Loss Making Companies Royalty Paradox : A Governance Dilemma

Why do financially struggling companies prioritize royalty payments over recovery?

Corporate royalty payments are meant to support growth through brand and technology transfer. However, SEBI’s findings reveal a startling reality: loss-making companies in India continue to prioritize royalty payments to related parties (RPs) over financial recovery. This article dissects the paradox and explores its governance implications.

Table of Contents

The Royalty Paradox

“Why do loss-making companies still pay royalties?”

SEBI’s analysis of 233 listed companies reveals:

₹1,355 crore paid in royalties by 63 companies that incurred net losses at least once between FY 2013-14 and FY 2022-23.
In 97 of 185 instances, royalty payments exceeded 5% of the absolute value of net losses.
10 companies consistently reported losses for five years while paying ₹228 crore in royalties.

These payments suggest a misalignment between corporate priorities and shareholder interests, especially for struggling firms.

Governance Gaps in Royalty Oversight

“What enables such spending despite financial strain?”

The lack of robust governance mechanisms often allows royalty payments to take precedence over recovery strategies. Key issues include:

Absence of Profitability-Based Thresholds: Current SEBI regulations focus on turnover rather than profitability, enabling loss-making companies to bypass scrutiny.
Vague Disclosures: Companies rarely justify royalty payments in the context of their financial performance.
Minimal Shareholder Oversight: Shareholders lack visibility into cumulative royalty outflows and their impact on recovery plans.

The Shareholder’s Perspective

“How do royalty payments affect investor confidence?”

For shareholders, royalty payments by financially unstable companies raise red flags:

Erosion of Trust: Persistent losses coupled with high royalties undermine confidence in management.
Poor Returns: Companies prioritizing RPs over dividends deliver subpar value to investors.
Transparency Issues: Inadequate disclosures make it difficult for shareholders to assess the necessity and fairness of these payments.

Recommendations for Policy Reforms

“What steps can ensure alignment with financial recovery?”

To address the royalty paradox, SEBI and policymakers can consider the following reforms:

Profitability-Based Thresholds: Introduce royalty payment caps linked to net profits rather than turnover.
Enhanced Disclosures: Mandate companies to explain the rationale for royalty payments during loss periods, including a cost-benefit analysis.
Shareholder Approvals: Require majority approval for royalty payments by companies with consecutive losses.
Periodic Reviews: Make royalty agreements subject to regular reviews, ensuring alignment with financial health.

Striking a Balance Between Growth and Recovery

“Can royalty payments coexist with financial recovery?”

Royalty payments, when justified, can drive long-term value through brand equity and innovation. However, in loss-making scenarios, unchecked payments risk alienating shareholders and compromising recovery efforts. Striking a balance requires transparent disclosures, robust governance, and shareholder engagement.

Fixing the Royalty Governance

The data is clear: loss-making companies must rethink their royalty payment strategies. By prioritizing financial health and shareholder value, Indian corporates can restore trust and ensure sustainable growth. SEBI’s proposed reforms offer a pathway to better governance, but their success depends on company boards’ willingness to embrace transparency and accountability.