Why Promoters Cheat?

As the capital markets flourish there will always be new businesses entering to tap the vast pools of capital available. As the middle class grows & technology makes it easier to transact on the exchanges, a lot of retail capital will flow through. But with all these innovations one thing cannot be said for certain, the honesty of many of these business promoters to look after shareholder’s interest rather than just their own.

The market regulator has a difficult time to keep track of all these known & future offendors. But should we as investors rely solely on the regulator’s ability to track these offendors down or should we question the intentions of business owners before we invest with them?

To start with, I believe we need to understand what makes these promoters want to cheat their partners (shareholders). Perhaps that may open a window into their personality to figure out if they will be prone to cheat or not. In Hindu philosophy there are these objectives that we ought to live by throughout our life. They are, Kama, Artha, Dharma & Moksha. The first one deals with Desire (Kama), the second deals with Wealth (Artha), the third deals with Moral well-being (Dharma) & finally retirement (Moksha) or spiritual liberation.

As much as we are tempted to go by their mythological association, we must look at it from a practical point of view. Kama, or the desire – can be about anything we feel the most passionate about. For an entrepreneur, it can be the desire to be independent & start a business of his own in an area where he believes the opportunity lies. This is usually an intense desire which drives the entrepreneur to scale the business up from the first client to several more in the future. Artha, of course a business without monetary rewards is a bad proposition. There is always an incentive to make money through the business, otherwise no wise man would (should) invest in it. Dharma, it is the ability to run the business in the most ethical & just way or competing in a dignified manner. This objecetive sets up a culture within the business & is by far the most important of all the four. Finally Moksha, as the entreprenuer ages & realizes his inability to move on with the same energy, he feels like taking a step back & enjoy his wealth, meanwhile provide direction to the younger generation of managers to run the business.

Well all this sounds too good to practise but not impossible. How can anyone who has such crystal clear objectives feel like wavering from them & cut corners? Why cheat when all is laid out so beautifully?

I could think of four reasons so far:

1. Ability – Many promoters have the ability to start a business & enter into an industry but most of them do not have the ability to scale these businesses up to the next level. It may be a personal inability rather than intellectual. But the desire to go the next level is very dominant. When the ability doesn’t catch up with the plans of scaling up, there is a huge incentive to cheat. (example: promoters who misreport sales figures showing perpetual growth, etc)

2. Greed – We are all greedy for something or the other. Some people are greedy for money. It is a very bad combination, to be at the head of a business & develop greed. Greed consumes the mind with a singular objective to have more of something, always. A promoter who is greedy for money has the tendency to use his business as a vessel to pour more cash into himself. (example: Businesses that have unlisted (private) subsidiaries owned by the promoter who seem to somehow constantly need loans from the parent company, etc)

3. Envy – When two businesses compete, one may be better than the other in terms tapping the market, providing better quality, having good relations with clients & a good image about it. The other business who is playing catch-up might feel envy towards the former. The envy of not being able to make things work like the other can be a massive distraction for the promoter, which will eventually lead to making wrong tactical decisions.
(example: businesses that create artificial market share by giving kick backs to customers so the sales look good but the bottom line bottoms out, etc)

4. Environment – Lastly the environment in which the entreprenuer is established may be a deciding factor in what actions will be taken. Despite being good, he might be tempted to cheat in order to win. Competition is good, but when it becomes cut throat it is anti-competition. There are promoters who want to compete in a healthy way, but when the other players play rough most find it difficult to stay clean but still abstain from playing rough. Also the competition can be with the stock market expectation irrespective of the business fundamentals, which can cause the promoters to focus on quarterly growth rather than sustained long-term growth.
(example: using predatory tactics to avoid smaller businesses from becoming big, creating artificial barriers by cornering supply, use soft incentives to keep the distributors from distributing other competitors products)

There might be many more reasons why promoters would want to cheat & shareholders must always lookout for such offendors by either studying the financial statements properly or by asking really pointed questions about the business practices during the AGM’s. Not all promoters are bad & many uphold the tenets of capitalism & try to protect them by always playing fair. We would like to have partners that don’t cheat & respect our stake. Partnering with cheating owners is out of question & even out of our moral character.

Note: SEBI has launched this website for keeping investors aware of known offendors.

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