The problems with Reliance’s Jio
With much fanfare Mr. Mukesh Ambani, the chairman of Reliance Industries Ltd. (RIL) introduced Jio, the company’s next big venture, at the Annual General Meeting of its shareholders. In my opinion Jio stands for a number of things wrong with corporate governance in family controlled firms.
Let me first start by highlighting the obvious winners from Jio.
The first group are the customers.
Jio is a big shot at reducing the cost of Internet access in India. The U.S., despite being the richest country in the world, lags far behind in terms of cost and penetration of Internet access. Cheap access to the Internet is an important step in bridging the access gap – access to good education, good healthcare, etc. The Khan academy, a free online education portal is a good example of this. This can only be good for India in the long-run.
Lasting impact
The second winner is Mr. Ambani. Having left his imprint on the petrochemical and petroleum sectors in India, he can potentially make a lasting impact as the man who brought Internet to millions of Indians. He also gets to play entrepreneur again and experience a heady start-up environment.
Now we come to the losers. The first group are the shareholders of other telecom companies. On announcement, the market capitalization of the three main competitors of Jio fell by about Rs. 13,000 crore. This is a good thing. This illustrates the power of competition. This is what creative-destruction is all about. So I am not shedding any tears on behalf of these investors.
The second loser is the Government of India. The big money the Indian Government was raking in selling cellular bandwidth was actually coming from the pockets of the cellular consumers. Through its aggressive pricing, Jio has shifted the power back to the consumer. One cannot help but think that this will impact the revenue the Government can expect to get from future auctions. This again is a great thing. The large amount of revenue the Government of India gets from auctioning off the nation’s natural resources is not necessarily a good thing because the Government does not have a stellar track record when it comes to spending the money. A large fraction of Government spending is wasted.
Current shareholders
That brings me to the final group of losers which motivates the title of the piece. These are the current shareholders of RIL. On announcement of Jio, the stock price of RIL fell. Its market capitalization decreased by Rs.9,357 crore. The stock market thought that the money RIL is investing in Jio is unlikely to provide an adequate return to its shareholders. This assertion is likely to get the usual criticism that the market is short-sighted and does not realize the long-term value of Jio. Unfortunately, much of the research both in India and in the U.S. indicates otherwise.
It shows that the market’s short-term reaction is usually proven correct in the long-run. The market reaction to Jio is similar to the U.S. market’s reaction to firms announcing their intention to diversify. Typically such diversification announcements are greeted as bad news and they turn out to be so in the long-run.
Activist investors
If something similar were to happen in the U.S. now, the shareholders and activist investors will be up in arms against the controlling shareholder to reverse the decision and return their cash in the form of dividends. But this is unlikely to happen in India.
Unfortunately, the announcement is very typical of how family controlled firms behave not only in India but all over the world. They use the cash generated by their most profitable firms as their personal piggy bank to be used for whatever they see fit. In doing so they blur the distinction between the firm and the family. Investors in family controlled firms look at their investments as not in a particular firm but in the family. They know that once they part with their money, the family will have unfettered power to do what it sees fit with the money. This translates into a value discount (a governance discount) for family controlled firms. The fact that the controlling family is so closely identified with the firm is not without its cost to the family. When things go south, i.e., when the firm is not able to fulfil its obligations, the wrath of the market turns to the family.
Mallya example
The recent example of Mr. Vijay Mallya illustrates this very well. A controlling shareholder should not be required to flee the country because a public firm under his control defaulted on its debt. Since he is the one with the most knowledge about the firm, he should be around to salvage as much value as possible from the assets. That is not likely if the investors are intent on putting the controlling shareholder behind bars for the sins of his company. As India develops and its corporate sector improves, it is crucial for the firms to improve their governance. This means not giving the controlling family unfettered power to do whatever it wants with the firm’s resources and ensuring that all shareholders have a say in how a firm is run.
Source: The Hindu