Rising royalty payments to parent firms evoke calls for frequent shareholder approvals

Royalty payments by India-listed companies to their parents or related parties should be backed by frequent shareholder approvals, according to experts, as such payouts have been rising.

Royalty payments are not just rising, but are also higher than dividends in some cases, found a recent study conducted by the Securities and Exchange Board of India’s (Sebi’s) Department of Economic and Policy Research Analysis, which reviewed 1,538 instances of such payouts across 233 listed companies from FY14 to FY23.

The findings prompted calls from proxy advisory firms for stricter regulations, better disclosures, and stronger shareholder protections to improve governance in such transactions.

A Mint's analysis of annual reports of companies also revealed an increase in royalty payments in FY24 when compared to FY23.

Colgate Palmolive India Ltd paid ₹256 crore in royalties in FY23 on a revenue of ₹522 crore, which rose to ₹279 crore in FY24 alongside revenue of ₹568 crore.

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

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Maruti Suzuki India Ltd paid ₹4,220 crore in royalties in FY23, with it reported a revenue of ₹1.18 trillion; the payout rose to ₹4,900 crore in FY24 on a revenue of ₹1.42 trillion.

Nestle India, which pays royalty at a rate of 4.5% of its consolidated turnover, has proposed increasing it to 5.25%, pending investor approval.

The companies mentioned earlier didn’t respond to Mint’s queries.

To address concerns about indefinite royalty payments from Indian subsidiaries to multinational parent companies, Sebi could require periodic shareholder approval, either through board approval or a “majority of minority” vote, said Viral Mehta, head of M&A and private equity practice at Nishith Desai Associates.

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

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

The study revealed that in many cases, royalty payments to related parties far exceeded the dividends paid to non-related party shareholders. For example, in 417 instances, royalty payments were three times higher than dividends.

However, Ketan Dalal, managing director of Katalyst Advisors, a structuring and advisory firm, while not opposing more comprehensive disclosures but said that an explanatory statement from a royalty-paying company detailing the amounts before a shareholder vote was sufficient.

“It is important not to overload the already burdensome disclosure system,” he Dalal said. He pointed out that current regulations set an upper limit on royalty charges, allowing room for factual nuances in these payments. “While there may be a case to reconsider some thresholds, a more logical approach would be to put it to a shareholder vote. However, guidelines may be necessary to prevent disruptions and lack of support from multinational parent companies," he said.

Dalal said that adjusting thresholds based on profitability or net income seemed logical but noted that it would be difficult to implement. He also observed that shareholders are typically more focused on capital appreciation than dividends.

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The study also highlighted inadequate disclosure on royalty payments. Proxy advisory firms have suggested that requiring shareholder approval for such payments could compel companies to provide clearer justifications. Although shareholder approval is required for payments exceeding 5% of a company’s consolidated turnover, some companies have circumvented this by making multiple smaller payments to different related parties, avoiding the need for approval, the study said.

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

Royalty payment agreements, typically signed for three-five years, were not difficult to amend, he said, and the most essential aspect of royalty payments was shareholder disclosures, which required a push from regulators.