The Honest Truth
By Ajit Dayal

Tata troubles: Corporate Philosophy, Corporate Governance

22 November 2016

The trouble at Tata Sons is really an issue of whether you think Corporate Philosophy guides the very existence of the Tata group as a family and a business - or whether the actions of the various hired hands (from CEOs to Directors) should be determined by Corporate Governance.

Corporate Philosophy is spiritual. Kind of Zen-like with many social objectives that cannot be measured in the near term and may or may not have positive outcomes in the long run. Its measurement is difficult. It's a bit like the blind men who are asked to touch the elephant and describe what it is.

Corporate Governance is a soulless, dumb list of "check the box" sheets of paper. It is possible that the most distrustful and crooked company in the world can get high marks on corporate governance from the many service providers who peddle their databases and proxy service systems in an intensified regulatory world. Investing in these companies may cause you a potential loss of capital or denial of a fair share of profits. If you don't believe me, visualize the worst company you know in India and ask a typical service provider of corporate governance and proxy voting for a sample report to get a view on that company and its management. Be prepared to laugh - or cry!

A quick litmus test.

Before I proceed, a quick check of your pulse:

Imagine you are back in 1981 (for those born after that, please consult your elders!).

There is no internet, no smart phones, no shouting matches that pretend to be TV channels, and no reams of dead trees that pretend to be newspapers when they are actually "presstitutes" (to use a word from President Elect Donald Trump) that are willing to sell their cover pages, mastheads, and their lesser desirable inner portions for a price.

So, here you are reading the very black and white - and trusted - Times of India in 1981 because you wish to buy a second hand Fiat car. The small box ad on page three reads:

Parsi-owned car for sale. No inspection allowed. If you call me - and if your Department of Telephone provided phone line actually works and connects to me - the car is yours. The deal is closed. No backing out. You give me the money and I give you the car. For your information, the owner of the car is Mr. Ratan Tata.

My question to you: Will you make that phone call?

Will you take a chance and gamble with the fact that you need to pay a lot of money (a second hand Fiat car in 1981 cost as much as an 800 square foot flat in Mumbai!) to the seller of this car without any opportunity to see what is under the hood or kick the tyres?

It boils down to one question: Do you trust the seller of the car?

Do you trust Mr. Ratan Tata?

Note your answers in the table below:

The owner of the car is: Will you make the phone call: Yes or No?
Ratan Tata  
Anil Ambani  
Mukesh Ambani  
Rahul Bajaj  
Kumar Birla  
Adi Godrej  
Narayan Murthy  
Cyrus Mistry  
Deepak Parekh  
Shashi Ruia  
Nusli Wadia  

A clash of cultures?

Keeping in mind the responses to the queries above, recognize that the "trust" factor that you have effectively answered to is a reflection of decades of experiences, knowledge, or impressions that you have of each of the very well respected individuals and the business empires that they have built.

I have often said that there are four things of value in this country: (1) Gold, (2) HDFC brand, (3) Infosys brand, and (4) Tata brand.

Of the four, gold has still retained its value and purity - though its price may be moving all over the place and it may be under threat of a government that has run amuck with the recent "demonetization" scheme!

Each of the other three living objects (HDFC, Infosys, and Tata) have lost a lot of their sheen for a variety of reasons ranging from:

- The lack of focus on doing the right thing for customers in a bid to grow revenues and profits: HDFC Mutual Fund and its willingness to play along with a dirty, opaque distribution system that was legally correct but morally questionable - given that this is a company from the stable of the very eminent HDFC group;

- The apparent practice of having each of the founders of Infosys being given a crack at being CEO of Infosys - even though Infosys presented itself as a highly professional company where meritocracy was the sole criteria for decision-making;

- The strange phone calls between corporate lobbyist Niira Radia and Ratan Tata as revealed by the phone tapping operation of Radia's phones between 2008 and 2009. The discussions regarding the 2G spectrum issues did not sound right or read well, even if nothing illegal happened from a Tata perspective.

Tata and the art of Zen-ism.

However, despite the few blips that the Tatas have had, they still seem to work in the spirit of the Corporate Philosophy of the founder, Jamsetji Tata who founded the Tata group in 1834. Amongst his many quotable quotes, here is one that symbolizes what the Tata group stands for:

In a free enterprise, the community is not just another stakeholder in business, but is in fact the very purpose of its existence.

Business, said the founder, exists to serve the community; not to extract from the community!

According to the Tata web site, Jamsetji 'spelt out his concept of a township for the workers at the steel plant in a letter he wrote to Dorab Tata in 1902, five years before even a site for the enterprise had been decided. "Be sure to lay wide streets planted with shady trees, every other of a quick-growing variety," the letter stated. "Be sure that there is plenty of space for lawns and gardens. Reserve large areas for football, hockey and parks. Earmark areas for Hindu temples, Mohammedan mosques and Christian churches." It was only fair that the city born of this sterling vision came to be called Jamshedpur.'

And this is what JRD Tata (Chairman, Tata Sons, 1938 to 1991) had to say about Jamsetji:

The wealth gathered by Jamsetji Tata and his sons in half a century of industrial pioneering formed but a minute fraction of the amount by which they enriched the nation. The whole of that wealth is held in trust for the people and used exclusively for their benefit. The cycle is thus complete. What came from the people has gone back to the people many times over.

So, here we are: Tata Trust is for society. No discussion about it.

Tata Trust owns 65% of Tata Sons, the "holding" company of the Tata Group which owns an equity stake in many operating companies.

Given this background, any investor in Tata listed companies - or in the unlisted Tata Sons - should be aware that any decision made by Tata group will likely be made with other, non-profit motives. It is a bit like owning shares in a PSU bank: you know that the government will use its majority to do something which will push a national objective (Hey, Shaitaan's Bank of India, write off loans to all farmers and crony capitalists so that we can win an election!) even at the cost of destroying profit.

Every research analyst or fund manager and pretty much every investor knows that. And they price the shares of the Tata company or the PSU bank accordingly. The valuation one is willing to ascribe to a future stream of earnings of a Tata company has inefficiencies built in. Staff will be looked after well, costs will not be the most competitive in the industry....you get the picture.

In the 1990's ACC was the largest cement company in India. Upstart Gujarat Ambuja had a more efficient cement operation helped by state tax benefits and better technology. It took ACC nearly a decade to change and restore its status as a force in the cement industry. Essar Steel introduced a new method making steel that was more efficient that the open blast furnace technology used at Tata Steel. It took Tata Steel over a decade to get to some level of competitive standing. When something looked difficult, the Tata group did get rid of the business: Tata Textiles / Tata Finlay and Tata Oil Mills (Tomco). Painfully. Slowly.

For Shaitaan's Bank of India, every research analyst and fund manager and pretty much every investor knows that there will be some really stupid loans that will never come back and that the balance sheet needs to be adjusted for these periodic handouts to the poor and daily gifts to crony capitalists. And the valuation they are willing to pay for an estimated stream of earnings from a Shaitaan's Bank of India will be lower than that of the private sector banks.

Did God appoint the Independent Directors?

Now we come to a crucial aspect of the Tata Sons issue: who appointed the Independent Directors on the operating companies which Tata Sons owns an equity stake in?

Last I checked there was nothing in the Vedas or in the Ten Commandments that gave the Independent Directors some God-given birthright to be on the boards of the operating companies.

They were invited to be on the boards of the operating companies by Tata Sons, effectively.

Their mandate as Independent members of the Board is to:

- Ensure that the corporate philosophy of Tata Sons, as ordained by the Tata Trusts and by the founder Jamsetji Tata, are followed; and

- Ensure that the rules as prescribed by mortals that man the various regulatory agencies are followed.

Take the case of Quantum Asset Management Company, of which I am currently the Director.

We have a corporate philosophy of working in the sole interest of the unit holders; our success is a by-product of that focus. We refused to pay commissions to the distribution channels unless the distributors disclosed the commissions we paid them - and all the other fund houses paid them - to all their clients. That is the corporate philosophy of Quantum AMC.

The Independent Members of the Board did not fall on our lap by some verse in the Holy Scriptures. We invited the very respectable gentlemen to sign on to our vision, to protect it - and to ensure that we followed the rules and regulations issued by SEBI from time to time. These rules may include things like: (1) ensuring we calculate NAV as per a prescribed format, (2) ensuring that we have a backup of our files or keep records in a Disaster Recovery Site, etc., etc., etc.

That, as you can see, is: Corporate Philosophy and Corporate Governance.

Now assume that when I am out of Quantum AMC and a successor Mr NewPerson takes over as the Chairman. NewPerson decides to eject the corporate philosophy and adopt the common mantra in the field of finance which, bluntly put, is: Make Money from the customer. Anyhow. At Any Cost.

This new mantra upsets me. I come back from retirement and say, "Hey, NewPerson, that's not why we set up Quantum AMC!"

What should the Independent Directors on the Board do?

- Tell me, "Sorry, Ajit, but NewPerson is a real nice guy. I like my board fees and the status symbol of being on the Board of India's largest and most respected fund house and I will not quit. Please don't trouble us."

- Tell me, "Ajit, we were appointed by you to look after the Corporate Philosophy. We don't agree with your views anymore. The world has changed. Wake Up. Your old ways will sink the company you started and damage the ability of the Trusts to serve humanity. We need to be competitive and do what the other not-so-moral folks are doing. In the meantime, we will take the honourable decision of resigning. We no longer agree with your corporate philosophy. Please feel free to find the next group of Independent members of the Board to adopt your archaic and irrelevant Corporate Philosophy."

The shareholders and unit holders have the full right to react to the actions of the Board. The investors may agree with the Board in their assessment that "Ajit has lost it" and redeem their units - or sell their shares if Quantum AMC is a listed company.

The Independent Members of the Board have no moral right to back NewPerson as in option 1 above.

They have the full freedom to issue whatever statement they wish to on why they resigned, as in option 2 above.

(For the record, I would like to add that I have full faith that Jimmy and his team at Quantum AMC will never subvert our Corporate Philosophy! This is merely for illustrative purposes! And for the record, I am sure that - over the next few years - Quantum Mutual Fund will be India's largest and most respected fund house! That is a vision that you will help make come true! ☺)

The last piece of the puzzle: The SP Mistry family.

Cyrus Mistry was on the Board of Tata Sons effectively representing the 18.5% equity stake held by his family. After a global search to find a successor to Ratan Tata, Tata Sons announced that Cyrus Mistry was "the man" - and he took over as Chairman of Tata Sons in December 2012.

Table 1: A clash of the titans!
Some of the listed companies of the Tata Group Market Cap As on Nov 1, 2016 Tata Sons' Equity Stake (%) Value of SP Mistry Group's 18.5% Stake On Pro-Rata Basis (Rs. Cr)
TCS 4,62,591 73.8 63,158
Tata Motors 1,53,296 28.2 7,983
Tata Steel 40,568 30.4 2,279
Titan 33,226 20.8 1,281
Tata Power 21,136 31.6 1,234
Tata Communications 18,360 44.2 1,500
Tata Motors-DVR* 17,719 0.1 3
Tata Chemicals 13,932 26.3 677
Voltas 12,743 30.2 713
Indian Hotels 11,713 26.5 574
Tata Global Beverages 8,753 28.1 455
Trent 6,875 31.5 400
Tata Elxsi 4,087 42.2 319
Tata Investment 3,258 69.7 420
Tata Tele (M) 1,392 56.1 145
Total of above     81,140

Source: Times of India, dated November 2, 2016/BSE, companies annual reports
*DVR: Differential voting rights

The SP Group has little manufacturing experience. Their success rate in the field - Specialty Steels and South India Viscose - is not encouraging. Real estate development of slum projects or construction and engineering of buildings and structures may not be a great training place for being groomed to manage a global conglomerate which has layers of formal decision makers and established systems.

While there is much success in the group and profits are presumably good, there is the looming - but mostly forgotten - question of what went wrong with the pollution control systems of South India Viscose around 1994. A search on the internet suggests that the dangerous chemicals on the site were not cleaned up and - after the company went into BIFR - the plant was to be sold and to be cleaned up by the new buyers. It is possible that the Tamil Nadu government was being difficult or that there was no solution to the problem given the kind of chemicals and raw materials that are used to make viscose staple fibre. It is an old issue and maybe the SP Group had no choice and it may not be worthwhile to ask "if South India Viscose was a Tata company, would the outcome with regards to the pollution issue been the same?" On the other hand, the Radia tapes are more current and worrying. Many NGOs are upset with Tata Steel and Tata Power for their mining and pollution issues. So, one faction may not be able to claim to be holier than the other!

The press reports also suggest that a clash of managing styles led to this abrupt parting.

Or that there was a desire to clean up the financially disastrous decisions made during Ratan Tata's tenure by various companies which are now laden with debt and sub-optimal operating metrics. The Tata-Corus steel and the Nano car have been mentioned.

There is also the issue of the court case filed by NTT DoCoMo against the Tata group. I think it takes a lot for a Japanese company to file a suit against anyone in any court in any country! And I cannot recall another instance when Tata was sued by any joint venture partner. To have a partner sue the Tata group is a rude shock to the reputation of the Tata group.

Some suggest that the reality of life factor is that Ratan Tata is old: he has no heir. There is no point in backing Ratan Tata when the other group has a solid blood line that will last decades into the future.

It really does not matter what the reasons are.

We must assume that all the individuals on the stage are honourable men but may not have acted correctly at a point in time.

As an uncle once told me, "aadmi ache hai, pur waqt bura hota hai".

Both parties probably made a mistake: Tata Sons for selecting Cyrus Mistry as the guardian of the Tata Corporate Philosophy and Cyrus Mistry for accepting the role of guardian of the Tata Corporate Philosophy, with all its limitations.

Because Tata Sons is an unlisted company, there is no requirement for them to reveal what happened.

The legal opinion seems to be that Tata Sons has the right to ask for the changes in the composition of the Boards.

In my view, the Independent members of the Board should remember who appointed them.

And either agree to listen to the diktats of Bombay House - or quit in protest.

The service providers who rate companies for corporate governance should do what they are good at: see if all the boxes were ticked and procedures followed. Instead, they sniff the opportunity to make money with more audits and more fees for doing these audits. They are circling the bloody fight that will ensue for some more months and rubbing their hands in glee.

Don't get me wrong: corporate governance is important, but ensuring that the nature of the animal - the corporate philosophy - is not compromised, is a far superior responsibility. And no rubber-stamping service provider can fix that. Just as a lawyer fighting a brief for any client without any moral judgement on what is right or wrong cannot bring "justice"; the lawyers can merely apply the law.

Members of boards have a right and responsibility to protect that corporate philosophy, or quit in protest - and allow the majority and minority shareholders to appoint a new Director to replace them. But they don't get to play the role of the Guiding Light.

That role belonged to Jamsetji Tata. And to no one else.

Every shareholder in every listed Tata company must understand that - and decide whether they wish to own a part of a company with these laid out principles, or not.

Now, back to that advertisement in the Times of India in 1981 for that used car...send in your completed table and we will publish it. I know that I would love to see it!


Ajit Dayal is a Director at Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd.

The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site.

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