Institutional EYE

Commentary on Corporate Governance Issues

Tata Group: Structural Fixes Necessary

November 12, 2016

 

IiAS believes the current back-and-forth between Tata Sons and Cyrus Mistry, with Independent Directors of listed companies in the fray, is reactionary – and unlikely to provide a long-term solution. The Tata Group needs to focus on making its complicated holding and governance structure work.

 

 

IiAS believes the current combative conversation between Tata Sons and Cyrus Mistry is a distraction from the core issue. While both Cyrus Mistry and Tata Sons have their positions, the discourse is unlikely to provide any meaningful long term solution. Tata Chemicals Limited’s (Tata Chemicals) and Indian Hotels Company Limited’s (IHCL) Independent Directors decision to support Cyrus Mistry adds to the growing complexity of the current narrative. The Independent Directors in the operating companies are right in taking a stand and providing guidance. But we are concerned with the way the situation is playing out: their decision threatens to dismember the companies from Tata Sons and effectively, the group. Moreover, the contrarian positions of Tata Sons and the two listed companies on the issue is further confusing investors.


Leaving aside the personalities involved, the root cause of the current conflict is the Tata group’s operating structure itself. Currently the Tata Trusts exert control over Tata Sons, which exerts control over operating companies, several of which are listed and subject to scrutiny by external stakeholders including shareholders. While shareholders expect them to operate along commercial lines, given that the companies belong to the Tata group, these are overlaid with additional expectations regarding behaviour and the brand.
A philanthropy running a commercial business creates its own paradoxes. The Trusts elegantly solved this problem by putting Tata Sons between themselves and the operating companies: The trusts could remain philanthropic even as Tata Sons pushed businesses to deliver higher profit.


The Tata group needs to address possible areas of conflict and clearly set the terms of engagement between the three tiers of the group. They need to put in place an operating structure that outlives individuals. There can be many solutions. We put forward one of our own.


To align the interests of the Tata Trusts and Tata Sons, the Chairperson of the Tata Trusts and Tata Sons must be the same individual. In the past when this has been so, this has worked smoothly. It needs to revert to back to this structure with some minor fixes. The Tata Trusts and Tata Sons should in future be run by independent CEO’s. The Chairperson should be the custodian of the Tata brand.


The role of the CEO of Tata Sons will be a bit more than that of a portfolio manager. The Tata Sons CEO will monitor the performance of companies, establish dividend policy and will be responsible for capital allocation between companies. Additionally, the Tata Sons CEO will ensure adherence to the brand identity, and exploit group synergies by providing common services. The CEO will have the flexibility to rebalance portfolio companies, within reason given the Tata brand is associated with these. Like in corporate boards, the Tata Sons CEO will be answerable to the board and the Chairperson. To see that costs and the bureaucracy at Tata Sons does not balloon – a recent charge, it should be desirable to cap costs as a fixed percentage of income

 

To ensure that the operating companies adhere to the culture and ethos of the Tata group, IiAS believes Tata Sons will need to exercise influence over operating companies. For this, IiAS recommends that Tata Sons and maybe even the Trusts nominate directors to the board of operating companies. To balance between the philanthropic agendas of the Tata group against the need for investor returns, the operating companies must have an Independent Chairpersons and professional CEO’s (-the Tata companies already have professional CEOs). As a controlling shareholder, Tata Sons CEO will have material say in evaluating performance.
Just like with Tata Sons, Tata Trusts CEO will be responsible for the trusts programs and philanthropy. The mandate should be broadened to include philanthropic investments – and this could well shape the future of the group. To serve even more meaningfully in the communities they operate in, the Trust should examine the feasibility of monetizing its holdings by selling down some stake in Tata Sons, and park the money in fixed income securities, to reduce its dependence on dividends. Here too, it will be desirable to cap operating expenses.


Well-defined roles and an unambiguous chain of command should ensure that all participants are clear about their roles and responsibilities. The proposed structure is likely to be beneficial for all stakeholders – the stakeholders of listed companies as well as the Tata Trusts.


All ideas should now be put forward and debated. The current turbulence creates the right opportunity for the Tata group to set the structure right. The group should make the most of it.

 

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