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Ease of doing biz is fine but what about corporate ethics

By Nitin Desai
September 17, 2015 16:24 IST

Over the past year we have heard a lot about policy reforms to improve the ease of doing business in India. But we also need reforms that encourage corporations to take a long view of how business should be done, says Nitin Desai.

Image: Azim Premji, chairman, Wipro seen with Anand Mahindra, chairman, Mahindra Group during an event in Mumbai. Photograph: PTI

Two recent events have provoked this reflection on the role of large corporations in our economy.

The first is the Prime Minister's meeting with corporate leaders aimed at reviving investment.

The second is the exchange between Narayana Murthy and C N R Rao on the role of our corporations in the innovation process.

Take first the matter of corporate investment trends. A recent RBI study has painted a bleak picture, with project investments falling from a peak of Rs 3.8 lakh crore in 2010-11 to Rs 1.93 lakh crore in 2014-15.

Unless there is a massive increase in spending on new projects, the prospects for this and the next financial years are for a further decline as the carry-over of project expenditure from current projects is just Rs 84,000 crore in 2015-16 and Rs 37,000 crore in 2016-17.

Many explanations have been advanced for this decline in corporate investment and the large number of stalled projects.

This year's Economic Survey, after a careful analysis, attributes "over-exuberance and a credit bubble as the primary reasons (rather than lack of regulatory clearances) for stalled projects in the private sector."

A more granular analysis indicates lack of demand growth and loss of promoter interest as the dominant reasons for this.

The lack of demand growth is plausible for projects producing capital goods as the growth rate of fixed investment has collapsed from 12.8 per cent in the decade before 2011-12 to 2.4 per cent in the last three financial years.

Export growth has also slowed down, particularly in the last and current financial years.

However, the slowdown in the growth in private consumption is quite small, from 7.8 per cent in the decade to 2011-12 to 6 per cent in the last three financial years.

The corresponding figures for government consumption are 7.3 per cent and 5.5 per cent.

The loss of promoter interest is because of corporate myopia. Investment in capacity expansion, market development and technology upgradation has to be framed with a long-term view of corporate strategy.

In fact, a slowdown is a good time to invest for the long term, as equipment and construction service providers will offer more favourable terms than in boom-time.

But, of course, this assumes that the corporates plan their cash flow with this long-term perspective and do not over-commit during booms, retaining the capacity to ride the cyclical troughs that are unavoidable in any open-market economy.

That is what is missing in the Indian corporate sector - the long view, that stays within corporate goals in good times and bad and that does not get diverted by irrational exuberance for unrelated areas of activity, which happen to be the rage at the moment.

It is this which led many to overcommit to expensive infrastructure projects and accumulate debts which today hold them back.

We have seen this herd instinct in the past also, leading to overcapacity and profit erosion.

The short-sightedness of corporate owners and managers is as much to blame for the current slowdown in corporate investments as public policy failures.

The failure to take a long view is particularly evident in the low commitment to research and development in our corporate sector.

The share of the corporate sector in total R&D expenditure has increased from around 25 per cent in 2002-03 to 34 per cent in 2009-10, the latest year for which data is available on the DST website.

This is well below the global norm of 65-80 per cent private sector share. More than half of the private expenditure is in three sectors - pharmaceuticals, transportation and infotech. India has a huge advantage, in the low cost of our research scientists and engineers.

This has been recognised by global corporations who are investing substantial sums in in-house or outsourced R&D in India.

According to the Indian Brand Equity Foundation, their procurement of R&D and engineering services is about $18 billion - and this far exceeds the aggregate R&D spending of Indian corporations.

This involves not just US and European firms but also Chinese MNCs like Huawei and Xiaomi who are setting up large R&D facilities employing thousands in Bengaluru.

If Indian corporations took a long view, they would have used our pool of scientific and engineering talent to prepare for the day when they would have to move beyond imports of recently obsolete technology, reverse engineering and cost-cutting. Mr Murthy seemed to blame our research and teaching institutions for the absence of any game-changing innovation.

But such innovations have generally come from corporate R&D spending, either in in-house establishments or through sponsored research elsewhere.

The fault lies much more in corporate board rooms than in our research labs. How can we push our corporations into taking a long view?

The answer does not lie in yet another misguided regulatory initiative like the CSR obligation.

It has to come from an environment that makes this a necessity for management survival. This requires two key changes in our business environment.

First we need an ecosystem that brings together research, finance and entrepreneurship as the driving force for corporate growth.

We are getting towards this for start-ups; now we need to push it for established corporations also.

Second, those in control of management must always live in fear of a hostile takeover if they are not using company assets effectively to deliver growth.

This is not the case at present when our takeover codes favour incumbent managements.

In many promoter-managed corporations promoter control has increased with corporate funds being used for share buy-backs rather than for growth.

This is a regulatory issue and our takeover codes must encourage a rational market for corporate control.

Over the past year we have heard a lot about policy reforms to improve the ease of doing business in India.

But we also need reforms that encourage corporations to take a long view of how business should be done in India.

Nitin Desai
Source: source