Listing of L&T’s subsidiaries: Management creates its own ‘options’
L&T’s executive directors have been opportunistic – they have generously issued themselves stock options at face value from subsidiaries before their IPO’s. The manner and timing of these issuances raise questions on L&T’s governance practices, and the checks and balances the company has in place.
As part of its long term strategy to unlock value, Larsen & Toubro Limited (L&T) decided to list two of its 121 subsidiaries in 2016 – Larsen & Toubro Infotech Limited (Infotech) and L&T Technology Services Limited (TechServices). As a conglomerate with several businesses, L&T’s decision to list these businesses as they reach critical mass is good for its shareholders. But, L&T’s management has also made the most of the opportunity – through the issuance of stock options.
IiAS believes that stock options serve as a good measure for long-term incentives. By stipulating conditions of grant, vesting and exercise, stock options can help link pay with price performance and therefore, align management and shareholder interests. Having said so, there are five issues we would like to focus on with regard to these grants:
Responsibilities as part of the holdco board Three of L&T’s board members (A M Naik, S N Subrahmanyan, and R Shankar Raman) have received stock options from Infotech and / or TechServices. Both these companies were, and continue to remain, part of the L&T group. Therefore, as board members of L&T, they are already responsible for the growth of these businesses – do they need to be rewarded separately just because these businesses are getting listed? We believe not – especially since all three executives draw remuneration from L&T, which we believe, is commensurate with the size and performance of the consolidated entity.
Remuneration committee composition The Nomination and Remuneration Committees of both Infotech and TechServices include members of the L&T board – those that have rewarded themselves.
Generous dole-outs IiAS looks at issuance of stock options at deep discounts as deferred compensation – in both these cases though, the rewards have been generous. In the case of Infotech, 35% of the ESOPs granted have been to the board, and 19% of the total pool has been granted to the non-executive directors belonging to the L&T board. In TechServices case, 53% of the total pool has been granted to its board, and 36% of the total pool has been granted to L&T’s board members.
Further, take the case of Infotech – the IPO price was Rs.710 and it closed on 21 September 2016 at Rs. 637.75. Investors in the IPO are currently losing money, while Infotech board’s options, including those granted to L&T’s executive directors, are well in-the-money.
Timing The timing of the TechServices grant should also raise eyebrows. These stock options were issued between the filing of the draft red herring prospectus (DRHP) and the red herring prospectus (RHP) 1. Between the DRHP and the RHP, companies will have estimated the market appetite for the equity as well as arrived at a broad understanding of the price range at which the book-building process will close. Issuing stock options this close to listing at face value is assured money, irrespective of what the vesting and exercise periods are.
Disclosures
The disclosures on stock options are poor. Until the RHPs were filed, there were no available disclosures on the stock options being granted to L&T’s board members from subsidiaries (Related Research: Unlisted Subsidiaries – The New Cloaking Device)2. How do shareholders then vote on overall compensation of L&T’s executive directors, if material components of the remuneration structure are not being disclosed?
L&T forms part of the major indices and has garnered respect for being one of India’s largest professionally managed conglomerates. However, this episode shows that L&T’s executive directors behaved opportunistically. It raises questions on the company’s governance quality and the checks and balances it has in place.
Independent of the imminent change of guard, L&T needs a stronger (and not larger) board that can stand up to the company’s history and provide the required push-back to its senior management. The board must uphold the value system3 that the company has been built on.
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