Promoter Holding: What is it? And how does it Impact your Investments
Created on 20 Feb 2023
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Many individuals find investing in the stock market to be a difficult task, but it may be a pretty effective way to build your wealth in the long run. When considering where to invest your money, there are many factors to consider, including the performance of the company, market trends, and the overall economic climate. However, one often-overlooked factor that can significantly impact your investment returns is the level of promoter holdings.
Promoters are the individuals or entities who founded the company or have a significant ownership stake in it. When a promoter holds a large percentage of a company's stock, it can be a positive sign for investors. Here's why.
Promoter holding is a term used to describe the ownership stake that a promoter or founder has in a company. This ownership stake is important because it gives the promoter a significant amount of control over the direction of the company. In this article, we will explore the concept of promoter holding and look at some examples of good and bad promoter holding.
Promoter Holdings: Why They Matter and How They Impact Your Investments
First and foremost, when promoters have a substantial stake in the company, it signals their confidence in the company's future prospects. It's natural for the founders of a company to have a deep understanding of its operations, business model, and long-term vision. As such, their decision to maintain a significant stake in the company they founded is a clear vote of confidence in the business's ability to create value over time.
In contrast, when promoters sell their shares in a company, it could be a sign that they have lost faith in the business or that they need to liquidate their holdings for other reasons. In either case, this is not a positive signal for investors, as it can lead to a decline in the company's stock price.
In addition to signalling confidence, promoter holdings can also align the interests of the company's management team with those of the shareholders. When promoters own a significant percentage of the company, they are incentivized to make decisions that benefit the long-term growth of the business and its profitability. This alignment of interests can help reduce the risk of conflicts of interest between the company's management team and its shareholders.
Good Promoter Holding Examples
One example of good promoter holding is Avenue Supermarts, DMart, an Indian retail corporation that operates a chain of hypermarkets in India. Founded by Radhakishan Damani in 2002 when its first store was opened in Powai, Mumbai. As of December 2022, it has 306 stores across 14 states in India.
The promoter group continues to hold significant ownership stakes in the company amounting to 74.99%, giving them a strong say in the company's decision-making processes. This has allowed the company to remain focused on its core business objectives and maintain its competitive edge.
Tata Group is another example of good promoter holding. The main investment holding firm and sponsor of Tata enterprises is Tata Sons. Tata Sons is a philanthropic trust that assists the arts, health, livelihood generation, and education, holding 66% of Tata Sons' equity share capital.
Even today, the Tata family continues to hold a significant stake in the company, with Ratan Tata being one of the shareholders. This has allowed the company to maintain a long-term vision and focus on its core values, including social responsibility.
Bad Promoter Holding Examples
One example of bad promoter holding is the case of Satyam Computers. In 2009, it was revealed that the company's founder, Ramalinga Raju, had been involved in a massive accounting fraud that overstated the company's profits for several years. This scandal resulted in the company's collapse and raised serious questions about the role of promoter holding in corporate governance.
Another example of bad promoter holding is the case of Kingfisher Airlines, which was founded by Vijay Mallya. The company was plagued by financial difficulties, and Mallya's refusal to relinquish control of the company, even as it spiralled into bankruptcy, was seen as a major contributor to the company's downfall.
The Importance of Promoter Holding
The examples mentioned above illustrate the importance of promoter holding in corporate governance. When a promoter has a significant ownership stake in a company, it can be beneficial for the company as long as the promoter is focused on the long-term interests of the company and not just their personal gains. However, when a promoter is more concerned with maintaining their control and influence over the company, it can be detrimental to the company's overall health and viability.
Promoter holding is a critical aspect of corporate governance, and it can have a significant impact on a company's success or failure. As the examples above illustrate, a promoter's ownership stake in a company can be a double-edged sword. It can be beneficial for the company as long as the promoter is focused on the long-term interests of the company, but it can be detrimental if the promoter is more interested in maintaining their control over the company. Ultimately, it is up to the company's board of directors and shareholders to ensure that the promoter's interests align with the company's interests and that the promoter holding does not become a liability.
Promoters are the individuals or entities who founded the company or have a significant ownership stake in it. Understanding the different types of promoter holdings can help investors make informed decisions.
Let's take a closer look at the different types of promoter holdings.
Active promoter holdings
Active promoter holdings refer to situations where the promoter is actively involved in the day-to-day management of the company. In such cases, the promoter's decisions can significantly impact the company's operations and financial performance.
For example, Mukesh Ambani, the chairman of Reliance Industries, holds a significant stake in the company and is actively involved in its management. Under his leadership, Reliance Industries has become a dominant player in India's oil and gas industry, as well as a major player in the retail and telecommunications sectors.
Passive promoter holdings
Passive promoter holdings refer to situations where the promoter has a significant ownership stake in the company but is not actively involved in its management. In such cases, the promoter may not have a direct impact on the company's day-to-day operations, but their decisions can still significantly impact the company's financial performance.
For example, Azim Premji, the founder of Wipro, holds a significant stake in the company but is not involved in its day-to-day management. Despite this, Premji's decisions as a shareholder can still influence the company's strategic direction and financial performance.
Promoter pledges occur when promoters use their ownership stake in the company as collateral to raise funds from lenders. While this can provide short-term liquidity, it can also increase the risk of a sharp decline in the company's stock price if the promoter is forced to sell their shares in the event of a default.
For example, in 2019, the founders of Coffee Day Enterprises pledged their shares in the company as collateral to raise funds. However, after the unexpected death of the company's founder, the company's financial situation deteriorated, and the pledged shares were sold, leading to a sharp decline in the company's stock price.
Promoter dilution occurs when promoters sell a portion of their ownership stake in the company. While this can provide the company with additional capital for growth and expansion, it can also dilute the promoter's control over the company and signal a lack of confidence in the company's future prospects.
For example, in 2018, the founders of Flipkart sold their ownership stake in the company to Walmart. While this provided the company with significant capital for expansion, it also signalled a loss of control over the company by the original founders.
Why do some companies have a very low promoter holding?
In recent years, the concept of a professionally managed company has gained prominence as an alternative to promoter-led companies. In such companies, the board of directors and the management team are entrusted with running the company, and the promoter or founder plays a more passive role. This approach can have many benefits, including improved corporate governance, better risk management, and increased transparency.
One example of a professionally managed company is Infosys, a leading Indian IT services company. While the company was founded by Narayana Murthy and a group of his friends, the company has been run by a professional management team since the early 2000s. This has helped the company maintain its focus on innovation and customer service while ensuring that the management team is accountable to the board of directors and the shareholders.
Another example of a professionally managed company is Alphabet, the parent company of Google. While the company was founded by Larry Page and Sergey Brin, they stepped down from their roles as CEO and President in 2019, handing over the reins to Sundar Pichai. This move was seen as a positive step for the company, as it ensured that the company would continue to innovate and grow under the leadership of a seasoned executive.
The advantages of a professionally managed company are many. By separating ownership from management, such companies can ensure that the management team is focused on the long-term interests of the company rather than on the short-term goals of the promoter or founder. This can lead to improved corporate governance, better risk management, and increased transparency, all of which can be beneficial for the company and its stakeholders.
In contrast, promoter-led companies can be prone to conflicts of interest and may prioritise the interests of the promoter over those of the company and its shareholders. For example, in the case of the aforementioned Satyam Computers, the company's founder engaged in accounting fraud to boost the company's stock price, benefiting himself at the expense of the company and its shareholders.
While there are many advantages to this approach, such as access to specialised expertise and resources, there are also some notable drawbacks to be aware of. One of the main disadvantages is that decision-making within professionally managed companies can be slow due to the large number of members on the board, each with their own opinions and ideas. Additionally, the short-term perspective of professionals can lead to decisions that prioritise immediate gains over long-term stability and growth. Another potential downside is that professionals often charge higher fees and may receive lucrative stock options to retain their services, which can put a strain on the company's finances. Ultimately, while professionally managed companies can offer many benefits, it's important to carefully weigh the pros and cons before deciding if this approach is right for your business.
The Bottom Line
Promoter holding is a critical aspect of corporate governance that can have a significant impact on a company's success or failure. Promoters are the individuals or entities who founded the company or have a significant ownership stake in it. Ultimately, the key is to ensure that the promoter's interests align with the company's interests and that the promoter holding does not become a liability.
The concept of a professionally managed company is a promising alternative to promoter-led companies. While both strategies have advantages and disadvantages, the benefits of a professionally managed company are becoming increasingly clear in the modern business environment. Companies like Infosys and Alphabet have shown that it is possible to separate ownership from management and still achieve success, and more companies may follow in their footsteps in the years to come.
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