Consentia on Law

Disinvestment for Better Governance: How Regulatory Bodies Reinforce PSUs in the Slump


Public Sector Units (PSU) are autonomous and semi-autonomous government owned and government operated agencies involved in commercial and industrial activities.  Disinvestment in PSUs, also known as divestment or divestiture and referring to the action of an organization (or government) selling or liquidating an asset or subsidiary, has become essential for inculcating professionalism and sound managerial skills, and working from this base the paper strongly aims at contending how disinvestment can be used as an effective tool for better governance under the aegis of regulatory bodies.

While disinvestment has provided concrete results so far as resource generation is concerned, the results in terms of efficiency are mixed. There is a need to revisit the subject and plug some of the remaining loopholes in the otherwise robust evolution of disinvestment policy in the country. Over 400 PSUs have been identified with plans in place to divest some of these PSUs, making funds available for social projects under the Planning Commission. In addition to the funds raised, it is also hoped that increased privatization of these undertakings can improve efficiency and productivity. The disinvestment policies, framed by the Department of disinvestment under the Ministry of Finance, provide guidelines and regulate the process of disinvestment in PSUs ensuring that these units working efficiently without any loss. Reserve Bank of India is another regulatory body from which approval for pricing has to be obtained at the time of investment and disinvestment so as to maintain economic stability and capitalistic framework of the economy. Lastly, SEBI plays an important role in providing the guidelines for setting up the stages for disinvestment and has framed critical provisions for the government to meet its disinvestment targets. These regulatory bodies facilitate the process of disinvestment so as to bring targeted PSUs come out of loss, raise the level of economic development and contribute towards social development by ensuring better governance with high efficiency and effectiveness. Hence, it is needless to add that the disinvestment process requires to be taken up more seriously by the government to pull PSUs out of crisis, aiming at a time bound program armed with transparency.


For the first four decades after Independence, the country has been pursuing a path of development in which the public sector is expected to be the engine of growth. However, the public sector overgrew itself and its shortcomings started manifesting in low capacity utilization and low efficiency due to over manning, low work ethics, over capitalization due to substantial time and cost over runs, inability to innovate, take quick and timely decisions, large interference in decision making process ,etc.

Hence, a decision was taken in 1991 to follow the path of Disinvestment. The change process in India began in the year 1991-92, with 31 selected PSUs disinvested for Rs.3, 038 crores. In August 1996, the Disinvestment Commission, chaired by G V Ramakrishna was set up to advice, supervise, monitor and publicize gradual disinvestment of Indian PSUs. It submitted 13 reports covering recommendations on privatization of 57 PSUs. Dr R.H. Patil subsequently took up the chairmanship of this Commission in July 2001.However, the Disinvestment Commission ceased to exist in May 2004. 

The Department of Disinvestment was set up as a separate department in December, 1999 and was later renamed as Ministry of Disinvestment from September, 2001. From May, 2004, the Department of Disinvestment became one of the Departments under the Ministry of Finance.[1]

As the government mulls a step-up in the divestment programme, it may be appropriate to assess the results of the program in India to date – whether it is just a revenue raising exercise or are there sustainable improvements in profitability, productivity, employment, and reduction in government interference in public sector undertakings (PSUs), which are important objectives generally associated with privatisation of PSUs.[2]

Divestment offers an opportunity for big investors to buy a big chunk of shares at one price. However, these stocks are relatively illiquid thus limiting the ability to exit. Except for the ‘long-only-funds’, most of the other investors consider liquidity or ease of exit as a key parameter before making their investment and becoming party to the disinvestment procedure.  The fact of the matter is few public sector companies are investment worthy. Most of the public sector companies have lost their charm, thanks to poor management, bad environment and a visible bias towards private and foreign players. What the government considers as its family silver has lost its value in the market. And the government is partly responsible for it.[3]

The public sector presence is predominant in public utilities and infrastructure. Railways, post & telegraph, ports, airports and power are dominated by CPSEs or department-owned enterprises. In the roads sector, while some roads are owned and maintained by the private sector, publicly owned and maintained roads dominate. Road freight capacity is almost entirely private, while road passenger traffic capacity is also significantly privately owned and managed. In telecom, the public sector continues to be dominant in the provision of fixed line telephone services, while private licensees are operating in some urban areas. Mobile services are predominantly private, particularly in urban areas, and inter-state and international linking services are significantly privately managed and owned. In the tradable goods sector, the public sector is dominant in coal; oil and gas exploration, development, extraction and transportation, though nearly one third of oil refining capacity is now owned by the private sector. The public sector is also a significant player in steel, fertilizer, aluminium and copper. In the engineering industry, the public sector has been losing market share except in electrical machinery, where BHEL is a significant player. In construction and project services, the public sector is a minor player. The bulk of the remaining tradable sector is privately owned and managed.[4]

 The Government has constituted various committees to guide the process of disinvestment through public offer at different stages of the transaction. Such committees include the Core Group of Secretaries on Disinvestment (CGD) for taking decisions relating to the procedural issues and considering any deviations required from the present procedure for effective implementation of CCEA decisions; Inter Ministerial Group (IMG) for overseeing and guiding the process of divestment; and Committee of Officers for recommending to the Empowered Group of Ministers (EGoM) the price/price band/floor price of a public issue, Issue Price, inter se allocation of shares amongst different categories of investor and other related issues in case of pure offer for sale by the Government of India. The EGoM considers the recommendations of the Committee of Officers and decides the price/price band/floor price and other related issues before the public issue opens and after the closure of the Issue it decides the final issue price of the shares and the inter se allocation amongst the investor categories. In case the public offer involves issue of fresh equity and simultaneously Government is also disinvesting a part of its shareholding, an IPO/FPO committee is formed by the Board of Directors of the concerned CPSE for assisting the Book Running Lead Managers (BRLMs) and the Legal Advisors to the Issue, in the preparation of the offer document and carrying out such other tasks as may be required in relation to the public offer. Such transactions are generally referred to as piggy back transactions. The Committee could also be empowered to recommend to the Board of Directors. The work done by the Committee of Officers in the case of pure disinvestment refers to the above-mentioned. The recommendations of the Board of Directors on pricing and price related issues are sent to Department of Disinvestment for placing it before the EGoM for a final decision.[5]

The major thrust for Disinvestment Policy in India came through the Industrial Policy Statement 1991. The policy stated that the government would disinvest part of their equities in selected PSEs. However it did not stake any cap or limit on the extent of disinvestment. It also did not restrict disinvestment to any class of investors. The main objective was to improve overall performance of the PSEs.[6]

Industrial Policy statement in 1991 was framed after the crisis of 1991. After regulations of economic policy, disinvestment was also introduced as a measure. The Industrial Policy, 1991 reads as follows:

• Public Sector Portfolio of public sector investment will be reviewed with a view to focus the public sector on strategic, high-tech and essential infrastructure. Whereas some reservation for the public sector is being retained there would be no bar for areas of exclusivity to be opened up to the private sector selectively. Similarly the public sector will also be allowed entry in areas not reserved for it.

• Public enterprises which are chronically sick and which are unlikely to be turned around will, for the formulation of revival/rehabilitation schemes, be referred to the Board for Industrial and Financial Reconstruction (BIFR), or other similar high level institutions created for the purpose. A social security mechanism will be created to protect the interests of workers likely to be affected by such rehabilitation packages.

• In order to raise resources and encourage wider public participation, a part of the government’s shareholding in the public sector would be offered to mutual funds, financial institutions, general public and workers.

• Boards of public sector companies would be made more professional and given greater powers.

• There will be a greater thrust on performance improvement through the Memorandum of understanding (MoU) systems through which managements would be granted greater autonomy and will be held accountable. Technical expertise on the part of the Government would be upgraded to make the MoU negotiations and implementation more effective.

• To facilitate a fuller discussion on performance, the MoU signed between Government and the public enterprise would be placed in Parliament. While focusing on major management issues, this would also help place matters on day-to-day operations of public enterprises in their correct perspective[7].

 Disinvestment Policy of Government of India

The present disinvestment policy has been articulated in the recent President’s addresses to Joint Sessions of Parliament and the Finance Minister’s recent Parliament Budget Speeches. The salient features of the Policy are:

(i)                 Citizens have every right to own part of the shares of Public Sector Undertakings

(ii)               Public Sector Undertakings are the wealth of the Nation and this wealth should rest in the hands of the people

While pursuing disinvestment, Government has to retain majority shareholding, i.e. at least 51% and management control of the Public Sector Undertakings[8]

National Investment Fund

The Government of India constituted the National Investment Fund (NIF) on 3rd November, 2005, into which the proceeds from disinvestment of Central Public Sector Enterprises were to be channelized. The corpus of the fund was to be of permanent nature and the same was to be professionally managed in order to provide sustainable returns to the Government, without depleting the corpus. National Investment Fund was to be maintained outside the Consolidated Fund of India.

The NIF was initialized with the disinvestment proceeds of two CPSEs namely PGCIL and REC, amounting to Rs 1814.45 crores.[9]

Role of Securities and Exchange Board of India (SEBI) in Disinvestment

SEBI also guides the disinvestment process and procedures through Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeover) Regulations, 1997.

Under Section 2(1) (c) (cc) of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997, disinvestment means the sale by the Central Government or by the State Government as the case may be, of its shares or voting rights and/or control, in a listed Public Sector Undertaking. Securities and Exchange Board of India designed Offer for Sale (OFS) and Institutional Placement Program (IPP) instruments for promoters to divest their holdings to meet the public shareholding norm. These also serve as tools for the divestment of government.[10]

The Government on 17th January, 2013 has approved restructuring of the National Investment Fund (NIF) and decided that the disinvestment proceeds with effect from the fiscal year 2013-14 will be credited to the existing ‘Public Account’ under the head NIF and they would remain there until withdrawn/invested for the approved purpose. It was decided that the NIF would be utilized for the following purposes of subscribing to the shares being issued by the CPSE including PSBs and Public Sector Insurance Companies, on rights basis so as to ensure 51% ownership of the Government in those CPSEs/PSBs/Insurance Companies, is not diluted and preferential allotment of shares of the CPSE to promoters as per SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 so that Government shareholding does not go down below 51% in all cases where the CPSE is going to raise fresh equity to meet its Capex programme. The other purposes for which the NIF would be utilized are as follows:

  • Recapitalization of public sector banks and public sector insurance companies;
  • Investment by Government in RRBs/IIFCL/NABARD/Exim Bank;
  • Equity infusion in various Metro projects;
  • Investment in Bhartiya Nabhikiya Vidyut Nigam Limited and Uranium Corporation of India Ltd; and
  • Investment in Indian Railways towards capital expenditure.

With a view to monitoring the investment through offshore derivatives issued against underlying Indian securities (collectively known as participatory notes), SEBI inserted Regulation 20A in the FII (Foreign Institutional Investors) Regulations , making it mandatory for the FIIs to report the issuance/renewal/cancellation/ redemption of such instruments. The FII regulations have been further amended stating that FIIs can issue offshore derivatives against underlying securities listed or proposed to be listed on any stock exchange in India only in favour of regulated entities subject to compliance with “know your client” requirements. Further, FIIs or sub-accounts have to ensure that no downstream issue or transfer of such offshore derivative instrument will be made to any person other than a regulated entity. The FII Regulations have also been amended to allow FIIs to participate in delisting offers so as to extend the exit opportunity (provided to all other shareholders) to them. FIIs have also been allowed to participate in sponsored ADR/GDR programs as well as in disinvestment of securities by the Government of India.[11]

Under the FEMA Regulations, only NRIs and SEBI registered FIIs are permitted to purchase Government Securities/Treasury bills and corporate debt. The details are as under:

A. A Non-resident Indian can purchase without limit,

(1) on repatriation basis

(i)     Dated Government securities (other than bearer securities) or treasury bills or units of domestic mutual funds;

(ii)   Bonds issued by a public sector undertaking (PSU) in India; and

(iii) Shares in Public Sector Enterprises being disinvested by the Government of India.

(2) on non-repatriation basis

(i)     Dated Government securities (other than bearer securities) or treasury bills or units of domestic mutual funds;

(ii)   Units of Money Market Mutual Funds in India; and

(iii) National Plan/Savings Certificates.

B. A SEBI registered FII may purchase, on repatriation basis, dated Government securities/ treasury bills, listed non-convertible debentures/ bonds issued by an Indian company and units of domestic mutual funds either directly from the issuer of such securities or through a registered stock broker on a recognised stock exchange in India.[12] An Indian Party will have to comply with the following: –

(i)                 receive share certificates or any other documentary evidence of investment in the foreign entity as an evidence of investment and submit the same to the designated AD within 6 months;

(ii)               repatriate to India, all dues receivable from the foreign entity, like dividend, royalty, technical fees etc.;

(iii)             submit to the Reserve Bank through the designated Authorized Dealer, every year, an Annual Performance Report in Part III of Form ODI in respect of each JV or WOS outside India set up or acquired by the Indian party;

(iv)             report the details of the decisions taken by a JV/WOS regarding diversification of its activities /setting up of step down subsidiaries/alteration in its share holding pattern within 30 days of the approval of those decisions by the competent authority concerned of such JV/WOS in terms of the local laws of the host country. These are also to be included in the relevant Annual Performance Report; and

(v)               in case of disinvestment, sale proceeds of shares/securities shall be repatriated to India immediately on receipt thereof and in any case not later than 90 days from the date of sale of the shares /securities and documentary evidence to this effect shall be submitted to the Reserve Bank through the designated Authorized Dealer.[13]

A. Disinvestment by the Indian party from its JV/WOS abroad may be by way of transfer/ sale of equity shares to a non-resident / resident or by way of liquidation/merger/ amalgamation of the JV/WOS abroad.[14] In case of disinvestment of stake in overseas JV/WOS, can an Indian party disinvest with write off of part of investment?

A. Indian Party may disinvest without prior approval of the Reserve Bank, in the under noted cases, where the amount repatriated on disinvestment is less than the amount of the original investment:

(i)     in cases where the JV / WOS is listed in the overseas stock exchange;

(ii)   in cases where the Indian Party is listed on a stock exchange in India and has a net worth of not less than Rs.100 crores;

(iii) where the Indian Party is an unlisted company and the investment in the overseas JV/WOS does not exceed USD 10 million and

(iv) where the Indian Party is a listed company with net worth of less than Rs.100 crores but investment in an overseas JV/WOS does not exceed USD 10 million.[15]

As per regulation 10 of the SEBI (Acquisition of Shares) Regulation, 1997, no acquirer shall acquire shares or voting rights in a company, unless such acquirer makes a public announcement to acquire shares of such company in accordance with the regulations. Hence SEBI’s Takeover Code gets triggered when a person (Strategic Partner) acquires more than 15% of the Voting equity shares is required to make a public offer to purchase shares not less than 20% of the equity of the company. This provision has a great impact on the strategic sale transaction. For instance, in such case the Strategic Partner would be required to buy another 20% of the shares from public, which means SP, has to buy total 45% of the shares.

Role of Reserve Bank of India (RBI) in Disinvestment

After the completion of several successful disinvestments in PSUs by GOI, RBI has issued guidelines governing the provisions of bank finance for PSU disinvestments exempting the banks from the restrictions earlier imposed on lending against shares and lending for acquisition of corporate control. Now a day’s all PSU disinvestments are funded primarily by pledging of the shares acquired through the disinvestments with additional/third party security of varying degrees as appropriate from bidder to bidder.

As a safety policy, the government insists that the successful bidder remains committed to not disturbing the status quo with the PSU for at least 3 years that means the shares initially purchased from government are subject to a contractual ‘lock-in’, requiring the winning bidder not to sell these shares.

Even a financial pledge of these shares has to be approved by the Government and enforcement to the pledge requires government approval. RBI guidelines impose a condition that the bank finance may be extended only for acquiring shares from the government and under open offer prescribed under the SEBI Takeover Code. Subsequent acquisition can’t be funded and hence put and call options will not enjoy bank funding.

RBI guidelines permit bank finance only for disinvestments approved by the government and therefore, bidders for state levels PSUs are excluded from access to bank finance. RBI has also directed to banks not to lend unless the bidder has an excellent track of record of servicing the loans from the banking systems.[16]

Reasons for Disinvestment: What is the Need?

 There are mainly two reasons in support of disinvestments. One is to provide fiscal support and the other is to improve the efficiency of the enterprises. The argument for fiscal support emphasis that the resources raised through disinvestments must be utilized for retiring past debts and there by bringing down the interest burden of the Government. The second argument in support, to improve the efficiency of the public enterprises through disinvestments, is the contribution that it can make to improve the efficiency of the working of them.

The following are the main objectives of disinvestments policy of the Government.

  • To reduce the financial burden on Government.
  • To improve public finances.
  • To introduce, competition and market discipline.
  • To find growth.
  • To encourage wider share of ownership.
  • Help them upgrades their technology to become competitive.
  • Build competence and strengthen their R&D.
  • Rationalize and retain their work force.
  • Initiate diversification and expansion programmes[17].

As part of the economic reforms, the public sector reforms are also initiated to improve their efficiency and productivity. In this direction disinvestments and privatization are steps to improve the performance and working of public sector undertakings. The new industrial policy provides that “in order to raise resources and encourage wide public participation, a part of the Government shareholding in the public sector, would be offered to mutual funds, financial institutes, and general public and employees”. The goals of disinvestments are clearly identified and classified into short term and long term. Disinvestment may be undertaken to reduce or mitigate fiscal deficit, bring about a measure of economic stabilization or to improve efficiency in public enterprises through structural adjustments. It is in this context the PSUs have been demanding that a part of the disinvestments proceeds should be allowed to be retained by PSUs in order to be use to further their research and development, build and enhance their workforce and step into the shoes of diversification of activities. In other words, the objectives of disinvestment vary from improving efficiency of public sector undertakings to transforming society.

Disinvestment as a means results into the end of privatization. The touchstone for privatization is the concept that private ownership leads to better use of resources and therefore more efficient allocation. Throughout the world, the preference for market economy received a boost after it was realized that the State could no longer meet the growing demands of the economy and the State shareholding inevitably had to come down. The State in business argument thus lost out and also the presumption that direct and comprehensive control over the economic life of citizens from the Central government can deliver results better than those of a more liberal system that directly responds according to the market driven forces was rejected. Another reason for adoption of privatization policies around the globe has been the inability of the Governments to raise high taxes, pursue deficit inflationary financing and the development of money markets and private entrepreneurship[18].

Further, technology and W.T.O. commitments have made the world a global village. Unless industries, including public industries do not quickly restructure, they would not be able to survive. Public enterprises, because of the nature of their ownership, can restructure only slowly and hence the logic, of privatization gets stronger. Besides, techniques are now available to control public monopolies like Power and Telecom, where consumer interests can be better protected, by regulation / competition, and investment of public money to ensure protection of consumer interests is no longer a convincing argument.

The problem associated with our public enterprises is not the quality of their assets or manpower, but the overall decision-making environment. Under private management, these enterprises would realize their true potential, thus realizing the ultimate goal of the disinvestments programme, i.e., optimal utilization of the investment locked-up in the PSUs. The successful privatization of non-critical PSUs would pave way for better governance and improve the overall work environment.

Another gain of privatization has been the stock market discovery of the latent worth of public sector enterprises. The market capitalization of PSUs zoomed up to Rs. 1, 66,000 Crores in May 2002- a raise of almost 76%. Disinvestment of loss-making PSUs would entail the infusion of fresh capital by the Strategic Partner and these would be under excellent management control with specific accountability and ability to take quick decisions.

 Methods of Disinvestment: The Step by Step Breakdown of the Disinvestment Process

 The disinvestments process is related to the procedure adopted by the Government. The procedure involves the valuation of shares and modalities to be adopted for sale of such shares. There are three broad methods, which are used for valuation of shares, namely,

  • Net Asset Value Method: This will indicate the net assets of the enterprises as shown in the books of accounts. If shows the historical values of assets. It is cost price less depreciation provided so far on assets. It does not reflect position of profitability.
  • Profit Earning Capacity Value Method: The profit earning capacity is generally based on the profits actually earned or anticipated. It is excess of earnings over expenditure. It does not really indicate the intrinsic value of the enterprises.
  • The Discounted Cash Flow Method: This technique is popularly used to evaluate viability of an investment proposal. In this method the future incremental cash flows are forecasted and discounted into present value by applying cost of capital rate. This method indicates the intrinsic value of the enterprises. This method is a far more comprehensive and complicated method of reflecting the expected income flows to the investors.

Out of these three methods the discounted cash flow method is of greatest relevance though it is the most difficult to conduct.

The step by step process of disinvestment is as follows:

  • Proposals for disposal of any PSU (Public Sector undertaking), based on recommendations of DC (Disinvestment Commission) or CCD (Cabinet Committee on Disinvestment).
  • After CCD clears, selection of Advisor through competitive bidding process.
  • The Advisor assists GOI (Government) in the preparation and issue of EOI (Expression of Interest) in newspapers.
  • After receipt of EOI from interested parties, prospective bidders are short-listed.
  • Due diligence (DD) by concerned PSU.
  • Based on Due Diligence by PSU, the Advisor prepares Information Memorandum for giving it to the short-listed bidders who has entered into a Confidentially Agreement.
  • Advisor, with the help of Legal Advisor, prepares Share Purchase Agreement.
  • Discussions among Advisors, Govt. & representatives of PSU.
  • Valuation of the PSU in accordance with the standard national practice.
  • The share Purchase Agreement (SPA) is finalized based on the reactions received from the prospective bidders.
  • These Agreements are then vetted by the Minister of Law and are approved by Govt.
  • Thereafter these are sent to prospective bidders for inviting final bidding bids.
  • The bids received are examined, analyzed and evaluated by the IMG (Inter Ministerial Group) and placed before the CCD for final approval of bids.
  • After the transaction is completed, all papers and documents relating to it are too turned to the C&AG (Controller and Auditor general of India, to enable C&AG to undertake an evaluation of the disinvestments, for placing it in parliament and releasing it to the public[19].

In the disinvestments process explained, the DOD (Department of Disinvestment) is assisted at each stage by an IMG (Inter Ministerial Group) comprising, Officers from the Ministry of Finance, Department of Public Enterprises, and the administrative Ministry, Department of controlling PSUs (Dep’t. of (HI&PE) and Officers of Department of disinvestments & Advisors.

Positive Co-Relation between Disinvestment and Corporate Governance

 A new trend of global integration began to emerge and countries all over the world, whether developed or developing, capitalist or socialist, started undergoing vast economic changes, witnessed by the decline in the role of the State in commercial activities and increasing privatisation of state owned enterprises. In 1980s, privatisation had started in real earnest in several parts of the world. This was facilitated by the gradual integration of the world economies, which ensured that capital and goods flowed more freely to countries suffering from lack of resources. Foreign capital became freely available to finance large infrastructure projects, for want of which the domestic private parties were hitherto unable to come forward, and State support was necessary. Acceptance of the W.T.O regime by most of the countries has since led to gradual abolition of quantitative restrictions and reduction in duties and removal of restrictions on inter country trade. As a result, the relevance of the State in providing resources for various commercial activities and protecting the interests of consumers has considerably reduced.[20]

In the evolution of modern capitalism, with separation of ownership from control as firms grow in size and complexity, agency problem arises: how to ensure that the managers (“promoter” in Indian parlance) work to maximise return on shareholders’ capital. Given the information asymmetry, managers could pursue their private goal disregarding the shareholders’ interests. This is at the heart of the problem of modern literature on corporate governance. Various institutional and contractual mechanisms have evolved in the last century to grapple with this problem.

In the context of efficiency of resource use in a socialist economy, economist Oskar Lange sought to solve the problem of how to ensure that managers of public firms maximized efficiency consistent with the goals set by the central planners. However, looking at the microeconomics of firms in a socialist economy, economist Jonas Kornai argued that they were unlikely to be efficient because of the soft budget constraint: that is, firms do not go bankrupt or managers do not lose their jobs for their poor performance. Firms can always renegotiate their contracts with the planners to hide their inefficiency. In India public sector firms are often face with multiple objectives, and multiple owners or monitors – central government, state governments, legislators, public auditors and so on.

Managers may not necessarily maximise profits as they could always highlight a particular achievement to suit their convenience. Managers may be risk averse as they face constitutionally mandated procedural audit by the Comptroller and Audit General if an enterprise is majority government owned. Managers’ efficiency objectives may come in conflict with dysfunctional political interference in operational matters (at the expense of policy issues) to meet narrow political goals. However, at the same time, poor performance by managers does not involve any punishment as they can re-negotiate the output prices, budgetary support, or have access to soft and/or government guaranteed loans; in other words they do not face a hard budget constraint. Thus, the agency problem is endemic to all economic systems. Moreover, problem of soft budget constraint is not restricted to socialist economies but evident in market economies as well when the firm is question is large and considered of strategic importance for the economy, though perhaps to much lesser extent. Rescue of Chrysler Corporation – the third largest automotive firm in the US – in the late 1970s and United Airlines after “9/11” in the US are clear instances of state support for failing companies. Such support is more common in financial sector, where failure of firms can have significant systemic risk.[21]

The Government announced on 24th July 1991 the ‘Statement on Industrial Policy’ which inter-alia included Statement on Public Sector Policy, put forth the decision that portfolio of public sector investments will be reviewed with a view to focus the public sector on strategic, high-tech and essential infrastructure. Whereas some reservation for the public sector is being retained, there would be no bar for area of exclusivity to be opened up to the private sector selectively. Similarly, the public sector will also be allowed entry in areas not reserved for it.

Public enterprises which are chronically sick and which are unlikely to be turned around will, for the formulation of revival/rehabilitation schemes, be referred to the Board for Industrial and Financial Reconstruction (BIFR), or other similar high level institutions created for the purpose. Social security mechanism will be created to protect the interests of workers likely to be affected by such rehabilitation packages.

In order to raise resources and encourage wider public participation, a part of the government’s shareholding in the public sector would be offered to mutual funds, financial institutions, general public and workers.

Boards of public sector companies would be made more professional and given greater powers.

There will be a greater thrust on performance improvement through the Memorandum of Understanding (MOU) System through which managements would be granted greater autonomy and will be held accountable. Technical expertise on the part of the Government would be upgraded to make the MOU negotiations and implementation more effective.

To facilitate a fuller discussion on performance, the MOU signed between Government and the public enterprises would be placed in Parliament. While focusing on major management issues, this would also help place matters on day-to-day operations of public enterprises in their correct perspective”.

In accordance with the decision announced in the aforesaid statement on industrial policy on public sector and also as per budget speech of July 1991, in order to encourage wider participation and promote greater accountability, the Government equity in selected CPSEs (Central Public Sector Enterprises) was offered to mutual funds, financial institutions, workers and the general public.

In the subsequent years, there have been constant policy changes. While on one hand, disinvestment as a policy has been much debated, there have also been changes and disagreements in terms of the different approaches that can be taken for disinvestment to happen and ensure good governance[22]


 Disinvestment Ensuring Better Corporate Governance

Corporate governance serves as a mechanism for shareholders to discipline managers and control overinvestment. Strongly governed firms deviate less from the optimal investment policies and have a higher value of growth options and higher value of disinvestment options than weakly governed firms. Growth options are riskier and disinvestment options are less risky than assets-in-place. A higher value of growth options, therefore, leads to higher stock returns and a higher value of disinvestment options leads to lower stock returns. The net effect of corporate governance on cross-sectional stock returns depends on the relative importance of growth options and disinvestment options to firm value. Because the value of growth options is larger than the value of disinvestment options during expansion and vice versa during contraction, the model predicts a procyclical relation between corporate governance and stock returns[23]

By releasing the voluntary guidelines on corporate governance, the government has expressed a strong desire to improve the corporate governance standards in Corporate India. As the government’s disinvestment strategy gathers momentum, there is a genuine need to improve the levels of transparency, and accountability within PSUs. As a first step towards achieving that, the corporate governance norms for Central Public Sector Enterprises (CPSEs) introduced in 2007 have now been made mandatory for all unlisted PSUs. However, there continues to be concerns around effective implementation of these norms. Autonomy of PSUs, functioning of the PSU boards, failure on the part of many listed PSUs (Navratnas and Miniratnas) to comply with Clause 49 of the SEBI Listing Agreement and the vast differences that exist between the governance standards prevalent in central and state PSUs are some of the key issues that need to be tackled on a war footing.[24]

It is the ability of the government to ‘overrule’ boards and regulators — sometime through legislations — that is hampering any progress of PSUs in corporate governance. It is easy to understand that the government is able to extract preferential treatment, and then, what is the incentive of the management of the Public Sector Undertakings to comply?

Government ownership is widely seen as an obstacle to good governance. Managers lack incentives, decision-making is slow. But in at least two respects, PSUs have advantages over private firms. One, given the elaborate checks and balances in the public sector, there is less scope for manipulation of accounts. The Satyam type of disaster is less likely in PSUs.[25]

Disinvestment is often a cheaper and cleaner alternative than closure of loss making public sector unit. However, it is very important to calculate the financial effect of divestment before any final decision is made. Also it must be ensured that proceeds of disinvestment are utilized for the betterment of research, workforce and governance of public sector undertakings.

[1]Disinvestment- A Historical Perspective, available at: (Visited on August 18, 2013)

[2]Kumar V. Pratap, “Disinvestment Programme in India: A Look at the Returns”, Financial Express, March 28, 2013

[3]Shishir Asthana, “PSU Disinvestment- Chidambaram has Enough Reason to be Worried”, Business Standard, September 6, 2013

[4]White Paper on Disinvestment of Central Public Sector Enterprises, available at: (Visited on August 29, 2013)

[5] Handbook on Disinvestment through Public offering, available at: (Last visited on August 25, 2013)

[6] Vaibhav, “Current Disinvestment Policy of Government of India”,, March 21, 2013

[7] Chaitanya Kini, “Disinvestment Policy of the Government: Pros and Cons”, GIM Society of Finance,  May 12, 2012

[8] Disinvestment Policy, available at: (Visited on August 20, 2013)

[9]National Disinvestment Fund, available at: (Visited on August 25, 2013)

[10] Ashwin Ramarathinam, “All PSUs Meet SEBIs Public Shareholding Norms”, Live Mint, August 12, 2013

[11]Part One: Policies and Programmes, available at: (Visited on August 10, 2013)

[12] Foreign Investments in India, available at: (Visited on August 29, 2013)

[13] Overseas Direct Investment, available at: (Last Modified March 18, 2013)

[14] ibid

[15] ibid

[16] L. Rajarajeshwari, “Disinvestment an Overview”, available at: (Visited on August 26, 2013)

[17] Shyamal Banerjee, “A Good Reason for Disinvestment”, Live Mint, April 2, 2013

[18] ibid

[20] Disinvestment Manual- February 2003, available at: (Visited on August 15, 2013)

[22] Policy on Public Sector and Disinvestment, available at: (Visited on August 23, 2013)

[23] Erica Li, “Does Corporate Governance Affect the Cost of Equity Capital, available at: (Visited on August 28, 2013)

[24] Corporate Governance in the Public Sector- The Road Ahead, available at: (Visited on August 18, 2013)

[25] TT Ram Mohan, “Disinvestment for Better Governance”, Economic Times, November 19, 2012


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