Royalty Payment by Subsidiaries: Bane of Minority Investors?

(Image taken from here)

Payment of royalty has been one of the time-honoured ways of incentivizing knowledge and technology transfer and usage of brand name or trademark for business affairs. Few years back in 2009, the Indian government had waived the requirement of payment of such royalty by Indian companies to multinational corporations to be subjected to prior government approval (by the Project Approval Board in the Department of Industrial Policy and Promotion). Instead, such payments up to any amount had been allowed by the automatic route, with an intention to promote modern technology transfer to India.

A recent market analysis by Business Standard has revealed that such relaxation of norms is being used by the multinational corporations to squeeze out a huge chunk of the profit made by their Indian arms in the form of royalty payments and technology transfer fees. This is in turn depriving the minority investors in those Indian concerns of their rightful dividend.

The analysis, involving a survey of 75 BSE 500 companies, has identified a trebling of royalty payments and technology transfer fees paid by these companies over the last four years, whereas the sales growth and cumulative net profit growth are chalked at 79.6% and 31.2 % respectively. As a result, the profit margin of these companies has dwindled perceptively. Instead of distributing the profit earned in the form of dividend so as to benefit all the shareholders, the companies are leaning more and more towards satisfying the controlling shareholders, viz. the foreign corporations to whom the royalty and transfer fees are going, at the expense of others. The smaller the company, the steeper seems the rise in royalty payment during this period.

The government probably never intended such an outcome when it had relaxed the royalty payment norms 4 years ago, but it may have to come to terms with the fact that it is from that move only that this scenario has resulted, a conclusion that has received support from experts like the proxy advisory firm Institutional Investors Advisory Services. IIAS has carried out its own study and opined that the foreign sponsors do not seem concerned about the impact royalty payments have on the bottom line of Indian subsidiaries and the personnel who are negotiating the quantum of royalty on behalf of the subsidiaries are often employed by the parent foreign bodies, which of course does not augur well for driving a competitive bargain.

The questions that are increasingly worrying the minority investors include the difficulties involved in quantifying the value of technical knowhow being transferred, whether the usage of foreign brand names and trademark actually has any positive bearing on sales and profit margins and whether the use of the latest technology has actually lowered manufacturing costs etc. The disproportionate increases in royalty payment and profit seem to indicate that the worst fear of these investors is not entirely ill-founded. There have even been instances where companies have not announced any dividend at all during this period, but have been steadily paying out royalties!

Nor is this phenomenon confined to any specific industry, with companies having as diverse business interests as Maruti Suzuki, ABB and Nestle India having the top 3 slots for royalty payments. Given the usual strict stance of Indian corporate regulators like SEBI towards safeguarding the interest of minority shareholders, it is a wonder why it took such a long time for this phenomenon to be discovered. While payment of royalty and technology transfer fees is of course an integral part of attracting and incentivizing the latest technology, yet such encouragement is only desirable as long as it plays a significant role in enhancing the business efficiency and profit margins insofar as corporate bodies are concerned.