For many years now, concerns have been expressed about the quantum of royalties paid by companies to their parents overseas for the use of brands and technology. The amounts being remitted to them, it has been pointed out, are often disproportionate to the financial performance of the local businesses. In other words, the royalty payments are not correlated to the sales and profits of the subsidiary company. A recent study by the Securities and Exchange Board of India (SEBI) of 233 listed companies, over the FY14-FY23 period, found that in one out of four times, they paid a royalty that exceeds 20% of their net profits. Moreover, the study listed 185 instances of royalty payments even by loss-making companies. While this might appear to be going against the interests of shareholders of the local company, there’s no denying that creating a brand and/or developing technology has a cost attached to it for which the parent needs to be compensated fairly.
There can of course be several opinions on what the royalty rate should be. In some cases, the payments do appear outsized. For example, the SEBI study found that there have been more than 100 occasions during this decade when the royalty paid was as much as 40-100% of the net profits. If that seems somewhat overdone, there were 74 instances where the royalty to related parties exceeded 100% of net profits. However, the fact is that imposing a cap, as has been done before, would amount to undue interference. Where the government could probably draw the line is with regard to dividend payouts. The SEBI study revealed that in half the cases, companies paid royalty, but not dividend, or paid more royalty than the dividend distributed to the other shareholders. In fact, there were as many as 315 instances of royalties being paid but no dividend was distributed. That seems patently unfair to the minority shareholders.
SEBI has done well to point out that disclosures by companies relating to royalty payments are often sketchy with adequate explanations for the amount paid out. The Kotak Committee had recommended that better disclosures are called for on the value that a company gains from the use of a brand or technology for which it is remunerating the parent company or the promoters. However, an analysis by the regulator shows that companies often place the royalty payment merely as an item in the statement of transactions with related parties, in the annual report, with no details whatsoever. In fact, there have been instances of companies approaching shareholders for their approval without even specifying a period for which the payments are to be made.
Having taken such blanket approvals for indefinite periods, shareholders are not approached for recurring transactions unless the rates are revised upwards. Also, companies get around the current regulation which demands shareholder approval for royalty required if payment to a related party exceeds the threshold of 5% of consolidated turnover by spreading the amount across several related parties. In other words, they get away with paying a total amount in excess of 5%. Such malpractices are undesirable and the government must ask for better disclosure standards from these companies who often take a moral high ground on corporate governance in public forums. The best way, however, for minority shareholders to deal with such companies would be to vote with one’s feet.