Page 233 - ES 2020-21_Volume-1-2 [28-01-21]

216 Economic Survey 2020-21 Volume 1

Weakening of Corporate Governance in Borrowers benefitting from forbearance
7.21 As highlighted in the previous section, the forbearance regime witnessed a significant
increase in credit supply to corporates with poor operating metrics and a simultaneous decrease
in their investment-to-debt ratio. This suggests that the increased credit supply was not used
productively by firms. Chopra, Nishesh, and Tantri (2020) show that this credit was instead
diverted for the private benefit of the incumbent management. They argue that the incumbent
managers’ ability to get loans restructured under the forbearance policy strengthened their
influence within the firm. Getting a loan restructured involved negotiations with the bankers
who had discretion in selecting cases for restructuring. In an era of relaxed provisioning
norms, firm managers formally or informally connected with bankers could persuade them to
restructure loans, plausibly even unviable ones. This ability made the incumbent management’s
influence stronger. It became difficult for the firm’s board to overthrow such managers even if
they were otherwise inefficient. The increased influence of the incumbent management resulted
in the weakening of the firms’ governance which, in turn, had detrimental consequences in the
longer run.

Deterioration in the Quality of the Board
7.22 The institution of independent directors on the board is a robust mechanism to maintain
checks and balances at the board level. Given that promoters are the controlling shareholders in
most Indian firms, the non-promoter directors are specifically required to uphold the interests of
minority shareholders. They are supposed to act as watchdogs against the likelihood of firms’
management indulging in unhealthy practices such as expropriation of resources or investments
in value-destroying projects that may personally benefit the promoters. Therefore, a decline in
the proportion of non-promoter directors implies a weakening of governance among firms.

7.23 Figure 16 shows the percentage change in the average proportion of non-promoter
directors two years after and two years before firms’ loans were restructured. To highlight the
impact of regulatory forbearance, the figure compares restructured firms during the forbearance
regime (2009-2015) with those that were restructured before forbearance (2002 – 2006). As
2
evident, the percentage of non-promoters on the board decreased significantly after restructuring
during the forbearance regime, while it slightly increased upon restructuring before forbearance.
Hence, boards became increasingly dominated by firms’ promoters during forbearance. This is
further strengthened by the findings in Box 6 which show that forbearance led to an increase
in incumbent management’s influence as: (i) the presence of independent directors on boards
declined, (ii) the propensity of a CEO becoming the chairman increased, (iii) having a connected
director on board became more likely, and (iv) the bank monitoring declined as a lower number
of bank-nominated directors occupied board seats.

Inefficient allocation of capital by borrowers that benefited from forbearance
7.24 Aided by poor governance, beneficiary firms under the forbearance regime also seem to have
misallocated capital in unviable projects. As shown in figure 17, the total capex projects increased
only modestly for firms restructured both during the forbearance regime and before. However,
there was a much higher rise in the number, proportion, and rupee value of stalled projects for

2 The pre-period is restricted until 2006 so that two years post-restructuring does not coincide with the
Global Financial Crisis and the subsequent introduction of the forbearance