Fix royalty payment

The Securities and Exchange Board of India (Sebi) has decided to put on hold its mandate to give minority shareholders a greater say in deciding royalty payments by listed companies. Starting April 1, listed companies had to seek approval from a “majority of minority” shareholders for making royalty payments to a related party, with respect to brand usage exceeding 2 per cent of the annual consolidated turnover. The decision to review the move and defer implementation till June 30 was prompted by the adverse feedback it had received on the proposed move. In a board meeting memorandum, Sebi has listed out half a dozen concerns raised by industry. The finance ministry has also reportedly opposed the decision on the grounds that it might hamper ease of doing business and disrupt initiatives such as Make in India aimed at boosting the manufacturing sector. Though flawed, the ministry has been consistent in its approach as it had blocked similar proposals to curb royalty payments in 2015, saying such a move could lead to the outflow of foreign capital. Royalty payments were earlier subject to central government approval if they exceeded 5 per cent of gross annual sales or $2 million. But this was discontinued in 2009.

No one should fault Sebi for its decision to insist on shareholder approval for royalty payment, as cosy related party deals have been the bane of India Inc. While the regulator does not intend to stop brand usages in the country, all it wants to establish is a fair and transparent practice of charging royalty payments. There is no denying that a high amount hurts minority shareholders who do not have a say in determining the royalty fees. A study by proxy advisory firm, Institutional Investor Advisory Services (IiAS) showed that 27 Indian listed companies paid royalties of Rs 6,737 crore in 2017-18, which was 16 per cent of their pre-tax pre-royalty profits and more than 25 per cent of their aggregate profit after tax. This is a significant amount. Obviously, minority shareholders bear the brunt of high royalty payments, as this favours one class of shareholder — the promoter — over all others. In the interests of corporate governance, minority shareholders must be informed and their consent taken on the amount and duration of royalty payment and the impact on margins and shareholder returns.

But where Sebi perhaps went overboard is in fixing the royalty payment threshold for seeking the approval of minority shareholders. The regulator’s decision was based on the recommendations of the Kotak committee on corporate governance, but the committee wanted this to apply only to royalty payout levels exceeding 5 per cent of consolidated revenues. The regulator, however, went in for a harsher provision by fixing the threshold at 2 per cent. Putting more checks and balances to arrive at royalty payments and wanting the company boards to be more mindful of approving such agreements is a prudent move, but Sebi should be more practical in its approach and move towards the 5 per cent threshold. In any case, a low threshold for triggering need for minority shareholder approval may provoke more international companies to de-list in India and therefore could be counter-productive. The focus, thus, should be on the high-paying ones, who should articulate why they are being charged for brand royalty and what is the criticality, instead of creating a bureaucratic hurdle for all.

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