Institutional EYE

Commentary on Corporate Governance Issues

IiAS: Royalty payments: At last, the dog wags its tail

After years of the tail wagging the dog, we are seeing signs of the dog wagging its tail. Put differently, after a few years of seeing royalty payments outpace sales and profits, performance of MNCs is catching up with their royalty pay-outs.

Multi-national corporations (MNCs) based in India benefit from having a globally-recognized brand and access to technology. That the NIFTY MNC index has tended to outperform most others, shows that investors value the benefits of having a global parent. To that extent, royalty is a legitimate expense. The most tangible measurement of this benefit is, however, if the MNCs outperform the other companies of their relevant industry indices – in revenues, profits, or both. While this benefit was not visible in the past, the pace of growth in pre-royalty pre-tax profits (PR-PBT) is now closer to that of royalty. The narrowing of this gap reflects on the MNC’s increased absorption capacity for royalty payments.

Even so, royalty payments continue to remain high, and are depressing margins – in FY17, 31 MNCs paid an aggregate of Rs.77.78 bn, which accounted for almost 20% of their pre-royalty pre-tax profits. Shareholders should be wary that the large quantum of liquid funds with these MNCs does not flow to controlling shareholders as royalty but gets distributed equally to all shareholders.

The increased focus on royalty payments being made by multinationals to their parent companies has resulted in them becoming a little more cautious. IiAS continues to believe that royalty payments are a legitimate expense. However, shareholders need to be informed about the course that royalty expenses will follow. We continue to push companies to improve their disclosures with regards to royalty payments and provide shareholders information about both the quantum, duration of the royalty contracts and most important of all the basis for the payment.

You can read IiAS’ fifth annual review of royalty payments by MNC by clicking on this link.

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