Sebi brings corporate governance in focus
Feb 01 2013
Proposed modification of buyback mechanism is in shareholder interest
The watchdog under chairmanship of Upendra Kumar Sinha, an IAS officer who has worked in the union finance ministry and also headed UTI mutual fund, has been quick to spot loopholes lending themselves to exploitation and draw up a comprehensive, step by step plan to plug them, so that interests of shareholders are not compromised. Its recent discussion paper on proposed modification to the buyback mechanism is one such detailed exercise. The regulator pointed out that the mechanism for repurchase of shares through the open market had instead failed to achieve the objective of increasing underlying share value. In many cases, buybacks were being used by managements/promoters to effectively influence the secondary market price of a company’s security.
The regulator now proposes to restrict the buyback period from 12 months to three months. It has also said that a minimum of 50 per cent of the buyback amount should be used and a quarter of the maximum buyback amount be put in an escrow account at the outset itself. The regulator has also said that if a company is unable to buyback 100 per cent of the proposed amount of shares, then it will not be allowed to launch another buyback in a year’s time. This will ensure that companies don’t use such announcements to manage the sentiment towards their stock on the bourses.
If implemented, companies will have to take the process of buybacks seriously and announce a scheme only when they actually intend to purchase shares rather than using such announcements to manage the stock price. The present system, where the maximum price at which shares would be repurchased is disclosed, effectively caps the stock upside by conveying to the market what the management thinks is the fair value of the share. But this does not tell shareholders what is the intrinsic value below which the promoter thinks the shares are a steal and will hence buyback from the market.
Worse still, public shareholders have no idea on what are the parameters, the company would use to decide whether or not to purchase shares on any given day. Sebi has, therefore, tried to make the whole process transparent by requiring companies to disclose on a daily basis the shares repurchased and the amount spent, which will allow the calculation of the average price at which shares are being acquired. The regulator also proposes that companies should disclose on a monthly basis, why a proportionate quantity of shares was not bought back from the market in cases where this is applicable. This puts the onus of adequate disclosure on companies and allows minority shareholders to take an informed investment decision.
In cases where the buyback constitutes 15 per cent or more of the paid up capital and free reserves of the company, Sinha has proposed that firms adopt the far more efficient tender offer method to repurchase shares from shareholders. Should this be implemented, buybacks can be completed swiftly and the impact on the book value as well as the market price of the shares is likely to be immediate. The tender method is also nondiscriminatory and conducted via transparent means, another reason to support the Sebi proposal.
Keeping the principle of transparency utmost, Sebi has abolished the practice of companies setting up trusts to buy shares from the secondary market, for allotment as ESOPs. Sebi said such trusts could be abused to control the company’s share price by engaging in ‘fraudulent and unfair’ trade practices. While the move may impact reputed groups such as Godrej, which set up similar trusts to purchase shares from the market as they did not wish to dilute earnings per share by issuance of new shares, the reduced flexibility but increased transparency, is a net gain for governance in India.
Sebi has also asked such companies to disclose the extent to which promoters and directors are beneficiaries of such ESOP entitlements and how the trusts intend to dispose of shares acquired via secondary market purchases, but not yet allotted to employees. Companies will also be required to disclose all allotments via ESOPs aggregating to over one per cent of the paid up equity capital of the company and separately purchases of all shares by trusts in this fiscal year from the secondary market. This will allow share owners to have a better view of executive compensation for performance and will enforce better rigour.
Indian firms have for long been used to rather lax standards compared with what their counterparts in the US are required to meet. It’s time they learnt to be more transparent like their overseas counterparts.