Bhushan Steel bribery case highlights need for bankruptcy law, management exit

First Biz  Jagannathan 9 AUG 2014

The NDA government is planning to change labour laws to make it easier for companies to hire labour on more flexible terms. The argument is that if companies cannot fire labour, they won’t hire either – and this fact has been demonstrated by the very slow growth in organised sector employment over the last two decades.

However, an important adjunct to more flexible labour laws is even more flexible laws on management change. If the inability to hire and fire labour is hampering jobs growth, the inability to chop and change managements is hampering corporate accountability and competence. It is, in fact, encouraging crony capitalism. The lack of a quick and effective law for management exits needlessly traps capital in the wrong businesses. This too prevents the creation of new jobs as capital is endlessly locked up in bad businesses, sometimes run by bad promoters.

It was the inability, or unwillingness, of bankers to pull the plug, and/or  change management at Kingfisher Airlines that has now left them stuck with Rs 7,000 crore of bad loans. In fact, if they had chucked Vijay Mallya out and revamped the management some time in 2010 or even 2011, they might well have not only saved Kingfisher but Mallya’s liquor empire as well. Now, banks are busy selling his collateral to recover their cash.

Exhibit Two in the argument making management change easier is the bribery case involving Bhushan Steel. In this case, a nationalised bank’s Chairman and Managing Director (Syndicate Bank’s SK Jain) is in the dock for allegedly accepting a bribe for going easy on the company’s loans. It has also led to the arrest of Bhushan’s Managing Director Neeraj Singhal.

With Rs 40,000 crore of bank loans at risk involving 51 banks, State Bank of India Chairman Arundhati Bhattacharya said yesterday (8 August) that they were looking for an agency to monitor the loan. SBI, as lead banker to Bhushan Steel, has an exposure of Rs 6,000 crore.

As yet, the loan hasn’t gone bad, and the company’s performance is said to be satisfactory. But if this is truly the case, one wonders why anyone needed to be bribed at all. Clearly, at the very least, a forensic audit is required of the company’s operations and accounts.

At this stage, the bankers can at best insist on planting their own nominee on the company’s board. It is only after the loans formally go bad and are declared non-performing assets (NPAs) that they can try and change the management.

However, this leaves too much to chance. In a market economy, the sense that something may be wrong can be a self-fulfilling proposition, and banks or regulators should have the option of making temporary changes in management when things appear to go wrong so that they can arrest any attempt to cover up wrongdoing. They can also assure investors that things are under control. The old management needs to be shown the door till it is clear that they did no wrong.

There are three reasons why we need a strong law to allow bankers (or a group of minority investors or the regulators) to appoint a new boss or independent directors in companies where public interest is at stake.

First, regardless of whether their loans are good or likely to turn problematic, banks need to have the right to make a pre-emptive strike on management before the operations actually get into a tailspin. Once a company’s operations start winding down, failure is self-propelling for credit starts drying up and the stock starts tanking. Change of management (even a temporary change) is needed to assure all lenders and shareholders that corrective steps are being taken and the operations of the company will not be affected.

Second, bankers usually have a fair idea about how a company is faring based on account statements and audit reports – and their own understanding of how the industry itself is faring. But public sector banks, with their dilatory systems and lack of accountability, are likely to be more vulnerable to bribery and hanky-panky for the simple reason that bankers have short tenures and keep getting transferred. The system of rewards and penalties for performance and non-performance is weaker in public sector banks. The Satyam Computers fraud case shows that several banks, which allegedly held the company’s non-existent cash and bank balances, had no clue that the company had very little actual cash with any of them. Either the bankers knew and kept quiet, or they were too complacent about their borrower. They were wrong. If banks had been more vigilant, the Satyam fraud could have been detected earlier and the management changed. In fact, the management had pledged so much of its own shareholding that it effectively had no shareholding control. But it still did damage.

Third, cronyism thrives primarily through its ability to influence bankers and regulators – of course, with help from politicians and bureaucrats. This calls for a clear separation of public sector banks’ reporting structures from their administrative ministry (in this case, finance). RBI governor Raghuram Rajan said the other day that the government could put all bank shakes in a separate special purpose vehicle so that bankers were insulated from political pressures to lend.

In the case of government-owned institutions, you can’t change the owner, but you can at least prevent the owner from damaging taxpayer assets.

A key measure to end crony capitalism is the enactment of a strong bankruptcy law that also enables lenders and minority shareholders to show bad managements the door.

More than an exit policy for labour, we need an exit policy for management.