Suzuki Motor Corp, the Japanese promoter of Maruti, wants to set up its own unit at Gujarat to make cars for the listed company. This bit of news has sent investors into a tizzy.
They smell a rat in this announcement. If the new Suzuki produces cars for Maruti, this will become a ‘related party transaction’ in accounting parlance and this has implications with a capital I.
Your brother has urgent financial needs and you have a big bank balance. So you decide to lend him money at zero interest. This is a great deal for him compared with what he would have got from a bank. When a company enters into a deal like this, with parties known to its management or promoters, it is entering into a ‘related party transaction’.
The legal definition of a ‘related party’ for a company includes promoters, those who exercise ‘significant influence’ on the management or key employees. Holding and subsidiary companies, group companies and joint ventures are also deemed ‘related’.
Why is it important?
It is perfectly okay for you to enter into generous deals with your relatives, but related party deals by listed companies are frowned upon. This is because a listed company isn’t owned by its promoters or even its directors; it is owned by thousands of public investors who have invested in its shares.
Shareholders don’t participate in the day-to-day decisions of a company; these are made on their behalf by the board of directors. So when a company enters into related party transactions with promoters, directors, relatives or entities controlled by them, there is a worry that these deals may favour the latter and cause a loss to public share- holders.
The most common types of related party deals in India are of companies renting premises from promoters, extending liberal loans and guarantees to group companies and setting hefty pay for employees who are related to the promoter. Such related party deals by companies aren’t banned, but they need to be done at arm’s length, at market prices and certified by auditors.
Why should I care?
Users of financial statements — be they banks who have lent to the company or suppliers or investors — need to have a clear picture about all the transactions that can affect the firm’s financials. Take Maruti. The worry is, if the new Suzuki supplies its cars, will the price be padded up to favour the promoter firm? With a new entity now producing cars from Gujarat, will Maruti be forced to idle its older Gurgaon and Manesar units? Will Maruti lose out on export opportunities? If you are an investor in Maruti shares, you may rethink your investment with so many grey areas.
Once the new Companies Act 2013 comes into effect, you may be able to do something about cases like these. The new law requires companies to seek shareholder approval through a special resolution for related party transactions. Shareholders can also file a class action suit with the Company Law Tribunal if they feel the move is against their interest.
The bottomline
Dealings with friends and relatives may make you popular at a personal level. But if you’re a company, they count as a blot on your governance record.