Aswath Damodaran is a Professor of Finance at the Stern School of Business at NYU. He specialises in corporate finance and valuation. Below is an extract from his blog post Family Feuds: The Promise and Peril of Family Group Companies.
On October 24, 2016, the board of directors of Tata Sons fired Cyrus Mistry as the Chairman of Tata Sons for non-performance, a failure to deliver on promises.
Mistry did not go quietly into the night and fought back, arguing that the removal was not in keeping with Tata traditions of decorum and fairness, and was effectively a coup by old-time Tata hands who were threatened by his attempt to clean up mistakes made by the prior regime (headed by Ratan Tata). He argued that many of the high-profile acquisitions/investments that Ratan had made, including those of Corus Steel (by Tata Steel) and forays into the airline business (Vistara and AirAsia) were weighing the company down and that it was his attempts to extract Tata companies from these messes that had provoked the backlash.
Defenders of the removal argued that Cyrus had been removed for just cause and that his numbers-driven (and presumably short-term) decisions were not in keeping with the Tata culture of building businesses for the long term.
The opacity that surrounds the Tata companies (you can see it here) with their incestuous corporate governance structures (with directors sitting on multiple Tata companies) and complex holding structures makes it difficult to decipher the truth, but the two sides seems to be in surprising agreement on one point: bulk of the value of the Tata Group derives from two investments, TCS and Jaguar Land Rover.
In fact, the area of disagreement is about why the rest of the group was in in trouble and what should have been done about them.
The Mistry camp argues that the troubles at the rest of the group can be traced back to ill-advised and expensive acquisitions (Corus, Tetley) and investments (Nano) made during Ratan’s tenure and the Tata camp suggests that Mistry knew about those problems when he was hired and that he did little to fix them during the four years of his tenure.
Whatever the truth, the company has a mess on its hands. While Mistry has been forced out at Tata Sons, he remains on the boards of the other publicly-traded Tata companies and was chairman of the board at TCS until a couple of days ago (at the time of writing this post). That sets the stage for a war of attrition, which cannot be good news for any Tata company stockholder or for either side in this dispute, since they both have substantial stakes in the group.
Why I would not invest in a Tata company
The more general question raised by this episode is a troubling one: If a corporate governance dispute of this magnitude can occur at a family group that many viewed as one of the least conflicted in India, and you and I, as stockholders in Tata companies, can do nothing but watch helplessly from the outside, what shred of hope can we have of being protected at other family groups that are much more open about putting their interests over that of stockholders?
After I had completed a valuation of Tata Motors a few years ago, I was asked whether I would buy its stock and shocked my audience by saying that I would never buy a Tata company for my portfolio.
When pushed for my rationale, I said that buying a family group company is like getting married and having your entire set of in-laws move into the bedroom with you; in investment terms, if I invest in Tata Motors, I will (unwillingly) also be investing in many other Tata Group companies, because about 30-40% of the value of Tata Motors comes from its holdings in other Tata companies. (You can see the group structure here.)
However, if forced to invest in a family group company, I would take a Tata company over many other family group companies. The problem that I see in this latest tussle is less one of venality and more of a failure to adjust to the times and a clash of egos.
Ratan Tata's global ambitions, manifested in a spate of acquisitions during his tenure, put the group into businesses and markets where their historical advantages no longer provide an edge. It is ironic that the two most successful pieces of the Tata group are Tata Consultancy Services, or TCS, the company that is at odds with much of the rest of the Tata group in terms of focus and characteristics, and Jaguar Land Rover, a global luxury auto maker with a brand name that has little to do with the Tata family.
What the group needs to do
The dispute between Cyrus Mistry and Ratan Tata has to be settled and soon. Nothing good can come from continuing to fight this out in public and both sides have too much to lose.
It seems to me that the fight has become a personal one, with managers and directors taking sides (voluntarily or otherwise) between Ratan and Cyrus. That tells me that any rational solution will be tough to reach, unless both personalities withdraw from the fray. It seems to me that, for this crisis to abate, Ratan Tata has to step down as chairman and let a third party that both sides find acceptable step in, at least for the interim.
- Separate the public companies from the private
If this episode shows the danger of tying together all of the Tata companies to Tata Sons and the family group (see structure here), the first step in untangling them is to separate the 29 public companies from the private companies in the group. The dangers of self dealing and conflicts of interest are greatest when the private businesses interact with the public companies.
The next step in this process is to make each public company truly independent and that will require (a) selling cross holdings in other Tata companies and (b) removing family group directors who serve on the boards of the stand alone companies.
- Restrict intra group activities
It would be impractical and perhaps even imprudent to bar Tata companies from interacting with each other, but those interactions should follow first principles in finance. Hence, while intra-group loans may sometimes make sense, the interest rates on these loans should reflect the risk of the borrowing entity and intra-group equity investments should be value adding, i.e., earn a return on capital that exceeds the cost.
Disentangling cross holdings and restricting nitric will be a big step towards making the financial statements of the Tata companies more informative.
Lessons for India Inc.
For most of the last two decades, the lament in India is that China has beaten it handily in the global growth game. While it would be unfair to blame this on family group businesses, it is worth noting that the one sector where India seems to have move forward the most is technology and where it has fallen behind the most in in infrastructure and manufacturing.
It may be coincidence that technology is the sector where, TCS notwithstanding, you have seen the most entrepreneurial activity and that traditional manufacturing is dominated by family group businesses. As India moves towards being a global player, opening up hitherto unopened sectors (like retail and financial services) to global players, the family group structures in these sectors may operate as handicaps.
While I don’t believe that it is the government’s place to insert itself within family groups, it should stop tilting the playing field in their favour by doing the following:
- Reduce the need for connections to do business
At the core of connection-driven business success is the existence of licenses and bureaucratic rules governing businesses. Reducing the licensing needs and the rules that govern how you run businesses will create a fairer business environment, though that may sometimes require governments to accept the result that a foreign company will win at the expense of a domestic competition
- Government-based or influenced investors (LIC) should be more activist
The largest stockholder in the Tata Group is the Life Insurance Corporation (LIC), a state-owned company, that has holdings in almost every large Indian company. For decades, LIC has chosen to back incumbent managers against activist investors and has allowed the woeful corporate governance at many family group companies to continue without a push back.
- Banking/Family Group Nexus
Bankers, many government picked and influenced, have historically had cozy relationships with family group companies, lending money on projects with little oversight and often with implicit backing from the family group (rather than the company that is getting the loan). Those relationships not only give family group companies an advantage but are bad for banking health and need to be examined.
The turmoil at the Tata Group has all the makings of a soap opera and can be great entertainment if you are an armchair observer with no money in Tata company shares. It would be a mistake, though, to view this as an aberration because the palace intrigue and the infighting that you observe can not only happen in other family groups but take an even darker tone.
To the extent that family group companies pushed their companies into public markets because they wanted to raise fresh capital and monetize their ownership stakes, they have to play by the rules of the game.