Chapter 06:

The Turbulent Market of Modern Debt-Overleveraged and

Promoter Dominated Corporations
Executive Summary
Before the September-October 2008 Financial Crisis, investment banks were hooked on debt. In 2007, a year
before its failure, Lehman Brothers held equity just 3.3% of its balance sheet (that is, its debt/equity ratio well
exceeded twenty-nine); virtually all the rest was financed by borrowing. Leverage is an elixir that makes profits
soar when times are good, but magnifies losses when the economy sours. Currently in India, several companies
have seen their balance sheet out of shape because of over-leverage, but banks continue to be benevolent, often
forced by political interventions (See Cases 6.1 and 6.2). Most of these business groups are nearly dead, with
their equity almost wiped out. There is little chance they will survive but for their banker’s largesse. Ever-
greening of loans is keeping them alive, but what could be the end game? For instance, just a year before
economic liberalization in India, a few enterprising men invested in the steel business. They borrowed monies
from the banks and banks continued to finance their operations, and now they are realizing that the promoters
cannot meet with their debt obligations. The banks, however, did not want to accept financial loss and hence
commonly agreed to ease the payment obligations so that the loans remained good and not degenerate to non-
productive assets (NPAs). This is tantamount to refinancing to service your loans. But now the banks
overwhelmed with accumulated non-productive assets (NPAs) are trying to sell debt. How do you legally,
ethically, morally and spiritually (LEMS) justify share-market concentration in the hands of very few promoter
investors? What are their long-run unintended economic, legal, ethical and moral consequences, and why? This
Chapter studies this market turbulence and the role of bankruptcy laws and court systems in bringing about some
change in the debt-overleveraged corporations.

Case 6.1: RBI refers Bhushan Steel, Essar Steel and Electro Steel to NCLT
over Overleveraged Debts
A forum of lenders, led by the State Bank of India (SBI), India’s largest bank, on Thursday, June 22, 2017
refer three large non-performing accounts — Bhushan Steel, Essar Steel and Electro Steel — to the National
Company Law Tribunal (NCLT) for further action under the Insolvency and Bankruptcy Code (IBC). A reference
to NCLT is the first step towards initiation of bankruptcy proceedings. Once admitted by the tribunal, the board is
dissolved and insolvency professionals take charge. Lenders are then given 180 days to resolve the loan, with a 90-
day extension possible. If a package is not possible, NCLT is empowered to allow liquidation of assets. Banks refer
Bhushan Steel, Essar Steel, Electro Steels NCLT for recovery of bad loans under the Insolvency and Bankruptcy
Code.

Indian banks have initiated a big crackdown on bad loans armed with the Insolvency and Bankruptcy Code
(IBC). The attack on the non-performing assets (NPAs) began first in 2015 when the Reserve Bank of India (RBI)
stipulated norms for early recognition of stressed assets in the banking sector. Subsequently, the RBI came with a
March 2017 deadline for banks to clean-up their balance sheets by disclosing all the hidden NPAs. While this
exercise pushed banks to account for a big chunk of impaired assets, the recovery of money still remained a major
concern for the sector and the policymakers.

But, the passage of bankruptcy code came with the promise of a major change in banks’ NPA battle. Under
this, if the majority lenders agree, banks can take companies to National Company Law Tribunal (NCLT) with a
request for time bound resolution plan. If the resolution process fails within a maximum of 270 days, insolvency
process is initiated against the concerned company. Under a mutually agreed framework between banks and other
stakeholders in the firm, the proceeds from the liquidation process will be shared.

Sources said SBI will take the two companies Bhushan Steel and Essar Steel with combined loans of Rs.
85,000 crore to the joint lenders forum and formal action is expected to be initiated by July 2017. The decision was

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taken at a marathon meeting chaired by the SBI. While Bhushan Steel is in default of Rs 44,478 crore to banks,
Essar Steel owes Rs. 37,284 crore and Electro Steel owes Rs. 10,273.6 crore. These three borrowers are among the
12 accounts identified by the Reserve Bank for immediate reference to NCLT.

While unlisted Essar Steel had a consolidated debt of Rs. 37,284 crore, Bhushan Steel’s debt stood at Rs.
44,478 crore at the end of 2015-16. The latest financial numbers of both companies are not available as yet, but
bankers said the debt would have gone up in the last one year. Kolkata-based Electro Steel had a debt of Rs. 10,274
crore at the end of March 2016.

These 12 accounts alone constitute a quarter of the over Rs.8 trillion of non-performing assets (NPAs). Some
of these stressed borrowers include Amtek Auto, which is in default of Rs.14,074 crore, Alok Industries (Rs.22,075
crore), Monnet Ispat (Rs.12,115 crore) and Lanco Infra (Rs.44,365 crore). Era Infra (Rs.10,065 crore), Jypaee
Infratech (Rs. 9,635 crore), ABG Shipyard (Rs. 6,953 crore) and Jyoti Structures (Rs. 5,165 crore), according to
reports in Live Mint – e- paper, June 22, 2017.

The internal advisory committee (IAC) of the RBI after its meeting on 13 June, 2017 had recommended 12
accounts totaling about 25% of the gross NPAs of the banking system for immediate reference under Insolvency and
Bankruptcy Code. These 12 accounts referred by the RBI have an exposure of more than Rs. 5,000 crore each, with
60% or more classified as bad loans (NPAs) by banks as of March 2016.

Lenders led by SBI are set to initiate action under the Insolvency & Bankruptcy Code (IBC) against Bhushan
Steel and Essar Steel, which will join companies such as Electro Steel, Monnet Ispat, Alok Industries and Jyoti
Structures. In case of the other stressed companies, SBI plans to approach the National Company Law Tribunal
(NCLT) by June 30, 2017.

Separately, Punjab National Bank is initiating action against Bhushan Power and Bushan Steel. The two
Bhushan Group companies with combined debt of over Rs. 80,000 crore are seen as examples where the lenders
were more than liberal in sanctioning loans and are among the most capital-intensive steel plants, at least in India.

Bankers, led by IDBI Bank, will be meeting on Friday (June 23, 2017) to decide on Bhushan Power & Steel
which has been in default of Rs. 37,248 crore to the lenders.

On Saturday, June 24, 2017, Lanco Infratech said the Reserve Bank of India (RBI) has directed its lead banker
IDBI Bank to initiate insolvency procedure for the company. Once a case is referred to NCLT, there is a 180-day
time line to decide on a resolution plan though 90 days can be given in addition. If a plan is not decided, then the
company will go into liquidation.

References:
Bad loans: Lenders refer Bhushan Steel, Electro steel, Essar to NCLT. (2017, June 23), Deccan Chronicle, 11:13 IST.
Banks including SBI take Bhushan Steel, Essar Steel to NCLT over loans. (2017, Jun 22, Thursday), Live Mint - e-Paper, Last
Updated 22:16 IST.
Chatterjee, D., Lele, A., & Dutt, I. A. (2017, June 23). Insolvency: Lenders take Bhushan, Essar and Electro steel to NCLT’
Three steelmakers have combined debt of nearly Rs 1 lakh crore. Business Standard, Mumbai/ Kolkata, Last Updated at 09:12
IST.
Lenders drag Essar Steel, Bhushan Steel, Electro steel to NCLT. (2017, June 22), Press Trust of India, Mumbai, Last Updated at
20:42 IST.
NPA crackdown: Read here for financial details of these 12 big loan defaulters likely to go for bankruptcy. (2017, June 19),
First-Post.
Sahu, Prasanta (2017, June 21). Narendra Modi government set to shut down 5 sick PSUs, PEC, Bharat Wagon, Elgin Mills on
list. The Financial Express, New Delhi, Published at 08:07 AM
SBI-led lenders to offer prescription to Essar Steel, Bhushan Steel, Electro steel; refer them to bankruptcy court. (2017, June 23),
India Today.
Sidhartha (2017, June 23). Essar Steel, Bhushan face bankruptcy proceedings. The Times of India, 10:08 IST.

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Case 6.2: The Modern Debt-Stressed Corporation
Since the 2008 crisis regulators have cranked up their supervision and control of banks and ordered them to
hold more equity than debt (See “Free Exchange: Miraculous Conversion,” The Economist, May 16, 2015, p. 63).
On a similar note, Business Outlook (a prominent business magazine in India) featured a front page article: “Bad
Debt or Death Bed?” (December 11, 2015, pp. 26-40). Recently, HDFC Bank sold its Essar Steel exposure of Rs
550 crore (about $85 million) to an asset reconstruction company (ARC) at a 40% discount, while a SBI-led joint
lenders’ forum restructured the company’s Rs 30,000-crore (about $4.615 billion) exposure. Industry insiders
believe that refinancing and rolling-over are going to be commonplace in the Indian banking system which is short
on innovative ideas but big on its set of NPA problems.

In a study of highly leveraged Indian business groups, analysts at Credit Suisse say that $15 billion worth of
long-term debt is due in 2017 and would need to be refinanced. Additionally, another $20 billion short-term debt
would need to be rolled-over. The total outstanding debt among these over-leveraged firms is at a staggering Rs
730,000 crore (over $123 billion). With some of the banks already stretching to meet the Basel-III capital
requirements, feeding these groups would put additional burden on their capital base. Rating companies, however,
keep the industry debt-rating of these stressed-out business groups at BB and better.

The genesis of the debt over-leveraging problem is politically directed loans made in 2009 and 2010 and
genuine errors of judgment made in 2008, opines Saurabh Mukherjea, head of institutional equities at Ambit Capital.
Over the past eight years, according to a study conducted by the Credit Suisse, the House of Debt report, corporate
debt of some ten over-leveraged corporate industry groups covered by the study ballooned by an explosive 730%,
from a borrowing of Rs 100,400 crore in FY 2007 to Rs 733,500 crore in FY 2015 (See Business Outlook,
December 11, 2015, p. 28). Apparently, the Indian promoter community realized that foreign investors were
providing generous equity funding to Indian industry groups and they had to match it by equally generous funding
from public sector unit (PSU) banks based on the premise that it is the only way long-term infrastructure funds could
be funded. Based on this pretext, politically directed loans were made with very little prospect of repayment,
observes Saurabh Mukherjea.

Business Outlook conducted a similar study towards the middle of 2015 from the Bombay Stock Exchange
(BSE) universe of companies that met with several filtering stringent criteria. The first criterion was debt/equity
ratio > 2.5. Within this filtered group the study selected companies that verified three more debt-related criteria: a)
interest coverage ratio ≥ 1.5; b) [(opening cash + CFO)/interest cost] ≥ 1.5; and c) market capitalization/debt <
100%. Twenty companies got netted in this group (incidentally, six of these also belonged to the stressed
corporations group of Credit Suisse “House of Debt” study). The total outstanding debt of these companies in 2015
was Rs 406,000 crore ($73.818 billion). Twelve of these 20 were infrastructure companies (e.g., power,
construction, and road business) and accounted for 77% of the total outstanding debt. Other companies in this list
were in textile, aviation, steel, and telecom. Technically, these twenty companies are the most vulnerable to debt
troubles, as they face a highly challenging environment in meeting their debt obligations (Kripalani & Gupta, 2015,
p. 26). However, the rating companies and the banking systems in India did not ring their alarm bells on these
heavily debt-burdened companies. For instance, for twelve of these debt-stressed companies, ratings scores did not
go below BB; in fact, ten of these companies scored investment grades BBB and above. Only six companies were
rated D (that is, at default).

According to Pradip Shah, Chairman of IndAsia (who while at Crisil introduced the concept of credit rating to
India), some of the Indian credit rating agencies award ratings without much due diligence (cited in Kripalani &
Gupta, 2015, p. 28). If ratings reflect your capacity to pay back loans or debts, then higher ratings may give false
information to the investors. Experts do not seem to think that a benign inter rate cycle is going to help improve
matters. RBI cuts (e.g., Repo, CRR) are not going to help matters much as far as improvement in fundamentals is
concerned, says Sanjay Bakshi, a widely followed value investor in India as also adjunct professor at MDI, Gurgaon,
India.

Deep N. Mukherjee, visiting faculty, IIM Calcutta, believes there is no reason to expect the debt woes to
mitigate unless all the stakeholders (i.e., policy-makers, banks and promoters) are willing to end the charade. The

3
only endgame is that FII debt providers or FDI would come in over the next two to three years. They could if, for
instance, can say that their cost of debt is 4-6% and they could afford to infuse debt at 2-3% above the 10-year bond
yield of 7.7%. That is, you could infuse new money to turnaround the distressed companies. Analysts add that 17%
of the total loans are stressed, and of this 5% are non-productive assets (NPAs). So some provisioning is done for
them; but the balance of loans need haircuts if they stand any chance of recovery. But currently, it does not look
bright. Three to four years have passed already and in India, the cost of waiting is close to 12-13%, which is the
additional interest rate that you will need to pay on the debt because of the delay, adds Mukherjee (Business
Outlook, December 11, 2015, p. 40).

Meanwhile, the government is planning to introduce a bankruptcy Code by the end of December 2015 to help
bankers recover their investments faster so that there is efficient flow of capital across the economy. But if the Code
does not have teeth, then it may not deter erring promoters. Moreover, the Code when notified and enforced may
not be fully complied with for the next two to five years. That the Code will enable economic growth and efficient
capital flows come back is anybody’s guess, especially if there are external shocks (e.g., another financial crisis,
another war) that bring about further deterioration.

One wonders the “morality” of borrowing indiscriminately, of over-leveraged companies, of banks trying to
feed the debt-ridden business groups, of politically pressured public sector bank loans to the floundering companies,
and the morality of rating agencies that continue to rate such companies with investment grade (i.e., BBB) and
above. This is the market turbulent challenge of corporate morality today; this is the nightmare of corporate ethics.
Most Western countries and economies sweeten the cost of borrowing. This is bad economic idea; it is also
ethically and morally questionable. It is bad intersection of corporate morality and political morality. Despite the
fact that the world is mired with debt, governments make borrowing costs tax deductible, cheapening debt and
encouraging borrowers to borrow more. In contrast, the dividend payments and retained earnings that flow to
shareholders are taxed in most places (See “A Senseless Subsidy,” The Economist, May 16, 2015, p. 15).

References:
Bad Debt or Death Bed? Several Companies are nearly dead, with their Equity almost Wiped out; there is little Chance they will
survive but for their Banker’s Largesse. (2015, December 11), Business Outlook, 26-40.
Briefing Ending the Debt Addiction: A Senseless Subsidy. (May 16, 2015), The Economist, 15-18.
Free Exchange: Miraculous Conversion. (May 16, 2015), The Economist, 63.
Kripalani, J., & Gupta, J. K. (2015, December 11). Ever-greening of Loans is keeping several Over-leveraged Companies alive.
What could be the Endgame? Business Outlook, 36-40.
Mahalakshmi, M. (2015, December 11). House of Cards. Editor’s Note, Business Outlook, 5.
The Great Distortion: A Dangerous Flaw at the Heart of the World Economy. (2015, May 16-22), The Economist, 7, 15-18, 63.

Ethical Concerns
1. Discuss the morality of the 12 corporations listed by RBI in 2016 that borrowed indiscriminately.
2. Discuss the morality of these over-leveraged companies that have neared insolvency or bankruptcy.
3. Discuss the morality of rating agencies that continue to rate failing companies with positive investment grade (i.e.,
BBB and above).
4. Discuss the ethics of public sector banks (like SBI, PNB, BOM, IOB) trying to feed debt-ridden business groups.
5. Discuss the ethics of politically pressured public sector bank loans to these floundering companies.
6. Study the ethics of creditor banks (e.g., SBI and other public sector banks) referring sick steel companies to the
National Company Law Tribunal (NCLT) for further action under the Insolvency and Bankruptcy Code (IBC).
7. Study the ethics of NCLT in dealing with the debt-pressed units referred by RBI-authorized banks for further action
under IBC.
8. In the absence of a clear cut Indian Bankruptcy Law and professional bankruptcy attorneys in India to what extent
would the action of NCLT be legally effective, ethical and moral?
9. To what extent would this referral by banks to NCLT lead the Indian steel sector to emerge strong in the long run?

4
Case 6.3: Why does India need a Bankruptcy Law?
In the context of debt-over-leveraged companies (as illustrated in cases 6.1 and 6.2), India needs desperately a
bankruptcy law, and hence, bankruptcy courts and bankruptcy attorneys universally applicable and deployable
throughout the country and all its states.
The Rajya Sabha (House of Lords!) on Wednesday, May 11, 2016, passed the Insolvency and Bankruptcy Code
2016, a vital reform that will make it much easier to do business in India. Once the President signs the legislation,
India will have a new bankruptcy law that will ensure time-bound settlement of insolvency, enable faster turnaround of
businesses and create a database of serial defaulters. The bill, which received the Rajya Sabha’s nod on Wednesday,
was passed by the Lok Sabha (House of Commons!) last week. A majority of the parties in both Houses supported this
legislation after all the amendments proposed by a joint parliamentary committee were accepted by the government.

The Insolvency and Bankruptcy Code 2016 (IBC 2016) is the bankruptcy law of India which seeks to consolidate
the existing framework by creating a single law for insolvency and bankruptcy. The IBC was introduced in Lok Sabha
in December 2015. It was passed by Lok Sabha on 5 May 2016. The Code received the assent of the President of India
on 28 May 2016. Certain provisions of the Act have come into force from 5 August and 19 August 2016.

The Code seeks to repeal the Presidency Towns Insolvency Act, 1909 and Sick Industrial Companies (Special
Provisions) Repeal Act, 2003, among others. The Code outlines separate insolvency resolution processes for
individuals, companies and partnership firms. The process may be initiated by either the debtor or the creditors. A
maximum time limit, for completion of the insolvency resolution process has been set for corporates and individuals.
For companies, the process will have to be completed in 180 days, which may be extended by 90 days, if a majority of
the creditors agree. For startups (other than partnership firms), small companies and other companies (with asset less
than Rs. 1 crore), resolution process would be completed within 90 days of initiation of request which may be extended
by 45 days.

The Code establishes the Insolvency and Bankruptcy Board of India, to oversee the insolvency proceedings in the
country and regulate the entities registered under it. The Board will have 10 members, including representatives from
the Ministries of Finance and Law, and the Reserve Bank of India. The insolvency process will be managed by
licensed professionals. These professionals will also control the assets of the debtor during the insolvency process.

The Code proposes two separate tribunals to oversee the process of insolvency resolution, for individuals and
companies: (i) the National Company Law Tribunal (NCLT) for Companies and Limited Liability Partnership firms;
and (ii) the Debt Recovery Tribunal (DRT) for individuals and partnerships

The bill proposes the creation of a new class of insolvency professionals that will specialize in helping sick
companies. It also provides for creation of information utilities that will collate all information about debtors to prevent
serial defaulters from misusing the system. The bill proposes to set up the Insolvency and Bankruptcy Board of India to
act as a regulator of these utilities and professionals. It also proposes to use the existing infrastructure of National
Company Law Tribunals and Debt Recovery Tribunals to address corporate insolvency and individual insolvency,
respectively.

The new code will replace existing bankruptcy laws and cover individuals, companies, limited liability
partnerships and partnership firms. It will amend laws including the Companies Act to become the overarching
legislation to deal with corporate insolvency. It will also help creditors recover loans faster. Regarding resolving
insolvency, India is ranked 136 among 189 countries. At present, it takes more than four years to resolve a case of
bankruptcy in India, according to the World Bank. The code seeks to reduce this time to less than a year.

Incidentally, the bankruptcy law provides for even suppliers to initiate insolvency proceedings. If no resolution
is arrived at within 180 to 270 days, the assets have to be auctioned off to recover dues.

The move is also expected to help India move up from its current rank of 130 in the World Bank’s ease of doing
business index, since all reforms undertaken by 31 May are incorporated in the next ranking. But implementation will
remain the key, analysts point out, as the new code is presaged on the creation of a complementary eco-system
including insolvency professionals, information utilities and a bankruptcy regulator.

5
 Stressed assets, i.e. bad loans and restructured loans, totaled 20% of the total loans in the system, according to
the Economic Survey 2017. Many of these are long-term loans from banks which depend mostly on short-term
funds. The banks, also blamed for ignoring the need to match asset and liability, may have to halt long-term loans,
and wherever they do, may have to sell them off quickly. 

Ashwin Bishnoi, a partner at law firm Khaitan and Co., said the insolvency code proposes a vast change and its
implementation will take time. “The code has set the framework for bringing in changes in the debt recovery tribunals,”
he said adding that India has many professionals who can easily step into the role of insolvency professionals.

The bankruptcy code has provisions to address cross-border insolvency through bilateral agreements with other
countries. It also proposes shorter, aggressive time frames for every step in the insolvency process - right from filing a
bankruptcy application to the time available for filing claims and appeals in the debt recovery tribunals, National
Company Law Tribunals and courts.

The code assumes the existence of institutional infrastructure like information utilities and insolvency
professionals, information repositories like stock depositories; a new regulator, without the failings of existing
regulators; and a high-quality adjudication infrastructure. Unless these four pillars are in place, the Code will fail
because of the huge dependencies faced in the debt recovery tribunals.

To protect workers’ interests, the code has provisions to ensure that the money due to workers and employees from
the provident fund, the pension fund and gratuity fund should not be included in the estate of the bankrupt company or
individual. Further, workers’ salaries for up to 24 months will get first priority in case of liquidation of assets of a
company, ahead of secured creditors.

Responding to the debate in Rajya Sabha, Minister of State for Finance, Jayant Sinha said the government will try
to go through a stage-wise process to ensure smooth implementation, “notifying provisions as and when the necessary
infrastructure is ready”.

Along with the proposed changes in India’s two debt recovery and enforcement laws, it will be critical in resolving
India’s bad debt problem, which has crippled bank lending.

Bankruptcy applications will now have to be filed within three months; earlier, it was six months. There are also
provisions that disqualify anyone declared bankrupt from holding public office, thereby ensuring that politicians and
government officials cannot hold any public office if declared bankrupt.

Sinha said the code seeks to protect interest of workers who are the most vulnerable. “It enables workmen to
initiate the insolvency process and they will be first in line to get the proceeds of liquidation,” he said.

After a public consultation process and recommendations from a joint committee of Parliament, both houses of
Parliament have now passed the Insolvency and Bankruptcy Code, 2016 (The Code). While the legislation of the
Code is a historical development for economic reforms in India, its effect will be seen in due course when the
institutional infrastructure and implementing rules as envisaged under the Code are formed.

References:
Legislative Brief of the Code (PDF). (2016, August 18). PRS India. Retrieved from
http://www.shanlaxjournals.in/pdf/COM/V5N3/COM_V5_N3_010.pdf
Lok Sabha passes bill to fast track debt recovery. (2016, August 2), The Economic Times.
India Overhauls Century-Old Bankruptcy Laws in Win for Modi.  (2016, May 11), Bloomberg.
India: The Insolvency And Bankruptcy Code, 2016 - Key Highlights. (2016, May 18), Trilegal.
Insolvency and Bankruptcy Code (PDF). (2016, May), Gazette of India. Retrieved from
http://www.mca.gov.in/Ministry/pdf/TheInsolvencyandBankruptcyofIndia.pdf.
Notification (PDF). E-Gazette. (2016, August 22), Gazette of India. Retrieved from http://www.cbec.gov.in/resources//htdocs-
cbec/customs/cs-act/notifications/notfns-2016/cs-nt2016/csnt113-2016.pdf.
Vikraman, Shaji (2015, November 5). Explaining the Bankruptcy law - and the need to have one. Indian Express.

6
Ethical Concerns
1. Discuss the morality of not having a formal bankruptcy Law in India.
2. Discuss the morality of over-leveraged companies that have neared insolvency or bankruptcy and who yet lobby
against Bankruptcy Laws for India.
3. Discuss the legality, ethicality, morality and spirituality of NCLT or IBC as substituting a formal bankruptcy
Law for India.
4. If formal bankruptcy law in India can improve the index of safety and security of doing business in India, is
India morally obliged to provide such security and safety to foreign investors (e.g., NRI, FII, MNCs)? Discuss.
5. Study the ethics of politically pressurized loans of commercial public sector banks to already over-leveraged
companies like those 12 referred by RBI to NCLT.
6. In the absence of a clear cut Indian Bankruptcy Law and professional bankruptcy attorneys in India to what
extent would the action of NCLT and INC be legally effective, ethical and moral in the long run?
7. To what extent would this referral by RBI to NCLT lead the Indian infrastructure (e.g., oil, gas, steel, energy)
companies to emerge strong and self-dependent in the long run? Discuss.

Ethics of Promoter Dominance in Modern Corporations

Currently in the USA, promoters can legally invest in as many shares as they want in a firm.
Moreover, the law entitles the promoters to have one representative on the board for every 17 percent
shares that they hold in that firm. As it often happens, if a group of promoters with vested interests buys
17% and more of shares, then each 17% share entitles them one board membership. Hence, if they
collectively owned a total 68% or 85%, then they can control the company management with four or five
members on the board, and that can enable them to dictate managerial policy for the company as a whole.
If promoters are primarily interested in getting high and immediate returns on their invested capital, then
that can constrain long term new product and new market development policies of the managers. This
empowers the promoters over the traditional customer-employee based management system, whereby the
promoter can force the management to increase the return on their investment by whatsoever means it
takes. That is, the promoters could enforce a dubious ethical system which affirms that means justify
ends, and not vice versa.

This also may lead to the culture of allotting ESOPs to the top and mid-level managers. This can be
painfully detrimental to the long term future of the firm, because the management tends to get more
concerned about maximizing profits, increasing net worth and enhancing share prices to meet targets.
They can completely ignore “ends” in the form of vision and missions, values, goals and objectives and
even jeopardize long run growth and profitability of the firm. This phenomenon will also jeopardize the
contribution and responsibility of the corporation to the country in terms of new product and services
development, employment, CSR, ecology and sustainability. Moreover, what happens in today’s
corporate world is that whatever target gets achieved becomes a standard, and the next quarter’s targets
are made more stringent. This leads to a tendency amongst the employees to manipulate cash flows,
inflate earnings, to deflate debts, and thereby forging profits, showing better return on assets, higher net
worth of the firm, all of which can increase share prices and market capitalization.

This is ethically and morally wrong. And this is happening due to the fact that there is a lot of
pressure on the employees from the board of directors. The directors’ panel, as we have discussed above
under Case 6.3, consists of the representatives of the Investment Banking firms in majority. They have
nothing to do with the vision and mission of the firm. Their sole target lies in maximizing the returns on
the investment of their respective investment banks. They do not care whether the company is following
an ethical path in doing so or not. The company management tries to bypass through the loopholes in the
laws and the legislations to reach their short term targets. Or else, the managers who want to be ethically
correct in their approach leave the corporate and move to startups where they receive a handsome pay
package which is in equivalent terms with that of the corporates, and, apart from this, they get a whole lot

7
of independence and autonomy in the decision making process. Thus, they get a better work environment
in the startups rather than the corporates. A top level manager leaving a company is not a good sign for
the firm as it leads to reputational loss for the company and its share prices can see a downhill turn if the
news of a rift between the employees and the board of directors reaches the market.

In the long run, this kind of approach is really very unhealthy for the firm as we can take example
from the cases of Enron and Satyam where in order to increase share prices, the processes and the cash
flows were manipulated so as to mislead the market in increasing the net worth of the companies. But
what happened at the end is tragic - both these companies went bankrupt and the respective chairmen
were under imprisonment. So basically in the long run it leads to a dead end, where the person involved,
the firm, the investors and the millions of people who invest in the firm’s shares have nowhere to go.

Such scenarios must be avoided. Playing with the lifetime savings of so many people is not at all
justified. It might be legally acceptable at that particular juncture of time, but, deep within the conscience
a person knows that whatever he is doing is wrong on his part. The best question one can ask to himself at
that point of time is: would I do the same thing if my family members were at the receiving end of my
deeds? Then the concerned person will take a morally, ethically and spiritually correct decision - he will
do something which he ought to do. He will not just get away with something that he should do. This kind
of critical, visual and moral based thinking will help a person in taking the right decision at the right time,
at the right place, and involving the right reasons and principles.

The legal system in any country as we know is mostly reactive and retroactive. Laws are made once
a wrong deed has already happened. It is almost impossible to pre-empt the effects of an action and
making a law to prevent it. So we cannot blame our legislatures and law-makers for not coming up with
some proactive laws and legislations well before the crime or the scam happens. It will be like a bonus if
the senators or the MPs come up with laws which would prevent wrong doings. But as a person, we all
must be aware that whatever we are doing is ethically and morally correct or not, and how many people
will be affected by this one decision made by me. If we reach at a conclusion that a lot of people will be
at the losing end due to our action, it is our moral responsibility not to take that decision or action. If we
fail to do so, we must be rest assured that one day or the other, a law will be made which would make our
actions illegal and that we would be convicted and prosecuted at that point of time, as in the case of Enron
and Satyam.

The Morality of Promoter Dominance

Looking into the long term economic effect of this share concentration within top promoters in
investment banking firms, and its ill-effects on the thinking, ethicality and morality of the firm’s
managers, the thinking process of the employees will turn more short-term based and there is a high
probability that their decision making may turn myopic with long-term benefits taking a severe backlash.
Other unfortunate consequences of this phenomenon could be that there will be scarcity of visionaries in
the corporate world. The growth of the corporates will become directionless due to the lack of visionaries
and there will be a downfall in the valuation of the corporates. And once the devaluation starts for the
corporates, there will be a high probability of attrition among the employees as they would be unsure
about the future perspectives of their careers. This will lead to further degradation of the firm’s reputation
which in turn will lead to further devaluation of the share prices.

Thus, it is a vicious circle where the companies are getting trapped into, just due to a set of immoral
practices of making faster money. Moreover, this kind of management system will encourage more
practices like those of Enron and Satyam, and more and more managers will try to find loopholes and
shortcuts in the legal system to maximize profits. This will lead to a number of immoral practices

8
growing in the corporate and one day or the other some whistle-blower’s conscience will wake up and
would bring the firm shattering to the ground. This would not only pose a threat to the individual firms
only, but to the nation’s economy on the whole as well. The failure of one company can lead to the
downfall of an entire economy and its bond value, the credit ratings of the nation as in the case of Brazil.
Same was evident in the case of the Volkswagen scandal in which one bad call by the company’s
management not only destroyed the reputation of the company, but also initiated a downhill turn for the
finances of the company. Moreover, the reputation of Germany which is known for its extremely
advanced automotive engineering and technology got a bad hit and the goodwill of other German
carmakers like BMW, Audi and Mercedes was also impaired. Thus Germany which was the savior of the
European Union was all of a sudden finding itself in a situation of crisis. Therefore, a set of morally
incorrect judgments can not only be devastating for the company, it can lead to the downfall of an entire
nation’s economy.
Share market concentration in the hands of a few promoter investors might be legally correct at this
point of time. But it is morally, ethically and spiritually wrong. And taking into consideration the
competition and the profit maximization goals, there is a high probability that people will resort to much
worse practices in order to retain their jobs or get promotions. This can even lead to the downfall of great
economies or at-least dent the growth pace of a developing economy. Hence, we predict that the
government will come up with legislations that will fix the upper cap of shareholding in a firm as
suggested by Dr. Raghuram Rajan, the then governor of the Reserve Bank of India - he has asked for an
upper limit of 20% shareholding by a single promoter in a corporate firm. Thus, given this legislation,
promoter concentration could be illegal as well in India.
As a first step in ethical analysis, let us study the undergirding distribution of wealth in the world.
Exhibits 6.1 and 6.2 record the distributions.

[Exhibit 6.1 about here].

[Exhibit 6.2 about here].

Exhibit 6.1: Wealth Distribution by Type of Asset (in 2007)

[Source Wolff 2009]
Investment Asset Type Top 1% Next 9% Bottom 90%

Business Equity 62.4% 30.9% 6.7%

Financial Securities 60.6% 37.9% 1.5%
Trusts 38.9% 40.5% 20.6%
Stocks and Mutual Funds 38.3% 42.9% 18.8%
Non-Home Real Estate 28.3% 48.6% 23.1%
Total Investment Assets 49.7% 38.1% 12.2%

Exhibit 6.2: Investment by Deposits, Pension Accounts, Liquid Assets, Housing, and
Debt (Data: 2007: Source: Wolff 2009)
Investment Asset Type Top 1% Next 9% Bottom 90%

Deposits 20.2% 37.5% 42,3%

Pension Accounts 14.4% 44.8% 40.8%
Life Insurance 22.0% 32.9% 45.1%
Principal Residence 9.4% 29.2% 61.5%
Total Other Assets 12.0% 33.8% 54,2%
Debt 5.4% 21.3% 73.4%

9
 Given the uneven possession of financial wealth in the world as seen from these Exhibits, the
promoter concentration of investment share of the stock market seems to be a logical consequence and
economically consistent. But how did the former (i.e., financial wealth possession inequality) come
about? From income inequality, from social inequality, or from economic inequality? All three sources
of inequality are unjust, even though some form of income inequality seems to be justified given
individual different skill abilities and intellectual capacities for gainful work and differentiated incomes.
Hence, currently, almost everywhere in the world, ownership and investment by the big firms remain the
single most popular way of financing new ideas.

Share market concentration within the hands of a few promoter investors can be advantageous as
well as disadvantageous, legally, ethically and morally:

 Legally, it is the choice of the promoters of a particular corporation to decide to hold shares within a
few hands or release an offering and go public. Thus justification in legal terms for concentration of
shares in a few hands is not really a concern. The role of justifying in terms of legality comes when
the firm has violated some laws that have led to the firm as a whole coming under the scanner. It is
not uncommon, especially for private firms, to fiddle with their balance sheets and P&L statements
to paint a bright and colorful picture in place of gloomy scenery. The case of Satyam, where the
owners themselves fudged the books to maintain the investor confidence is a perfect example of a
firm cheating with its investors. The long-term unintended consequences can be severe in case one
violates the legal terms the firm is bound to follow. Firms have ended up paying hefty fines in such
cases and even faced closures and bankruptcy.

 Ethically, the outcome of having few promoters investors depends upon how aligned their thinking
is with what the firm plans to achieve and what principles it plans to follow. Since the power of
critical decision making lies with these few people, their understanding of the firm’s goals and their
thinking process for arriving at the implication of their decisions affects the whole organization.
Ethical standards often define organizations, examples of which can be, from a single sector, the
community builder TATA Steel and the profit maximizing Jindal Steel. In terms of the future, firms
with weak ethical grounds might be successful and profitable in the short run, since they are quickly
able to change and adapt to profit maximizing strategies without thinking the long term
implications of their actions. On the other hand, firms with a strong focus on building and adhering
to strong ethical standards will always, despite small periodic losses, ensure that the firm has a long
future ahead of it and will continue to reinvent itself as per the changing times.

 Morally, the fate of an organization lies in the hands of a chosen few investors, and this is wrong.
The organization consists of lots of individuals and it is of huge importance for the firm to
functional normally, that the goals of an organization and their thinking capability match with what
the firm plans to do. Thus resting power with a few can be dangerous where the investors sway
from their paths and start fudging with the image brand. An example of this can be again, the
Satyam debacle, where the choices of a few individuals led to the closing of the entire organization.

Collectively analyzing these areas, one can look at the unintended economic consequences that such
a firm has. It might look easy for a firm to break away from these standards and earn a quick profit, but it
is only those strong organizations that foresee the loss about to happen, prepare themselves to steer
comfortably in such conditions. Severe unintended consequences can be the plea by a firm to accept
certain ‘face saving’ details resulting in a legal trial of the firm ultimately leading to closure.

The Morality of Tax Subsidy and Debt Distortion

A vast distortion in the world economy today is wholly man-made. A major distortion in this regard
is tax subsidy that governments give to debt. Tax breaks for debt have two principal forms: a) interest
payments on home mortgage debt are tax deductible for personal tax purposes (this in USA, and most

10
Western European countries such as Belgium, Italy, Netherlands, Spain, Switzerland and all four Nordic
states of Denmark, Norway, Sweden and Finland); b) interest payments of debt-holders are tax deductible
from corporate taxable earnings (and this holds for corporate firms across the world). For instance, most
rich governments of the world allow their citizens to deduct the interest payments on home mortgages
from their personal taxable revenue. This subsidized cost of debt enables people to buy more property
than they can otherwise afford, raising house prices and encouraging over-investment in real estate,
instead of in assets that create employment, growth and wealth. The tax benefits are largely reaped by the
rich, thus worsening income inequality – this is a moral issue. Corporate financial decisions, accordingly,
are often motivated by maximizing tax relief on debt instead of the needs of the underlying business.
Almost all countries allow firms to write-off interest payments on borrowings against taxable earnings
(see “The Great Distortion,” The Economist, May 16, 2015, p. 7).

This cost of debt subsidy is immense. In 2007, the annual value of the foregone tax revenues in
Europe was around 3% of GDP ($510 billion), and in America almost 5% of GDP ($725 billion). That is,
these governments were spending more on cheapening the cost of debt than on defense. In America, with
interest rates close to zero, USA-led debt subsidy cost the federal government over 2% of GDP – as much
as it spends on all its policies to help the poor (see The Economist, May 16-22, 2015, p. 15-18).

Advantages of Debt

No doubt, debt has many wonderful qualities, allowing firms to invest and individuals to benefit
today from tomorrow’s earnings. Debt serves many useful economic functions. It allows money to travel
through space, time and social divides. A firm that is short of cash but which has good prospects can
raise funds and repay them in time. People who have surplus cash can lend to those who have less but
great use for it. Corporate executives like debt because it allows them to raise funds without losing
control. Savers like to own bonds or make loans to banks because of safe, steady and sure income
streams of interest payments. If borrowers get into trouble, creditors have first claim on their assets.
Banks like debt for several reasons: a) it is cheap compared to equity since bank’s creditors charge
relatively less, given that they are protected if the bank fails; b) as said before, tax breaks for interest
payments make debt cheaper and more attractive; c) issuing debt, unlike equity, does not entail any
dilution of control. On the other hand, governments prefer equity since investors can absorb losses during
downturns and thus ward off bailouts.

Logically there is no limit to the amount of debt as long as cost of debt is significantly lower than cost
of equity. In this sense, one man’s debts are another man’s assets. That is, at the global level debts
should cancel out to zero. The flip side of debt is credit, consumer or trade credit. Credit is the vital fluid
and sign of a strong commerce. It has excited credit unions, stimulated manufacturing, and expanded
businesses beyond traditional horizons. 4Without debt or borrowing, national infrastructure of energy
production and transmission - roads, rail, air transport, and shipping - would not be possible for
developing and emerging economies.

Debt is the magic ingredient that makes modern finance possible. In general, American investment
banks and financial institutions engage in producing ingenious instruments to drum up business. For
instance, risky cash flows can be neatly packaged into apparently steady payments, making it deceptively
attractive to customers. For example, arbitrage (exploiting differences in price between similar assets,
e.g., foreign hard currencies) is possible and profitable when magnified by leverage. By using layers of
debt with different seniority, risk can be transformed in almost infinite ways.

Disadvantages of Debt

But beyond a point, debt is bad for the economy. Excess of debt hurts growth in many ways: in the

11
rich worlds new debts do not finance new productive assets like factories, inventions, innovations and
technology; they either pay off debts or debt obligations (called “overhanging") or are used to restructure
or reshuffle claims on existing debts, which, in turn, is done by a complicated financial industry to
administer them and suck most of the new debts, says Stephen Cecchetti, Brandeis International Business
school, formerly an executive in the Bank of International Settlements (BIS). Debt also hurts growth by
creating fragility: of defaults among households burdened with heavy mortgage payments, and among
banks that accumulate non-productive assets (NPs) that they must sell at a discount to be operational.

But in the real world, there is a strong bias for debt. The reason: tax breaks on debt payments. That
is, government tax subsidies favor debt. In fact, tax subsidies have tilted the economy in a wrong
direction – they have created a financial system that is prone to crises and biased against productive
investments. Economies biased towards debt are more prone to crises since debt imposes a rigid regime
of amortization and interest payment obligations, whereas equity is expressly designed to spread risk and
losses onto investors. They have reduced economic growth. Subsidies that make borrowing irresistible
need to be discouraged and even phased out (as Britain did in the 1990s). Canada and Britain stopped tax
subsidies or breaks long back.

China has saved a ton over the years in dollars. In theory, China could invest its dollars buying US
multinational shares. Had it done so, China could have easily owned a fifth of the S&P 500 index and
could have had de facto control of corporate America, a politically dangerous position. So China and its
exporting firms bought safer and less controversial debt – during 2004-2008, over 75% of foreign
ownership was in the form of debt, most of that in mortgage and corporate bonds (see The Economist,
May 16, 2015, p.16).

The dotcom crash in 2000-2002 caused losses to shareholders worth $4 trillion and a mild recession.
Satyam was deeply affected by the dotcom crash that eventually led to its bankruptcy Some 18 global
mega investment banks suffered a total loss of $2 trillion in market capitalization since the financial crisis
of September 2008. A more neutral tax system would encourage firms to sell more equity and carry less
debt, as also lead to more efficient choices by savers and lenders. In rich countries today more than 60%
of bank lending is for mortgages. Without a tax break, people would borrow less to buy houses, and
banks would lend less against property. A more neutral tax policy would encourage investment in new
ideas and businesses that would enhance productivity thus boosting growth (see The Economist, May 16-
22, 2015, p. 7).

A New Breed of Hybrid Financial Instruments

Newly created hybrid products currently floating in the financial markets are called contingent
convertible bonds (“Cocos”) that turn debt into equity when a bank is struggling. Coco issuance has
soared since 2010, as investment banks keep regulators happy by bolstering their ability to withstand
losses. Apparently, these fancy bonds or Cocos enjoy the upside of debt in good times, but provide a
cushion during a crisis. Cocos usually convert when regulators decree that a bank’s capital has fallen
below some threshold during a crisis peak. But this is arbitrary and puts regulators in a bind. When and
how does the regulator identify a crisis serious enough for a Coco issuance? Moreover, when the
regulator does announce that a bank is in crisis, it may throw the bank into panic. A Coco conversion
imposes sudden losses on bondholders, who find themselves owning shares much less in value than the
bonds that spawned them. That is, Cocos support corporations and banks, but impoverish common people
as bond holders – a very inequitable proposition to begin with. If the bondholders are themselves in
distress, those losses can reverberate around the financial system (see The Economist, May 16, 2015, p.
63).

12
 To overcome these problems two finance economists, Paul Klemperer of Oxford University and
Jeremy Bulow of Stanford University, have devised a new instrument called an Equity Recourse Note
(ERN). Like Coco, ERN functions as debt in normal times. But its trigger for the conversion is the
bank’s share price, rather than a regulatory call. For instance, when the share price falls, say, to 25% of
its initial value, the bank can make repayments on the bond with new shares rather than with cash.
Suppose a bank issues a $50 million ERN when its shares are worth $100 each, the ERN would pay
interest like a normal bond at that share price. When the share price hits $25, the bank could issue new
shares at $25 each. But in order to redeem its $50 million ERN, the bank would have to issue 2 million
shares and sell them at $25 each, even if the price per share might have gone down further by that time.
But ERNs have not been tested yet. They seem to favor the distressed bank and not the innocent
bondholder – a serious moral issue again. ERNs best work for firms with debt-overhang – that is, the
banks divert new cash to pay off debts rather than fund new investments (see The Economist, May 16,
2015, p. 63).

For instance, following Case 6.1, the problem of overleveraged corporate debt cannot be seen from
the CEO’s or CFO’s individual perspectives. Debt must be understood, perceived and analyzed from
multiple viewpoints and functional platforms such as finance, accounting, investment, marketing, human
resources development (HRD), R&D, venture capital, innovation, and new product development (NPD).
On the other hand, if debt is seen only from the view of clearing critical short-term liabilities (such as
payroll and taxes), or if debt is primarily raised for servicing existing debt burdens (such as interest and
amortization), then “overhanging” debt becomes unproductive but cumulative; it spells chronic
indebtedness. Instead, if debt finances HRD and R&D, creativity and innovation, new products and
services development, new market entry and penetration, new joint ventures or acquisitions, and the like,
then debt can leverage quality and productivity, employment and HRD, ecology and sustainability,
market presence, and hence, market capitalization, corporate growth and profitability (Mascarenhas,
Wright, & Amin, 2013). In other words, debt becomes a positive force for boosting one’s net-worth,
brand image and equity. This is corporate ethics and morals – you give back to society that finances your
operations. This is corporate legitimacy and justice.

The process of cleaning up bad loans from the system received an impetus from the lenders on
Thursday, June 22, 2017, with banking behemoth State Bank of India being authorized to refer Essar
Steel, Bhushan Steel and Electro steel to the bankruptcy court, which may eventually lead to the merger
of some of these firms to bring them back to health. With SBI set to take lead in the process and act as a
main negotiator, the position of banks has been strengthened.

Restructuring of debt or a merger of the companies could be in offing. The process would involve
infusion of new capital into the company and the lenders could respond with easier loan terms. The move
will lead to the steel sector emerging strong in the long run, Jayanta Roy, senior vice-president at ICRA
told ET.

Insolvency proceedings for stressed accounts may lead to consolidation in the steel sector. As a
result, stronger steel players with healthy financial profile would have a chance to raise their market share
by bidding for these assets at attractive valuations, said Roy. Subsequently, the steel sector, facing a
weak demand and an overcapacity situation would benefit in the long run, Roy added.

Understanding Debt from Multiple Viewpoints

For instance, following Cases 6.1and 6.2, the problem of overleveraged corporate debt cannot be
seen from the CEO’s or CFO’s individual perspectives. Debt must be understood, perceived and
analyzed from multiple viewpoints and functional platforms such as finance, accounting, investment,
marketing, human resources development (HRD), R&D, venture capital, innovation, and new product

13
development (NPD). On the other hand, if debt is seen only from the view of debt, for instance, to clear
existing debt burdens (such as interest and amortization), then “overhanging” debt is unproductive but
cumulative; it spells chronic indebtedness. Instead, if debt finances HRD and R&D, creativity and
innovation, new products and services development, new market entry and penetration, new joint
ventures or acquisitions, and the like, then debt can leverage quality and productivity, ecology and
sustainability, market presence, and hence, market capitalization, corporate growth and profitability
(Mascarenhas, Wright, & Amin, 2013). In other words, debt becomes a positive force for boosting one’s
net-worth, brand image and equity. This is corporate ethics and morals – you give back to society that
finances your operations. This is corporate legitimacy and justice.

Bankruptcy in the legal sense occurs when the firm cannot pay its bills or when its liabilities exceed
the fair market value of its assets. In either of these situations, a firm may be declared legally bankrupt.
However, creditors generally attempt to avoid forcing a firm into bankruptcy if it appears to have
opportunities for future success. Edward Altman (1968) estimated the impact of five financial ratios on
the probability that a firm will declare bankruptcy. i Most external observers of a firm rely on these
financial indicators to predict decline and bankruptcy.

The failure of businesses impacts employees, shareholders, lenders, and the broader economy. In a
country like India particularly — because of delays in making decisions on the viability of businesses,
tactics employed by company promoters to delay reorganization or attempts to sell off assets, changes of
management or litigation that goes on and on— the drag on new business units, jobs, income generation
and economic growth can be significant.

India does have some laws — including one on Securitization and Enforcement of Security — and
other mechanisms, like Corporate Debt Restructuring or CDR, to address the problem of insolvency of
firms. But the fact is some of these laws, such as the Sick Industrial Companies Act or SICA, have not
worked because of inefficient enforcement and court delays.

Like in the West, a modern law with a focus on speedy closure will help firms on the brink to be
either restructured or sold off with limited pain for all involved. In some cases, if this is done swiftly,
assets can be put to good use and the firm can be revived. Delaying a decision on whether to shutter a
firm or to try to revive it causes destruction of value for all involved. Indian policymakers have
recognized this. For banks or lenders, the money recovered can be lent again, promoting efficient
allocation of resources, besides development of financial markets such as a bond market with clarity on
repayment for debtors. An efficient and swift insolvency regime ensures greater availability of credit or
funds for businesses by freeing up capital, and is thought to boost innovation and productivity.
Hopefully, the current regime of NCLT and IBC will do just this.

Ethics of Financing Decisions such as EBITDA

EBITDA is one indicator of a company's financial performance and is used as a proxy for the earning
potential of a business, although doing so has its drawbacks. Further, EBITDA strips out the cost of debt
capital and its tax effects by adding back interest and taxes to earnings. EBITDA = Operating Profit +
Depreciation Expense + Amortization Expense; hence, it is essentially net income with interest, taxes,
depreciation and amortization added back to it. EBITDA can be used to analyze and compare profitability
between companies and industries because it eliminates the effects of financing and accounting decisions.
EBITDA is often used in valuation ratios and compared to enterprise value and revenue. ii Hence, in
general, EBITDA overstates the valuation of a company.

EBITDA is calculated by taking net income (= gross profit of earnings after product costs and

14
operating costs are deducted) and adding interest, taxes, depreciation and amortization expenses back to
it. EBITDA is generally used to analyze a company's operating profitability before non-operating
expenses (such as interest and "other" non-core expenses) and non-cash charges (depreciation and
amortization). A common misconception is that EBITDA represents cash earnings. EBITDA is a good
metric to evaluate profitability but not cash flow. EBITDA also leaves out the cash required to fund
working capital and the replacement of old equipment, which can be significant. Consequently, EBITDA
is often used as an accounting gimmick to dress up a company's earnings. When using this metric, it is
important that investors also focus on other performance measures to make sure the company is not trying
to hide something with EBITDA.

The interest coverage ratio (ICR) is a measure of a company's ability to meet its interest payments.
ICR is measured by EBIT/Debt: that is, earnings before interest and taxes (EBIT) for a time period, often
one year, divided by interest expenses for the same time period. The interest coverage ratio is a measure
of the number of times a company could make the interest payments on its debt with its EBIT. It
determines how easily a company can pay interest expenses on outstanding debt.

Debt/EBITDA is a measure of a company's ability to pay off its incurred debt. The ratio gives the
investor the approximate amount of time that would be needed to pay off all debt, ignoring the factors of
interest, taxes, depreciation and amortization. Commonly used by credit rating agencies to assess a
company's probability of defaulting on issued debt, a high Debt/EBITDA ratio suggests that a firm may
not be able to service its debt in an appropriate manner and warrants a lowered credit rating. For instance,
the Essar Group would have taken 11.1 years to clear all its debt in FY 2014, while it would have taken
only 8.5 years in FY 2015. The Lanco Group would have taken 24.6 years to pay all its debt in FY 2014,
while it would have taken just 23.1 years in FY 2015. The worst offender is the Videocon Group: it would
have taken an eternity of 285.5 years to clear all its debt in FY 2014, while the corresponding figure for
FY 2015 was not meaningful (NM) as it could have been either negative (if EBITDA is negative) or the
debt could have been too large to make the ratio interpretable.

Other things being equal, a declining debt/EBITDA ratio is better than an increasing one because it
implies the company is paying off its debt and/or growing earnings. Likewise, an increasing
debt/EBITDA ratio means the company is increasing debt more than earnings. Some industries are more
capital intensive than others, so companies should only be compared against other companies in the same
industry.iii

Another leverage ratio useful in this regard is the Long Term Debt to Capitalization Ratio calculated
as: Long term debt / (Long term debt + Preferred Stock + Common Stock). The denominator (long term
debt, preferred stock and common stock) contribute as the total capital of the company. This ratio allows
the investors to figure out the total risk of investing in a particular business, which can be easily
determined by the long term debt to capitalization ratio. It also shows how financially strong the company
is. This formula helps in determining the financial risks that the company has taken. If the percentage is
higher, it means that the finance of the company mainly comes from the debt which can be quite risky and
is sometimes a reason for bankruptcy. The higher ratio percentage shows how weak the company is
financially. Similarly, a decrease in the long term debt to capitalization ratio would mean that there is an
increase in the stockholder’s equity.

A long term debt to capitalization ratio which is greater than 1.0 indicates that the business has more
debts than capital which is not a good thing for a business as it can lead to lots of financial problems,
especially the company getting bankrupt. A high long-term debt to capitalization ratio would indicate the
financial weakness of the firm and the debt would most likely increase the risk of the company. The
company should make sure that their long term debt to capitalization ratio is controlled so that their debt
is under control. An out of hand debt would create problems to the company as a whole. A lower long-

15
term debt to capitalization ratio indicates that the business is not having any major financial difficulties.

Lastly, the debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of entity's
equity and debt used to finance an entity's assets. This key financial ratio is also known as financial
leverage; it is used as a standard for judging a company's financial standing. It is also a measure of a
company's ability to repay its obligations. When examining the health of a company, it is critical to pay
attention to the debt/equity ratio. If the ratio is increasing, the company is being financed by creditors
rather than from its own financial sources which may be a dangerous trend. Lenders and investors usually
prefer low debt-to-equity ratios because their interests are better protected in the event of a business
decline. Thus, companies with high debt-to-equity ratios may not be able to attract additional lending
capital. A debt-to-equity ratio is calculated by taking the total liabilities and dividing it by the
shareholders' equity i.e., D/E = Liabilities/Equity. Both variables are shown on the balance sheet. iv

Bankruptcy and Credit

Bankruptcy assumes credit. It is premised on the issuance of credit. We live in a market society
where extensions of credit are woven into the fabric of our everyday life. We use water, heat, electricity,
phones, and other daily utilities on credit - the bills come only at the end of the payment period. Without
credit, most of us could not afford to pay for our education, our first home, our first new or used car, that
exotic vacation or that expensive wedding. Most people pay back every penny they owe, mostly due to self-
esteem than out of fear of collection agencies or the law. Others repay debt out of a feeling of moral
obligation. Creditors seldom have to resort to the legal process. Creditors, however, would not grant us
credit if there were no mechanism by which their rights over debtors could be safeguarded. Bankruptcy
Law is one such instrument.

However, not all of us are equally honest in paying off our debts or equally smart in managing them.
Those who fail to pay their creditors are most often not those who are dishonest but rather those who find
themselves in dire financial difficulties brought about by circumstances ranging from imprudence to bad
luck. Business bankruptcies usually result from a combination of poor business management and
unfavorable market conditions (Stanley & Girth, 1971). Thus, American law has always put limits on
creditors’ ability to use the legal process. Even though in the 17 th century, English law frequently treated
debtors as miscreants who deserved whatever fate befell on them, the 17 th and 18th century American
lawmakers tried to balance the rights of creditors and debtors. Laws ensuring creditors’ rights to recover
money owed to them were always tempered with the concern for the debtor’s procedural and substantive
rights (Baird, 2003, p. 30-31). In general, the English Bankruptcy Law is creditor-friendly, while the
American Bankruptcy Law is debtor-friendly.

Concluding Remarks
The concept of a company being a long lasting and a stable institution is ceasing to exist. We are
now witnessing the birth of a new Corporation which is no more a colossal monster moving in torpor but
is agile and hungry. The life of a company has also come down to 20 years from 61 years. The falling of
the old corporation brings forth many moral and ethical issues. The central issue of the rise of institutional
investors changes how a company is owned and exercises decision-making chain in a company. The
silver lining is that the fast paced change, constructive break-down and the new way of doing business
provides ample opportunities for the daring and the dreamers. The tall walls that were built and guarded
by the old organizations are crumbling to the ground and making way for the new age companies.

16
 Corporations invoke chapter 7 or chapter 11 bankruptcy protections for a variety of reasons many of
which do conform to doctrinal, legal or economic predictions. Firms may choose bankruptcy for 1)
forestalling law suits, 2) to force a compensation system in place of the tort system, 3) to eliminate union
contracts, 4) to reduce a court award in a corporate takeover battle, 5) to force the government to take
over responsibility for a pension plan or healthcare coverage promised to the retirees, 6) to avoid cleaning
up a toxic waste site, 7) to alter a bargaining relationship, or 8) revenge against a competitor (Delaney,
1992, p. 161). In general, organizations with larger resources, superior public relations and legal
knowledge, and access to legal and financial specialists are able to use bankruptcy more easily than
organizations or individuals without these resources.

Whatever might be the internal reasons of the individual debtor or the corporation in financial
distress, the bankruptcy law presumes the debtors are honest but improvident and unlucky. The
bankruptcy proceedings are meant to bring timely relief to the debtors so that they have a fresh start, the
creditors have justice meted out to them, and the nation and the world at large are better off from the
future earnings of the debtors.

Ethical and Moral Concerns:

1. Promoter dominance and interference can seriously paralyze otherwise able CEOs and Managing
Directors. Investigate the social and economic implications of this phenomenon.
2. Promoter dominance and interference can seriously paralyze otherwise able CEOs and Managing
Directors. Investigate the ethical implications of this phenomenon, especially in reference to skewed
distribution of wealth as described in Exhibits 6.1 and 6.2.
3. Promoter dominance and interference can seriously paralyze otherwise able CEOs and Managing
Directors. Investigate the moral implications of this phenomenon.
4. The central issue of the rise of dominating institutional investors changes how a company is owned and
the decision- making chain in a company. Investigate the legal, economic, social, ethical and moral
implications of this phenomenon.
5. The concept of a company being a durable, robust and stable institution is ceasing to exist. We are now
witnessing the birth of a new Corporation which is no more a colossal bastion but agile and hungry. The
life of a company has also come down to 20 years from 61 years. The falling of the old corporation brings
forth many moral and ethical issues. Discuss, investigate and corroborate this event with further facts
and figures.
6. How can you legally, ethically, morally and spiritually save the corporation from promoter dominance in
the coming years?

17
End Notes

18
i
In a model prepared by Altman (1968), five basic ratios were utilized in the prediction of corporate bankruptcy. Analyzing empirical
evidence from firms that failed, Altman (1968) estimated the impact of five financial ratios on the probability that a firm will declare
bankruptcy with the following Z scores equation: Z = 1.2 x1 + 1.4 x2 + 3.3 x3 + 0.6 x4 + 1.0 x5 where x1 = Working capital/total assets; x2
= Retained earnings/total assets; x3 = Earnings before Interest and Taxes (EBIT)/book value of total debt; x4 = Market value of equity and
preferred stock/book value of total debt (or total liabilities) and x5 = Sales/total assets.
Variable one is a liquidity ratio; variable two is a financial gearing ratio; variable three is a profitability ratio or earnings ability; variable
four is a size of a firm’s total equity to debt leverage ratio, a liability ratio or indirectly, a shareholder wealth creation metric, and variable five
is a revenue performance ratio. The model attaches highest weights to profitability ratio (x 3) and lowest weight to shareholder value
variable(x4). According to Altman, a Z score below 1.8 indicates sure failure; a score of 1.8 to 2.99 indicates probable non-failure, and a score
of greater than 3.0 indicates assured corporate health or non-failure. This model predicts bankruptcy with 95 percent accuracy one year prior
to bankruptcy and with 72 percent accuracy two years prior to bankruptcy.

The Z scores, however, are not a good predictor for more than two years before bankruptcy. In this sense, the model is not very useful,
since banks and investors, using conventional methods, can predict bankruptcy or that a firm is headed for insolvency two years before it
actually happens. One could enhance predictability by including the standard deviations of these ratios in the Z equation. [For further
improvements on predictability of Z scores, see Altman, Haldeman and Narayanan (1977); Dambolona and Khoury (1980)].
Because it is difficult to determine the market value of private companies (see x 4), this model was designed for public companies.
Altman (1983: 108) believed that the market value of a firm is a more effective indicator of bankruptcy than the commonly used ratio of net
worth to total debt. Book value may be used when calculating the X score for privately held companies. If book value is substituted for
market value, however, then the X coefficients would be changed.

Altman (1983:120-24) suggested the following revised model: Z' = 0.717x 1 + 0.847x2 + 3.107x3 + 0.420x4 + 0.998 x5. A larger area
of uncertainty is associated with Z' scores, which indicates bankruptcy at a value of 1.23 (compared to 1.81 for Z scores) and non-
bankruptcy at 2.90 (compared to 2.99 for Z scores). Z or Z' scores, weights and cut-off points, however, may differ across countries,
industries and markets, will change over time as economic conditions change, and accordingly, Z scores will differ in their predictive
capacity. Hence, great care must be exercised in interpreting and drawing conclusions from the Z scores (Slatter & Lovett, 1999). For
instance, Argenti and Taffler (1977) applied Altman’s (1968) model to UK financial data and concluded that financial gearing and
profitability measures were the most significant ratios in predicting failure, and that liquidity ratios are of less importance. Currently,
with the information of data and large computer processing capacity, Z scores for industries have been developed (e.g., Syspass in the
UK, S&P in the US).

ii
EBITDA is a non-GAAP (Generally Accepted Accounting Practices) measure that allows vast discretion as to what is and what is not
included in the calculation of gross profit. This also means that companies often change the items included in their EBITDA calculation
from one reporting period to the next. EBITDA first came into common use with leveraged buyouts in the 1980s, when it was used to
indicate the ability of a company to service debt. Later, it became popular in industries with expensive assets that had to be written down
over long periods of time. EBITDA is now commonly quoted by many companies, especially in the tech sector — even when it is not
warranted (for more details see Investopedia).

iii
Financial analysts like the Debt/EBITDA ratio because it is easy to calculate. Debt can be found on the balance sheet and EBITDA can
be calculated from the income statement. The issue, however, is that it may not provide the most accurate measure of earnings. More than
earnings, analysts want to gauge the amount of cash available for debt repayment. Depreciation and amortization are non-cash expenses
that do not really impact cash flows, but interest can be a significant cash-paid expense for some companies. Banks and investors looking
at the current Debt/EBITDA ratio to gain insight on how well the company can pay for its debt may want to consider the impact of
interest on debt, even if that debt will be included in a new issuance. In this way, net income minus capital expenditures, plus depreciation
and amortization may be the better measure of cash available for debt repayment (Investopedia).

iv
Optimal debt-to-equity (D/E) ratio is considered to be about 1.0 when liabilities = equity; but the ratio is very industry specific as it
depends on the proportion of current and non-current assets. The more non-current the assets (as in the case of capital-intensive
industries), the more equity is required to finance these long term investments. For most companies the maximum acceptable D/E is 1.5 -
2 and less. For large public companies D/E may be much more than 2, but for most small and medium companies it is not acceptable. In
general, a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations.
However, a low debt-to-equity ratio may also indicate that a company is not taking advantage of the increased profits that financial
leverage may bring (Investopedia).