THEORY OF TRUST AND A POSSIBLE IMPLICATION ON PREVALENCE OF CORRUPTION

Being corrupt implies destroying integrity by being dishonest and tainting the object in question. The object is generally a relationship between an institution (or an officer of an institution) and an individual (a customer or stakeholder of that institution) in most cases. However, corruption also extends to individual relationships and that is in the simple form of trust. Trust is the corner stone of all relationships in my view; be it a parent-child or sibling relationship, friendship, boss-subordinate or peer-peer liaising, a doctor-patient association, state-civilian relationship etc. The presence of trust provides confidence that the individuals/institutions related in the equation will conduct themselves in an expected fashion. When that expected behavioral pattern is altered, uncertainty increases and doubts creep in causing friction in an otherwise agreeable equation.

In my experience and discussions, such encounters of broken trust are becoming increasingly common and frequent across social set-ups. These instances are of also of varieties and intensities. I am told there once was an individual who feigned illness with one friend to be able to go out partying with another set of friends. All was well until the time the friend who was lied to spotted her friend all hale and hearty making merry. No big deal really, but this definitely corroded an otherwise solid friendship especially since the trust was broken for a trivial reason. There are innumerable stories of bosses filling in their own bonus kitties and not fulfilling promises made to subordinates or alternatively unwarranted promotions being granted out of partiality. At the end of the year not only does it lead to heartburn but increases churn rates of employees in an organization impacting the team morale and general foundation of the entity in question. Negligent and unconcerned doctors cause grave damage to lives and the medical profession alike. Spousal mistrust leading to violence and abuse is only on the increase if media is to be believed. The state and the representatives of the state not delivering on their promises is now sadly an accepted part of life in India.

Why the breakdown of trust at individual levels leads to societal and professional discord is quite interestingly illustrated by Roy J. Lewicki’s framework[1] of trust and distrust.

HIGH TRUST characterized by: Hope, Faith Confidence, Assurance Initiative	· High-value congruence · Interdependence promoted · Opportunities pursued · New initiatives	· Trust but verify · Relationships highly segmented & bounded ·Opportunities pursued & risks/vulnerabilities continually monitored
LOW TRUST characterized by: No Hope, No Faith No Confidence Passivity, Hesitance	· Casual acquaintances · Limited interdependence · Bounded, arms length transactions · Professional courtesy	·Undesirable eventualities expected & feared · Harmful motives assumed · Interdependence managed · Pre-emption, Best offense is good defense · Paranoia
	LOW DISTRUST characterized by: No fear, No Vigilance Absence of Skepticism Absence of Cynicism Low Monitoring	HIGH DISTRUST characterized by: Fear, Vigilance Skepticism, Cynicism Wariness Watchfulness

If we were to assume a starting point, it may be fair enough to say that most relationships start in the quadrant of Low Trust – Low Distrust(1). There is little expectation from the involved parties of one another. However, a society largely prevailing in this mode is prone to be inefficient given the limited interdependence.

From this quadrant, the relationship in the best case scenario moves to the quadrant with High Trust – Low Distrust (2). Entities and societies in this mode are more likely to be very proficient, cohesive and with a higher quotient of well being as they are most prone to resolving conflicts arising due to trust issues[2]. With a high trust factor and a low distrust factor there is a higher likelihood of people not wanting to destroy integrity. Once that integrity is broken the relationship moves into a place which has the presence of High Distrust. It will be unfair to assume that with one instance of broken trust the relationship cascades into the least desirable quadrant of Low Trust – High Distrust (4).

Taking the case of the friend sighted above and that of professional environments, it is likely that from quadrant 2, the relationship first transgresses to High Trust – High Distrust quadrant (3). If repeated interactions lead to situations where the expected behavioral patterns are altered and/or dishonesty pursues, then the relationship is doomed for quadrant 4. In this environment interactions are fairly guarded, conversations monitored, information exchange not optimal and there are significant inefficiencies in the system.

If I take the context of the urban Indian environment today we are in the High Distrust quadrants. With the state, the relationship of the civilians is in the least desirable quadrant 4. In the case of urban middle class amongst themselves, in my view we are in quadrant 3. There are too many expectations that are laid on people in personal contexts and when these are not met with, the situation is of quadrant 4. This partly explains, in my view, the rising spousal violence, killings of employers (unorganized sector) etc. In the true professional environment money is becoming a key motivating factor and that in the environment of recession if monetary payments are not met there is severe corrosion of trust. Thus at work we are shuttling between quadrants 3 and 4. There are fewer people who trust in the “goodness” of another individual or institution.

Thus, in my view, whether we eradicate corruption or not is dependent on whether we can restore trust and eradicate distrust. If we can at least lower the prevalence of distrust, we will be able to move towards creating an environment where dishonesty is lower. Lower dishonesty will promote trust. There is a chance then that we may be able to create an environment of existence are quadrants 2 and 3. Whether, the Jan Lokpal bill, can achieve this aim, I remain skeptical! Not because of lack of trust or dominance of distrust, but because I do not believe centralization of an issue is an efficient means of arriving at a resolution.

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[1] Ref: A Cognitive Theory of Trust, Hill & O’Hara

[2] Lewicki et al., A Cognitive Theory of Trust, Hill & O’Hara

We Don't Need No Legislation

I was in London the last week and hence missed the hoopla in the country with Anna Hazare’s fast unto death. I was back in the country for a few hours on Saturday and all I could read and hear was how this one man had given the country some hope of seeing lower dishonesty. I was not convinced; not with Anna Hazare’s spirit but with the suggested course of action, the bill itself. Call me a skeptic, call me a cynic; I just do not believe that another law in this country will actually help reduce corruption. The only thing it will do is generate employment – first for those who help the committee research the draft and then for those who become a part of the Lokpal. In fact if the Lokpal is set up it will bejust another way of exploitation and influencing.

These thoughts were loitering in the corners of my brain cells on Saturday night as I queued outside the airport waiting to get in for my next international flight. Suddenly the lingering thoughts burst to the forefront. There were two youngsters praising Anna and cursing the politicians. It was not their chatter that got my sleepy thoughts to wake up and skip around. It was their actions. As they spoke of the rampant treachery in the nation, they were trying to jump the queue. I was amused with the hypocrisy. I encountered the duo yet again at the security check, scurrying around to see how they could move ahead of turn once more.

This attitude and insincerity is what makes me a believer that legislation will not be effective in reducing or ridding the country of corruption. The interest around Anna Hazare’s fast probably benefited the media the most and the telecom company as some attention has been diverted away, finally! The rest of us will talk of this for a while and then move on to being who we are – finding the quickest route possible to achieve our goals.

Aboard my flight I was fighting my time zone clash and decided to watch a movie. I stumbled across a Naomi Watts film, Fair Game. The film is based on the autobiography of an ex-CIA covert agent, Valerie Palmer, who at the time of the US attacking Iraq was almost about to prove that there were no WMD in Iraq. As the invasion started, her husband, an ex-ambassador to Niger started questioning the government’s motives. In order to divert attention away from the tough questions that were posed, the White House made the couple a pawn. Valerie’s cover was blown, her credibility and track record trashed and her husband was made to look like an anti-American. The world knows today that there were no WMD in Iraq but there is a lot of Oil. If the White House could stoop to abysmal levels only to safeguard the President’s ratings and cover up the lies; I am sure that less powerful people, hungrier for power could stoop to lower levels. With resources and might on their side, a legislation will only be a small hurdle. Yes, I was all along thinking of the Lokpal bill.

Corruption is prevalent world over. The difference in India is that we see it blatantly in our faces every single day. That does not mean that we condone it or do not work to rid society of this ill. However, legislation can never work in the absence of willingness. Valerie Palmer and her husband decided to take the challenge head on and speak the truth. They did not succumb to the might of the White House. Anna Hazare did not worry about himself or how would his actions be received by the government. He believed that it was his duty to bring attention to the rampant corruption in the country and the need to address it and so he fearlessly forged ahead with his mission. It is fortitude that got the system to pause and pay attention. It was his sincerity and courage that got the nation to support him, however, the spirit that he would probably like to see (in my view) is probably absent; my point in case being the duo at the airport.

Legislation can work when there is a need to enforce a right, for e.g. the right to vote or the right to religion. Legislation cannot replace ethics, moral conduct or righteousness. So there can be a legislation that provides citizens with the right to query processes and get information, however, then it is up to law and lawmakers to enforce justice. Giving powers to a centralized committee to enforce “justice” in case of corruption related issues only provides an opportunity for the influential to exert pressure on one body rather than fight their ills through the system. We need to acknowledge that in any form or shape, the center of power and influence will remain the same. To bring change we need to change that core. To strengthen and alter that foundation we as citizens need to speak fearlessly and acknowledge our duties. Our primary obligation and most powerful right is the right to vote. If we execute this duty sincerely and sensibly, in time we will be able to rid the system of the leeches it has come to harbor. Our right to free speech and expression is what we need to capitalize on and not rest till the guilty are brought to justice. Numerous examples exist where with the help of truth and media, the aggrieved have secured justice. Yes there is a cost attached to all this. The cost of giving up some of our own comforts, of acknowledging that the blame game needs to start with self and of respecting that the rights that are ours are equally those of the other billion citizens of the country.

It has become fashionable to blame the government for every difficulty that we face. It has equally become a fashion to heap praises on someone who speaks against the system (rightly or wrongly). Grumbling and washing our dirty linen in public has become second nature to us Indians. We need to stop that, pause, reflect and then take a steadier course where we are in not a hurry to reach our final destination. In pace will come sensibility and responsibility. In stride will come the innate ability to render obligations, shoulder responsibilities and apportion credits. It is our country and it is up to us to shape its future. We can either speed into chaos or walk into prosperity. The choice is ours. No legislation can give it or take it from us.

Jalan Committee Report - Cautiously Over Cautious

With the growth of the Indian economy the Indian stock exchanges too have witnessed a steep growth trajectory. In keeping with globalization and to compete more successfully, local stock exchanges would like to attract additional and diversified capital. However, the recent Jalan committee report has become a hurdle in that direction and in setting up of newer exchanges by non financial sector participants. The committee is of the view that

i. Anchor Institutional Investors (AII) should be limited to Public Financial Institutions[1] and Banking Company[2] having a net worth of more INR 1,000 crores
ii. for a new entity seeking recognition as a Stock Exchange, AII should be identified from amongst the shareholders holding more than 15% but up to 24% of the equity capital of the exchange
iii. AII should reduce their holding over a 10 year period to a maximum of 15%. The 10 year period will be cumulative for the initial and any subsequent AII
iv. other Stock Exchanges and insurance companies should be allowed equity ownership between 5% and 15%
v. all anchor institutional investors put together should not hold more than 49% of the total equity capital of an exchange
vi. FII should be allowed to acquire shares through off market transactions including initial allotment
vii. to ascertain the holding of an investor in a Stock Exchange (or another Market Infrastructure Institution) the maximum permissible limit should be computed based on the overall direct and indirect, straight and structured investment
viii. given the stable, long term nature of investments required in Stock Exchanges and that listing would bring in conflicts of interest in regulation; Stock Exchanges should not be permitted to list
ix. the maximum return that can be earned on the net worth of a Stock exchange (and other MII) and distributed to shareholders should be capped to ensure that unreasonable profits are not earned

These view points are all valid in varying degrees but, in entirety, at places these views contradict the very concerns that the committee has tried to address.

The analysis presented here is based on:
i. the fact that the Committee views Stock Exchanges as utilities with the objective of providing stable infrastructure for an efficient and well regulated trading market platform at reasonable costs for public consumption
ii. the fact that Stock Markets are no longer geographically restricted
iii. the particular nine recommendations mentioned above

Stability comes from a long term investor ready to commit the significant initial capital and willing to exit at a return without the need to earn a regular return in the short run. To that extent the committee makes a valid point that there has to be minimum net worth of the AII to be able to invest and support the Stock Exchange through its growth phase and there is merit in the proposed 10 year period provided to bring down the AII holding down to a maximum of 15%. This will give the initial AII sufficient time to sell at a reasonable return once the business has stabilized[3]. However, with the capping of the profits and the listing ban the committee seems to have closed the exit for AII. Institutional investors manage monies for third parties who they are accountable to. Their needs to be a justification for them to be investing in equity of an entity that has restricted profit sharing during the tenure of the investment and which at the time of exit might not even find takers. With a risk free rate governed cap[4] on investment there would be better investment opportunities available, maybe even in the debt markets without the risks of an equity investment and probably a more liquid option available. The listing ban further narrows return and exit opportunities for institutional investors. In India, with its shallow investor base, this implication then contradicts the committee’s own views that Stock Exchanges should have a diversified holding. Another contradiction to diversifying holding is restricting the AII to Banking Company and Public Financial Institution, a proposition which in addition loads the risk of investment on the institutions that already bear significant long term risk for the economy(specially in the absence of public corporate debt markets). The ownership as defined by the committee is vague in mentioning a capped 49% cumulative holding by all AII. It is unclear whether this limit is defined at the time of seeking recognition or post the 10-year divestment period. With lack of such clarity, there is also a lack of taking on from global experience.

Global Stock Exchanges have witnessed evolutionary changes in the last decade that have probably outpaced any development in this segment since its considered establishment in 1460 (with the setting up of the Antwerp Stock Exchange)[5]. Historically, world over, exchanges were set up as non-profit organizations by the broker dealers who used the services that the exchanges offered. On 24th September 1996, the Australian Stock Exchange (ASX) became the first exchange to notify its members of its intention to demutualize[6]. Since then there have been a vast number of demutualizations and listings of Stock Exchanges across the world. The World Federation of Exchanges, which has about 70 members, reports that 42% of its members are publicly listed exchanges and another 18% are demutualized. These numbers highlight the fast pace at which the holding structure of global Stock Exchanges has changed in the last 12 years and that even in a deep economic crisis, a wide number of exchanges have managed conflicts and maintained stability despite being listed. The Committee’s concern on conflict resolution is a serious concern, however, one that can be addressed by the regulator. SEBI is a globally respected markets’ regulator with world class surveillance systems. Upon listing the regulatory function should either be moved out from the Stock Exchange to SEBI or the regulatory arm should report to SEBI and not to the Stock Exchange management. Both these models have been successfully adopted by exchanges such as NYSE, LSE, ASX, Deutche Boerse etc. These are exchanges that upon listing have been able to increase their footprint across regions and adopt better policies as integration brought in best practices to the larger organization.

One of the biggest benefits of globalization has been the increase in competition and hence the reduction of the commissions that Stock Exchanges charge. Ultimately that is also the aim of Jalan committee, to have affordable transaction costs for the end user of the Stock Exchanges’ services. In order to ensure this there needs to be competition in the sector which can only happen when the entry barriers are reduced. The report does not lead to that direction. In fact with a restriction on who can be an AII and profit sharing, the entry barriers only increase. The Indian telecom sector is a classic example of how reducing entry barriers benefit the end consumer. It also highlights how a strong regulator can ensure policy formation to protect the interests of the consumers. Thus even if global experience is neglected, domestically we have examples that can aid opening up of the Stock Exchange forum to the benefit of the general public.

While there are significant alterations that can be made to the Committee’s recommendations (in context that was laid at the onset), there are two recommendations which are noteworthy. The first being permitting FII to become equity holders via an initial allocation, this will be a more economical means to invite newer investors leading to diversification. The second is calculating maximum exposure limits using direct and indirect, straight and structured investments; once again this in the true sense will allow more investors to participate and also prevent dominance of any one investor.

There are a number of other recommendations that can be debated. However, in the context of time and criteria laid out it will be sufficient to say that there is a lot more analysis and deliberation required before any ownership recommendation is accepted. If we propose to become a global economy of stature and significance then cautious risk taking will be required as opposed to the conservative crawl that appears in the current form of the report.

[1] Defined under section 4A of the Companies Act 1956
[2] Defined under clause (c) of section 5 of the Banking Regulation Act
[3] This is with the assumption of a new Exchange being set up
[4] As mentioned in the report “The cap may be fixed by SEBI after taking into consideration ‘risk free return’ based on the yield on a 10 year GOI bond and a ‘risk premium’ to account for the risks faced by MIIs including equity risk premium and liquidity risk due to non listing of MIIs.”
[5] The origin of Stock Exchanges is traced back to Antwerp Stock Exchange established in 1460, however, Amsterdam Stock Exchange established in 1602 by the Dutch East India Company is considered the first Stock Exchange in the world as we know it
[6] ASX finally demutualized in 1998