CORPORATE LAW

SUBMITTED BY:

SHWETA RAUT

(PG-07)

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CORPORATE GOVERNANCE

• The last few years have seen some major scams and corporate collapse across the globe. In India, the major example is Satyam which is one of the largest IT companies in India. All these events have caused the pendulum of public faith to shift away from free market to a more closely regulated one. However "corporate governance," in spite of being the new object of interest and inquisitiveness from various quarters, remains an ambiguous and often misunderstood phrase. So before delving further on the subject it is important to define the concept of corporate governance.

• To get a fair view, it would be prudent to give a narrow as well as broad definition of corporate governance

• In a narrow sense, it involves a set of relationships amongst the company’s management, its board of directors, its share holders, auditors and other stakeholders. These relationships which involve various rules and incentives provide the structure through which the objectives of a company are set and the means of attaining and monitoring performance are determined. In a broader sense, corporate governance is important for overall market confidence, the efficiency of capital allocation, the growth and development of countries’ industrial basis and ultimately the nations’ overall wealth and welfare. In both narrow as well as in the broad definitions, the following concepts occupy a centre stage:

1. Rights and equitable treatment of shareholders

2. Interests of other stakeholders

3. Role and responsibilities of the board

4. Integrity and ethical behaviour

5. Disclosure and transparency

• Ever since the first writings on the subject appeared there have been many debates as to whom should corporate governance really represent: the interest of the shareholders or that of all stakeholders. The shareholder primacy is embodied in the finance view of corporate governance, i.e., the primary justification for the existence of the corporation is to maximise shareholders’ wealth. Since ownership and control are

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separate the issue here is to align the objectives of management with the objective of shareholder wealth maximisation

• The issue raised in the stakeholder theories is whether the recognition of a wider set of claims than those of shareholders alone is the legitimate concern of corporate governance. It is argued that the new technology world has reduced the opportunity, ability and the motivation of consumers to engage in rational decision making. So the development of inclusive stakeholder relationships rather than production at a lower price will be the most important determinant of viability and success. It implies searching for a balance among the distinct company interest groups – i.e., shareholders, workers, banks etc. - and also looks for their participation

• A natural question to ask is why we need to impose particular governance regulations. There are at least three reasons for regulatory intervention:

1) If the founder of the company was allowed to design and implement a corporate charter he likes. He may not clearly address the issues faced by other shareholders and thus conjure inefficient rules. E.g. in the absence of regulations founders could employ anti-takeover defences excessively but shareholders may favour takeovers that increase the value of their shares even if they involve greater losses for unprotected creditors or employees. So the collective bargaining process may not yield socially acceptable solutions and may be at the mercy of few stakeholders.

2) Another argument comes from the externality argument. An externality may be defined as a good generated as the result of an economic activity, whose benefits or costs do not accrue directly to the parties involved in the activity. E.g. one corporate scandal can erode shareholder trust in the whole of the corporate sector. In such cases where private action fails to resolve widespread externalities involving many parties the state has the responsibility to intervene and prevent market failure.

3) Regulation is also needed to avoid a situation where efficient rules are designed initially but due to lack of active tracking by dispersed shareholders, are altered or broken later.

• While regulations are necessary, there are however, a few issues that need to be considered. The first relates to policing and punishment. The SEBI envisages that all these corporate governance norms will be enforced through listing agreements

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between companies and the stock exchanges but for companies with little floating stock deregulation because of non compliance is hardly a credible threat. The second issue has to do with form vs. Substance. There is a fear that by legally mandating several aspects of corporate governance the regulators encourage the practise of companies following the letter of the law instead of focussing on the spirit of good governance. The third concern relates to apprehension about excessive interference that unwittingly leads to micro-management of companies.

• Considering these apprehensions, what we need is a small corpus of legally mandated rules, buttressed by much larger body of self-regulation and voluntary compliance.

• So after careful weighing of all pros and cons it is not tough to conclude that good Corporate Governance makes for good business sense. It increases confidence of shareholders in the company leading to better stock prices. Research has shown that the good Corporate Governance brings down the cost of capital for the company. Good disclosure practices lead to a more liquid market for the company. This lowers cost of debt. Thus for the CEOs of today, there is a clear business case for complying with principles of good Corporate Governance.

Corporate Governance in India

• The 1956 Companies Act as well as other laws governing the functioning of joint-stock companies and protecting the investors’ rights built on this foundation. The beginning of corporate developments in India were marked by the managing agency system that contributed to the birth of dispersed equity ownership but also gave rise to the practice of management enjoying control rights disproportionately greater than their stock ownership. The turn towards socialism in the decades after independence marked by the 1951 Industries (Development and Regulation) Act as well as the 1956 Industrial Policy Resolution put in place a regime and culture of licensing, protection and widespread red-tape that bred corruption and stilted the growth of the corporate sector.

• The situation grew from bad to worse in the following decades and corruption, nepotism and inefficiency became the hallmarks of the Indian corporate sector. Exorbitant tax rates encouraged creative accounting practices and complicated emolument structures to beat the system. In the absence of a developed stock market, the three all-India development finance institutions (DFIs) – the Industrial Finance

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Corporation of India, the Industrial Development Bank of India and the Industrial Credit and Investment Corporation of India – together with the state financial corporations became the main providers of long-term credit to companies. Along with the government owned mutual fund, the Unit Trust of India, they also held large blocks of shares in the companies they lent to and invariably had representations in their boards

• The situation grew from bad to worse in the following decades and corruption, nepotism and inefficiency became the hallmarks of the Indian corporate sector. Exorbitant tax rates encouraged creative accounting practices and complicated emolument structures to beat the system. In the absence of a developed stock market, the three all-India development finance institutions (DFIs) – the Industrial Finance Corporation of India, the Industrial Development Bank of India and the Industrial Credit and Investment Corporation of India – together with the state financial corporations became the main providers of long-term credit to companies. Along with the government owned mutual fund, the Unit Trust of India, they also held large blocks of shares in the companies they lent to and invariably had representations in their boards

• In this respect, the corporate governance system resembled the bank-based German model where these institutions could have played a big role in keeping their clients on the right track. Unfortunately, they were themselves evaluated on the quantity rather than quality of their lending and thus had little incentive for either proper credit appraisal or effective follow-up and monitoring. Borrowers therefore routinely recouped their investment in a short period and then had little incentive to either repay the loans or run the business. Frequently they bled the company with impunity, siphoning off funds with the DFI nominee directors mute spectators in their boards.  

• This sordid but increasingly familiar process usually continued till the company’s net worth was completely eroded. This stage would come after the company has defaulted on its loan obligations for a while, but this would be the stage where India’s bankruptcy reorganization system driven by the 1985 Sick Industrial Companies Act (SICA) would consider it “sick” and refer it to the Board for Industrial and Financial Reconstruction (BIFR). As soon as a company is registered with the BIFR it wins immediate protection from the creditors’ claims for at least four years. Between 1987 and 1992 BIFR took well over two years on an average to reach a decision, after

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which period the delay has roughly doubled. Very few companies have emerged successfully from the BIFR and even for those that needed to be liquidated, the legal process takes over 10 years on average, by which time the assets of the company are practically worthless. Protection of creditors’ rights has therefore existed only on paper in India. Given this situation, it is hardly surprising that banks, flush with depositors’ funds routinely decide to lend only to blue chip companies and park their funds in government securities.

• Financial disclosure norms in India have traditionally been superior to most Asian countries though fell short of those in the USA and other advanced countries. Noncompliance with disclosure norms and even the failure of auditor’s reports to conform to the law attract nominal fines with hardly any punitive action. The Institute of Chartered Accountants in India has not been known to take action against erring auditors.

• While the Companies Act provides clear instructions for maintaining and updating share registers, in reality minority shareholders have often suffered from irregularities in share transfers and registrations – deliberate or unintentional. Sometimes non-voting preferential shares have been used by promoters to channel funds and deprive minority shareholders of their dues have sometimes been defrauded by the management undertaking clandestine side deals with the acquirers in the relatively scarce event of corporate takeovers and mergers.

• Boards of directors have been largely ineffective in India in monitoring the actions of management. They are routinely packed with friends and allies of the promoters and managers, in flagrant violation of the spirit of corporate law. The nominee directors from the DFIs, who could and should have played a particularly important role, have usually been incompetent or unwilling to step up to the act. Consequently, the boards of directors have largely functioned as rubber stamps of the management. For most of the post-Independence era the Indian equity markets were not liquid or sophisticated enough to exert effective control over the companies. Listing requirements of exchanges enforced some transparency, but non-compliance was neither rare nor acted upon. All in all therefore, minority shareholders and creditors in India remained effectively unprotected in spite of a plethora of laws in the books.

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• The years since liberalization have witnessed wide-ranging changes in both laws and regulations driving corporate governance as well as general consciousness about it. Perhaps the single most important development in the field of corporate governance and investor protection in India has been the establishment of the Securities and Exchange Board of India (SEBI) in 1992 and its gradual empowerment since then. Established primarily to regulate and monitor stock trading, it has played a crucial role in establishing the basic minimum ground rules of corporate conduct in the country. Concerns about corporate governance in India were, however, largely triggered by a spate of crises in the early 90’s – the Harshad Mehta stock market scam of 1992 followed by incidents of companies allotting preferential shares to their promoters at deeply discounted prices as well as those of companies simply disappearing with investors’ money. These concerns about corporate governance stemming from the corporate scandals as well as opening up to the forces of competition and globalization gave rise to several investigations into the ways to fix the corporate governance situation in India. One of the first among such endeavours was the CII Code for Desirable Corporate Governance developed by a committee chaired by Rahul Bajaj. The committee was formed in 1996 and submitted its code in April 1998. Later SEBI constituted two committees to look into the issue of corporate governance – the first chaired by Kumar Mangalam Birla that submitted its report in early 2000 and the second by Narayana Murthy three years later. The SEBI committee recommendations have had the maximum impact on changing the corporate governance situation in India. The Advisory Group on Corporate Governance of RBI’s Standing Committee on International Financial Standards and Codes also submitted its own recommendations in 2001

Recommendations of various committees on Corporate Governance in India

CII Code recommendations (1997)

• No need for German style two-tiered board.

• For a listed company with turnover exceeding Rs 100 crores, if the chairman is also the MD, at least half of the board should be independent directors, else at least 30%.

• No single person should hold directorships in more than 10 listed companies.

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• Non-executive directors should be competent and active and have clearly defined responsibilities like in the Audit committee.

• Directors should be paid a commission not exceeding 1% (3%) of net profits for a company with (out) an MD over and above sitting fees. Stock options may be considered too.

• Attendance record of directors should be made explicit at the time of re-appointment. Those with less than 50% attendance shouldn’t be re-appointed.

• Key information that must be presented to the board is listed in the code.

Audit Committee: Listed companies with turnover over Rs. 100 crores or paid-up capital of Rs. 20 crores should have an audit committee of at least three members, all non-executive, competent and willing to work more than other non-executive directors, with clear terms of reference and access to all financial information in the company and should periodically

• interact with statutory auditors and internal auditors and assist the board in corporate accounting and reporting.

• Reduction in number of nominee directors. FIs should withdraw nominee directors from companies with individual FI shareholding below 5% or total FI holding below 10%.  

Birla Committee (SEBI) recommendations (2000)  

• At least 50% non-executive members.

• For a company with an executive Chairman, at least half of the board should be independent directors, else at least one-third.

• Non-executive Chairman should have an office and be paid for job related expenses.

• Maximum of 10 directorships and 5 chairmanships per person.

Audit Committee: A board must have a qualified and independent audit committee, of minimum 3 members, all non-executive, majority and chair independent with at least one having financial and accounting knowledge. Its chairman should attend

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AGM to answer shareholder queries. The committee should confer with key executives as necessary and the company secretary should be he secretary of the committee. The committee should meet at least thrice a year -- one before finalization of annual accounts and one necessarily every six months with the quorum being the higher of two members or one-third of members with at least two independent directors. It should have access to information from any employee and can investigate any matter within its TOR, can seek outside legal/professional service as well as secure attendance of outside experts in meetings. It should act as the bridge between the board, statutory auditors and internal auditors with arranging powers and responsibilities.

Remuneration Committee: The remuneration committee should decide remuneration packages for executive directors. It should have at least 3 directors, all Nonexecutive and be chaired by an independent director.

• The board should decide on the remuneration of non-executive directors and all remuneration information should be disclosed in annual report.

• At least 4 board meetings a year with a maximum gap of 4 months between any 2 meetings. Minimum information available to boards stipulated.

Narayana Murthy committee (SEBI) recommendations (2003)

• Training of board members suggested.

• There shall be no nominee directors. All directors to be elected by shareholders with same responsibilities and accountabilities.

• Non-executive director compensation to be fixed by board and ratified by shareholders and reported. Stock options should be vested at least a year after their retirement. Independent directors should be treated the same way as non-executive directors.

• The board should be informed every quarter of business risk and risk management strategies.

• Boards of subsidiaries should follow similar composition rules as that of parent and should have at least one independent directors of the parent company.

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• The Board report of a parent company should have access to minutes of board meeting in subsidiaries and should affirm reviewing its affairs.

• Performance evaluation of non-executive directors by all his fellow Board members should inform a re-appointment decision.

• While independent and non-executive directors should enjoy some protection from civil and criminal litigation, they may be held responsible of the legal compliance in the company’s affairs.

• Code of conduct for Board members and senior management and annual affirmation of compliance to

Weaknesses of Corporate Governance In India

• The Satyam debacle has exposed the chinks in Indian corporate governance mechanism and the monitoring authorities. It has raised many questions about corporate governance in India—the role of boards, of independent directors, of the auditors, of investors and of analysts. Unanimously it has been a gross failure of corporate governance standards in India and protection of rights of minority investors.

• The board of directors is central to good governance, and the role of the board has featured prominently in discussions about Satyam. The board is the body charged with having oversight of the operations of the firm and setting its strategy. It should ensure that the company is upholding high standards of probity and conduct, and provide a probing analysis of the activities of management. In particular, non-executive directors are supposed to give an independent assessment of the quality of management. But time and time again, failures of corporate governance suggest that they do not. The infractions of law have arisen despite independent directors which were stopped by external forces. There are several reasons pointing to these anomalies-

• First, it is difficult to appoint truly independent directors. This is particularly hard to achieve in countries such as India where family ownership is widespread and there is a close-knit group of corporate leaders. It is difficult for non-executive directors to perform a scrutiny objective at the best of times,

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but it is particularly difficult to do so when faced with a dominant CEO who expects support not criticism from the company’s board. Many countries have sought to separate the roles of chairman and CEO. However, it can inhibit firms from implementing effective strategies, especially in companies operating with new technologies, such as Indian IT/ITES firms, requiring visionary strategies.

• Next, the very idea of independent directors is to ensure commitment to values, ethical business conduct and about making a distinction between personal and corporate funds in the management of a company. Yet, most independent directors have become sidekicks for the management, eying their commission and fees, forgetting their very purpose of appointment. In the process, they implicitly transform into dependent directors.

• To add to that the present corporate governance modelled on the Western Anglo-Saxon model which does not address many of the current crises faced by India Inc. Professor Jayant Rama Verma of IIM Bangalore had extensively commented on the unsuitability of the Western Code of Corporate Governance in his well researched paper on the subject titled 'Corporate Governance in India - Disciplining the dominant shareholder'

• According to him, the governance issue in the Anglo-Saxon world aims essentially at disciplining the management which is unaccountable to the owners. In contrast, the problem in the Indian corporate sector, he pointed out, is disciplining the dominant shareholder and protecting the minority shareholders, vindicated in the recent Satyam case. To understand the issues that driving corporate governance in the West, a brief idea about it is inevitable. After successfully working over the decades separating ownership and management, owners, (especially, institutional owners) realised that they have lost control over the management or the board. Professor Verma points out succinctly," The management becomes self-perpetuating and the composition of the board itself is largely influenced by the whims of the CEO. Corporate governance reforms in the US and the UK have focussed on making the board independent of the CEO

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• In contrast, the issues in India are entirely distinct - primarily due to our overall social-economic conditions. Therefore the issue in Indian corporate governance is not a 'conflict between management and owners' as elsewhere, but 'a conflict between the dominant shareholders and the minority shareholders'. And Professor Verma rightly concludes, "The board cannot even in theory resolve this conflict" and that "some of the most glaring abuses of corporate governance in India have been defended on the principle of shareholder democracy since they have been sanctioned by resolutions of the general body of shareholders."

• By now it is increasingly obvious that the very concept of corporate governance modelled on the Western system is un-workable in a country like India. These efforts are akin to taking a hair of an elephant, transplanting it on the head of a bald man and making him look like a bear. In the West the focus is on ownerless, CEO-driven paradigm. In India, it is still family-controlled, owner-driven paradigm. CEOs do not matter much in the management of the company. Yet, the general discussion centres on a standard, global prescription to manage diverse situations. Needless to emphasise, the solution to these problems in India lies not within the company, but outside. This is precisely what happened in the Satyam case where outsiders of the company took the lid off the fraud.

• In spite of numerous suggestions by the Securities and Exchange Board of India (SEBI), for peer reviews of audits among the companies listed in the Nifty and Sensex indices they have fallen flat on the industry fraternity. Presumably, SEBI will allocate the audits to firms that are part of a panel of reputed auditors. The simple solution would be for the regulator to make this course of action mandatory—auditors could be allotted audits by the regulator. To avoid the allegations of overregulation, companies can submit a list of their preferred auditors, from which the regulator will have to choose. Audits could also be rotated annually, keeping them on their toes. And these same rules could also be applied to rating agencies, internal auditors, independent directors etc. From time to time these mechanisms can be fine-tuned and made more practical.

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• The moot question is why these reformative suggestions have not been implemented? The answer is that it depends on who’s got more lobbying power. In the US, the large pension funds that have been instrumental in getting more transparency from company managements. India, on the other hand, has no tradition of shareholder activism, despite organisations such as the Life Insurance Corporation of India having substantial stakes in companies. The dependence of political parties on business interests to fund elections also doesn’t help. The failure of governments and regulators to pass what seems like very basic safeguards preventing conflicts of interest, not only in India, but across the world, clearly establishes the clout that corporate interests have. Corporate governance is thus a charade, a cosmetic exercise rather than an attempt to get to the root of the problem.

• Of course, too rigid a focus on the stock market also has its own set of problems. As Satyam Computer Services Ltd’s founder B. Ramalinga Raju said in his confession, the apparent reason why he inflated earnings was because he feared that bad results would lead to a fall in the stock and a takeover attempt. We needn’t take Raju’s word for it, but the fact remains that too much of a focus on quarterly earnings and the linking of executive compensation with the stock market via stock options could act as powerful incentives for inflating earnings.

Recommendations to Implement Corporate Governance

• After a slew of scandals, politicians and regulators, executives and shareholders are all preaching the governance gospel. Corporate governance has come to dominate the political and business agenda.

• There is a growing concern among executives that hasty regulation and overly strict internal procedures may impair their ability to run their business effectively. CEOs have to bear in mind the potential trade-off between polishing the corporate reputation and delivering growth—for all the headlines on corporate responsibility, are investors prepared consistently to sacrifice earnings for the sake of ethics?

• Regulations are only one part of the answer to improved governance. Corporate governance is about how companies are directed and controlled. The

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balance sheet is an output of manifold structural and strategic decisions across the entire company, from stock options to risk management structures, from the composition of the board of directors to the decentralisation of decision-making powers. As a result, the prime responsibility for good governance must lie within the company rather than outside it.

• A key lesson from the Enron experience, where the board was an exemplar of best practice on paper, is that governance structures count for little if the culture isn’t right. Designing and implementing corporate governance structures are important, but instilling the right culture is essential. Senior managers need to set the agenda in this area, not least in ensuring that board members feel free to engage in open and meaningful debate. Not all board members need to be finance or risk experts, however. The primary task for the board is to understand and approve both the risk appetite of a particular company at any particular stage in its evolution and the processes that are in place to monitor risk.

• Culture is necessary but not sufficient to ensure good corporate governance. The right structures, policies and processes must also be in place. Transparency about a company’s governance policies is critical. As long as investors and shareholders are given clear and accessible information about these policies, the market can be allowed to do the rest, assigning an appropriate risk premium to companies that have too few independent directors or an overly aggressive compensation policy, or cutting the costs of capital for companies that adhere to conservative accounting policies. Too few companies are genuinely transparent, however, and this is an area where most organisations can and should do much more.

• If any institution, inside or outside the company, deserves scrutiny, it is the board of directors. Executives have a clear responsibility consciously to define and implement corporate governance policies that offer a decent level of reassurance to employees and investors. Thereafter, disclosure is the most effective way for companies to resolve the thorny tensions that do exist between vision and prudence, innovation and accountability.

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• There is an inherent tension between innovation and conservatism, governance and growth. Asked to evaluate the impact of strict corporate governance policies on their business, executives thought that M&A deals would be negatively affected because of the lengthening of due-diligence procedures, and that the ability to take swift and effective decisions would be compromised. State-of-the-art corporate governance can bring benefits to companies, to be sure, but also introduces impediments to growth. Some procedures and processes that companies can implement to enhance corporate governance are detailed as follows.

• Scheduling regular meetings of the non-executive board members from which other executives are excluded. Non-executives are there to exercise “constructive dissatisfaction” with the management team. ]

• They need to discuss collectively and frankly their views about the performance of the executives, the strategic direction of the company and worries about areas where they feel inadequately briefed.

• Explaining fully how discretion has been exercised in compiling the earnings and profit figures. These are not as cut and dried as many would imagine. Assets such as brands are intangible and with financial practices such as leasing common, a lot of subtle judgments must be made about what goes on or off the balance sheet. Use disclosure to win trust.

• Initiating a risk-appetite review among non-executives. At the root of most company failures are ill-judged management decisions on risk. Non-executives need not be risk experts. But it is paramount that they understand what the company’s appetite for risk is—and accept, or reject, any radical shifts.

• Checking that non-executive directors are independent. Weed out members of the controlling family or former employees who still have links to people in the company. Also raise awareness of “soft” conflicts. Are there payments or privileges such as consultancy contracts, payments to favourite charities or sponsorship of arts events that impair non-executives’ ability to rock the boat?

• Auditing non-executives’ performance and that of the board. The attendance record of nonexecutives needs to be discussed and an appraisal made of the

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range of specialist skills. The board should discuss annually how well it has performed.

• Broadening and deepening disclosure on corporate websites and in annual reports. Websites should have a corporate governance section containing information such as procedures for getting a motion into a proxy ballot. The level of detail should ideally include the attendance record of non-executives at board meetings.

• Leading by example, reining in a company culture that excuses cheating. If the company culture has been compromised, or if one is in an industry where loose practices on booking revenues and expenditure are sometimes tolerated, take a few high-profile decisions that signal change

• Finding a place for the grey and cautious employee alongside the youthful and visionary one. Hiring thrusting graduates will skew the culture towards an aggressive, individualist outlook. Balance this with some wiser, if duller heads—people who have seen booms and busts before, value probity and are not in so much of a hurry. Making compensation committees independent. Corporate bosses should be prevented from selling shares in their firms while they head them. Share options should be expensed in established companies—cash-starved start-ups may need to be more flexible.

• Corporate governance is not just a box ticking exercise, companies need an exchange of practical guidance in order to conceive and implement successful governance mechanism. Instead of a menu of corporate governance options it would be more appropriate to present best practice guidelines applicable to businesses. These will serve as a benchmark for appropriate customization in different companies. Corporate governance should be considered as an obligation not a luxury. Its spirit is going to expand further and deeper in the future.

KINGFISHER CRISIS

• The current crisis going inside the kingfisher Airlines which can be realized by the press statement from KFA, on 12 March 2012, highlights the challenges: “The flight loads have reduced because of our limited distribution ability

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caused by IATA suspension. We are therefore combining some of our flights. Also, some of the flights are being cancelled as a result of employee agitation on account of delayed salaries. This situation has arisen as a consequence of our bank accounts having been frozen by the tax authorities. We are making all possible efforts to remedy this temporary situation.”

• They need to discuss collectively and frankly their views about the performance of the executives, the strategic direction of the company and worries about areas where they feel inadequately briefed.

• Explaining fully how discretion has been exercised in compiling the earnings and profit figures. These are not as cut and dried as many would imagine. Assets such as brands are intangible and with financial practices such as leasing common, a lot of subtle judgments must be made about what goes on or off the balance sheet. Use disclosure to win trust.

LET US INVESTIGATE

• Investigate the reasons behind the failure of the Kingfisher airline in the year 2012. To investigate the government policies and the various steps taken to fix the current crisis. To investigate the reasons due to which the whole Aviation Industry is suffering from higher operating losses. What went so terribly wrong with Kingfisher when rival Jet Airways has comparatively much higher

INTRODUCTION : Global aviation industry is passing through challenging times due to unprecedented fuel price hike during the last 4 years, turbulent financial markets and economic recession. Vijay Malaya’s dream bird, Kingfisher Airlines - popularly known as The King of Good Times - is witnessing its worst phase. Indian domestic aviation is suffering from a serious market failure, caused by misguided government policy and ministers need to step in quickly to fix it. In India, most of the upcoming airlines added a large number of aircraft since 2006 and deployed them mostly on metro sectors resulting into suicidal price war among all the airlines. Every airline in India is currently suffering from operating losses.

FINDINGS : · While doing the research, we find that there are four main reasons why Indian Aviation Industry is in so much pain, which can be reviewed as given below:

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REASON BEHIND THE FAILURE:

APART FROM AGGRESSIVE PRICE CUTTING FROM AIRINDIA

• Kingfisher’s net worth has been completely eroded, while its auditors had raised several questions about its accounting practices in its annual report. · Kingfisher Airlines Ltd’s loan funds stand at Rs7, 543 crore (debt-to-equity ratio of about 3.2) & that of Jet Airways (India) Ltd’s is Rs14, 123 crore (debt-to-equity about 4.2). · Spice jet Ltd, on the other hand, has lowest debt at Rs712 crore (debt-to-equity about 0.7). · Kingfisher’s fixed assets stand at Rs2, 286 crore, but it has a negative net working capital (excluding cash and bank balance) of Rs1, 970 crore. Jet Airways has a much stronger asset base with the value of its fixed assets at Rs14,417 crore; its negative net working capital (excluding cash and bank balances) is relatively much lower at Rs560 crore. Spice Jet has a total fixed asset base of Rs1, 115 crore.

• Kingfisher could not deliver on profitability even last year when the going was considered to be good. According to analysts, the sector experienced its best returns in the quarter ended December 2010. Even during such times, Kingfisher’s net loss for fiscal 2011 stood at Rs1, 027 crore. That’s when Jet had managed a net profit of Rs9.69 crore—on a stand-alone basis—and Spice Jet posted a net profit of Rs101 crore. Spice Jet’s net profitability, of course, was also supported by relatively lower interest expenses.

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RISING FUEL PRICES

FALL IN THE RUPEE

HIGH COST OF LANDING AND FUEL PRICES

SHARE PRICES WENT STEEPER DOWN

• For the September quarter, Kingfisher’s operating losses are higher than the other two, with Jet’s operating loss being far lower. Kingfisher’s fuel and interest expense (Kingfisher’s debt is also probably costlier than that of Jet Airways) as a percentage of revenue is higher than that of Jet. · A higher interest cost, coupled with higher operating losses, has led to pressure on Kingfisher’s ability to service its interest and debt obligations. Further, Kingfisher’s current liabilities have increased by 23% in September from March (an indication that it may be · Stretching payments to suppliers). Naturally, Kingfisher seems to be the worst affected of all the three. · Revenue growth for Kingfisher domestically was very weak, falling 3% to Rs. 1,184 Crore from Rs. 1,227 Crore

• International Revenue growth was even worse, falling 9% to Rs. 363 Crore from Rs. 398 Crore · Passengers carried fell 15% to 2.63 million; antithetical to general market trends. · Domestic Passenger Yield fell 3% to Rs. 3,804 despite capacity discipline. · International Passenger Yield rose 5% to Rs. 10, 864. · EBTIDAR Profit (which measures operating results before taxes, interest, depreciation , loan amortization, and rents) of Rs. 125 Crore (Rs. 284 Crore in Q3 10-11), EBITDAR profit of Rs. 161 Crore on Domestic (Profit of Rs. 225 Crore in Q3 10-11), and EBITDAR loss of Rs. 36 Crore on International (Rs. 59 Crore profit in Q3 10-11) · Kingfisher deferred almost 213.4 Crores worth of losses into future taxes under “Deferred Tax Asset” · There was a onetime special item of almost Rs. 79.25 crore that contributed to the loss.

RISK MANAGEMENT FAILURES

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STRATAGIC RISK MARKET ANALYSIS

STRATAGIC RISK MERGER WITH AIR DECCAN

STRATAGIC RISK INVESTMENT IN PLANES

FINANCIAL RISK EXCESSIVE DEBT

OPRATIONAL RISK COST ANALYSIS

STRATAGIC RISK MARKET ANALYSIS

• KFA Was launched as a premium Business class aircraft

• A lack of understanding of customer requirements and basing a decision that LUXURY SELLS IN AIRLINES

• MR MALLYA highly successful in Liquour business did not comprehend the difference in customer preference in both the INDUSTRIES

STRATAGIC RISK MERGER WITH AIR DECCAN

• KFA ACQURIED THE DECCAN AIRLINES and entered the airdecans international flying rights and thus simultaneously entered the cheaper market segment.

• It became the LARGEST AIRLINE IN INDIA WITH 27.5% MARKET SHARE and increase in 30% domestic travel increase.HOWEVER DIDN’T MAKE ANY PROFITS..COMPARITIVELY JET AIRWAYS had shown CONTINUOSLY PROFITABLE QUARTERS,

STRATEGIC RISK MERGER WITH AIRDECCAN

WITH THE MERGER OF AIRDECCAN IT LOST ITS BRAND IMAGE AS A LUXURY AIRLINE

STRATEGIC RISK INVESTMENT IN PLANES

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JET AIRWAYS 15%

AIRINDIA 15%

INDIGO 16.7%

SPICE JET 13.4 %

KINGFISHER 18.2%

• 366 DOMESTIC FLIGHTS AND 28 INTERNATIONAL FLIGHTS( AS PER REPORT ENDING 2011)

• AIRCRAFT ENGINE /LEASE RENTALS STOOD AT 984 CRORES(US DOLLAR 197 MILLION)

• 12 MONTH PERIOD APRIL 2010 TO 2011MARCH.

FINANCIAL RISK EXCESSIVE DEBT

• KINGFISHER AIRLINES POSTED 1027.39 CRORES LOSSES(US 205.95 MILLION DOLLARS)DEC 2011 QUARTER

• NET WORTH NEGATIVE 3633.08 CRORE as of 31st march 2011.(US D 728.29 million dollars)

• AT PRESENT TOTAL DEBT ESTIMATED

• 7057.08 CRORES ( USD 1414 MILLION DOLLARS) AND TOTAL ACCUMLATED LOSSES OF 6000 CRORES (1202 MILLION USD)

OPERATIONAL RISK COST ANALYSIS

MESSED UP MERGERS…

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EXPENDITURE ON AIRCRAFT FUEL:::2274 CRORES DURING 12 MONTH PERIOD 2010 -11 MARCH ACCOUNTING FOR 28% OF TOTAL LOSSES

INDIAN CUSTOMSDUE TO CUMULATIVE IMPACT OF CUSTOMS DUTYINDIAN AVIATION HIT MORE ADVERSELY

SALES TAX BURDENON ACCOUNT OF SHARP INCREASE IN INTERNATIONAL FUEL PRICES

• All the full-service boys messed up their mergers. Coincidentally, all three – Jet, Kingfisher and Air India – went in for acquisitions and mergers in 2007-08. While Jet bought Sahara, Kingfisher bought Air Deccan and Air India merged with Indian Airlines. The traditional logic of mergers is cost savings and synergy, where two and two equals five. The management ignored the warning signs of stormy weather and failed to navigate the company into safety.

THE CBI ON TRACK NOW:

CONCLUSION: Running an airline in India is a mugs’ game. Once defined as the simple business of “getting bums on seats” – more “bums” means better bottom line – the way the Indian industry is being run, one wonders if the “bums” are paying enough for the seats they sit on. Almost paradoxically despite their continual shrinkage in the domestic market, Kingfisher has continued to post solid, if unspectacular operating figures in the domestic market. Kingfisher plans to increase revenues through more efficient operations, while simultaneously controlling costs by shedding some realty assets (including its Mumbai corporate office), entering sale and leasebacks for some Airbus aircraft, and switching some high-cost rupee loans into low-cost foreign currency loans. There has also been speculation the carrier will permanently reduce its fleet of 66 aircraft (the same level as Jun-2010) to 35 aircraft. Kingfisher Airlines is also working “aggressively” with a consortium of banks, which hold a 23% stake in the company, to further reduce interest costs and raise working capital

• The Central Bureau of Investigation (CBI) is investigating a loan made by state-run IDBI Bank Ltd(IDBI.NS) to debt-laden Kingfisher Airlines(KING.NS) worth 9.5 billion rupees ($155.38 million), a police spokeswoman said on Saturday.

• The crime fighting agency is looking into why the loan was approved when the airline has a negative net worth and a negative credit rating

• The CBI has registered a preliminary inquiry to inquire into the role of IDBI and Kingfisher Airlines .

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• "There was no need for the bank to take the exposure outside the consortium when already other banks' loans were getting stressed."

• A preliminary inquiry is usually the first step before a formal case is filed.

• Kingfisher Airlines, controlled by liquor baron Vijay Mallya, has not flown in almost two years and owes about $1 billion to a consortium of mostly state-run banks, and hundreds of millions of dollars more to airports, tax authorities and others.

CORPORATE FRAUDS AND CBI

• According to more than three-fourths of the respondents, the incidence of fraud has increased in the country in this last one year. But the fact that around two-thirds of the respondents said that scams and corporate frauds were unearthed because of legislations such as the Right to Information Act (RTI) and Public Interest Litigation (PIL) speaks volumes about public awareness in India.

• Two-thirds of India's bank assets are controlled by state-run banks, which in turn account for three-quarters of the sector's bad loans.

• Last week, CBI arrested Sudhir Kumar Jain, the chairman of state-run Syndicate Bank Ltd (SBNK.NS) over allegations that he was seeking bribes to favour debtors.

(1 US dollar = 61.1400 Indian rupee)

GUIDELINES FOR REPORTING FRAUDS TO POLICE/CBI

• 6.1 Private sector banks (including foreign banks operating in India) should follow the following guidelines for reporting of frauds such as unauthorised credit facilities extended by the bank for illegal gratification, negligence and cash shortages, cheating, forgery, etc. to the State Police authorities:

• In dealing with cases of fraud/embezzlement, banks should not merely be actuated by the necessity of recovering expeditiously the amount involved, but should also be motivated by public interest and the need for ensuring that the guilty persons do not go unpunished.

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• Therefore, as a general rule, the following cases should invariably be referred to the State Police:

a. Cases of fraud involving an amount of `1 lakh and above, committed by outsiders on their own and/or with the connivance of bank staff/officers.

b. Cases of fraud committed by bank employees, when it involves bank funds exceeding `10,000/-.

Cases to be referred to Local Police

Cases below ` 300 lakh – Local Police.

• Cases of financial frauds of the value of `1 lakh and above, which involve outsiders and bank staff, should be reported by the Regional Head of the bank concerned to a senior officer of the State CID/Economic Offences Wing of the State concerned.

• Cases of frauds above `10,000/- but below ` 1 lakh should be reported to the local police station by the bank branch concerned.

• All fraud cases of value below `10,000/- involving bank officials, should be referred to the Regional Head of the bank, who would scrutinize each case and direct the bank branch concerned on whether it should be reported to the local police station for further legal action.

• 6.3 Filing of Police complaint in case of fraudulent encashment of DDs/TTs/Pay Orders/Cheques/ Dividend Warrants, etc.

• 6.3.1 In case of frauds involving forged instruments including those cleared under CTS, the paying banker has to file the police complaint and not the collecting banker.

REPORTING CASES OF THEFT, BURGLARY, DACOITY AND BANK ROBBERIES

• 7.1 Banks should arrange to report by fax / e-mail instances of bank robberies, dacoities, thefts and burglaries to the following authorities immediately on their occurrence.

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• The General Manager, Reserve Bank of India, Central Fraud Monitoring Cell, Department of Banking Supervision, 10/3/8, Nruputhunga Road, P.B. No. 5467 Bengaluru – 560001.

• Regional Office of the Department of Banking Supervision, Reserve Bank of India under whose jurisdiction the Head Office of the bank falls.

• Financial Conglomerate Monitoring Division (FCMD) in respect of 12 large banks in the country under whose jurisdiction the Head Office of the bank falls. The names of which are given in Annex.

• Regional Office of Reserve Bank of India, Department of Banking Supervision, Reserve Bank of India, under whose jurisdiction the affected bank branch is located to enable the Regional Office to take up the issues regarding security arrangements in affected branch/es during the State Level Security Meetings with the concerned authorities (endorsements).

• The Security Adviser, Central Security Cell, Reserve Bank of India, Central Office Building, Mumbai – 400001.

• Ministry of Finance, Department of Financial Services Government of India, Jeevan Deep, Parliament Street, New Delhi.-110001.

• The report should include details of modus operandi and other information as at columns 1 to 11 of FMR – 4.

• 7.2 Banks should also submit to the Reserve Bank, Department of Banking Supervision, Central Fraud Monitoring Cell at Bengaluru as well as the concerned Regional Office of the Reserve Bank/FCMD under whose jurisdiction the bank’s Head Office is situated a quarterly consolidated statement in the format given in FMR – 4 (soft copy) covering all cases pertaining to the quarter. This may be submitted within 15 days of the end of the quarter to which it relates.

• 7.3 Banks which do not have any instances of theft, burglary, dacoity and / or robbery to report during the quarter, may submit a nil report.

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