues and the Insurance Regulatory and Development Authority of India is moving in a similar direction. A whole ecosystem of proxy advisory firms has also sprung up to provide professional and independent advice on all resolutions put to vote at shareholder meetings.
The whole concept of stewardship has now gained prominence globally and in India. Institutions today recognise their obligation to exercise their vote and safeguard their interests. A decade ago, almost 90 per cent of institutional votes would be abstentions, this number is now down to less than 10 per cent. Everyone now realises the value of their vote. In the past, faced with poor governance, most institutional shareholders would just sell their stock and move on. Today, the environment is different. Depending on relative shareholding and the extent of undervaluation, many institutions may choose to vote and bring change themselves.
What are the implications of this increased activism? Obviously companies and promoters have to be far more focused on their shareholder base. Who are their top investors? What is the concentration? Have a more sophisticated investor relations effort to fully comprehend their concerns and priorities. Like we see in the West, companies will more actively target an optimal shareholder base. Focus on funds that are truly long term, have a partnership mindset and are willing to back the vision of the promoter group. Distinctions will need to be made between short-term and long-term investors, passive versus more active and their focus or lack of on environmental, social, and governance issues.
The days of promoters ignoring minority investor opinion, appointing whoever they like as directors and indulging in related party transactions with no checks and balances are over. Investor pressure to maintain governance standards will only increase. As the governance rankings of India improve, inward global capital flows will increase further.
Boards will gain stature and importance as they will need to be more independent and take more cognisance of varied stakeholder interests. There will be far more scrutiny of the track record of board members. India has not had a stellar record with board managed companies. In many cases, strong CEOS have come to dominate the board and become de facto promoters themselves. We will need to create more success stories of independent board-managed organisations. The new technology and start-up listings may show the way.
Increased activism should improve the productivity of capital and raise returns, like we have seen in the West. Ultimately, in any company with low promoter shareholding, unless they optimise for delivering long-term shareholder returns, the promoters will be vulnerable. Companies with poor governance and thus low valuations but high institutional shareholding will be ripe for change.
Given all this additional power, institutional investors have to exercise their vote carefully, while the proxy advisory firms have little choice but to be mechanistic and rule-based in their recommendations, given the number of companies and resolutions they have to opine on. Institutional investors have to build the internal capability to exercise independent judgement on controversial issues. One may not always agree with the point of view of proxy advisory firms, and need the conviction, capability and independent judgement to disagree.
India is entering an age of shareholder democracy and investor activism. The building blocks are in place and one must compliment the regulators for empowering the investor base. The ecosystem is coming together. Investors are starting to ask the right questions. What we have seen in India this week, as shareholders start to exercise their voting power, is not at all common in the emerging market universe. India has a chance to stand out on these metrics. This is a big catalyst for better corporate governance and will improve the return on capital for corporate India as everyone aligns with shareholder value creation. This is an unambiguous positive for the markets and valuations.