April 14, 2009 — drsubrotoroy
Textbook corporate finance theory says that when a going concern takes over an ailing or bankrupt company (with low or zero or negative value), it does so in expectation that the net value of the combined entity shall, at least in due course, exceed the present value of the successful buyer.
The most peculiar aspect of the Satyam auction process has been the delay and obfuscation that greeted attempts by potential buyers to ascertain the extent of its liabilities (many of which may be contingent liabilities depending on the outcomes of American class-action suits.) Even so, Satyam appears to have been taken over. Caveat emptor! may be all that needs to be said. We are like this only.
March 10, 2009 — drsubrotoroy
We in India are justly proud to have once discovered the Zero, which arose, as far as I recall, from a philosophical notion of possible Nothingness (Shunya), though of course there is a long history that came to follow in Indian mathematics.
The Government of India’s Company Law Board (and the pompous honchos they have gone about appointing here and there) may need to be reminded that by any system of mathematics, 51% of Zero still remains, uhmmmm, Zero.
Bankrupt companies get sold for nominal prices like Rs 100 or perhaps $2. But of course it is not impossible a notorious Government contractor or two will pump money in as a backdoor public subsidy aimed at creating a zombie.
January 18, 2009 — drsubrotoroy
Satyam may be able to summarily solve the problems caused by its high-level corporate fraud by transforming itself into a “Labour-Managed Firm”.
One of the new Government-appointed board members has stated publicly today that the company has little or no debt. If this is true it would be interesting because not only were the vast cash-assets non-existent, the liabilities-side of the balance-sheet also may be small, which could mean the company was simply far smaller in terms of value than it had made itself out to be. In a bankrupt firm, the remaining assets normally come to belong to the creditors but what if the main creditors happen to be the work-force? If that is in fact the situation in this case, Satyam may be a prime candidate to be transformed into a “Labour-Managed Firm” of the sort discussed by Jaroslav Vanek (The General Theory of Labour Managed Firms and Market Economies, 1970) and James Meade (The theory of the labour-managed firm and profit-sharing, Economic Journal 1972), and surveyed by e.g. Louis Putterman in the New Palgrave Dictionary and by Martin Ricketts in The Economics of Business Enterprise 2003.
As I had briefly mentioned earlier here, the transition could be made by Satyam’s existing technical and other staff being allowed to participate (with their personal savings and claims to future income) in any auction of the “works-in-progress” that constitute the client contracts the company presently has around the world and which constitute its major intangible asset. This may be the single best way to preserve the firm’s value as well as the income-streams of its staff.
The staff would have to make a transition from being employees to becoming self-managers which may not be easy in practice, although in theory the information-technology industry may be well-suited to labour-managed firms given the peculiarly intangible nature of their products. The marginal cost of production of (true) information is typically very high but the marginal cost of dissemination of information is near- zero.
If this happened and a corrupt bankrupt Satyam-I transformed itself into a viable Labour-Managed Satyam-II, the newly appointed board would become redundant even more quickly than it would have done otherwise — though this board may be even less likely to know of Vanek and Meade than to be familiar with modern corporate finance. Time perhaps to hit the textbooks, gentlemen, and burn that midnight candle! Is that something we can expect from some of the key lobbyists of India’s organized business sector?
Postscript 1 : Of course if the asset-side has been fraudulently exaggerated while the liabilities-side has been small, the fraud has been directly perpetrated on equity-holders who held stock that was overvalued by the market as a direct result of the fraud.
Postscript 2: I find (grotesquely) amusing the new found emphasis on “Independent Directors” in view of the obvious fraud in the advertised biographies of some rather notorious Independent Directors in the IT-business and other sectors of corporate India and the higher bureaucracy! There seems in fact to have been a wild hyperinflation of reputations generally, especially in Delhi, Mumbai, Bangalore, Pune and other such hip with-it places — people claiming to have earned PhDs when they have none, people calling themselves “Dr” on the basis of some defunct Soviet management institute having once paid them off, people claiming to be Harvard postgraduates on the basis of some outsourced executive development programme of a few weeks’ duration, people claiming academic publications and academic affiliations which are non-existent, etc etc. All that for another day! (But any former students of mine who may find the above pertinent to themselves may please know their old prof is cross with them! Tsk tsk!) (And then there was the one of the senior government economic planner who told his astrologer on the telephone his correct date of birth but had lied to the Government of India by a couple of years…. clearly he did not want to get his own Ptolomaic horoscope wrong even if his plans for India in the Copernican world went awry!)
January 8, 2009 — drsubrotoroy
Corporate Governance & the Principal-Agent Problem
for a conference on corporate governance
I am most grateful for this opportunity to speak at this distinguished gathering. I have to say I have had just a day to collect my thoughts on the subject of our discussion, so I may be less precise than I would wish to be. But I am delighted I have a mere 7 minutes to speak, and I will not plan to speak for a second more!
I would like to ask you to consider the following pairings:
SHAREHOLDER: DIRECTORS & MANAGERS
You will recognize something in common to all of these pairings I am sure. A patient goes to a doctor with a problem, like a swelling or a stomach ache or a fever, and expects the doctor to do his/her best to treat it successfully. A client goes to a lawyer with a problem, of a contract or a tort or a criminal charge, and expects the lawyer to represent him to the best of his ability. A student attends a University or higher educational Institute, and expects the professors there to impart some necessary knowledge, to explain some difficult or complex natural or social phenomena, to share some well-defined expertise, so the student too may aspire to becoming an expert.
In each case, there is a Principal – namely the patient, the client, the student, — and there is an Agent, namely, the doctor, the lawyer, the professor. The Agent is not acting out of charity but is someone who receives payment from the Principal either directly through fees or indirectly through taxes.
The Agent is also someone who necessarily knows more than the Principal about the answer to the Principal’s problem. I.e. there is an asymmetry in the information between the two sides. The Agent has the relevant information or expertise — the Principal needs this information or expertise and wishes to purchase it from him one way or another.
A company’s Board of Directors and the management that reports to it, may be similarly assumed to have far greater specific knowledge than the company’s shareholders (and other stakeholders) about the state of a company’s operations, its finances, its organisation, its position in various input and output markets, its potential for growth in the industry it is a part of, and so on. Yet the shareholders are the Principal and the directors and managers are their Agents.
And indeed the Government of a country, i.e. its political leadership and the bureaucracy and military that are reporting to it, also have much more relevant decision-making information available to them than does the individual citizen as to the economic and political direction the country should be taking and why, and again the body of the ordinary citizenry of any country may have a reasonable expectation that politicians, bureaucrats and military generals are acting on their behalf.
In each of these cases, the Principal, having less information than the Agent, must necessarily trust that the Agent is going to be acting in good faith on the Principal’s behalf. There is a corporate governance problem in each case simply because the Agent can abuse this derived power that he acquires over the Principal, and breach the contract he has entered into with the Principal. Doctors or lawyers can practise improperly, professors can cheat their students of their money and teach them nothing or less than nothing, boards of directors and managers can cheat their shareholders and other “stakeholders” (including their workers who have expectations about the company) of value that should be rightfully theirs — and of course politicians, bureaucrats and military men are all too easily able to misuse the public purse in a way that the public will not even begin to know how to rectify.
In such situations, the only real checks against abuse can come from within the professions themselves. It is only doctors who can control medical malpractice, and only a doctor can certify that another doctor has behaved badly. It is only lawyers who can control legal malpractice, and testify that yes a client has been cheated of his money by some unscrupulous attorney. It is only good professors and good teachers who can do what they can to stand out as contrasting examples against corrupt professors or incompetent teachers.
In case of managerial malpractice, it is only fellow-managers who may be able to comprehend the scam that a particular CEO has been part of, in stealing money from his shareholders. And in case of political malpractice, similarly, it is only rival political parties and when even those fail, rival political institutions like the courts or the press and media, who can expose the shenanigans of a Government, and tell an electorate to throw the rascals out in the next election.
In other words, self-policing, and professional self-discipline are the only ultimate checks and balances that any society has. The ancient Greeks asked the question “Who guards the guardians”, and the answer has to be that the guardians themselves have to guard themselves. We ultimately must police ourselves . I think it was William Humboldt who said that a people get the government they deserve.
In India today, indeed in India in the last thirty or forty years, perhaps ever since 1966 after the passing away of Lal Bahadur Shastri, we may be facing a universal problem of the breach of good faith especially so perhaps in the Government and the organised corporate sector. Such breaches occur in other countries too, but when an American court sends the top management of Enron to jail for many years or a Korean court sends the top management of Daewoo to jail for many years, we know that there are processes in these countries which are at least making a show of trying to rectify the breaches of good faith that may have occurred there. That is regrettably not the situation in India. And the main responsibility for that rests with our Government simply because our Government is by far the largest organised entity in the country and dwarfs everyone else.
As an economist, I have been personally intrigued to realise that Government corruption is closely caused by the complete absence of serious accounting and audit norms being followed in Government organisations and institutions. Get control of as big a budget as you can, is the aim of every Government department, then spend as little of it as is absolutely necessary on the publicly declared social or national aim that the department is supposed to have, and instead spend as much as possible on the travel or personal lifestyles of those in charge, or better still transform as much as possible into the personal property of those in charge – for example, through kickbacks on equipment purchases or building contracts. For example, it is not unknown for the head of some or other government institution to receive an apartment off-site from a builder who may have been chosen for a major construction project on site. This kind of thing has unfortunately become the implicit goal of almost all departments of the Government of India as well as the Governments of our more than two dozen States. I have no doubt it is a state of affairs ultimately being caused by the macroeconomic processes of continuous deficit-financing and unlimited printing of paper-money over decades. For the first two decades or so after Independence, our institutions still had enough self-discipline, integrity, competence and optimism to correct for the natural human instincts of greed and domination. The next four decades — roughly, as I have said, from the death of Shastriji — there has been increasing social and political rot. I have to wonder if and when a monetary collapse will follow.
January 16, 2001 — drsubrotoroy
Preface May 26 2009: Despite the harshness of this review, I should like to add that Ms Sucheta Dalal of Mumbai is my favourite financial journalist in India.
Review of A. D. Shroff: Titan of Finance and Free Enterprise by Sucheta Dalal, with a foreword by N. A. Palkhivala, Viking 2000.
First published in Freedom First, 2001
A. D. Shroff died on October 27 1965. But if you want to know when he was born you will not find it in this biography – it could be deduced to be 1898, 1899, 1900 or 1901 depending on where you look in this book. We are told Shroff got a second at Bombay University and proceeded to the LSE in the early 1920s. That was an exciting time to be in Europe and at the LSE in particular, yet this biography tells us nothing of what Shroff may have felt or experienced there, except that he got a job with an American and not an English bank, and attended evening classes at the LSE. Shroff is said to return in 1924 and almost immediately becomes a partner in Batlivala & Karani, stockbrokers, where he remains until 1939 when he joins the Tatas. Now Shroff was a Parsi, and his early education, career and professional relationships in the Bombay financial world were doubtless governed by this central fact. Yet even this vital aspect of his life has not seemed worthy of serious development by Sucheta Dalal.
Then Ms. Dalal tells us numerous times that Shroff was “astonishingly successful” and a “financial wizard”, yet she does not offer a single concrete example which may have illustrated this definitively for us to reflect upon or learn from. Shroff was a stock-broker who actively traded, we are told, on the international exchanges, yet we do not come to know whether he made money or lost money during the boom of the 1920s, the Great Crash of 1929 or the Great Depression of the 1930s. Ms. Dalal tells us (p. 16) the young Shroff’s tax return for 1935 showed an income of Rs. 167,000. As a “well-known financial journalist” herself, she could have calculated this to amount to something like Rs. 20,752,707 at today’s prices. But Ms. Dalal makes no attempt to explain how Shroff made this enormous income, nor does she delve into the further obvious question how a man like Shroff was then eventually to die with taxes unpaid, leaving his family in some financial distress or difficulty. We may have reasonably expected some explanation of all this, but no, it is all going to be left a mystery. That Shroff was “particularly charming to women”, was fond of throwing “lavish” parties, or that he suffered a “nervous breakdown” in 1938, only serves to deepen the mystery. Practically the only concrete example of Shroff’s financial wizardry given by Sucheta Dalal in this biography is that he seems to have been close to the regime of the Nizam of Hyderabad, and borrowed from that source to get the Tatas out of a financial jam.
Ms. Dalal makes much of Shroff being considered for the job of Deputy Governor of the Reserve Bank of India in 1936, in succession to Sikander Hyat (later Premier of Punjab), a job which went to Manilal Nanavati, a senior administrator of Baroda. Dalal says that Shroff was the preferred candidate of the RBI’s first Governor, an Australian banker by the name of Osborne Smith, and that his appointment was sabotaged by the machinations of the senior Deputy Governor, James Taylor, and his fellow civil servant and Finance Member, James Grigg. Now the RBI’s official history spends long pages discussing some of the roots of a conflict between Smith, Taylor and Grigg (History of the Reserve Bank of India, 1939-1951, RBI Bombay 1970, p. 222 et. seq. ). Ms. Dalal has done well to throw some new light on that early conflict, but she makes no comment on why the official history makes no mention at all of Shroff, then a youthful stock-broker, being a candidate for the job, only that “about 25 people were in the run for the post” (History, p. 227). The same official history mentions Shroff and others being members of the “Currency League” which agitated against parts of the original RBI Bill, but Ms. Dalal seems not to have looked up Shroff ‘s name in the index of that book and so says nothing about it.
Leave aside facts and economic history and turn to the sort of gossip, anecdote and rumour which fills many of these pages. Ms. Dalal tells us Shroff had monumental confrontations with two senior contemporaries of his in the Bombay financial world: J. R. D. Tata and Ardeshir Dalal. Fascinating, the reader says, tell us more about this at least. But again there is only disappointment, and we learn almost nothing of the depth or dynamics of these conflicts either. Time after time, a reader is forced to decide whether the biographer has been merely lazy in dealing with her chosen subject or whether facts are being glossed over thirty five years after his death.
This is a great pity. A. D. Shroff’s lasting legacy for India has been the Forum of Free Enterprise, run so ably by his friend and disciple M. R. Pai for so long. Post-Independence Indian liberals, like many liberals elsewhere, are of two kinds – those who were arguing for liberalism before it became fashionable to do so, and those who are filled with newly discovered liberal ideas now that it has become fashionable to be so. The way to fix which category one belongs to is by recalling one’s opinions before and after the fall of the Berlin Wall. Before the fall of the Berlin Wall, our nation of hundreds of millions of people, produced a sum total of perhaps a dozen or so genuine liberals in political economy: Rajagopalachari, Masani, Shenoy among them.
Shroff’s Forum of Free Enterprise was one rare beacon of hope that Indian liberals had in those dark days before 1989. (To her credit, Ms. Dalal records Shroff’s assessment of Nehru: “Pandit Jawaharlal Nehru has indulged in a very serious self-contradiction when he wants a rapid industrialization of the country and at the same time preaches the abolition of private property”). The Forum’s little, plain, inexpensive pamphlets, with their massive reach among unknown multitudes of Indian students, often seemed more important than most Indian newspaper editorials at the time, because they defiantly permitted the opinions of a Milton Friedman or a Peter Bauer to be expressed to contradict the Sovietesque intelligentsia in Delhi and elsewhere. From each of those pamphlets peered out a photograph of and a quotation from A. D. Shroff. Many Forum readers must have wondered who this man was who had given them the chance to read these little pamphlets in the darkness. The opportunity after all these years of even a sponsored biography was an outstanding one. It should have been seized properly and professionally, for the production of a full and comprehensive picture of the man — his talents as well as his faults. This reviewer has little doubt that Shroff was a strong, hard, rambunctious kind of man, who hated all things puny and narrow-minded, who may have had in him rare qualities of economic leadership which India did not come to properly utilize. (Suppose Nehru had made him Finance Minister — could he have been India’s Ludwig Erhardt?) A chance to properly write the biography of that man has been squandered.
Kharagpur, January 16, 2001.