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Case study Modi Rubber vs. Financial Institutions - A Mukund The case gives a detailed insight into the events during a decade long dispute between Modi Rubber and its lender/owners financial institutions. The case examines how the FI threat to sell their stake in the company, in the open market, led to a major debate regarding the role of FIs in the companies in which they had an equity stake. The case is so structured as to help the readers understand how and why the FIs decided to sell their MRL stake and the controversy this decision led to. They should be able to look at the controversy from the company's as well as the FIs' point of view. How can they not offer us the right of first refusal to the shares? Can anyone question our commitment to the company? BK Modi, commenting on the FIs selling their stake in Modi Rubber in the open market, in August 1996. The Power Struggle On June 30, 2001, a statement issued by Panduranga Rao1, Chairman of Modi Rubber Ltd., (MRL) came as a big surprise to Indian corporate watchers. The statement revealed that the MRL board had, after a special meeting decided to strip Managing Director BK Modi of his functionary powers. Rao said, "We have been compelled to transfer all areas hitherto looked after by Dr. BK Modi to the second MD (VK Modi - BK Modi's brother) for he is not giving enough attention to the affairs of the company." The board also suspended three other directors, BK Gupta, RL Ahuja and Atul Prakashall reported to be close aides of BK Modi. What was more intriguing was the fact that BK Modi was absent from the meeting though a notice had been duly served to him. Rao commented, "The notice was served and the agenda was circulated. He cannot make us wait." Further, the move was reported to have the backing of VK Modi as well. Though the two brothers were not known to be the best of friends, this move was rather unexpected. The very next day, BK Modi held a press conference where he announced his rejection of the board's decision. He asserted that he was still the MD of the company and that the board was not empowered to remove him from the post. He claimed that the constitution of the board itself was doubtful since the previous chairman Bodhishwar Rai (an independent director) was `unceremoniously' thrown out and replaced by a UTI nominee. This was against the guidelines of the capital markets regulator Securities and Exchange Board of India (SEBI), according to which the chairman should be an independent director and not a nominee director. He also said that there were no disputes between him and VK Modi. Analysts, however, took this with a pinch of salt as VK Modi was absent from the press conference. On July 5, BK Modi sent a notice to VK Modi, charging him of breach of a shareholder's agreement between them. (The agreement mentioned that while he

would look after the production side of MRL, VK Modi would look after sales and marketing. Moreover, it had been agreed that any change in this arrangement would require the mutual consent of the two brothers.) MRL's move against BK Modi eventually came to be seen as a major victory for financial institutions (FIs) in the decade long MRL/FI battle for control of the company. Background Note MRL, established in 1971, was a part of the Modi Group of companies. While BK and VK Modi held 23.87% of MRL's equity, the FIs held 44.5% and the public held 31.63%2. A major part of the FI stake in MRL was with Life Insurance Corporation (LIC) and UTI. The other FIs involved were the Industrial Finance Corporation of India (IFCI) and the Industrial Credit and Investment Corporation of India (ICICI). The FIs had acquired their stake in MRL over the years, both through conversion of unpaid loans into equity and market purchases. The company's business comprised the manufacturing and marketing of automobile tyres/tubes/flaps and retreading materials. A small portion of the revenue came from trading in tyres, tubes, flaps, garments and other articles. The company had a technical collaboration with Continental AG of Germany for manufacturing tyres. MRL's major customers included Telco, Ashok Leyland, Maruti Udyog, Punjab Tractors and Escorts. The company was present in almost all segments of the tyre industrytruck, bus, car, jeep, tractor (front, rear and trailer), scooter and motorcycle tyres. The company had an overall market share of 14.8% in June 1999 and its sales were concentrated in the Truck and Bus (T&B) tyres segment (around 45% in 1998-99). About 9.7% of the total production catered to the passenger car segment. Almost 10% of the total industry production of tractor tyres came from MRL. The company had two plants in Meerut district and one in Ghaziabad district in Uttar Pradesh. In 1998-99, on an installed capacity of 2.42 million tyres and tubes each, MRL produced 2.31 million tyres and 2.144 million tubes. The company sold around 2.279 million tyres and 2.142 million tubes. Tyre sales contributed 90.9% to the gross sales turnover while sales of tubes formed 7%. About 87% of its production was sold locally with the rest catering to the export market. MRL was quite successful in building a strong base for itself in the export market. The Modi Rubber Story Since the early days of MRL, BK Modi and VK Modi were reported to have `rarely seen eye to eye'. Even after they signed a shareholder's agreement, their relationship never really improved. One of the main reasons for their differences was BK Modi's desire to get a higher share in MRL. The Modis had been defaulting on FI loans since the 1980s. After a formal split in the family in 1989, the Modis refused to repay the money they owed the FIs on the grounds that the crossholdings of the various family factions in Modi companies were so complex that the liability of each of the brothers could not be fixed till the division of property was effected. Since the Modi brothers could not arrive at an equitable division of assets, the Government appointed an arbitrator from IFCI. The arbitrator came up with a solution, which was summarily rejected by the Modis. Unhappy with the constant fights between the Modis and the way MRL was being run, Continental suggested an operational restructuring for the company in 1993, making it a pre-requisite for a joint venture to manufacture radial tyres, which was then under consideration. The FIs sanctioned a Rs. 900 mn loan and the restructuring exercise was initiated. Exhibit I: Modi Rubber Financial Performance Period ended 1996 1997 1998 1999

Gross sales Excise duty Net sales Other income Total income Raw materials Stock adjustment (Inc)/ Dec Purchase of finished goods Cost of material Employee cost Power and fuel Advertising/promotion/public Freight and forwarding Other expenses Cost of sales PBIDT Interest and finance charges PBDT Depreciation PBT Provision for taxation Extraordinary items/Prior year Adjusted PAT Source: www.indiainfoline.com -

10,562.40 -2,236.40 8,326.00 89.3 8,415.20 5,020.10 -6 223.1 5,237.20 510.8 374.5 966.1

11,259.40 -2,428.90 8,830.50 42 8,872.50 5,748.30 -64.1 113.3 5,797.60 631.2 499.7 75.6 249.1

8,293.60 -1,637.10 6,656.50 127.5 6,784.10 3,839.00 73.3 105.8 4,018.00 537.3 471.2 60.3 220.3 933.8 6,241.00 543.1 477 66.1 94.1 -28 0.6

9,329.40 -1,916.20 7,413.20 93.3 7,506.40 4,307.90 5.3 58.7 4,371.90 653.6 518.7 97.2 239.5 1,027.90 6,908.80 597.7 404.1 193.5 98.2 95.3 0.6 -6.5

623.4 7,712.00 703.2 458 245.2 94.5 150.7 0.7 6.7 156.7

1,112.20 8,365.50 507 648.4 -141.4 122.1 -263.5 0.7 15.1-249.1

-28.6

88.3

At this point, Modistonea Modi group company slated to be merged with MRLfloated a Rs. 360 mn rights issue. This issue was heavily undersubscribed and UTI purchased Rs. 200 mn worth of shares it had underwritten. According to the terms of the merger, if the merger was approved, the remaining Rs. 160 mn had to be accounted for by MRL. However, if the merger was not approved, the Modis would have to bring in Rs. 80 mn each because of the personal guarantees they had provided. MRL sources revealed that BK Modi saw this as an opportunity to acquire a bigger stake in Modistoneand consequently in MRL. He came up with the plan of opposing the merger proposalwhich meant that the brothers would have to pay up Rs. 80 mn each. BK Modi was working on the premise that VK Modi would not be able to arrange this amount. In February 1995, BK Modi even stormed out of the meeting held for approving the merger proposal, hoping that it would be adjourned. However, the meeting continued and the merger was approved, dashing BK Modi's plans3. Even as the company was negotiating the joint venture with Continental in July 1996, the FIs announced their decision to sell their MRL stake in the open market. In August 1996, BK Modi's request to the FIs to reconsider their stance was turned down. This move was reported to be a result of a meeting, where BK Modi had misbehaved with PR Khanna, an independent director. This infuriated the FIs who then began thinking of ousting the Modis from the board. Media reports claimed that as a result of BK Modi's letter to the then prime minister Narasimha Rao, the FIs decided not to oust the brothers and agreed on a stake sell-off instead. In early 1997, the FIs initiated moves to change MRL's management. This resulted in the resignation of five directors. In March 1997, a committee headed by Unit Trust of India's (UTI) Chief General Manager, Research and Planning, Basudev Sen, (set up in 1996 to draw up guidelines on good corporate governance) submitted its report to the Government. In accordance with the report's recommendations, in August 1997, the FIs decided to recall their loans to the Modi group and offered their holding to the Modi family, provided the deal was struck at an acceptable price. This announcement was a major climb down from their earlier stand that they would sell their holdings in the market. However, the recall of the loans to the Modi group clearly indicated that the intense lobbying by the Modis to pressure the FIs to abandon the use of the group approach policy4 (on fresh loans) against them had failed. The FIs threatened that if the Modis failed to raise the requisite funds, the open market sale option could be utilized. The FIs also refused to stand guarantee for loans raised by the Modis from other sources. The Modis continued to argue that the FIs would be playing a partisan role if they offered the shares to any other party without first offering it to them. For the year ending June 30, 1997, MRL posted a loss of Rs. 150 mn, against a profit of Rs. 182 mn in the previous year. (Refer Exhibit I for a summary of MRL's financial performance). This prompted MRL to appoint consultants McKinsey & Co., who designed a 42-point turnaround program for the company with a focus on raising productivity levels. Around 29 of these action points were to be implemented at the plant level and were aimed at improving worker efficiency. The turnaround plan also involved outsourcing tyres in those categories, where MRL did not make a good margin. In December 1997, the FIs and Modis agreed to negotiate the purchase price of shares within a period of three months and acquire the stake in another three months. The FIs also agreed to withdraw a proposal of coming out with a rights issue and on clearing off loan defaults by MRL without linking the acquisition of shareholding by the Modis. Though the FIs held a series of meetings with the Modis, the issue remained deadlocked due to differences regarding the loan repayments. The FIs did not want to have any exposure in the company after disinvestment of their holding. On the other hand, the Modis argued that the sale of stake and the issue of loans should not be clubbed together. The stalemate continued over the next few months with neither of the parties willing to budge from their positions.

The Open Offer In March 1998, the Modis agreed to repay the entire outstanding FI loans if the FIs sold their stake to MRL for a price higher than the ruling market price of Rs. 26.90 a share. This development was attributed to an agreement between the Modi brothers to put an end to their quarrels. The Modis offered to buyback UTI's holding in MRL at Rs. 58 a share. However, UTI was asking for Rs. 70 per share. The FIs had formed a committee to negotiate the price at which their holdings were to be sold. However, the negotiations reached a deadlock since the FIs were not willing to bring down the sale price from Rs. 123 per share. Meanwhile, MRL's sales declined to Rs. 1.96 bn in the first quarter of 1998 from Rs. 2.16 bn in the same period the previous year. This was largely due to the shutting down of one of the company's units. In November 1999, the Modis appointed Hong Kong & Shanghai Banking Corporation (HSBC) to provide a blueprint for increasing their stake in the company to 51%. The FIs responded by appointing SBI Capital Markets to divest their MRL stake through an open offer. The issue dragged on into the new millennium when another controversy arose. In February 2000, some MRL shareholders filed charges against the FIs with the Monopolies and Restrictive Trade Practices Commission (MRTPC). The shareholders alleged that the FIs were acting in connivance with other tyre manufacturers. In March 2001, the Modis again made an open offer to buy a 35% stake in MRL at Rs. 80 per share5. By June 2001, the price was revised to Rs. 81.50. In a meeting of the heads of the FIs, it was decided that the price revision was not in line with the indicative offer made by the Modis earlier. They decided not to participate in the open offer and instead began planning their counter offer. By July 1, the open offer price had been increased to Rs. 90 per share, and within the next week the Modis picked up around 12% additional stake in the company. They also claimed to have reached an agreement with the FIs for buying out their stake at Rs. 90 per share. However, the FIs denied this and confirmed that they would not participate in the open offer as they were not willing to sell their stake on a piecemeal basis6. Reacting to this, BK Modi said, "I fail to understand this new development. We have agreed to all the demands by FIs, whether it be buying out their entire stake, giving them a bank guarantee or whatever else it takes." By the end of July 2001, the Modis had received about 36% of MRL's shares through the open offer. Of this, around 10.8% had been sold by LIC. This came as a big surprise to all the parties concerned as it was directly against the stand taken by the insurance company as part of the FI consortium earlier. The other FIs involved lashed out strongly against LIC's move. Things soon took an interesting turn when LIC sent a letter to MRL stating that it wanted to withdraw the shares it had tendered in the open offer. But the Modis accepted LIC's shares after consulting legal experts. These experts confirmed that a company could not go back on an open offer. The matter was referred to the SEBI, which decided that LIC could not withdraw the shares as it had itself tendered them in an open offer. SEBI argued that if such about-turns were allowed, the whole process of open offers would be plunged into chaos and people would begin finding different reasons for withdrawing their shares from open offers. LIC then moved the Mumbai High Court for an injunction against transfer of its holding in MRL to the Modis. LIC sources revealed that the transfer of its 12% holding had happened `inadvertently'. They said it happened without the approval of its investment committee, whose clearance was mandatory. The transfer documents allowing the Stock Holding Corporation of India (SHCIL) to transfer LIC's shares to MRL were signed by two officers `by mistake'both of whom were later suspended by LIC. The Court granted a temporary injunction on LIC's participation in the MRL open offer. In an interim order, the court said that LIC's shares could not be considered for the open offer. In turn, LIC was asked to submit an undertaking that it would not transfer its shares until the final hearing and disposal of the suit. Companies and Fis - The Issue of Corporate Governance

The Modis' predicament was not difficult to understand. The brothers claimed that on the one hand, the FIs refused to sell their stake; on the other, they were not allowing MRL to borrow from anyone else. The Modis also claimed that the interest rates being charged by the FIs (nearly 19%) were very high. After repaying these loans, they wanted to look for cheaper loans elsewhere. BK Modi said, "We want to return the entire loan taken from them, and look for cheaper loans from other banks. Why should we service such a high cost debt? And if we return their loan, we would also get them out of our board. For a long time, they sat on our board and did not allow us to borrow from other banks. With them out of our board, we would be able to run the company in a productive manner." The MRL issue came to be seen as an example of the controversial role of FI lenders in Indian companies. The FI announcement to sell their stake in the open market in 1996 sent shock waves through India's family-run businesses (in which the FIs held large stakes7.) For decades, the promoters had management control despite having low stakes because the FIs neither voted against the management, nor sold any shares. But now, businessmen across the country feared that if the MRL stake sell-off succeeded, FIs would make it a norm to sell out if any company defaulted on any loan. Besides, companies operating in industries suffering from cyclical downturns could be unduly penalized this way. KP Singh, President, Associated Chambers of Commerce and Industry (ASSOCHAM 8), said, "Certain cyclical industries may suffer a bad period, but this is no reason to punish an entrepreneur. This man has put in sweat for his company and now suddenly by selling out, the institutions are punishing him." MRL's predicament raised a heated debate in the chambers of commerce as well. Statements from business houses, chambers of companies and FI officials regarding the MRL issue kept appearing frequently in the media. A FICCI 9 source said that if the FIs decided to sell out, they should offer the first right of refusal to the promoter at the market price. Both FICCI and ASSOCHAM appealed to the Government to intervene and stop the FIs, while the Confederation of Indian Industry (CII)10 supported the FIs. Though there were rumors of some pressure from the Government, eventually it decided to keep out of the tussle. In November 1999, the Government declined to take sides in the MRL/FI tussle. Finance Minister Yashwant Sinha said, "Would you like the government to intervene in the commercial decisions of the financial institutions? Here, the question is of trust, and the FIs should not do anything to destroy this trust. They should work on mutual understanding, and transparency cannot be made a victim. If the FIs feel that they are getting a good deal by selling their stake, who am I to ask?" More than the fear of getting a bad price for their stake, the companies feared that no one could predict exactly when the FIs would decide to sell their stake. The FIs played a dual role in the companies in which they held stakesthey were term lending bodies as well as investors. This made it difficult to predict their moves. For instance, if an FI was facing a problem with Non-Performing Assets (NPAs), 11 it could either start selling shares indiscriminately to raise money, or it could selectively target companies or groups which were defaulting on their loans. The fact that different categories of FIs had different motivations for lending to companies further compounded the problem. Broadly, the FIs could be put in three categoriesdevelopment finance institutions (IDBI, ICICI, IFCI); insurance companies (LIC, GIC); and the UTI, an asset management company. The development finance institutions were believed to be rather stable, long-term shareholders, who claimed not to be interested in destabilizing existing managements. A senior IDBI official commented, "By selling in Tata Steel or ITC alone, we can provision for most of our NPAs. But I don't think this will ever happen. The whole country will be up in arms against us." A senior ICICI executive added, "Any sale of equity is bound to be controversial." However, it was a different story where the insurance companies and the UTI were concerned. These institutions were under increasing pressure to maximize returns on their investments, and they had to consider shifting their investments from traditional manufacturing companies to the then sunrise sectors like IT and Pharmaceuticals. Moreover, unlike development finance institutions, their investments were marked to markethence, they needed to constantly review their investments. UTI General Manager, Basudeb Sen said, "Institutions like ours are

asset managers, now we have a responsibility towards our shareholders. Now, decisions have to be made looking at the market. Conditions of 10 years ago don't have any meaning today." This was why UTI sold 7% of its stake in MRL in 1997. Though UTI, LIC and GIC sources said that they would never resort to selling shares of any company arbitrarily, they maintained that MRL was a special case. The core issue involved in the MRL affair seemed to be the accountability of the management to its shareholders. The fact that MRL had been performing badly over the years reflected badly on its commitment to enhance shareholder wealth. The company's defaults on loan repayments were largely responsible for FIs acquiring almost 44% of its equity. A report claimed, "Sound corporate governance can be effected only through an efficient market for corporate control. Companies should be allowed to be taken over by those who think that they can run them better. When a company is run suboptimally, it makes sense to buy up a controlling stake in it by making an outlay justified by future income streams from the company bought over, and to run that company." What Lies Ahead? In mid-2001, MRL was reported to have begun work on a comprehensive turnaround strategy. It infused Rs. 500 mn to modernize its operations and implemented stringent cost-cutting measures. The Modis also began negotiations for selling the non-tyre assets of the company to raise the money for augmenting the working capital base. This was deemed necessary to make the company profitable once again. The Modis had begun negotiations to get the FI loan freeze removed. The total capacity utilization of MRL's facilities was under 60-65%, which was proposed to be raised after the restructuring. Substantial salary cuts for senior executives of the company and the formation of a management team with well-defined work targets and instructions to report to the Modis were also on the anvil. Even as legal battles over the dispute with LIC's open offer issue continued, MRL suspended the manufacturing activities at its Modipuram plant in August 2001. Though the exact reasons were not revealed, sources cited certain administrative reasons, beyond the control of the management, for the decision. BK Modi meanwhile had unconditionally withdrawn the notice sent to VK Modi and the two brothers were reported to be working frantically to get the plant operational again. There appeared to be a lull in the battle between the FIs and the Modisat least until one of them made a move.

References 1. Ghosh Indranil, Will the Modi Brothers Lose MRL?, Businessworld, August 7, 1996. 2. Move to Appoint Executive Chairman at Modi Rubber, Business Standard , August 26, 1996. 3. Iyengar Jayanthi, FI Panel May First Enforce Code of Ethics in Modi Group, Business Standard, March 22, 1997. 4. Thomas Cherian, Modi Rubber Suffers Rs. 15 cr Net Loss, Business

Standard, July 21, 1997. 5. Dabke KB, Getting the Right Men on Board, Express India, August 12, 1997. 6. Iyengar Jayanthi, FIs Recall Loans to Modi Group, Business Standard, August 30, 1997. 7. FM Urged to Stall Modi Rubber Stake Sell-off by FIs, Business Standard, September 3, 1997. 8. Roy Choudhury Saibal and Bakshi Veeshal, Financial Institutions Plan to Fix Deadline for Selling Stake to Modis, Financial Express, January 23, 1998. 9. Padmanabhan Anil and Thomas Cherian, Modis Set to Regain Majority in MRL, Business Standard, March 3, 1998. 10. Chaudhuri Debashis, Unit Trust May Wash Hands Off Modi Rubber Holding, Financial Express, October 27, 1998. 11. Chambers Lobbying for Modis, Express India, November 5, 1999. 12. Market for Corporate Control, www.epw.org.in, November 6, 1999. 13. Mandal Kohinoor, Institutions Free to Decide on Stake Sale, Says Sinha, Financial Express, November 6, 1999. 14. Prasad Swati and Das Gupta Surajeet, Modis to Increase Stake in Modi Rubber to 51%, Business Standard, November 10, 1999. 15. Bhandari Bhupesh and Das Gupta Surajeet, Modis to Buyout 44.3% FI Stake in Modi Rubber, Business Standard, November 18, 1999. 16. Joseph Sandeep and Bhandari Bhupesh, Owners Under Fire, Businessworld, November 22, 1999.

17. Modi Rubber Shareholders Drag FIs to MRTPC Over Stake Sale, www.indiainfoline.com, February 22, 2000. 18. MRL Board Suspends 3 Directors of BK Modi Faction, Deccan Herald, July 2, 2001. 19. Iyengar Jayanthi, BK Modi May Have Walked into Trap, The Economic Times, July 3, 2001. 20. Modis Make Open Offer for Rs. 80 a Share for MRL, Business Standard, March 2001. 21. Modi Rubber Jumps 23% in 3 Days Prior to Open Offer, Financial Express, March 30, 2001. 22. Institutions May Make Counter Offer for Modi Rubber, www.indiainfoline.com, June 8, 2001. 23. MRL Board to `Strip' BK Modi of Powers, Business Line, June 30, 2001. 24. BK Modi Lashes Out at Financial Institutions, Hindustan Times, July 1, 2001. 25. Modis Claim 12% More Stake Under Open Offer, Deccan Herald, July 9, 2001. 26. FIs to Stay Away from Modi Rubber Open Offer, The Economic Times, July 14, 2001. 27. Speculation Over Offer by Modi Rubber, Business Line , July 20, 2001. 28. Srivats KR, Modi Rubber Open Offer Gets 36% Response, Business Line, July 24, 2001. 29. LIC Files for Injunction Against Transfer of Modi Rubber Shares, Business Line, July 24, 2001. 30. Sharma Sanjeev, Sebi Won't Let LIC Reverse MRL Sale, The Economic Times,

July 27, 2001. 31. Dubey Rajeev, Yes, the FIs Have Agreed to Sell, Businessworld, July 30, 2001. 32. Modi Rubber Suspends Manufacturing Activities at Modipuram Plant, www.capitalmarket.com, August 30, 2001. A nominee of the FI Unit Trust of India (UTI) on the MRL board, appointed as the Chairman on April 30, 2001.
1 2

1997 figures.

Modistone later turned sick and was referred to the Board of Industrial and Financial Restructuring (BIFR).
3

Under the group approach formula, the financial institutions stop advances to companies belonging to an industrial group if other sister companies have defaulted on loans.
4

At this point, MRL was involved in an insider-trading case as well, as in the three days prior to the open offer, the company's scrip gained 23% in three trading sessions. The stock rose from Rs. 49.55 on March 23 to Rs. 61.05 on March 28 and to Rs. 65.90 immediately after the open offer announcement.
5

MRL had received a 13% stake from the public in response to the open offer. The Modis could have bought only 22% from the FIs, but the FIs wanted to sell their entire 44% stake at one go. The FIs were not willing to sell on a piecemeal basis because that they were not sure of the Modis buying the remaining 22% stake later at the same price. Moreover, if the remaining 22% was purchased at this point itself, it was not clear whether the Modis would have to make another open offer. (Under SEBI's creeping acquisition guidelines, promoters holding 25-50% equity could acquire a maximum 5% stake in a year through the creeping acquisition route.)
6

FIs owned high stakes in these companies because most of them had borrowed heavily from FIs. Later, these loans were converted into equity.
7

The Associated Chambers of Commerce and Industry of India (ASSOCHAM) was a representative body of Indian companies aiming to impact the policy and legislative environment for balanced economic, social and industrial development.
8

The Federation of Indian Chambers of Commerce and Industry (FICCI) was a representative body of Indian companies that sought to look after the interests of corporates and to integrate the Indian economy with the global mainstream.
9

The Confederation of Indian Industries (CII) was a non-government, not-forprofit, industry led and industry managed organization, partnering industry and government alike through advisory and consultative services.
10

NPAs are loans on which interest payments have been due for more than one quarter and/or monthly installments have been due for more than three installments.
11

The author is a Faculty Member at ICMR and Consulting Editor, Case Folio. Case ANALYSIS

Modi Rubber vs. Financial Institutions - DG Prasuna Introduction The case of Modi Rubber Ltd. (MRL) brings to the fore a number of systemic issues that have bogged Indian businesses for long, such as intricately interwoven corporate holdings, the role of financial institutions and poor corporate governance practices to name a few. Family-owned business houses are a very common phenomenon in India and the biggest business groups (including the Tatas and Birlas) are managed by families. While it is undeniable that owners take a personal interest in the management of the company, it should also be accepted that family feuds could play havoc with the business as well. The fact that BK Modi and VK Modi had been at loggerheads with each other for the control of MRL, diverted the attention of the senior management and the board of directors from business operations. Even while the company was defaulting on loans and posting losses, the focus was on the power struggle between the brothers. Little wonder that MRL's profits fell drastically over the years. With financial institutions busy figuring out whom to support, the business itself was left to the winds. Minority shareholders suffer the most in such a scenario as they do not exercise much control on the management. Even in the issue of the merger of Modistone, a Modi group company with MRL, the struggle for power forced BK Modi to act in a manner wrongly assuming that his brother would not be able to gather the necessary resources. Moral Hazard In the working paper, `Equity Pattern, Corporate Governance and Performance: A Study of India's Corporate Sector', Murali Patibandla arrives at the following conclusion based on his research: "A large investor, who is protected by governments with taxpayers' money, tends to have higher degree of moral hazard than privately-owned large investors. Secondly, managers of firms through collusion can capture the agents of these large investors, which in turn results in diversion of accumulated capital for nonproductive personal goals of the agents." The impacts can be observed in the case of MRL. The collusion between managers of the firm and agents comes into play because most public financial institutions are represented on the board of borrowing firms. In the case of MRL too, nominees from UTI, LIC etc., were on the board. It could not have been very difficult for the management of MRL to lead these nominees, to act in the interests of the company rather than in the interests of their employers. MRL is a perfect example of how many Indian companies are structured. In India, public financial institutions including banks, Developmental Financial Institutions (DFIs), insurance companies and mutual funds have traditionally been the major providers of finances for companies. Most of them are in the public sector and have the implied guarantee of support from the government. DFIs in particular had been established with the explicit aim of facilitating industrial development in the country. Their performance has always been measured with the amount of disbursement rather than with the quality of their assets. This created an inherent moral hazard, which was perpetuated by the license raj. Promoters in nexus with politicians have abused these financial institutions. They took huge loans, which were rarely repaid. Also, financial institutions had little incentive or pressure to ensure that the loans were paid back. In the case of MRL too, it was the same story and neither did the management display any intentions of paying back. It is clearly mentioned that the Modis had been defaulting on loan paybacks since the 1980s itself. As early as 1989, in the light of a formal split, the Modis had refused to pay back the loans, on the ground that, "the crossholdings of the various family factions in Modi companies were so complex that the liability of each of the brothers could not be fixed till the division

of property was effected." The Modi brothers could not (or perhaps did not) arrive at an equitable distribution and the loans were not repaid. The institutions did get an equity stake, which came with its own concerns. However, it was not until 1996 that the financial institutions threatened to sell their stake in the company. This turn in events raises certain questions: Firstly, what use is an equity stake if the company is not doing well and its stock price is sagging? Secondly, do financial institutions or their nominees who have become standard fixtures at the board of such defaulting companies have any business there? Their expertise or experience in managing companies is questionable and whether they help or hinder the business of the company has to be considered. In fact, the constant threat of FIs to sell their stake could act like a Damocles sword for the management. FIs owe their equity stake to defaulting loans. Since they had never opposed the management's right to run the business, most business houses were nonchalant to the nonpayment of loans. But the threat of the kind that FIs consortium posed to MRL merits in-depth analysis. The threat of FIs to sell their stake in the open market is serious since it tends to reduce the stake of the promoters. Moreover, it could be a welcome opportunity for somebody who wants to take over the company. This could severely undermine the ability of the company's management. In the case of MRL too, the nominees from UTI, LIC had dominated the board. In addition, their role as lenders and owners were conflicting with each other, diluting their focus. There is a major social cost of this kind of functioning. The money channeled via these financial institutions is the hard-earned savings of millions of people and such misuse of funds could hamper the economy in the long run. In addition, the regulation for dealing with defaulters as well as their implementation is so weak that many companies get away with this kind of behavior. In fact, most NPAs that trouble the Indian financial system are accounted for by corporate defaults. This, in turn, affects the health of these financial institutions, which had lent freely (at times indiscriminately) due to the government's support. Most of the DFIs today are struggling for their own existence due to such loans. Even the concept of government's support cannot be relied upon completely today. In the case of UTI, after repeated bailouts within a short span of time, the government gave up and the investors took the brunt. And all the while, money was flowing in uninterrupted into unprofitable companies. The insider trading allegations that could not be resolved indicate the inefficient stock markets of India. The issue is not whether insider trading took place or not; it is more to do with the fact that the case was not resolved. There is also the issue of LIC's sale of its stake. Though the case went into the courts in 2001, no judgment has been passed even to this day. This proves the lax attitude of the judiciary. It also seems to be the motivation for companies to act as and how they want. Some Suggestions Given the present socio-economic environment in India, the case of MRL throws up a few points worth pondering upon. To begin with, financial institutions should be very clear as to their purpose and should lend after a thorough, rigorous screening of the businesses they are lending to. Since they are dealing with public funds, their responsibility should be erring on the side of caution. Given the fact that venture capitalists are there to support riskier ventures, a strict stand taken by financial institutions would not seriously hamper the entrepreneurial culture. Financial institutions, in their own interest, should not go hand in glove with the promoters, restructuring loans at every due date. They should act in a more proactive manner rather than wait till they get the stake and then threaten to dispose it in the open market. At the heart of the problem is the lack of proper corporate governance practices in the Indian scenario. Rather than merely adopting corporate governance codes, SEBI as well as the stock exchanges should make the implementation stricter.

Huge debts can undo the prosperity of a company in more ways than one. The cost of debt itself is formidable and the case of MRL proves that there could be larger concerns that accompany loans. The loser at the end of it all is the investor, and in developing markets like India, the society at large. The author is Assistant Editor, ICFAI Press. ICFAI Press. All Rights Reserved. ICFAI Center for Management Research (ICMR), an affiliate of ICFAI. All Rights Reserved. For accessing and procuring the case study log on to www.ecch.cranfield.ac.uk. Case ANALYSIS Modi Rubber vs. Financial Institutions - Madhu Vij Apart from referring to the controversial role of Financial Institutions (FIs) in the management of many Indian companies, the case study addresses the impact of the Modi family's disputes on Modi Rubber Ltd. (MRL). The emphasis given by SEBI in the recent past, to the adoption of fair and ethical business practices by all corporate entities is also highlighted. Since FIs holding stakes in companies act as owners as well as investors, it becomes difficult to anticipate their moves. Further, the fact that MRL had been performing badly is also a cause of concern. This reflects poorly on the company's commitment to enhance shareholders' wealth, which is directly linked to corporate governance. This issue is of significance, since during the last few years, corporate governance has become an indispensable requirement for survival, growth and progress of companies. An effective corporate governance system is one, which allows the Board of a company to provide leadership, strategic guidance and objective judgment independent of the management, while remaining accountable at all times to the shareholders. The importance of good corporate governance has grown because of the sheer size of the companies and it is a priority on the SEBI's agenda as well. The benefits of `good' corporate governance are: Creating investor confidence in the long run. Creation and enhancement of shareholders wealth. Improving the long-term health of the company. Promoting self-regulation. Making the company attain sustainable and high growth levels. A higher level of accountability and integrity is achieved. There is an increasing concern by the FIs about standards of financial reporting and accountability, especially after losses suffered by investors and lenders in the recent past, which could have been avoided with better and more transparent reporting practices. Millions of investors have suffered on account of the mismanagement of companies. In today's fiercely competitive business environment, good corporate governance

practices are being looked upon as a benchmark for corporate excellence. It is not only for the sake of accountability alone that good corporate governance is necessary. Several studies have shown that there is a strong link between how a company is governed and how it performs. Most companies having higher governance standards are also the ones delivering substantial higher returns to shareholders. In fact, good corporate governance practices ensure that companies enhance their wealth-generating capacity in a transparent and legal manner, meeting the expectations of both shareholders and the society. The FIs were not totally justified in adopting the group policy approach towards MRL. However, the company's poor performance over the years is also not because of the role of FIs in its management. The FIs threat to sell their stake in Modi Rubber, in the open market was to ensure that the Board of Directors remained committed to managing the company in a transparent manner. The efforts by FIs here was also to make the company proactive and take immediate steps to adopt good corporate governance practices. Thus, the Modis need to seriously reevaluate their strategies and adopt a greater degree of professionalism in management of MRL. Considering stiff competition in the industry it is operating in (both from the domestic players and imports), MRL is liable to face pressure on its profitability, in the future. Other top companies such as MRF, Apollo Tyre & Goodyear are also feeling the pinch of the competition. MRL thus needs to make efforts to survive the recession in the market. The company has already initiated steps to improve its position. A new range of tyres related to the specific market needs has been introduced, backed by an effective marketing strategy. The other initiative includes a structural reorganization aimed at improving the profitability of the organization. Good corporate governance practices should become a way of life at MRL. The role of the Board of Directors needs to be revolutionary, always ensuring that the company moves towards higher levels of creativity. Family disputes leading to separation invariably result in a division of the company, much to the detriment of the individual shareholders. To remain competitive in a changing world, MRL needs to take care of these issues so that it can grasp opportunities and meet the challenges of the future. The author is Reader, Faculty of Management Studies (FMS), New Delhi. Reference # 14-03-04-02 ICFAI Press. All Rights Reserved.