Time and again, while looking at public equities in India, one is often found peering at the promoter holding (%) before commencing research. Should the % of promoter holding be high, there is an automatic comfort that builds up in an investor’s mind. It is assumed that with the promoter holding being high, the interests of the minority shareholders are aligned with those of the promoter. However, having re-read Alastair Smith, Bueno De Mesquita, and Johnny Heller’s “The Dictator’s Handbook”- there is a serious case to be made, at least logically speaking, for this to be a reason for poor corporate governance in Indian companies vs. American peers. 

The Selectorate Theory

The Dictator’s Handbook draws from the selectorate theory and its consequent inferences to demonstrate lucidly how dictators can successfully hoard power. The theory divides the polity into the following constituents:

  • Residents: Members of the polity or the population that comprises it.
  • Nominal selectorate/ Interchangeables: Residents who possess characteristics that qualify them to elect the leadership, by the norms of the governing body/ authority.
  • Real selectorate/ Influentials: Interchangeables who actually chose the leadership.
  • Winning Coalition/ Essentials: Infleuntials which endow the leadership with sufficient power over the remainder of the selectorate.
  • Leadership: The ruler who has the ability to raise and spend capital.
selectorate-theory
Figure 1: Selectorate Theory via Set Diagrams

Applying this model, the rules to being a successful dictator can be simply distilled down to the following:

  1. Maintain a small winning coalition- the fewer people you need to please to empower you, the cheaper and easier it is.
  2. Have a large pool of interchangbles- the more people that are eligible to directly elect the leadership, the easier it is to keep your essentials (winning coalition) and influentials (real selectorate) in check; they need to feel that they are expendables.
  3. Control the flow of revenue- the larger your control is over the revenue in the system, the greater dependency your winning coalition has on you.
  4. Pay supporters just enough- as a corollary to the previous rule, give just enough to keep your winning coalition happy but not to have them independent of you.
  5. Do not indulge the residents or the polity at large at the cost of the winning coalition.

An Indian Case

A masterful demonstration of this formula for success for dictators, is ironically seen in the political party that fought to bring the largest democracy in the world to life. The Gandhi family, which can today be termed dictators ruling the INC- within the framework of this model- have successfully retained the INC president’s position for 32 of the past 40 years.

The 2crore+ members of the party act as the residents or the polity. The All India Congress Committee (AICC) with over 80 members forms the nominal selectorate that elects the Party’s President. However it is only a subset of those that actually chose the leadership- the Congress Working Committee (CWC) with 15 members- the real selectorate. Having a nominal selectorate over 5x the size of the real selectorate enables the leadership to keep them loyally fearful.

The winning coalition is simply a small group within the CWC that supports the leadership. This ensures that there are very few people that the leadership needs to cajole for retaining control. And the leadership has not let their regional entities (run by residents) flourish at the cost of the winning coalition.

The Corporate Governance Application

Applying this in the context of publically listed companies, one can denote:

  • All the shareholders to be the ‘residents’
  • The institutional (or those with over 1% stake) grade investors to be the ‘nominal selectorate’
  • The board of directors to be the ‘real selectorate’
  • The members of the board that support the MD to be the ‘winning coalition’.

A glance at the shareholding pattern of the top 10 companies in the US and in India by market capitalization, through the framework of the selectorate theory, compels one to expect relatively poor corporate governance norms in the Indian companies. (Note: The top 10 companies are taken to be representative of the market at large though they might not be a very accurate representation but simply a broad trend generalization). 

insider-ownership
Figure 2: Shareholding pattern in India and US

Having a larger shareholding percentage enables the promoters to justify a larger representation on the board. This reduces the effective number of the real selectorate members that need to be cajoled into being a part of the winning coalition.

Unlike the US where the Managing Director or the CEO must obtain sanctions for future plans from a large, diverse board, the Indian promoters operate in almost complete autonomy on the future plans of the company thus enabling them to exercise a more substantial control over the finances of the company. For USA the data set above has included all those shareholders that hold more than 5% of the company as they would be influential enough to call for a board representation. Barring Berkshire and Amazon, however, all the companies have diversified shareholding. Such a structure can be an enabling factor in an attempt to create an independent board.

I am not alleging that promoters that have skin in the game are necessarily poor at corporate governance. I am simply positing a hypothesis that illustrates the predisposition of the current shareholding patterns to poor corporate governance.