Is India Ready For Hostile Takeovers?

Uday Kotak recently reiterated the need for hostile takeovers as a credible tool to spur the market for corporate control in India, and provide a persuasive alternative to minority shareholders by shaking up the cozy promoter-management nexus out of its comfort zone in sub-optimally managed, publicly listed entities. This is a view that I've voiced often.

But are hostile takeovers feasible in India’s regulatory, cultural, institutional and political environment? Over the years, although we have witnessed takeovers with consistent regularity, nearly all of these have been friendly. To my recollection, there have been only seven unsolicited offers since the mid-1980s which could be considered hostile.

Much has changed for the better from a regulatory perspective since the regime prior to 1994. Back then, mergers and takeovers were subject to minimal regulation. Valuations were set to suit promoters, short-changing minority shareholders.

• The 1992 share and optionally convertible debenture issues of Reliance Polyethylene Ltd., and Reliance Polypropylene Ltd., and their mergers into Reliance Industries Ltd. (RIL) in 1995, resulted in an acquisition price of RIL shares that was substantially lower for the promoters than the minority shareholder.
• Brooke Bond's initial takeover bid for Kissan Foods in 1992 was Rs 6.7 crore and was raised to Rs 25 crore solely due to the entry of Nestle into the race, in what was one of the earliest instances of competing offers in India.

India's Takeover Code took its first, albeit hesitant, steps in 1994, and then successively in 1997 and 2011 with many progressive amendments in between. The hope in 1994 was that increasing participation in the Indian capital market by domestic and foreign financial institutions will precipitate the emergence of shareholder activism to combat promoter and management excesses, with hostile takeovers forming the bedrock for an institutionalised disciplining mechanism that would be available to the benefit of non-controlling shareholders.

The current Takeover Code - the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011, read with amendments in 2013 - is modelled towards the progressive U.K. City Code on Takeovers which promotes hostile takeovers through a ‘no frustration’ doctrine, and not the U.S. code which is more aligned to protect entrenched managements. Despite this orientation, expectations of an increase in hostile takeovers have been belied. Why? The answer to that question provides some key insights into the way we operate in India.

Do remember that our present code firmly addresses the twin objectives of transparency and minority protection. The provisions designed for a permissive takeover regime, and thus, ostensibly against the interests of entrenched managements or controlling shareholders include the mandatory bid rule (MBR), voluntary offers allowing full acquisition of capital, competing offers, lack of takeover defenses like the poison pill and other scorched-earth tactics.

The reasons for this are four:

• First, concentrated promoter holdings in approximately 50 percent of listed companies and tacit support from government institutions like the LIC and others form a formidable barrier. Creeping acquisitions and the exemption of preferential allotments from the mandatory bid rule augment mechanisms for reinforcement of control by incumbents even further, without invoking the Takeover Code's need to pay a control premium to minority shareholders.
• Second, the overall economic legislative framework makes this difficult, especially for takeover bids by foreign entities - notably before 2011. Legislated by the RBI, the soon-to-be-abolished FIPB and other governmental bodies like the Cabinet Committee on Economic Affairs, these were related to approvals covering limits of shareholding allowable for different sectors under foreign direct investment - foreign portfolio investment norms and other situations including open market operations. Even in the Takeover Code itself, conditions like the very limited circumstances for withdrawal of a bid increase the risk and costs for an acquirer. A short two-week window on competing offers surreptitiously works towards stifling competition in the market for corporate control. Furthermore, practice suggests that SEBI requires the acquirer to certify, and take responsibility for certain disclosures made public by the target company! These ‘subjective’ barriers to hostile takeovers make some aspects of the regulation opaque, and indirectly assist entrenched promoters.
• Third, factors related to the environment in which businesses operate in India imply the necessity of incumbents to maintain close connections with the political class. This is often used to invoke nationalistic and political sentiments to stall takeovers. It was used successfully over the years in different pretexts; from the Swraj Paul bid for DCM and Escorts in 1983, the Asian Paints bid by ICI UK in 1998, to IVRCL in the hostile attempt by Subhash Chandra's Essel Group in 2012. This approach also fits completely into the cultural aspect of the non-Anglo-Saxon world where direct confrontation, and shaking up the status quo is generally frowned upon. Loyalty to the incumbent class becomes the prime driver in governance paradigms, overriding considerations of efficiency and propriety.
• Finally, the absence of a vibrant and deep debt market with innovative instruments to fund leveraged hostile takeovers creates a significant institutional roadblock for an ideal market for corporate control.

Former Chief Justice of India PN Bhagwati, who chaired successive committees from the mid-1990s in India's journey towards a modern takeover code, said in January 1997 that the takeover code was “designed to be a tool for allowing promoters to consolidate holdings and better resist foreign takeovers”. Given the generation he represented, and India's baby steps to globalisation at that time, he cannot be faulted for this view.

However, 20 years later, a modern and confident India needs to fully embrace the best global standards of corporate governance, of which hostile takeovers are an integral part.

Concentrated holding as a means of takeover defense leads to a highly inefficient use of capital in a country with huge capital scarcity. Promoters who cling to inefficiently managed companies due to the comfort of concentrated holdings will only witness an erosion of value in comparison to well-governed companies. While companies like L&T, Infosys and a few others remain vulnerable to hostile takeovers due to their dispersed shareholding, the governance premium they enjoy in the financial markets serves in part as a barrier to any takeover threat.

Despite significant advances in the regulatory framework, the minority shareholder in listed entities continues to remain at the mercy of the entrenched promoter or controlling shareholder group. The agency problems between controlling shareholders with concentrated holdings and minority shareholders need to be broken, and hostile takeovers are ideally placed as a governance mechanism to augment this process. Sweden has demonstrated that a strong thrust on corporate governance by foreign institutional shareholders can lead to significant changes in the efficiency of family owned companies. Swedish companies have admirably solved their challenge of attracting foreign capital while maintaining their closely-held, family-dominated governance structures. FIIs played a key role in injecting corporate governance pressures into the Swedish domestic markets.

In fact, although India's Takeover Code has been developed through a public consultative process over the last two decades, corporates, leading corporate lawyers, and other interest groups have had a strong representation on SEBI-appointed committees. This perhaps led to incumbents retaining a dominant voice in the shaping of takeover regulations.

The speed at which Prime Minister Narendra Modi is dismantling entrenched structures across the spectrum, in the interest of the common man, I am hopeful that this too will receive his attention very soon. The growing influence of shareholder activist groups, proxy advisory firms, and FIIs should ensure adequate representation in the next round of enhancements to the Takeover Code.

Uday Kotak is totally correct in hinting publicly that the time for reopening the debate on hostile takeovers is at hand. His fund raising plan is not fortuitous. How his game plan unfolds will be fascinating for those with an interest in the future of the market for corporate control in India. The government faces a choice between the benefits of a liberal hostile takeover doctrine in terms of management efficiency, scale and promoting an efficient, value accretive investment climate in India; and the costs of maintaining the status quo with entrenched domestic promoters continuing to control sub-optimally performing entities.

Prabal Basu Roy is a Sloan Fellow from the London Business School and a Chartered Accountant. He presently manages a private equity fund and has formerly been a director and Group CFO in various companies.

The views expressed here are those of the author’s and do not necessarily represent the views of Bloomberg Quint or its editorial team.