Short Sellers, Short-Termism and Corporate Governance

I have been
following a corporate battle that erupted last month in Singapore. Muddy
Waters, a financial research firm based in the US, released a 133-page report
on Olam International, a Singapore-based company, alleging several accounting
flaws in the company’s financial statements that did not represent the true
state of its financial health. Upon this announcement, the price of Olam’s
shares fell. It was found that Muddy Waters also simultaneously entered into
short sales of Olam shares.[1]
Olam swiftly responded to the allegations in a number of ways.
First, it issued a counter-statement responding to Muddy Waters’ allegations.
Second, it filed a defamation suit against Muddy Waters before the courts
in Singapore. Third, it announced a rights offering of securities. A rights
offering is considered to be a defensive tactic employed against such short
sale attacks on companies because the lenders of securities to the short
sellers will then call back their securities so that they are able to
participate in the rights offering. This battle is still ongoing, and it is too
early to predict the possible outcomes.
While the above
episode is specific to Singapore, Muddy Waters has initiated similar efforts on
other companies by questioning their financial statements. For example, one of
their targets, Sino-Forest,
a Canadian-listed Chinese timber company had to file for bankruptcy following
such a battle.
Such occurrences
are not altogether alien to India. They have begun to take place here as well. The
year 2012 has witnessed several analysts publishing
regarding various Indian leading companies on matters that range
from accounting practices to governance standards to the role of controlling
shareholders. By highlighting
regarding governance of companies, which extends beyond the
traditional confines of financial analysis, these intermediaries are imposing
considerable pressure on managements and controlling shareholders to reexamine
their own governance standards and practices.
However, this phenomenon is very recent, and its impact on
overall governance standards is yet unknown. In any event, certain recent
reports issued by analysts have been surrounded by their own share
of controversies
. Not only have these reports been strongly refuted by
companies and their managements, in one case a criminal complaint was even
filed by the company concerned against the analyst firm and the individuals who
authored the report.
The impact of these efforts is likely to be mixed. On the
one hand, they will lend themselves to greater transparency on the part of the
companies, as the availability of more information and deeper analysis will
enable investors to take a more informed view of their investments. In other
words, it creates a market-based approach that will likely enhance overall
corporate governance standards, transparency and accountability on the part of
managers and promoters of listed companies.
However, there is also another side to the story. There is
no clarity whether these efforts by analysts and short-sellers will necessary
inure to the benefit of the minority and long-term investors. Analysts with
short positions are inherently conflicted as it is only their short term
interests that motivate their actions. That might not be in the long-term
interests of the company and its investors. Hence, it is likely that these
efforts may benefit a short group of investors to the detriment of the larger
investing community.
Currently, various scenarios are being played out through
market forces via steps taken by the analysts followed by responses by the
companies. If matters were to go out of hand (and there is not enough to
suggest that yet), then it would be interesting to see whether the regulators
would step in to moderate these contests.

[1] Short selling involves the selling of a security that an
investor or a trader does not have in possession when placing the sale order in
the system. A short seller borrows the security and then sells it in the market
with an expectation that it can buy back the same security at a later date for
a lower price than it was sold for. The difference in the selling price and the
buying price would be the profit earned on short selling.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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