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Assistant Professor of Economics,
Bethune College, Calcutta


( 534-6385

Since the initiation of the liberalization and globalization policies in India in July 1991,
an attempt is definitely being made by our policy makers to recast the institutional,
organizational and legal arrangements in line with those practiced in the established
market economies. In view of exploring the changing institutional framework in the
context of economic reforms, the objective of this paper is to examine the recent
corporate governance scenario in the private corporate sector in India and to evaluate
the position of corporate control mechanisms like mergers and takeovers therein. In the
course of analysis, the article reviews the various corporate governance policies adopted
or recommended in India over time and raises certain related issues of corporate
governance pertaining to the Indian situation, that might throw light on the on-going
process of designing of an appropriate code of corporate governance for India in the
post-liberalization regime.

Keywords: Corporate governance, mergers, takeovers, liberalization, economic reforms,

institutional framework.

This article is based on a chapter of my Ph.D. thesis that made an extensive study on the
nature, causes and consequences of merger and takeover activities in India in the post-
liberalization regime. I owe deep gratitude to my Ph.D. supervisor, Professor Amiya
Kumar Bagchi, Centre for Studies in Social Sciences, Calcutta, for his untiring guidance
in shaping my research and for his valuable comments and suggestions on this article. I
would also want to take this opportunity to render my sincere thanks to Dr. Sarmila
Banerjee, Professor and Head of the Department of Economics, University of Calcutta,
for inspiring me to probe into the intricacies of the contemporary mergers and takeovers
taking place in India and for training me to crystallize my thought in this particular area
of Industrial Organization theory. The usual disclaimers apply.


The issue of corporate governance (CG) has attracted explicit attention in India from
academics, government, the popular press and industry and capital markets with the
adoption of the structural adjustment and globalization policy by the government in July
1991 when the economy opened up of its industrial and financial sector to international
competition and increased private ownership. Various efforts have been taken at industry
and government circles regarding the formulation of a well-defined code of CG in India
since the second half of the 1990s.

The term ‘corporate governance’ broadly refers to the set of rules that are designed to
govern the behaviour of firms. The governance mechanisms, which are normally
considered pertain to the regulations monitoring product market competition and
industrial policy, the capital market, the market for corporate control and institutional
supervision through various government bodies (like Department of Company Affairs,
Securities and Exchange Board of India (SEBI), etc. as in India) and also the internal
monitoring and control system of the firm headed by the board of directors. Accordingly,
there emerge different sets of rules to handle the various dimensions of CG issues. Out of
the successive layers of governance, we will, in this article, concentrate on the association
between CG and the market for corporate control in India.

The uphauling of the industrial policies in India’s agenda for economic reforms has
resulted in a radical change of environment for the private corporate sector, boosting in
the process, a market for corporate control characterized by mergers, acquisitions,
takeovers (TOs) and similar corporate consolidation activities. Simplistically speaking, if
incumbent management of a company fails to deliver, investors are quite willing to look
for other teams to TO the companies. When a bidding firm acquires a target firm – for
instance, in the case of acquisition of Tata Oil Manufacturing Company Limited (Tomco)
by Hindustan Lever Limited (HLL) in 1994 – the control rights to the target firm are in
the process, transferred to the board of directors of the acquiring firm (Khanna (1998:
19)). How far the interests of the different stakeholders in a company are taken care of in
a TO process depends on the prevailing CG structure and the position of the market for
corporate control within that structure.

This paper explores the evolution of CG policies pursued in India for the private
corporate sector in relation to the market for corporate control with a view to identifying
the changing trend in such policies in the post-liberalization regime. The paper is
designed as follows. In Section II we have briefly clarified certain concepts. These
include the concept of CG as in the private corporate sector with joint-stock companies,
that of the market for corporate control and its activities, the requirement of regulations in
such a market as also the relevance of CG in monitoring a market for corporate control.
Section III reviews the various policies – actual and proposed -- regarding the different
dimensions of CG private corporate sector adopted or recommended in India prior to and
after liberalization and posits the implications of these policies, which might directly or
indirectly affect the prevailing characteristics of CG in India and the position of mergers
and TOs. e.g., the paradigm shift in shareholder-oriented policy proposals to those
oriented towards consumers. Section IV concludes the paper, where we have raised
certain related positive and normative issues of CG pertaining to the Indian situation, that
might throw some light on the on-going process of designing of an appropriate code of
CG for India.
Corporate Governance and the Relevance of the Market for Corporate

II.1 Corporate Governance

Limited liability joint stock companies form the cornerstone of the private corporate
sector in any economy. Here ownership is scattered among the various shareholders and
there is distinct separation between ownership and control. In such a corporate structure
firms thus increasingly shift to financial markets (equity markets, for instance) as the
source for capital. Focus on CG and related issues are inevitable outcomes of this
process. Moreover, a joint stock company may be viewed as a collection of different
stakeholders (such as shareholders, debt-holders, board of directors, top-management,
middle management, workers, suppliers and customers and finally the consumers) with
conflicting interests, many of which do not relate to firm profits. CG in the context of a
joint-stock company, deals with laws, procedures, practices and implicit rules that
determine a company’s ability to take managerial decisions vis-à-vis its claimants – in
particular, its shareholders, creditors, the employees, suppliers and the State. Good CG
implies that the institution is run for the optimal benefit of the stakeholders from short-
term and long-run perspectives so that the firm concerned may “flourish and grow so as
to provide employment, wealth and satisfaction, not only to improve standards of living
materially but also to enhance social cohesion” (Charkham (1994: 1)).

II.2 Market for Corporate Control

We define corporate control as the right to determine the management of corporate

resources; that is right to determine the composition of the management team, including
right to hire, fire and compensate senior managers. Market for corporate control is the
arena in which alternative management teams compete for the rights to manage corporate
resources (Jensen and Ruback (1983: 5-50)). In this market, competing management
teams make offer to shareholders for the right to manage the business, which these
shareholders own. Like all markets, this requires a number of buyers (bidders) and sellers
(targets), to approximate a price mechanism. The corporate internal control system in the
form of mergers, acquisitions, TOs, etc. are designed to prevent the loss of investor
capital and other social resources when factor and product market discipline is disrupted
(e.g., in situations where firms fail to supply the product that customers desire at a
competitive price).

II.3 Need for Regulations in Corporate Control Market and the Relevance of CG

Mergers and TOs are dynamic corporate events and all the various permutations and
combinations of the moves of the relevant parties and the resulting outcomes cannot be
envisaged. For the market for corporate control to perform efficiently in the sense of
effective utilization and management of corporate resources that will ensure improved
performance of companies after the consolidations take place, it ought to take place
within the orderly framework of regulations. Here comes in the relevance of CG. Thus, it
is important that such critical processes like substantial acquisition of shares and TOs,
which can significantly influence corporate growth and contribute to the wealth of the
economy through rational allocation and optimal utilization of resources, take place
within the orderly framework of regulations. The regulations have to be so devised that
they outline the principle, which could be the guiding lights for the unexpected events
that could crop up later. The major objectives of any framework of regulations governing
TOs are perceived to be:

* Protection of stakeholders’ (particularly, the shareholders') rights and interests.

* Allowing a free, fair transparent and equitable market for corporate control.
* Curbing malpractices in such transactions.

It transpires from the above discussion of conceptual issues that for the CG mechanism to
be effective, adequate and appropriate, the regulations designed to control the market for
corporate control under the general set of rules of CG ought to be more expansive in the
sense that not only the shareholders but all the stakeholders should be taken care of.

Corporate Governance and the Market for Corporate Control in India

With liberalization, we have observed in India, a distinct trend among promoters and
established corporate groups towards consolidation of market share and diversification
into new areas through merger and TO activities. However, although the market for
corporate control was technically existent in India even before the liberalization in 1991,
it had been relatively inactive by the standards of matured capitalist economies.

III.1 Stature of the Corporate Control Market in India before Liberalization

Although prior to 1991, mergers and acquisitions were restricted under Indian law, in
terms of industrial licensing laws and restrictive statutory provisions, TOs, mergers and
acquisitions were not unknown. In fact, business houses like the Goenka group, or the
Manu Chhabria group grew largely through acquisitions; earlier on some business houses
such as the Bangur group grew mainly by taking over erstwhile Anglo-Indian firms
(Bagchi (1999: 58)).

Merger and acquisition activities continued to take place in the manufacturing sector in
India during the 1980s. Since 1986 onwards, both friendly TO bids on negotiated basis
and a few hostile bids too, through hectic buying of equity shares of select companies
from the stock market have been reported frequently.

Regulations in Corporate Control Market Prior to 1991

The first attempt in regulating TOs in India were made in a limited way by incorporating
Clause 40 in the Listing Agreement that provided for making a public offer to the
shareholders of a company by any person who sought to acquire 25% or more of the
voting rights of the company. Apart from this, prior to 1991, mergers, acquisitions and
TOs were regulated by Companies Act, 1956, Industries (Development and Regulation)
Act, 1951, MRTP Act, 1969, FERA, 1973, Sick Industrial Companies (Special
Provisions) Act, 1985, Section 72A of the Income Tax Act, 1961 and SCRA, 1956 (with
respect to transfer of shares of listed companies vide clauses 40A and 40B). For example,
in case of MNC related acquisitions, provisions of the FERA applied which imposed a
general limit on foreign ownership at 40%. In addition, MRTP gave powers to the union
government to prevent an acquisition if it was considered to lead to ‘concentration of
economic power to the common detriment’. Moreover, in the event of a hostile bid for
the company, the board of a company, under Section 22A of the SCRA, had the power to
refuse transfers to a particular buyer, thereby making it almost impossible for a TO to
occur without the acquiescence of the existing set of managers. To this extent, the scope
of hostile TOs (as against friendly TOs) was limited in India prior to 1991. The refusal to
transfer share by the company board could be on two grounds:

• that the transfer was against the interests of the company, or

• against public interest.

Also, prior to the 1990s, an open offer was mandatory for acquiring 25% stake in a
company. In 1990, this threshold was reduced to 10% of a company’s capital.

III.2 Stature of the Corporate Control Market in India after Liberalization

Corporate Control Market after 1991

The policy regime in the 1990s has greatly liberalized the possibility of industrial
restructuring and consolidation through mergers and TOs by removing various
restrictions. With the adoption of liberalization policies in 1991, the Government omitted
the relevant sections and provisions from the MRTP Act, 1969 involving pre-entry
scrutiny, by the MRTP (Amendment Act), with effect from 27.9.91 (Sections 20-26 and
Sections 28-30G of Chapter III, -- “Concentration of Economic Power” were omitted).
With this, the need for prior approval of the Central Government for merger and
acquisition activities was abolished. The availability of flow of funds through global
depository receipts (GDRs) and Euro-issues has reduced the problem of finance. This,
together with the dismantling of the FERA controls in 1991, has led to a rise in the
number of mergers and TOs, actual and proposed the extent of which is shown in Table

Table 1 shows the number and percentage change in the number of merger and TO
activities in India from 1988 to 1998. These mergers and TOs include the realized as well
as abortive bids. Table 1 exhibits a sharp rise in the overall merger and acquisition
activity in the Indian corporate sector. While there were 58 mergers and TOs from 1988
to 1990, the number rose to 71 in 1991 and 730 in 1998. There was a jump in the number
of merger and TO activities in India from 1988 to 1993, the average rate of increase
being around 89% for the five-year period. Since then the rate of rise had maintained an
average of 20.5%. Khanna (1998: 10) has referred this situation in India as the “first
merger wave” in India.
Table 1

Number and Percentage Change in the Number of Merger and Takeover

Announcements in India from 1988 to 1998

Year Number Change

1988 15
1989 18 20.0
1990 25 38.9
1991 71 184.0
1992 135 90.1
1993 288 113.3
1994 363 26.0
1995 430 18.5
1996 541 25.8
1997 636 17.6
1998 730 14.8

Source: Collated from various newspapers including business dailies, various issues and
also Monthly Review of the Indian Economy, CMIE, various issues.

Table 1 presented above shows the number of merger and TO “announcements” over
1988 and 1998. These announcements were made in a number of newspapers including
business dailies and also the CMIE bulletin “Monthly Review of the Indian Economy”.
Each pair of firms (target and bidder) is treated as one announcement. However, if a firm
has more than one bidder and the press reports these bidders at different points of time,
our data-base will have multiple entries. This provides for some firms appearing in the
data-base more than once. One such example would be the case of Ahmedabad
Electricity Company for which the Torrent group made the first bid and the subsequent
bid was made by Bombay Dyeing. This led to an imbroglio after which the Torrent group
could finally acquire Ahmedabad Electricity Company (Mukherjee (1995); Maitra
(1995)). Our data records all merger and TO announcements irrespective of size. A large
number of consolidations in our data-base pertain to small investment firms used by
Indian business groups to maintain control over their own firm. In contrast, the
acquisitions made by foreign companies are of relatively large sized firms.

Regulations in Corporate Control Market after 1991

The policy and regulatory framework governing mergers and acquisitions has evolved
over the 1990s. In 1992, government created the SEBI with powers vested in it to
regulate the Indian capital market and to protect investors’ interests. SEBI also took over
the functions of the office of the Controller of Capital Issues (CCI). In November 1994,
with a view to regulating the TOs, SEBI promulgated the Substantial Acquisition of
Shares and TOs Regulations. The SEBI regulations on TOs were modeled closely along
the lines of the UK City Code of TOs and Mergers. The Indian regulations have
borrowed substantial concepts from and procedures from the UK code, e.g., the term
"persons acting in concert", the compulsory requirement of making a public offer on
acquisition of a particular level of shares, the emphasis on following the spirit, rather than
the letter, and so on. However, the essential difference is that the Indian TO regulation is
a law while the UK City Code is not (Thakur (1996)).

The 1994 TO Code was observed to be inadequate in handling the complexity of the
situation. Hence, a committee chaired by Justice P.N. Bhagwati was appointed in
November 1995 to review the 1994 TO Code. The committee’s report of 1996 formed the
basis of a revised TO Code adopted by SEBI in February 1997. The revised TO Code
provides for the acquirer to make a public offer for a minimum of 20% of the capital as
soon as 10% ownership and management control has been acquired. The creeping
acquisitions through stock market purchases over 2% over a year also attracted the
provision of open offer. However, acquisitions by those owning more than 51%
ownership do not attract the provisions of the code. The price of the public offer is to
depend on the high/low price for the preceding 26 weeks or the price for preferential
offers, if any. In order to ensure compliance of the public offers, the acquirers are
required to deposit 50% of the value of offer in an escrow account. Furthermore, the
acquirer has to disclose sources of funds.
Some more amendments to the code were announced by the government in October
1998. These amendments include revision of the threshold limit for applicability of the
code from 10% acquisition to 15%. The threshold limit of 2% per annum for creeping
acquisitions was raised to 5% in a year. The 5% creeping acquisition limit has been made
applicable even to those holding above 51%, but below 75% stock of a company.

Current regulations, by making disclosures of substantial acquisitions mandatory, have

sought to ensure that the equity of a firm does not covertly change hands between the
acquirer and the promoters. Moreover, the right of the existing management to withhold
transfer of shares under Section 22A of the SCRA, dealing with free tranferability and
registration of listed securities of companies has been withdrawn in the recently
introduced Depository Regulations Act, 1996, with effect from 20.9.1995. However,
under Sections 250 and 409 of the Companies Act, target companies can shelter against
raiders if the proposed transfer prejudicially affects the interests of the company.
Buyback of shares has been recently introduced and the TO code will not include
companies that are planning offers under the buy-back norms. However, TO defense
mechanisms as poison pills for incumbent management as in US and UK are not allowed
under the current regulations.

The main objective of the regulations governing TOs is to provide greater transparency in
the acquisition of shares and the TO of ownership and control of companies through a
system based on disclosure of information. Instead of discovering that the management of
the company one owns has covertly changed hands, resulting in huge gains for the
promoter, a shareholder could now expect to be informed each time, and at what price a
firm’s equity changed hands. Moreover, if the shareholder had less faith in the new
owners, he could sell the shares without incurring a loss, since SEBI regulations stipulate
that a buyer must make a public offer to buy shares at the same price at which the
acquisition is made. The current regulations on TOs in India seem to have taken a liberal
view towards TOs. TOs are thought to play an important role in building corporate
synergy, in raising shareholder value and in keeping companies on their toes.
III.3 Policy Proposals of the Government regarding CG and the Attitudes towards a
Market for Corporate Control

A number of reports and codes on the subject of CG have already been published
internationally – notable among them are the Report of the Cadbury Committee, the
Report of the Greenbury Committee, the Combined Code of the London Stock Exchange,
the OECD Code on Corporate Governance and the Blue Riband Committee on Corporate
Governance in the US. In India too, while the legal and institutional changes were taking
place in India since 1991 to ease the operation of corporate restructuring processes taking
place as a result of liberalization and globalization, the government and the industrialists
started taking initiatives to formulate codes of CG and also to rewrite Companies Act so
as to incorporate a smooth and transparent functioning of the market for corporate
control, among other things. From 1997 to 1999, three sets of recommendations on the
codes of CG have come from the industry and business circles in India. Together with
this, the proposals regarding competition policy formulated in 2000 is also another step
towards construction of CG policies.

CII Report on CG
The Confederation of Indian Industry (CII), a major body of the big industrialists of India
had published a code of CG titled “Desirable Corporate Governance in India – A Code”
in 1997 (CII (1997)). The report claims that TOs are internationally experienced to aid
the growth of industry and business by serving three purposes -- creating economies of
scale and scope, imposing a credible threat on management to perform for the
shareholders and enhancing shareholder value in a short and medium term. It has
therefore advocated for relaxation of restrictions on the financing of acquisitions.
Accordingly the CII recommended that the government must allow greater funding (till
April 1997, banks had imposed a credit limit of Rs. 10 lakhs against share collateral) to
the corporate sector against the security of shares and other paper.

Among other issues, the report pointed out to the failure of government-controlled
financial sector institutions (commercial banks, term-lending institutions and public
financial institutions (FIs)) to monitor companies in their dual capacity as major creditors
and shareholders. The report criticized the practice of the government financial sector
institutions as corporate shareholders, of supporting the existing management,
irrespective of performance, by generally not exercising their voting power as nominee
directors in company boards. This report on CG (Sayed (1997)) had also mentioned that
the reasons for the failure of the FIs to enforce good CG are -- lack of personal incentives
for nominee directors of FIs to monitor their companies, a perverse anti-incentive
structure within public sector FIs and the lack of senior-level competent personnel within
FIs who can properly discharge their responsibilities (Economic Times (1997)). It alleged
that government institutions are not concerned about the adverse income and wealth
consequences arising out of wrong decisions and inaction, their poor incentive structure
do not reward performance and punish non-performance, and most of all, they remain
highly susceptible to the pulls and pressures from various ministries which have nothing
to do with commercial accountability and which often destroy the bottomline (Economic
Times (1997)). In this sense, the Report has considered the FIs as inefficient monitors, so
much so, that the CII report has questioned the very basis of majority government
ownership in FIs. It has raised a debate as to whether the government should gradually
become a minority shareholder in all its FIs, in the sense of relinquishing their majority
control. However, this policy suggestion of the CII that the government as a proprietor of
the FIs would abstain from exercising its ownership rights seems unrealistic.

Given the supposed merit of TOs, the CII Report (Sayed (1997); Economic Times
(1997a)) subscribed to the idea of a dynamic market for TOs with minimum restrictions
on financing such acquisitions. Without allowing financial markets to freely fund TOs,
the Report said the only two types of raiders would be entrepreneurs from cash-rich
industries and foreign investors who can garner funds from abroad.

In this connection, the Report stated that the government should allow far greater funding
to the corporate sector against the security of shares and other paper; allow setting up of
medium-term leveraged buy-out funds and that the Companies Act should liberalize
inter-corporate flow of funds within group firms. Moreover, FIs should create mergers
and acquisitions subsidiaries to facilitate new entrants in the industry, catalyze TOs by
dynamic groups, and also facilitate the FIs to exit from poor debt or equity exposure via
the capital market. Once TO finance is easily available to Indian entrepreneurs, the
trigger should increase to 20%, and the minimum bid should reflect at least a 51% TO.

Only recently in early 1998 has the government has allowed the banks and FIs to lend
money to finance corporate TOs, albeit indirectly, as bonds or debentures to be raised by
the predator (Lahiri (1998); Economic Times (1998b)). These bonds and debentures are
to be specifically issued by companies for specific end-use, i.e., to finance acquisitions.
Subscriptions to such instruments can be made through the private placement route or the
public issue route, depending on the nature of the issue and whether the proposed
acquisition comes under the TO code.

Report of the Working Group on Companies Act

The Working Group on Companies Act was constituted in August 1996 at the behest of
Mr. P. Chidambaram, the then Union Finance Minister, to rewrite the Companies Act and
present it for public debate by early 1997. Neither the Report of Working Group on
Companies Act, 1956 (Taxmann (1997a)), nor the Working Draft of Companies Bill
1997 (Taxmann (1998)) have been explicit regarding the role of FI nominees in company

The Working Group of the Companies Act, 1956 has pointed out that there is an
important element that has been missed out by the new TO code, which ought to be
rectified as soon as possible. This has to do with the notion of “full buy-out”, which is not
so popular in India. According to the Working Group, “in many OECD countries, when a
person, group, or body corporate acquires over 90% or 95% of the equity of a public
listed company, it is incumbent upon the residual shareholders to sell their shares to the
buyer at a fair price that is set by the regulatory authority. This is not legislated for
The Working Group argues that a key feature of corporate democracy is that all
shareholders, who own a given class of equity, must be treated alike. Moreover, as a part
of corporate democracy, any shareholder has full freedom to sell, purchase, transfer and
acquire shares and that enhancing shareholder value through consolidation and growth of
companies would bring out the latent dynamism of Indian firms (Taxmann (1997a: 2,
11)). Without full buy-out provisions, the residual shareholders face one of two options,
both of which are inimical to this aspect of shareholder democracy. First, they may hold
out for a higher offer, which is palpably unfair vis-a-vis the other shareholders who sold
their stake. Or, second (and more likely if the company gets de-listed), these shareholders
may get squeezed by the buyer to accept a lower price, which is unfair to them.
Therefore, in the interest of shareholders and companies, the Group recommends that in
the event of any person, group or body corporate acquiring 95% of the shares of a public
listed company -- either through a TO or otherwise -- and the company getting de-listed,
residual shareholders should sell their shares to the 95 owner at a price based upon the
Sebi guidelines (Taxmann (1997a: 14)).

Report of the Kumar Mangalam Birla Committee appointed by SEBI on CG, 1999
The report (Report of the Kumar Mangalam Birla Committee appointed by SEBI on CG
(1999)) recognizes accountability, transparency and equality of treatment for all
stakeholders as the three key elements of CG. Although the report recognizes that the
issue of CG involves all stakeholders, yet it has concentrated mainly on shareholders and
investors because it believes that “they are the raison de etre for corporate governance
and also the prime constituency of SEBI”. However, it has claimed not to ignore the
needs of other stakeholders. The Committee agreed that the fundamental objective of CG
is the enhancement of shareholder value, keeping in view the interests of other
stakeholders. The various mandatory and non-mandatory recommendations are designed
to be applicable to all listed private and public sector companies and also to a certain
extent to the listed body corporates (e.g. private and public sector banks, FIs, insurance
companies, etc.).
Regarding accountability, the report makes different recommendations with respect to the
composition of board of directors and the role of independent and nominee directors
(nominees of financial or investment institutions to safeguard their interests as
debtholders and equityholders in the company). In relation to transparency, the report
makes recommendations on the composition, powers and functions of the audit
committee, the structure of remuneration committee and the extent of accounting
standards and financial reporting. With regard to the aim of equality, the report stresses
the role and functions of management, the rights and responsibilities of the shareholders
including the institutional shareholders.

Maximization of shareholder value and protection of shareholders’ rights and interests

are regarded as some of the major functions of the management. Within the purview of
shareholders’ rights the committee mandatorily recommends that the shareholders should
be allowed to participate in, and be sufficiently informed on decisions concerning
fundamental corporate changes relating to TOs, sale of assets or divisions of the company
and changes in capital structure which will lead to change in control or may lead to some
shareholders obtaining control disproportionate to the equity ownership. Similar to the
CII report on CG, the Kumar Mangalam Committee stresses the special responsibility of
FIs in CG in their capacity of being large shareholders either by themselves or on behalf
of the retail investors. Apart from this the Committee does not discuss about TOs in
relation to CG. Perhaps, this is because SEBI has its separate regulation of TOs through
its TO code.

The SVS Raghavan Committee on Competition Law, 1999

While the previous efforts at CG at the levels of the government and industry were to
primarily designed to protect the interests of the shareholders, the Competition Law
Committee was set up under the Chairmanship of SVS Raghavan on October 26, 1999
under the Department of Company Affairs, as a step towards effective CG, from the
perspective of another class of stakeholders, namely the consumers. In this regard this
effort was a welcome departure. The objective was to recommend a modern and concise
competition law suitable to the needs of the country in the light of the emerging
globalization of the Indian economy. The Raghavan Committee has put forth its
proposals for the Competition Law to the Prime Minister Atal Bihari Bajpayee on 22nd.
May 2000.

The need for a competition law was felt in the context of increasing globalization
process, involving several cross-border mergers, amalgamations, hiving off, and other
similar corporate restructuring activities. The new competition law is required to be an
effective instrument for engendering and protecting competition in the markets in the
interests of the consumers. The Committee was expected to suggest a framework for
supervising mergers and acquisitions besides examining the overlapping of the MRTP
Commission and consumer redressal forums. Cartel formation and other activities that
will ultimately hamper consumer interests are likely to be brought under the purview of
the new competition law. The proposed competition law seeks to stop any unhealthy TO,
acquisition or jacking up of prices by the mutual understanding between firms, so as to
ensure free and fair competition in the Indian economy. The salient proposals of the
Committee regarding mergers and acquisitions are summarized below.

• Dismantling of MRTP Commission and its replacement by the establishment of a new

“Competition Law Regulatory Authority” christened “Competition Commission of
India” (CCI) to enact and implement the Indian Competition Act in replacement of
the MRTP Act. Setting up of a two-member Mergers Commission within CCI
looking after the merger aspect of CCI’s work.

• Mandatory pre-notification to the proposed CCI for all cases of merger where the
assets of the merged entity exceeds Rs. 500 crore or if the assets of the business group
(group defined under the MRTP Act) to which the merged company belongs to
exceeds Rs. 2000 crore (assets defined as per Section 20 to 26 of the MRTP Act). The
proposed Commission will have 90 days from date of notification, to either accept or
reject the merger.
• Predatory pricing not to be always taken adversely as lower prices by a firm may
sometimes constitute a gain for consumers. It is to be viewed as an abuse only if it is
indulged in by a dominant undertaking.

• Agreements both between competitors (horizontal agreement) and actual or potential

relationship between buyers and sellers (vertical agreement) to be covered under the
competition law.

• State monopolies, government procurement and foreign companies proposed to come

under the ambit of the competition law.

One important feature of this proposed Competition Law is that the regulation of mergers
and acquisitions have acquired tremendous significance, so much so that the Committee
has suggested the formation of a separate two-member Mergers Commission within the
CCI to take care of the merger issues. The perspective of the Committee seems to be that
mergers and acquisitions have the potential to exploit economies of scale and drive down
costs for consumers. At the same time, mergers also have the potential of causing
dominance and greater monopoly power. Here arises a need to carefully evaluate the
trade-off between reduction in competition and potential gains in economic efficiency
before adjudicating the question as to whether the merger is anti-competitive in character.
If proved anti-competitive, there arises the need to regulate these consolidations for
preserving the interests of consumers through appropriate Competition Law.

According to the recommendations, for deciding on dominance, only the domestic

presence of merged entities would be taken into account, not their global position. The
Committee has, however, taken into consideration the assets of the merged entities and
not their market-share. By adopting this definition, the Committee has brought TOs by
the MNCs, which do not have a substantial market-share in the country, under the
definition of dominance. Had dominance been defined in terms of market-share, the
companies with globally dominant positions, but not domestically, would be able to TO
any domestic company without the merger process coming under the regulatory purview
for regulating competition.

The Committee has added a caveat in the form of pre-notification powers, which would
be given to CCI. Although mergers and amalgamations would continue to take place
under the provisions of Company Law under the supervision of courts, pre-notification
means that the CCI would have to be mandatorily notified of a merger plan under certain
circumstances. Within 90 days of intimation, the CCI would have the powers to oppose,
oppose conditionally, or pass the merger proposal. In case a merger plan remains
unopposed for the prescribed period, it would be considered to have been passed by the
CCI. Pre-notification and suo moto powers are also contained in several Acts, including
the English Act, where the Fair Trades Commission can proceed against any company for
abusing its monopolistic position to exploit consumers.

However, the recommendations of the SVS Raghavan Committee are to be further

debated extensively before they become part of policy. The DCA has constituted a five-
member core group to frame a draft Bill on Competition law following the
recommendations made by the SVS Committee on Competition Policy and Law. It may
be expected that these limitations will be taken care of and done away with, in the
forthcoming draft bill on Competition Law.
In Search for a Conclusion

IV.1 India’s CG Structure in Relation to the Systems of CG in US, Japan and


There are several CG structures that have emerged in the developed countries Each has
viewed mergers and TOs from its own socio-economic and cultural perspective. One is of
the Anglo-American (A-A) “market-based” type, the one pertaining mainly to USA and
UK. This belongs to the mainline price theory. The A-A or Fama-Jensen-Meckling type
of story [1] involves the notion of widely dispersed shareholders, owners of equity (i.e.,
shareholders) as the only stakeholders in the firm, reliance on the stock market alone or
principally, for disciplining the managers of a firm, and a fairly vigorous market for
corporate control in the form of TOs (Marris (1964); (Sheard (1994); Bagchi (1997: 18);
Kester and Luehrman (1993: 439-445); Lorsch and MacIver (1989: 2,9,18,58,87); (Black
(1997)). The other can be represented by the Japanese “relationship-based” system
characterized by less liquid capital markets, relatively inactive TO market and a greater
concentration of shareholder power with banks, firms and government through large bank
and inter-corporate holdings. This style acknowledges the existence of other disciplining
devices, than the stock market, in which workers are given a voice in running the firm
and in strategic decisions that affect their own future. The third one is the German style
of CG, which is also primarily a “relation-based” system and has more in common with
the Japanese system than the A-A (Kester and Luehrman (1993: 449-51); Kester (1997:

In the US, financial intermediaries play only a limited role in controlling the managers of
large corporations. Authors (Gilson and Roe (1992; 287-329); Grundfest (1990: 89-114),
Roe (1990: 7-41)) have ascribed this to various reasons, e.g. restricted growth and range
of operations of banks, and their ability to oversee managements by a web of regulatory
barriers arising out of banking, insurance, tax and security laws, especially following the
Great Depression. As a result, American managers are primarily controlled by
shareholders – existing and potential and motivated particularly by the nature of earning
disclosures to equity markets. In fact, CG in US has been viewed as control of managers
by their shareholders through the pattern of intermittent control exercised by the equity

In Japan, on the other hand, the conglomerates tend to be monitored on a relatively

continuous basis by a financial intermediary. A Japanese corporation has a main bank,
which is its largest creditor and also holds a substantial equity position. Also the lending
of the other banks to the concerned corporation is also often monitored by the main bank.
In cases of poor performance by the corporation, the main bank intervenes, often to
impose new management or strategies, or to bail out the company. In other words, the
functioning of the main bank substitutes the TO mechanism operative in US. Another
notable feature of Japanese conglomerates are the extensive cross-holding patterns. A
Japanese keiretsu typically consists of a number of semi-independent firms
manufacturing related products and each holding a large amount of each other’s stock.
This serves to restrict inducements to opportunistically exploit suppliers or customers.

There is a structural difference between US on the one hand, and Germany and Japan, on
the other, regarding the free operation of a market for corporate control enabling raiders
to mount hostile TO bids against the wishes of the incumbent management. Although
such a scenario is common in US, it is extremely rare in Japan and Germany. In Japan,
this may be attributed partly to the life-time employment system and also partly to the
pattern of large proportion of shares in a company held by its stakeholders and only a
small portion remaining with general public. For Germany, we may ascribe this to many
factors, including the company’s corporate culture, the 1976 co-determination act, the
employee representation on the corporate supervisory boards and the concentration of
share ownership (Singh (1998: 187-188)).

The two principal mechanisms used in the US to regulate the supply of specialized inputs
are vertical integration, and contracts with independent suppliers enforced through courts.
Japanese firms on the other hand, tend to be el ss vertically integrated, and rely more on
subcontracting with independent suppliers. Contracts enforced by the courts are also rare
in Japan, with long-term relationship based on trust and reputation serving to regulate
subcontracting relationships with suppliers.

Certain problems relating to supply of specialized management, marketing and technical

expertise, and specialized inputs continue to render useful patterns of inter-corporate
holdings, or vertical integration in India. In this respect, Indian corporate groups resemble
more the Japanese than the American pattern. However, the basic structural difference is
the weaker control exercised by FIs in Indian companies. The FIs in India do not appear
to play the continuous monitoring role that the main bank plays in the Japanese keiretsu
system. Neither are the stock markets historically liquid so as to foster corporate TOs,
although market for corporate control has recently received a thrust towards development
after economic reforms (Mookherjee (1999: 80-81)).

On the whole, what emerges from an analysis of the dimensions of CG prevailing in India
is that the CG structure in India is a blend of the A-A type and the Japanese variety of CG
structures. However, as observed in the various draft codes, be it of a the CII or of the
Working Group of the finance ministry as also in the code sponsored by SEBI, the thrust
is mainly in the A-A direction, with the shareholders as the primary interest group whose
interests are to be served.

IV.2 Issues Relevant to a “Good” CG Code for India

Recognition of the Role of ‘other’ stakeholders in CG

We have mentioned earlier in this article that one of the objectives of CG is the
accountability of firm management to all the stakeholders, i.e. owners, employees,
consumers and suppliers and the greater is the accountability in terms of transparency,
disclosure, etc., the better the quality of CG. From this standpoint a regulation cannot be
foolproof unless the interests of all the parties involved in the running of a company can
be reasonably taken care of. In this sense, TO of an existing management of a supposedly
inefficient unit, too, should be undertaken with an open eye to the interests of all
stakeholders. Enhancing shareholder value also appears to be a major objective of all the
three major policy recommendations on CG posed in our country over 1997 to 1999. In
this respect, all attempts to structure a code for CG in India seem to be limited and

There has been an alternative view that argues that good CG should go beyond
maximizing shareholders’ interests and encompass the interests of other stakeholders of
the company. This view has not drawn much attention because of the difficulty of
implementation of such an objective. The vast empirical literature on CG therefore
continues to accept the maximization of shareholder value as the prime objective of good
and effective governance.

However, it must be recognized that all input factors -- labour, suppliers, customers and
other societal groups -- are impacted by the activities of purposive organizations and
thereby become stakeholders. The production function of the firm, therefore become
multi-vectored in the sense of having to take account of the goals and preferences of
alternative stakeholders. So even if we hold that value increases are available to the
shareholders after a merger, the gains come at the expense of other stakeholders in the
firm. Expropriated stakeholders under the redistribution hypothesis may include not only
the above-mentioned stakeholders but also the bondholders, the government (in the case
of tax savings) and organized labour.

In recent years, this broader viewpoint of residual claimants has been well documented.
For example, when labour unions are granted a portion of the common stock of the firm,
this formalizes labour’s position as a residual claimant. Or, consumers’ lawsuits against
business firms dramatize their ability to assert their stakeholder position in formal terms.
Cornell and Shapiro (1987: 5-14) analyze the dependence of corporate policy on the
existence of non-investor stakeholders. They recognize that firms issue both explicit
contractual claims such as wage contracts and product warranties, and implicit claims
such as the tacit promise of continuing service and delivery of expected quality to
customers and job security to employees.

It is a reality that any TO involves a cost in terms of change and uncertainty and risk for
all the stakeholders, in varying degrees. In this sense, probably the greatest risk is borne
by the employees. But they are ignored in any discussion of CG. Even in India, the laws
are clearly intended to protect investors and shareholders. Moreover, proper incentives to
align employees with shareholder interests, such as stock options ought to be designed to
create long-term attachment of employees to the corporate entity. This will make possible
long term planning for the company and could ensure long run economic development.
Recently some effort is taken in India at the policy level in aligning the interests of
workers with shareholders in terms of employees stock option scheme etc., but the effect
is yet to be seen. Also, as we have mentioned above, the proposed Competition Policy
aims at taking care of the interests of the consumers of the society.

Relevance of Market-orientation versus Bank-orientation

However, in all fairness, the stock market in India today with a pronounced thrust
towards corporate control activities as a vehicle for corporate restructuring, is part of the
economic scenario. In this context, there is the fundamental question of a choice between
the market-orientation (as the A-A economies) and bank-orientation (as in Japan with its
main bank system and Germany with its Universal Banks) with respect to CG that
requires attention. An active market for corporate control, with hostile TOs is a central
feature of stock market dominated economies of the US and the UK. However, finance-
industry relationship is differently organized in Japan and Germany. There, banks play a
bigger role and have a long-term relationship with corporations.

Stock markets have some supposed benefits like encouragement of savings, efficient
allocation of investment, management disciplining through competitive selection for
control, etc. But there is an alleged disadvantage too -- in terms of short-termism and
speculation: investment geared to quick gains. On the other hand, it is argued in the
relevant economic literature that agency costs and information problems are generally
lower in bank-oriented systems compared to stock market systems. As a result, bank-
dominated systems can better ensure long-term financial commitments to client

Recent research links the competitive failure of the A-A economies (relative to those of
Japan and Germany for example) to the difference in the operation of the market for
corporate control and other features of the financial systems in these countries. In this
perspective, whether we should follow a bank-based financial system or a market-based
one will have definite CG implications for the economy.

FIs towards a more activist role in CG

For efficient CG, a system of effective internal controls is needed. As in Japanese CG, in
India too, FIs theoretically can have a strategic role to play in the internal control of
Indian firms, in their capacity of being large stakeholder (both shareholder and creditor,
and thus providers of liquidity to corporations) by successfully monitoring the
performance of firms. Yet in reality it has repeatedly been observed that passivity of FI
nominees at board meetings is very common. Nominee directors have no incentive for
monitoring companies on whose boards they are members since they are neither
rewarded for good monitoring nor punished for non-performance, save some criticism.
Attention to the passivity problem of the Indian FIs have been drawn by several
committees, including the Bhagwati Committee on TOs, the Kumar Mangalam
Committee of CG, both sponsored by the SEBI and also by the CII Committee on CG.
Moreover, the Working Group, has, in 1997 recommended some change in the
Companies Act, 1956, in favour of executive incentive and compensation. This, if
effective, could have the prospect of signaling the beginning of a new era in Indian CG.
Notwithstanding the general perception of passivity of institutional shareholders that has
proved to be detrimental to minority shareholders, there is an emerging trend of a more
proactive policy stance on the part of the FIs on CG issues.

Certain stands have been taken by the FIs in recent years that indicate towards more
proactive governance on their part (Sarkar and Sarkar (1999: 211)).
• FIs have been asked by the Finance Ministry to take ‘full responsibility for CG in
companies where they have substantial stakes. The objective is to boost investor
confidence and pep up the capital market. The government has issued a four-point
directive to FIs asking them to insist on

• making adequate disclosures

• moving towards internationally accepted accounting standards
• maintaining distance between the CEO and chairman where applicable
• holding regular board meetings with proper recording and dissemination of

• FIs have in recent times pressed for change in management of underperforming and
defaulting companies, one of which is Narmada Cement that figures in our sample of
mergers and TOs in India over 1994 to 1998.

• FIs have successfully opposed a move by the ACC to make preferential issue to the
Tata group that will enhance the latter’s stake, citing as justification the need to
protect the rights of minority shareholders of ACC.

• FIs have implemented new norms for the appointment of nominee directors, which
have drastically cut down the total number of such directors on company boards.
According to the new criteria for nomination, FIs are required to place their nominees
only in companies where their combined exposure is above Rs. 50 crore or their
shareholding is above 26% or in the event of companies showing signs of problems
such as default on loans.

• FIs are insisting on setting up of audit subcommittees comprising ‘adequate’ number

of non-executive independent directors of the company board in each and every large
and medium firm with a view to bringing in substantial financial discipline on the part
of the management and checking against executive malpractice. This is expected to
strengthen internal control structures and safeguard shareholder interests.

• The Unit Trust of India (UTI) is asking leading companies where it has sizeable
stakes to make presentations outlining their plans and expected performance after the
declaration of half-yearly results. This CG exercise is performed to give confidence to
unit-holders. Several big companies like Reliance have made presentations to the
UTI, Life Insurance Corporation of India (LIC) and the General Insurance
Corporation (GIC).

The participation of the FIs in the governance of corporations is gradually increasing in

India with liberalization. The government FIs, which are both shareholders and lenders,
seem to be realizing their responsibility of earning higher rates of return on their
investments and this has started to be the criterion for them to intervene or not to
intervene in board-room decisions.

ICICI is reported to be the first FI to enforce its own brand of CG through its nominee
directors who are on the boards of various companies (Prasad and Singhal. (1996)).
Among the directors, in principle, the institutional nominees appointed by the FIs, not
only have the fiduciary responsibility to the institution they belong but also are morally
responsible to the ordinary shareholders who often look up to these institutions to protect
their interests. In 1996, ICICI had asked all the directors nominated by it to file status
reports on the happenings at various board meetings. It may be taken as a signal to the
corporate sector that the FIs through monitoring the performance of nominee directors are
becoming active rather than hitherto passive shareholders in companies.

IV.3 Summing Up

Singh (1998: 190) has identified several serious problems in the prevailing CG system in
India. Some of these are conflicts of interest and lack of cohesion among many
controlling families, large interlocking and associated adverse effects, total exclusion of
minority investors from the firm’s decisions regarding corporate restructuring, etc. One
way of solving these governance problems could be to take the route of TOs, as is done in
the A-A system of CG. But experiences from USA and UK have shown that while
mergers and TOs do happen, they do not always increase shareholder value. Lubatkin
(1983: 218-25), in summarizing the empirical evidence on post-merger performance,
observes that bidding firms, on average, do not exhibit any significant gains in the post-
merger in the post-acquisition period. Nor are the mergers always sustainable as have
been documented in economic literature (Ravenscraft and Scherer (1987)).

Also, there are fears that increasing capital market dominance of company affairs will
lead to some form of short-termism and speculation and long term strategy of growth and
development will not be given its due. Also there is no evidence that the market for
corporate control works in such a way as to always punish the inefficient and unprofitable
companies and reward the efficient ones. Empirically size seems to be an important
criterion in the corporate control market (Singh (1998: 189)). Again, cultural integration
is one of the most intangible and hence one of the most difficult aspects of mergers and
TOs. Often mergers between two companies require a change in mindset -- employees
find it difficult to embrace yesterday’s competitors, gladly. For example, in the case of
horizontal integration, there is generally a competition at the sales level between the two
merged companies, in their pre-merger days. Here cultural integration imposes costs on
the employees and also has CG implications. The huge transactions costs associated with
mergers and TOs as also the possibility of very large unfavourable redistributions of
wealth, as pointed out by Schleifer and Summers (1988), should also be taken care of.
Also, a freely functioning market for corporate control is likely to increase industry
concentration especially in economies with large conglomerate enterprises as in India.
These are some of the costs associated with merger and TO activities that are to be taken
care of, by the policy makers while selecting the appropriate paradigm in designing the
code for CG in India.

However, in view of our empirical findings, it would be prudent to suggest that burden of
the strategy of CG based on TOs could be very costly for the country right at this moment
and it may not always generate the desired results. The need of the hour, therefore, is to
formulate a code of CG that would minimize some of the problems of CG in India, stated
above. One alternative route would be to follow the Japanese and German models of CG
and assign relatively greater role to the lead bank system and less to stock-market
activism, in view of the fact that lead bank system has lower transactions cost and can
handle problems of short-termism, asymmetric information and agency costs more
efficiently than the stock-markets (Singh (1998: 191)). Together with this, there is also
the need of suitable reforms of the various institutional mechanisms, like the different
areas of company, tax, labour and real estate laws, and also a more active and responsible
monitoring role for FIs, so as to resolve the agency problem in Indian industries
(Mookherjee (1999: 86)). Only if these efforts are taken simultaneously, can we expect
an “appropriate” code of CG to be formulated in India that would ensure maximum
returns to the stakeholders and, in the process, enforce corporate discipline.

It is indicated by our analysis that an attempt is definitely being made by our policy
makers to recast the institutional, organizational and legal arrangements in line with those
practiced in the established market economies. But many more structural changes in the
lines mentioned above and otherwise, need to be brought about, to make the CG
transparent and derive definite policy recommendations suitable for India at this juncture.
The length of our time series is too short to sketch the direction of CG. So we need some
patience to know the final outcome.


1. Fama, following Alchian and Demsetz, subscribed to the view that the firm was
simply a team of inputs bound by a set of contracts, without any locus of superior
authority. He took as his model a joint-stock company in which equity is owned
and consequently risk is borne by one set of persons and the management is
vested in another set of persons who will not generally fully coincide with the
first. In the words of Fama, “The firm is disciplined by competition from other
firms, which forces the evolution of devices for efficiently monitoring the
performance of the entire team and of its individual members. In addition,
individual participants in the firm, and in particular its managers, face both the
discipline and opportunities provided by the market for their services, both
within, and outside of the firm.”

Jensen and Meckling acknowledged this notion and held that managerial
discipline can be ensured and thus agency costs could be reduced through an
effective functioning of the market for corporate control, through the instrument
of corporate TOs. Since the A-A theory is based on similar spirit, they can be
regarded synonymous.

Refer to Alchian and Demsetz (1986: 111-134); Fama (1986: 196-208) and
Jensen and Meckling (1986: 209-29).


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