Peak Event Fallacy

By Shreenivas Kunte, CFA, Adjunct Faculty – In-charge Trade/Research Lab, S.P. Jain Institute of Management & Research

Call it duration neglect. Call it peak event fallacy. But about this time of the year, holidays notwithstanding, we find ourselves remembering the year gone by through the numerous summaries offered in the media. And then there is the top 10 series on what to expect in the new year – from stock picks, themes and ideas to people, companies and their horoscopes. In all this where does the minority shareholder stand? And what can the shareholder expect? It’s important to understand because upholding some of the minority shareholder rights through the newly notified Companies Act could just become another illusion.

Behavioural analysts often cite colonoscopy experiments as examples of both duration neglect and the tendency to remember extremes. Colonoscopy as one could imagine is a painful procedure that allows the doctor to put in an enormously long tube from behind. The only reassuring thing about this procedure is that the fatality rate is assuredly zero and that the doctor is in a better position to explore the linings of the large intestine for detecting disease. As it turns out, patients subjected to this unagreeable medical procedure, remember just the peak pain and are seen to be surprisingly indifferent to the duration involved.

Being a minority shareholder is not the same as undergoing colonoscopy (it’s not – after all there are so many good companies out there, correct?). But the pain experiment allows us to look at our biases. In the context of pain and the backdrop of hardships that the minority shareholder in India has faced, any success stories are bound to bring optimism and confidence. Denying executive compensation increase at an auto – major, rejecting counter-productive proposals at a liquor major, putting up resistance against outsourcing of manufacturing operations at another auto major are amongst the notable 2014 activism success stories. But against this backdrop it must be remembered that the Indian promoter has been constantly at work to find ways and means to wring out maximum gain.

For instance, the auto – major with manufacturing outsourcing plans has been seen to be deftly waiting for a potential change (read dilution) in the law against related party transactions. A major oil and gas company, moved before the new company act rules notification, and is seen to be earning a sub-par interest rate for itself by loaning a part of its cash reserve to another group company. It is curious and incomprehensible that a promoter associated with the oil and gas major has written about ways to contribute to India’s GDP and has disclosed plans to use a good proportion (75%) of personal wealth for philanthropy. Some of these actions relate ultimately to the endowment effect but net-net wealthy promoters at the expense of the minority holders can only be expected to retain and even increase control.

So here is one of the events to watch out for this year. Reportedly, the Loksabha has okayed dilution in some of the minority shareholder friendly provisions outlined in the Companies Act 2013. Completely scrapping away the requirement for a 75% vote to approve related party transactions could render the RPT related regulation toothless.  India, with an average promoter holding of more than 51%, should be wary as the average company would then be able to get a RPT transaction passed without the consent of the minority.  In 2015, under the garb of progress, will interest lobbies push minorityism toward a ghetto. India’s corporate governance and regional standing has improved marginally in 2014, but we are far far away from doing any victory laps. Will the government and or the regulator stand firm to protect good corporate governance?

– SK