By Raunak Onkar | [email protected]

Normally when we think of a word, our mind creates a mental image of it. We realise if we associate some strong meaning / feeling with that word. The word ‘corporate governance’ doesn’t invoke any of those things. It’s a bland, technical word which only seems like a good filler in an otherwise boring conversation about stocks.

If we wish to really create a mental picture for good corporate governance, first we need to create a good picture of the business world in general. Good governance, in simple terms, is being treated fairly when not in power by those who are in power. It applies as much to governments as to companies.

All this sounds very good in a blog post, but in reality many corporates engage in practices that will make shareholders cringe in fear. Why does it happen? Do non-controlling shareholders deserve to be treated fairly at all?

I argued (here) that most non-controlling shareholders hardly contribute in running the business. Operating a business is a tough job. To manage labour / employee morale, to manage client trust, create competitive products, pay suppliers on time & on top of that to maintain operational efficiency. This is no child’s play. The controlling promoters take all the pains & it might seem logical that they deserve to take away all the gains as well. It’s a logic only deduced by the person who doesn’t understand the importance of a well functioning secondary market.

Capital to start a business is not created out of thin air. The promoter starting a business can put his own money as initial equity. He/She may also pull along other investors or partners who can contribute to the initial equity. Let’s call these people, primary investors (aka, venture capital investors). A business with not even a rupee of sales made in its name so far, what are these primary investors seeing as the future course of the business? Of course, no one invests to lose money. They expect big returns, just like all other investors.

Are they crazy? On the contrary, they are practical and optimistic. The primary investors not only drive new ideas but help create an economic entity which provides a product/service that the customers want, and creates employment & eventually consumption potential in the system. On the other hand, they face a cliff. With the passing of each operating day they are either driving closer or farther away from this cliff. We know this cliff as ‘permanent loss of capital’.

Now let’s ask again, are these investor’s crazy? Maybe a little so that they won’t become cynical and put all their money into a bank FD.

Let’s probe further by asking –

  • How should a person be compensated for risking a permanent loss of capital?
  • How should the primary investor keep doing his/her job to help create new & productive businesses?

Let’s find answers to these questions in part 2.