Increase in royalties paid to parent companies sparks calls for frequent shareholder approval

Royalty payments by listed companies in India to their parents or related parties should be supported by frequent shareholder approvals, experts say, as such payments are increasing.

Royalty payments are not only increasing, but are also higher than dividends in some cases, according to a recent study conducted by the Securities and Exchange Board of India (Sebi‘s) Economic and Policy Research Analysis Department, which examined 1,538 cases of such payments in 233 listed companies from FY14 to FY23.

The findings have prompted proxy advisory firms to call for stricter regulations, better disclosures and stronger shareholder protections to improve the governance of these transactions.

A MintAnalysis of companies’ annual reports also revealed an increase in royalty payments in FY24 compared to FY23.

Colgate Palmolive India Ltd paid ₹256 crores in royalties in FY23 on a turnover of ₹522 crore, which amounts to ₹279 crores in FY24 along with revenue from ₹568 million.

Hindustan Unilever Ltd paid ₹1,003 crore in royalties in FY23 on a turnover of ₹59,144 crores, rising to ₹1,132 crores in FY24 against a turnover of ₹60,469 billion.

Maruti Suzuki India Ltd paid ₹4,220 crores in royalties in FY23, with a revenue of ₹1,180 billion; the payment went to ₹4,900 crores in FY24 on a turnover of ₹1.42 trillion.

Nestle India, which pays royalties to the tune of 4.5% of its consolidated turnover, has proposed increasing it to 5.25%, pending investor approval.

The previously mentioned companies did not respond Mintrequests.

To address concerns over payment of undefined royalties by Indian subsidiaries to multinational parent companies, Sebi could require periodic shareholder approval, either through board approval or a “majority” vote. of the minority,” said Viral Mehta, head of M&A and private equity at Nishith Desai Associates. .

For companies that pay more in royalties than dividends, Mehta suggested stricter disclosure standards, including the ratio of royalty payments to gross profits, especially for profitable companies that skip dividends.

“Linking royalty payments to the profitability of listed companies and strengthening disclosure requirements could improve management of fund outflows and strengthen investor confidence in corporate governance,” Mehta said, adding that Sebi should provide for a transition period for companies to reassess their royalty arrangements.

The study found that in many cases, royalty payments to related parties far exceeded dividends paid to unrelated shareholders. For example, in 417 cases, royalty payments were three times higher than dividends.

However, Ketan Dalal, managing director of Katalyst Advisors, a structuring and advisory firm, while not opposed to fuller disclosure, said that an explanatory statement from a royalty-paying company detailing the amounts before the shareholder vote was sufficient.

“It is important not to overload an already cumbersome disclosure system,” he said. He pointed out that current regulations set a cap on royalties, which leaves room for factual nuances in these payments. “While it may be wise to reconsider certain thresholds, a more logical approach would be to put the issue to a shareholder vote. However, guidelines may be needed to avoid disruption and lack of support from multinational parent companies,” he said.

Dalal said it seemed logical to adjust thresholds based on profitability or bottom line, but noted that would be difficult to implement. He also observed that shareholders generally focus more on capital appreciation than dividends.

The study also found insufficient disclosure of royalty payments. Proxy advisory firms have suggested that requiring shareholder approval for such payments could force companies to provide clearer justifications. Although shareholder approval is required for payments exceeding 5% of a company’s consolidated revenue, some companies have circumvented this requirement by making several smaller payments to different related parties, thereby avoiding the need for a approval, according to the study.

“If disclosures were made, there was nothing wrong with worrying about royalty payments,” said Shriam Subramanian, founder of proxy advisory firm InGovern Research Services. “The threshold had been raised from 2% to 5% for the shareholder vote; it could perhaps return to 2%, but no further regulatory intervention is necessary.

Royalty payment agreements, typically signed for three to five years, were not difficult to modify, he said, and the most essential aspect of royalty payments was disclosure to shareholders, which required an impulse from regulators.