Good governance is not an issue for Indian firms alone

Tags: Op-ed

MNCs have started behaving like some Indian promoters, who dip their hands into company pockets for personal fancies

Good governance is not an issue for Indian firms alone
Bloomberg
CLEAN DISPLAY: In this 2012 file photo, LG Electronics Cinema 3D televisions are displayed for sale at an electronics store in Seoul, South Korea.
Multinational companies have always been prized in India because of the perceived superior governance translating into superior performance and shareholder value creation for minority shareholders. As a result, across several industries, MNCs tend to enjoy a premium in terms of the price-to-earnings ratio that they command over their listed Indian counterparts.

But this governance premium may soon fall if the recent trend in payment of royalties by Indian arms of MNCs to their parents continues unabated.

A recent study by proxy advisory firm Institutional Investor Advisory Services (IIAS) illustrates how royalty payments have galloped ahead of the increase in sales, profit margins and net profits. On an average, MNCs with the high royalty payouts had failed to post superior sales or profit growth compared with the BSE 100 index average (incidentally, many of these firms studied were a part of this index). In effect, the study shows that the value of the inputs, technology or brands licensed to the Indian operations have not translated into a brand power that has led to superior profits or sales to justify their cost.

In effect, MNCs have started behaving like some Indian promoters who put their hands into company pockets to cater to their personal fancies. A number of MNCs claim that the payments are negotiated between the Indian arm and the controlling shareholder. But one can well imagine what power and ability an employee would have negotiating with his own boss in a job that the latter has installed him in.

Analysts who track these firms say that MNCs also tend to be more cagey about revealing their financial and strategic details compared with Indian firms. These firms should make public the detailed rationale justifying royalty payments that they submit to the transfer-pricing officer of the income-tax department to allow minority shareholders to make an informed judgment.

Royalty payments have become a tool in the hands of MNC parents to milk their subsidiaries profits, to shore up overseas bottomlines and show growth. The IIAS report talks about how much higher dividend some of these firms would pay if the companies’ royalty payouts were instead routed to shareholders in the form of tax-free dividends. The report outlines that the three companies with the highest royalty remittances have seen their payouts jump more than threefold while their revenues have not even doubled.

“The margins of two of the top three royalty paying companies over the five-year period from 2007-2012 have shrunk suggesting that the market does not attribute a similar value either to the technology or the brand (that have been licensed),” said the report. Royalty payouts at some of the Indian arms of these MNCs have drained profits so much that some of them have had to skip dividend payments altogether.

“The top 25 royalty paying companies paid out on an average 25 per cent of profits as royalty to foreign sponsors in FY 2012,” said the report.

At a time when probity in public life is increasingly being demanded, it’s sad to see that standards in corporate India are falling, even where they were once quite high. This may explain why recently the Delhi special bench of the tax tribunal ruled that advertisement, marketing and sales promotion expenditure being incurred by LG Electronics India was, in fact, brand building for its Korean parent and decided to disallow a portion of the expenditure. The tribunal reassessed it as brand-building services for its parent.

In a case harking back to assessment year 2007-2008, the transfer pricing officer of the income-tax department found out that LG India had spent 3.85 per cent of its sales as advertising, marketing and promotion expenditure compared with 1.39 per cent for two comparable companies. The tribunal, in its order earlier in January, said that with LG India prominently displaying brand of its foreign parent in its advertisements and the Indian arm having incurred expenditure proportionately more than that incurred by independent enterprises behaving in a commercially rational manner, it becomes essential to recharacterise the total advertising marketing and promotion expenditure.

While tax authorities are in a position to make such assessments, minority shareholders can only pray for the goodness of the hearts of managements to result in fair play for all stakeholders.

ypitalwalla@mydigitalfc.com

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