SOAS Research Online

Abstract

This thesis aims to provide an explanation for the causes of existence of many low capitalised companies (LCCs) listed on the Bombay Stock Exchange. The main theoretical framework for the thesis is derived from the agency conflicts approach. The agency model examines the relationship between managers and owners and determines managerial effort in a contractual arrangement under asymmetric information. Given the developing nature of the financial and industrial structure in India, the agency conflicts between the different claimants take a different form as compared to that suggested in the traditional agency literature, which is oriented towards developed market economies. Accordingly, the inherent governance structures, which are specific to India and changes initiated by financial reforms of the early 1990s, make a strong case for agency theory to be used as a tool to investigate the peculiarity of Indian stock markets. The dynamics of agency conflicts inherent in the firm structure influences all decisions made in the firm, i.e. debt-equity ratio, dividend policy. It then becomes important to study the impact of the firm's structure on its outstanding equity. This thesis is an attempt at analysing the low average market capitalisation of the BSE from the point of view of owner-managerial behaviour capacitating financial decision-making i.e. how the decision-making of the owner-managers affect the value of the outstanding stock. The existence of many LCCs on the BSE can be analysed by the simple "entry and exit" model of firms into the low capitalised category of the stock market. Among other reasons the entry of firms into BSE was facilitated by relaxation of many stringent bureaucratic policies towards new firms making their maiden public issues. Survival of a firm depends on its performance in the real market and effective monitoring is required to sustain both performance in the market and any improvements thereof. An LCC can move to a different capitalisation category through internal growth and takeovers or mergers. LCCs on the BSE face not only an ineffective outside monitoring (outside shareholders and debt holders) but also non-existent market "exit" mechanisms of takeovers or mergers. Most of the LCCs have exited from the stock exchange through de-listing (if firms fail to pay the listing fees and abide by the rules of the exchange) by SEBI, the regulatory authority. This corroborates to the insufficiency of the market mechanisms of "exit" in changing the status quo of LCCs. This thesis explores the causes behind the non-existent mechanisms of "exit" for LCCs. This thesis proposes that lack of exit mechanisms stem from a market for lemons syndrome. Effective monitoring from outside stakeholders i.e. diffused shareholders is non-existent because of the free rider problem. Whereas block debt holders base their monitoring on the relative position of a particular firm in their portfolio or the importance of a firm to the block debt holder determines the extent of monitoring. Lack of an effective outside monitoring is manifested in the dividend policy, which reflects accumulation of free cash flow used for the personal benefit of owner-managers. Lack of effective monitoring and exit mechanisms have led to the existence of many LCCs and them continuing in the similar status for a long period of time. These hypotheses were established with the help of an interview-based survey of managers working for these firms as well as econometric analysis of their financial data.