First, let me give some examples of what I mean - and why this is not the same as "management quality". Till the early nineties, it was assumed that investing in multi-national corporations was a sure fire way to make money. Post liberalization (early 1990's), this changed. Dividends fell, splits reduced, and profit growth slowed. While this could partly be attributed to greater competition from domestic companies, it was largely because liberalization allowed the overseas (majority) shareholders alternate mechanisms to reward themselves at the expense of domestic shareholders. Unfair transfer pricing was regularly resorted to (foreign owned pharma companies are a prime example). As was the setting up of wholly owned subsidiaries (e.g. P&G) by the overseas parent to the detriment of the prospects of the listed company (the list of such companies is long and illustrious !). Clearly, the management quality had not changed, only the incentives had.
It does not even have to be the machinations of some evil, greedy "promoter" with his grubby fingers in the cookie jar. The Gujarat governments recent diktat to state owned enterprises to pay 30% of pre-tax profits to the government in the form of a donation (?!) is a case in point. Similarly, the Central governments' use of the state owned oil companies to subsidise consumers while paying absurdly high taxes, penalises the minority shareholder.
Strangely, high shareholding by the principal shareholder does not seem to generate alignment. This is particularly true when the company has assets (say land) which are not being priced at prevailing market value - if the asset value (notwithstanding its current income generation) is more than the enterprise value. There is, almost invariably, an attempt by the principal shareholder to either take the asset out of the books of the public company, or to increase shareholding - usually through an merger with an over-valued, privately owned, company. Alembic and Cadilla have both tried/done this.
Even if the majority shareholder does not try to "strip" the assets, the market will surprisingly refuse to recognise the value in the company - till there is a requirement to raise capital in such a company. All "holding" companies come in this category. Many tend to be illiquid - which is taken as a reason for the dis-interest of the market (or, it is the other way around?). Holding companies often trade at 60% discount to holding value, for long periods of time. Here, it is not in the interest of the principle shareholder to "unlock" value and therefore it will not happen. Minority shareholders can wait till their patience runs out, and the current holder sells to another unsuspecting soul in search for a "value" stock.
On the other hand, an alignment of interest can work wonders. This, ofcourse, will not make a bad business good. Nor will it change the business profitability (though sometimes I have seen this magic happen). However, what it will do, is that it will increase the chances to make money when the going is good. Average businesses will deliver superior returns. Lets take a few examples:
United Breweries group has had a stranglehold on the liquor/beer business in India for decades. However, only when it became necessary to increase market capitalization to (a) ward off the threat of take-over by overseas corporates (b) raise capital for acquisition, and di-worsification (I borrow from Peter Lynch) - that a group restructuring was initiated and the stock price multiplied.
State owned company shares move up as soon as the government announces a dis-investment program. Logically, an increase in supply of stock, without any change in the outlook of the company, should have the reverse effect.
Decoding managment motivations is perhaps as important as poring over the notes to accounts.
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