The Noise Around Cyrus Mistry's Firing

CEOs of large corporations are fired by their boards only under extreme circumstances when they are either allegedly involved in major fraud or their companies' earnings exhibit dismal performance for several consecutive quarters. Even in the US, where lately shareholder activism abounds in the boardroom, on an average, only 2% of the CEOs are fired for incompetence or malfeasance. For example, Phil Condit of Boeing or Maurice ''Hang'' Greenberg of AIG were supposedly forced by their respective company boards to resign due to their apparent involvements in improper contracts or accounting manipulations. Mike Lazaridis of the RIM followed a similar path after the disastrous performance of the Blackberry 10.

Interestingly, no such events have triggered Mr. Mistry's forceful exit from the Tata Sons. Neither did Tata Sons grossly under-perform nor did anyone level any proven corruption charges even in the open spat that followed the forced departure. Hence, by sacking its CEO without any prior warning or signal, Tata Sons has created shock waves both at home and abroad. This incident raises two major questions: First, what triggered this extreme event leading to the removal of Mr. Mistry? Secondly and more importantly, what implication would such a highly-publicized event possibly have on the process of selection of the next CEO of the company? 

Unlike most of the rifts occurring in the boardroom of a stand-alone Western corporation, Tata Sons is a humongous family-dominated multinational conglomerate in existence for almost near 150 years with nearly 100 firms now. The control, management and structure of governance in such a complex family-based multinational is radically different from the ''stand-alone'' corporations with limited histories, and these innate differences can easily create ugly feuds even within an otherwise tranquil family.

One (among many others) important factor behind the emergence of such diversified business groups, particularly in Japan, Korea and in India, is the benefit of mutual insurance where business units within the group tend to help one another in bad times. For a concrete illustration, let us take the following three global operations of Tata for discussion: Tata Steel, Tata Consultancy services (TCS), a premium IT Company and Tata Motors.

In 2007, Tata offered 65% premium and bought Corus, the Anglo-Dutch steel maker, in a competitive auction. Tata spent $4.1 billion on its own and raised a further debt of $6.1 billion to finance this costly takeover. Shortly afterwards, the unforeseen global recession with reduced demand for steel together with low-cost exports of a variety of Chinese steel made the business unviable for many. Last year, Tata Steel UK alone experienced a 7% decline in sales and at some point, it started incurring a loss of $1.2 million per day. The added interest payments on its earlier expensive debt and an inherited pension scheme with a liability of £15 billion ($18 billion) made its bleeding heavier. 

However, during the same time, TCS generated a profit of $2.7 billion and together with Jaguar Land Rover (JLR) sales of 357,000 cars last year, the Tata group earned a modest 12.5% return on its capital invested in various projects. The point is: had Tata Steel UK been a stand-alone corporation, the CEO would be forced to sell it immediately at throwaway prices due to the constant pressure of displaying quarterly earnings results to its investors. But with other healthy units serving as rescuers, the conglomerate can afford to wait a longer time before it fire-sells ailing units because a multi-product firm can shift its resources either directly or indirectly (via transfer pricing or inter company loans etc.) and can afford to pursue a failing dream project for a while by resisting the hard dictum of an impersonal market.
   
Also, business groups owned by families with cross shareholdings, almost by definition are stakeholder (suppliers, customers, even communities) societies as opposed to singly-focussed business units which care only about shareholder value. The Japanese Keiretsu or Korean Chaebols are living examples of such reciprocity and the Tata group has followed similar traditions for many years. Hence, mutual insurance in a stakeholder society automatically creates an atmosphere of tolerance for business failures as opposed to a single-unit modern corporation. 

Various news reports indicate that Mr. Mistry, perhaps inspired by Western business education over-emphasizing the importance of shareholder value, was growing impatient in his dealing with debt-ridden, ailing business units within the organization and favoured a speedy write-down of $18 billion troubled assets. His statement (on September 12th) "It was clear to me relatively early that one needed to confront the challenging situations facing some of our business and this would entail hard decisions on pruning the portfolio'' certainly did not augur well with the old patriarch, Ratan Tata. So, these two differing approaches towards resolution of distress, where one calls for immediate closing down of unprofitable units (steel and hotels) versus the other advocating further reinvestment and restructuring for possible turnaround (the company indeed made a recent investment of £3.5 billion for upgrading technology for UK steel arm) must have been at the heart of the current conflict. Moreover, the recent tendency of rising steel prices together with a Brexit-induced sterling depreciation raised the possibility of a turnaround could lend some credence to the traditional approach. 

Certainly, the noise around Mistry's firing would complicate the succession process. First, a potential able outside contender could fear excessive interference and shy away. Second, the group has an enormously complicated structure with a maze of intra-group connections which impedes efficient governance. Tata Sons, the mother of all units, is unlisted and primarily owned by a charity, the Tata Trust, but most of the operating units like TCS are listed companies. These operating companies have cross-holding of shares in various units and together they own 13% of Tata Sons. That is, the listed companies are governed by varying degrees of market discipline, but Tata Sons itself is immune to such an environment, at least on the books. The group on the whole is neither a publicly-listed firm nor a pure private equity organization. This creates overlapping and multiple centres of corporate power with undefined jurisdictions in many spheres, blurring the boundary between internal organization and outside market forces. In such an environment, an outside CEO may be clueless on exercising authority or implementing plans.

Recent research shows that each succession in family-based firms in Asia reduces its market value by 60% due to an incompetent insider or an ignorant outsider destroying the accumulated long-term ethos of such organizations. Ratan Tata was both an insider and outsider. Steel was in his DNA, transmitted by earlier generations, yet he also looked globally and his two-decade-long tenure saw a boosting of group revenue from $6 to $100 billion. In a changing world, the old boundaries between family and outside markets are constantly shifting due to changes in technology, regulations and market competition. Can a new successor carve out another innovative path and rescue the group? The answer partly lies in the collective wisdom of the members responsible for the selection of the new CEO.

(Sanjay Banerji is Professor of Finance & Head of the Group University of Nottingham Business School, United Kingdom.)

Disclaimer: The opinions expressed within this article are the personal opinions of the author. The facts and opinions appearing in the article do not reflect the views of NDTV and NDTV does not assume any responsibility or liability for the same.