Royalty Payments By Few Listed Companies Exceeded 20% Of Profits, Says Sebi Study

The Securities and Exchange Board of India (Sebi) has raised concerns regarding royalty payments made by listed companies to their related parties. In a study, spanning 10 fiscal years from 2013-14 to 2022-23, Sebi said that royalty payments often exceeded reasonable thresholds, raising concerns over corporate governance and shareholder value.

This analysis by the market regulator examined 233 listed companies across various sectors and found that there were 1,538 instances of royalty payments within 5 per cent of the turnover of the company which does not require the need for minority shareholder approval.

However, a deeper analysis showed troubling trends regarding the scale and impact of these payments.

What Are Royalty Payments?

Royalty payments refer to the payment by a company towards technology transfer agreements or collaborations with another company. It also refers to payments made for using someone else’s intellectual property, such as trademarks and brand names. In India, listed companies make royalty payments to the holding companies or fellow subsidiaries for the purposes of brand usage, transfer of technology know-how, etc.

Key Findings Of Sebi Study

The analysis finds that there were 102 instances where royalty paid to related parties was between 40 per cent and 100 per cent of net profits. In 74 instances, it even exceeded 100 per cent of net profits made by the companies.

In 25 per cent of the cases, companies paid royalties to related parties exceeding 20 per cent of their net profits. Half of the royalty-paying companies either did not distribute dividends to shareholders or paid more in royalties than as dividends.

Over the decade, 63 companies paid royalties totalling Rs 1,355 core to their related parties despite incurring net losses.

A total of 10 companies (out of 63 mentioned above) consistently paid royalties for at least 5 years, accumulating payments of Rs 228 crore to their related parties

Is Royalty Growth Outpacing Business Growth?

A total of 79 companies consistently paid royalty to their related parties during all the 10 years under study. While aggregate royalty payments by these companies kept pace with growth in turnover and net profits till FY19, royalty payments tempered post-FY19, the report said.

Among these 79 companies, 18 showed royalty payment growth that far exceeded their turnover and profit growth.

According to the analysis, royalty payments grew at a compounded annual growth rate (CAGR) of 14.6 per cent compared to 6.5 per cent and 6.0 per cent for turnover and net profits, respectively.

In fact, 11 companies paid royalties exceeding 20 per cent of their net profit every year.

Issues Regarding Royalty Payments

Some proxy advisory firms have flagged multiple issues surrounding royalty payments, raising questions about their rationale and transparency. Royalty payments often show little relationship to the company’s revenue of profitability. Many companies make substantial royalty payments for brand usage despite significant spending on advertising and brand-building efforts locally.

Sebi said that the performance of royalty-paying companies is not of a higher order compared to their peers, including those who are not paying royalty. The concerns revolve around ambiguous fee structures. Payments categorised as ‘management fees’ or ‘technology license fees’ are significant, but fall outside the regulatory definition of royalty, making them harder to scrutinise.

Noting a lack of disclosure, the Sebi study highlighted that inadequate explanations about the benefits of royalty payments leave shareholders in the dark, especially in cases involving multinational corporations (MNCs). Additionally, valuation opinions on royalty agreements vary widely which reflects subjectivity on the matter and raises doubts over fairness practices.

“Independent fairness opinions by different agencies on royalty payments vary significantly in terms of valuation. This suggests a high degree of subjectivity surrounding the valuation, and the fairness of royalty rates arrived upon,” Sebi said.

The findings of the Sebi study point towards critical governance lapses. In some cases, Indian subsidiaries of MNCs have sought perpetual approval for royalty payments. Another area of concern is the lack of visibility into royalty rates applied across the parent company’s subsidiaries in other geographies. Therefore, the proxy advisors argue for stricter regulations, improved disclosures, and justification of royalty arrangements to uphold shareholder value and ensure fair practices, Sebi further said.