How to identify Promoters extracting Money via High Salaries

Promoters, many times, work full-time in their companies like any other employee of the company. It is only natural to think that when they dedicate their entire time to the business, then they would also expect to be rewarded for their hard work like any other employee of the company.

Therefore, an investor would appreciate that most of the promoters serving in active roles in their companies take salary & commission for their executive role apart from the dividends that they receive for their shareholding in the company.

However, an investor would also note that promoters are the persons who are directly in control of the company and its key decisions. This includes decisions related to their own salary. Most of the time, the promoters are able to get their desired remunerations recommended by the board of directors. In addition, usually, they are also able to get their remuneration approved by the shareholders in AGM/EGM. This is because, usually, they are the largest shareholder of the company and they are able to influence other major public shareholders as well.

The ability to decide upon their own remuneration, many times, creates a situation of conflict of interest where the promoters may attempt to benefit by taking as much money as remuneration as they can. The regulations have attempted to limit this conflict of interest by putting several conditions like:

• The promoters are not supposed to be a part of the remuneration committee that recommends the remuneration package of the promoters.
• The remuneration package of the promoters needs to be approved by the shareholders as a special resolution indicating that at least 75% of the shareholders (present and voting) should support it.
• There are limits on the maximum remuneration that the managing director and all the whole-time directors together can take. This limit is a percentage of the profits of the company.

However, despite all these limits attempting to restrain the promoters from benefiting at the cost of other shareholders due to their influential position in the company, we have come across many instances where promoters attempted to take out a substantial economic value from the company by way of high remuneration.

The current article is an attempt to present live examples of such cases along with citations of relevant sections of annual reports and other disclosures by the companies so that an investor is able to incorporate the assessment of promoters’ remuneration in her own analysis. The article is also anticipated to serve as a guide to the investor in order to enable her to find relevant information from annual reports and other disclosures to arrive at an informed judgment.

Promoters’ Remuneration: What is a high remuneration?

As discussed above, the law has stipulated a limit on the maximum remuneration that the managing director and all the whole-time directors put together can take as a percentage of profits of the company. Companies Act, 2013, Section 197 (Source: Ministry of Corporate Affairs website)

(1) The total managerial remuneration payable by a public company, to its directors, including managing director and whole-time director, and its manager in respect of any financial year shall not exceed eleven percent. of the net profits of that company for that financial year computed in the manner laid down in section 198 except that the remuneration of the directors shall not be deducted from the gross profits:

Provided that the company in general meeting may, with the approval of the Central Government, authorise the payment of remuneration exceeding eleven percent. of the net profits of the company, subject to the provisions of Schedule V:

Provided further that, except with the approval of the company in general meeting,—

(i) the remuneration payable to any one managing director; or whole-time director or manager shall not exceed five percent. of the net profits of the company and if there is more than one such director remuneration shall not exceed ten percent. of the net profits to all such directors and manager taken together;

Therefore, an investor may note that the legal limit of remuneration of any promoter, who is an executive/whole-time director of the company, cannot exceed 5% of the profits and the remuneration of all the promoters who are a part of the board cannot exceed 11%. For a remuneration higher than these limits, the company needs to take approval from the central govt.

However, after analysing hundreds of companies, we have noticed that the promoters of most of the companies limit their salaries within 2% to 3% of the profits. This includes primarily 2% of the profits as commission and an additional small component of fixed monthly remuneration.

Read: Remuneration of Promoters: What is the Ideal Benchmark?

However, an investor will appreciate that if any company/promoter has decided to give a higher salary to themselves, then they may not pay attention to these limits. E.g. the case of Globus Spirits Ltd.

1) Globus Spirits Ltd:

Globus Spirits Ltd is a manufacturer of country liquor (IMIL) and bottler for Indian made foreign liquor (IMFL) having a presence in multiple states with distilleries in Rajasthan, Haryana, West Bengal, and Bihar. The company owns IMIL brands like Nimboo, Narangi, Heer Ranjha, and Ghoomar.

While analysing the past annual reports of Globus Spirits Ltd, an investor notices an observation from its auditor that the company has paid a remuneration of about ₹70 lakh to a relative of one of the directors of the company without seeking proper approvals from shareholders and central govt. After this observation from the auditor, the company seems to have initiated the process to recover this remuneration paid by it to the related party.

FY2014 annual report, page 45:

Emphasis of Matter: Attention is invited to note no. 26, which describes that the Company has paid remuneration of ₹73.90 Lacs to the Relatives of Directors without special resolution in General Meeting during the current year and previous years, including ₹2.59 Lacs paid without obtaining the approval of the Central Government, which is not in line with provisions of Section 314 of the Companies Act, 1956. The Company has initiated the process for recovering the same and accordingly the balance has been shown as recoverable as on March 31, 2014.

An investor may read the complete analysis of Globus Spirits Ltd here: Analysis: Globus Spirits Ltd

It is necessary to identify cases where promoters are paying themselves high salaries without following the process of putting the remuneration to the voting by shareholders. This is because, many times, shareholders reject the high remuneration proposed by the company, which, in turn, is a loss of face for the promoter.

For example, recently,  shareholders protested the very high remuneration of promoters of Apollo Tyres Ltd by rejecting the proposal of reappointment of managing director (MD), who is a member of the promoter family.

Shareholders reject re-appointment of Apollo Tyres MD (Source: Economic Times)

As per the article, the MD was drawing very high salary despite declining profits of the company.

Kanwar took home an annual compensation of ₹42.8 crore in 2017, a 43% hike over his take-home of ₹30 crore in 2016. Apollo’s annual standalone net profit in 2017 was ₹622.4 crore, a decline of 23% over last year. Annual consolidated net profit also declined by 34% at ₹724 crore.

Because of the defeat of the proposal, the promoters of Apollo Tyres Ltd took a 30% reduction in their salaries.

Apollo Tyres’ Onkar, Neeraj Kanwar agree to 30% salary cut (Source Livemint)

Therefore, an investor would appreciate that when promoters are a part of the board of directors, then their appointment to the board along with their remuneration has to be approved by the shareholders. If the shareholders believe that the promoters are taking very high salaries, then they may vote against it.

Nevertheless, an investor will appreciate that even while abiding by the letter of the law; people are always able to find loopholes in the regulations and are able to work around the spirit of the law. The remuneration limits are no different.

While analysing companies, an investor will notice that many times, companies/promoters resort to innovative methods to bye-pass the statutory limits like in the case of Associated Alcohols and Breweries Ltd (AABL).

In the case of AABL, the promoters seem to have skipped taking any position on the board of directors in order to avoid statutory limits as well as shareholders’ voting for their remuneration.

2) The curious case of Associated Alcohols and Breweries Ltd:

Associated Alcohols and Breweries Ltd (AABL) is an India distillery based in Madhya Pradesh dealing in country liquor, extra neutral alcohol, rectified spirit and Indian made foreign liquor (IMFL). While analysing the company and the role of the promoter family of AABL, an investor comes across many insightful observations.

a) Names of Chairman and Vice-Chairman (promoter family members) not shown as a part of the board of directors of AABL:

While looking at the annual reports of the company, an investor notices that Associated Alcohols and Breweries Ltd has not included the names of the promoters, Mr Anand Kedia and Mr. Prasann Kedia as a part of details of the board of directors of the company.

FY2018 annual report, page 73:

BOARD OF DIRECTORS
Mr. Tushar Bhandari, Whole Time Director
Mr. Nitin Tibrewal, Independent Director
Mr. Manish Kumar Tibrewal, Non Independent Director
Mrs. Abhijit Nagee, Independent Director

An investor would notice that the names of Mr Anand Kedia and Mr. Prasann Kedia are not included in the members of the board of directors. Their names are not included even in the disclosures of the attendance in the meetings of the board of directors.

FY2018 annual report, page 36:

The above disclosures seem to indicate that the positions of Mr Anand Kedia and Mr Prasann Kedia namely Chairman and Vice-Chairman are not indicative of their roles in the board of directors. Instead, their designations of Chairman – Business Promotion & Development and Vice Chairman – Operation & Business Development may represent the positions within the functional departments of the company instead of the board of directors of the company.

FY2018 annual report, page 2:

Mr. Anand Kumar Kedia and Mr. Prasann Kumar Kedia are the key promoters of the Company.

Mr. Anand Kumar Kedia, Chairman – Business Promotion & Development, possesses a rich sectoral experience across almost three decades. He spearheads the strategic initiatives of the Company.

Mr. Prasann Kumar Kedia, Vice Chairman – Operation & Business Development, has been involved with the Company for more than two decades and oversees day-to-day operations.

In case, it is true that the promoter family members, Mr Anand Kedia, and Mr Prasann Kedia have decided to stay as a part of the management team of the company and not the members of the board, then it may seem perfectly fine. However, it poses other challenges.

b) Remuneration of highest-paid employees of AABL (promoter family members) avoids approval of shareholders:

While analyzing the remuneration of key management personnel including the directors of Associated Alcohols and Breweries Ltd, an investor gets to know that the two promoter family members, Mr Anand Kedia, and Mr Prasann Kedia, take the highest remuneration from the company.

In FY2018, Mr Anand Kedia and Mr Prasann Kedia have taken a remuneration total remuneration of ₹8.88 cr from the company (₹4.44 cr. each).

FY2018 annual report, page 55:

Mr. Anand Kumar Kedia, 53, Post Graduate in Commerce, Chairman – Business Promotion & Development, 01/04/1990, 28 years, ₹444.32 Lakh, Mr. Prasann Kumar Kedia, 46, MBA, Vice Chairman – Operation & Business Development, 01/04/1994 , 24 years, ₹444.32 Lakh.

If an investor considers this remuneration in comparison with the net profits of the company for FY2018 (₹25 cr), then she notices that the members of the promoter family have taken home a salary, which is more than 35% of the PAT (8.88/25 = 35.5%)

An investor would appreciate most of the times; the promoters of the company are a part of the board of directors of the company. As a result, their remuneration has to be approved by the shareholders of the company. In case, shareholders believe that the promoters are taking very high remuneration, then they may vote against such a proposal.

In the case of remunerations of Mr Anand Kedia and Mr Prasann Kedia, an investor would notice that it has been in the range of 35-50% of the net profits of Associated Alcohols and Breweries Ltd.

However, in the case of Mr Anand Kedia and Mr Prasann Kedia, Associated Alcohols and Breweries Ltd has not put their appointment and remuneration to the shareholders for approval at least since FY2010.

(Please note that only the annual reports of the company from 2010 are available in the public domain. We are not sure whether shareholders before FY2010 approved their remunerations as those annual reports are not available in the public domain.)

Therefore, the investor would notice that in the case of promoters of Associated Alcohols and Breweries Ltd, the company has paid about ₹28 cr to Mr Anand Kedia and Mr Prasann Kedia in remuneration since FY2015-2018. However, the shareholders of the company did not have an opportunity to express their opinion about their remunerations.

(Please note that the annual reports before FY2015 do not disclose the remunerations of Mr Anand Kedia and Mr Prasann Kedia and the annual report for FY2019 has not yet shared by the company on its website.)

c) Remuneration of promoter family members of AABL and the limit put by Companies Act 2013:

An investor would appreciate that the Companies Act puts a maximum limit of 11% of net profits on the remuneration of directors of the companies. In case, any company wishes to pay higher remuneration to its directors, then apart from shareholders’ approval, the company needs to take approval from the central government as well.

In most of the cases, the promoters of the company are also a part of the board of the directors of the company. Therefore, their remuneration proposals are put to vote by the shareholders. If the remuneration proposed by the company is high and the shareholders approve it, then the company needs to take the central govt. approval for the same.

However, in cases like Associated Alcohols and Breweries Ltd, where the promoters do not seem to be a part of the board of directors, then we are not sure whether the statutory limit on the remunerations and the central govt. approval is applicable to their salaries. Moreover, it is not clear whether Associated Alcohols and Breweries Ltd has taken such approval from central govt.

An investor may read the complete analysis of Associated Alcohols and Breweries Ltd here: Analysis: Associated Alcohols and Breweries Ltd

In light of the above example, it is advised that an investor should go beyond the remuneration of directors and extend her analysis to other highly paid employees of the company as well. This is because, if she makes it a habit to analyse remuneration of all the highly paid persons in every company, only then she would be able to identify instances where the salary of promoters may not have been put to vote of shareholders.

Let us now analyse steps that an investor may follow to identify if the promoters of a company are taking a high salary.

Steps to find out if the promoters are taking a high remuneration

1) Read the Auditor’s Report:

Many times, the auditor’s report in the annual report of a company is the best section to identify whether the promoters are taking a higher remuneration. This is because the auditors in their report are required to comment on whether any company has paid remuneration to its directors in line with the conditions put by the Companies Act.

Let us see the following examples for practical experience:

A) Sutlej Textiles and Industries Ltd:

Sutlej Textiles and Industries Ltd (STIL) is an Indian company focused on the production of Melange, Modal, Lyocell and Tencel yarns and home textiles segment. STIL is a part of the K. K. Birla Group of companies.

While analysing the auditor’s report of STIL for FY2017, an investor notices that the auditor of the company has pointed out that the remuneration (esp. the commission of ₹7.20 cr) paid by the company to its promoters is higher than the statutory limit placed by the Companies Act 2013. The FY2017 annual report, page 111:

According to the information and explanations given by the management, managerial remuneration has been paid /provided in accordance with the requisite approvals mandated by the provisions of section 197 read with schedule V to the Companies Act, 2013 except commission ₹7.20 crores payable to Chairman and other directors for which approval from shareholders are being taken in ensuing Annual General Meeting.

An investor may read the complete analysis of Sutlej Textiles and Industries Ltd here: Analysis: Sutlej Textiles and Industries Ltd

B) Machino Plastics Ltd:

Machino Plastics Ltd is an Indian auto ancillary player specializing in manufacturing injection plastic moulded parts for key players like Maruti Suzuki India, Suzuki Motorcycle India, Volvo Eicher, Hero Motors etc.

While analysing the company, an investor notices that over the years, Machino Plastics Ltd has been paying its promoters a remuneration, which is higher than the statutory ceiling stipulated by the companies act. The auditors have highlighted the same in the audit report for FY2013 by way of qualification in the report.

FY2013 Annual report, page 34:

Basis for Qualified Opinion: Managerial remuneration paid during the year ended 31 march, 2013 to the Managing Director & Whole time Director exceeds the limit prescribed by the section 198 and 309 of companies act, 1956 by an amount of Rs.1800000. The company is in the process of filing an application with the central government seeking approval for the excess remuneration paid as above.

An investor may read the complete analysis of Machino Plastics Ltd here: Analysis: Machino Plastics Ltd

Therefore, an investor would notice that reading the auditor’s report section of the annual report of a company can directly indicate to her whether the company is paying a high remuneration to its promoters.

Moreover, apart from the auditor’s report, the other most important section that an investor must-read is the “Remuneration of Directors and Key Managerial Personnel”, which is a part of the “Form No. MGT-9: Extract of Annual Return” section of the annual report.

2) “Remuneration of Directors and Key Managerial Personnel” section of the annual report:

This section of the annual report has a table containing the remuneration of each of the directors along with the limit stipulated under the Companies Act. An analysis of this section helps an investor arrive at multiple insights about the promoters.

A) Companies where promoters outrightly take a remuneration higher than the statutory limit:

In such cases, an investor would note that the sum total of the salaries taken by the promoter-directors would be higher than the limit put by the Companies Act. E.g. in the case of PIX Transmission Ltd.

i) PIX Transmission Ltd:

PIX Transmission Ltd is a manufacturer of power transmission belts applicable in industrial, agricultural, lawn & garden and automotive segments.

While analysing the FY2017 annual report of the company, an investor notices that the remuneration paid by the company to the promoters is significantly higher than the overall ceiling put in by the Companies Act 2013.

FY2017 annual report, page: 45:

On reading the remuneration details section, an investor would notice that PIX Transmissions Ltd has paid a remuneration of ₹5.25 cr to its promoters against the maximum limit of ₹1.17 cr put by the Companies Act.

An investor may read the complete analysis of PIX Transmissions Ltd here: Analysis: PIX Transmissions Ltd

B) Companies where promoters take the remuneration within the limit; but take home every single rupee of the maximum remuneration allowed by the law:

In such cases, an investor would notice that the promoters would have taken a remuneration, which will be exactly equal to the limit put in by the Companies act.

An investor would note that in such companies, the aim of the promoters might be to extract as much money from the company as possible by way of remuneration and the only factor limiting them is the ceiling put by the Companies Act. An investor can envisage that if the ceiling put by Companies Act was higher or if there was no ceiling in the Companies Act, then the promoters might have taken even higher remuneration.

Let us see some examples.

i) Bharat Rasayan Ltd:

Bharat Rasayan Ltd is an Indian player in the crop protection industry dealing in the entire range of products ranging from technical pesticides, formulations and its packaging material.

While reading the FY2017 annual report of the company, an investor would notice that the promoters/management of the company has drawn the maximum possible remuneration permitted by the Companies Act 2013. The maximum remuneration as per the Companies Act in FY2017 is ₹929.98 lac and the promoters have taken home the maximum salary permitted of ₹929.98 lac.

FY2017 annual report, page 36:

Moreover, a look at the remuneration levels of the promoters/management for the previous year (FY2016 annual report, page 29, indicates that in FY2016 also, the promoters have taken home the maximum remuneration allowed by the Companies Act. In FY2016, the promoters/management took home ₹572.84 lac as remuneration against the limit of ₹572.85 lac.

FY2016 annual report, page 29:

An investor may read the complete analysis of Bharat Rasayan Ltd here: Analysis: Bharat Rasayan Ltd

ii) Balaji Amines Ltd:

Balaji Amines Ltd is an Indian manufacturer of Amines and its derivatives (methylamine, ethylamine, DMF etc.) along with running a five-star hotel.

While reading the FY2017 annual report, an investor notices that the promoters of the company put together, have drawn the maximum possible remuneration allowed by the law, down to the last rupee. As per the Companies Act 2013, the maximum remuneration allowed for managing directors and whole-time directors is ₹14,21,14,060/- and the members of the Reddy family have cumulatively drawn the remuneration of ₹14,21,14,060/-.

FY2017 annual report, page 41:

An investor may read the complete analysis of Balaji Amines Ltd here: Analysis: Balaji Amines Ltd

C) Companies where surprisingly more than one promoters take home exactly the same remuneration as two people add exactly the same value to the company:

While analysing companies, an investor will come across instances where more than one promoter would take exactly the same salary down to the last rupee. Such instances are interesting because an investor would appreciate that in the real-life scenario there would hardly be any situation where two different people with different education and different experience would add exactly the same value to the company.

Investors would appreciate that in many such cases, the salaries of people may not be decided by the value they add but by other considerations like different family members want to take out an equal amount of money from the company in the form of salary whether they are adding equal value or not. Decisions of such remunerations may be internal arrangements of the promoter family instead of human resource evaluations about the value added by the persons.

Many times, in such situations, the company may end up paying a high salary to some of the family members of the promoters, which may be far higher than the actual value added by them to the company. Therefore, an investor needs to assess these companies accordingly.

Let us see some examples.

i) Balaji Amines Ltd.

While analysing the details of the remuneration taken home by the promoters of Balaji Amines Ltd in FY2017, an investor notices that the three members of the family: Mr. N. Rajeshwar Reddy, Mr. D. Ram Reddy and Mr. A. Srinivas Reddy have drawn an exactly equal salary of ₹2,84,22,812/-.

FY2017 annual report, page 41:

In the corporate world, where remuneration is usually linked to the value added by a person to the corporation, it might indicate that all the three persons mentioned above had added exactly equal value to the company. However, when an investor notices that all the three persons are of different age and experience including the fact that Mr. A Srinivas Reddy joined Balaji Amines Ltd in 2013, much later than the other two who joined the company in 1988-89, then it becomes difficult to accept that all the three persons would have added exactly equal value to the company and shareholders over FY2017 to warrant exactly equal remuneration.

An investor may read the complete analysis of Balaji Amines Ltd here: Analysis: Balaji Amines Ltd

ii) Ruchira Papers Ltd.

Ruchira Papers Ltd is a north India based paper manufacturing company dealing in writing & printing paper and kraft paper (packaging paper).

While analysing the remunerations taken by the promoters’ family from the company in FY2016, an investor comes across an interesting fact that all the eight relatives of founder promoters are being paid the same salary of ₹36.2 lakh by the company irrespective of their experience (7 to 23 years) or qualifications or age (29 to 69 years).

It hardly seems a coincidence as in professionally run organizations, the remunerations of different persons depend on their merit and are usually different for different employees.

Moreover, another strange finding that an investor would notice that all the eight relatives of founder promoters got the same hike in remuneration in the current year over the previous year. Annual report FY2016, page 100:

It is very strange performance evaluation by the board/human resource department of Ruchira Papers Ltd that all the eight relatives have added exactly equal value to the company that all the eight of them have received equal increments in remuneration.

By a far fledged leap of logic, it seems that the founder promoters are allocating equal allowances to the relatives via the company, which cumulatively amounts to ₹2.9 cr per year (₹36.2 lakh * 8), which is about 15% of net profits of the company for FY2016 (₹19 cr).

An investor may read the complete analysis of Ruchira Papers Ltd here: Analysis: Ruchira Papers Ltd

iii) PIX Transmissions Ltd:

Similarly, in the case of PIX Transmissions Ltd., an investor notices that three members of the promoter family, Mr. Sonepal Sethi, Mr. Rishipal Sethi and Mr. Sukhpal Sethi took home exactly the same salary over the years.

In FY2016, all three of them took a remuneration of ₹1.05 cr each:

Whereas in FY2016, all three of them, Mr. Sonepal Sethi, Mr. Rishipal Sethi and Mr. Sukhpal Sethi, took home a salary of ₹81.75 lac each.

FY2016 annual report, page 25:

Moreover, an investor would note that even in the previous year, FY2015, all three of them, Mr. Sonepal Sethi, Mr. Rishipal Sethi and Mr. Sukhpal Sethi, took home a salary of ₹75 lac each.

FY2015 annual report, page 39:

In the case of PIX Transmissions Ltd, an investor would notice that in all the three years, FY2015, FY2016 and FY2017, the company has continuously paid remuneration to the promoters, which is higher than the statutory limit put by Companies Ltd. In addition, the company has paid exactly the same salary to each of the three promoter family members, Mr. Sonepal Sethi, Mr. Rishipal Sethi and Mr. Sukhpal Sethi in FY2015, FY2016 as well as FY2017.

An investor should be cautious while analysing companies presenting such remuneration patterns.

An investor may read the complete analysis of PIX Transmissions Ltd here: Analysis: PIX Transmissions Ltd

D) High remuneration to promoter family members whose salary may seem very high when compared to the value-added by them:

In such cases, when an investor compares the remuneration paid by the company to the family member of the promoter with the value added by the concerned person, then she would realize that the salary paid to the person might seem comparatively higher. The investor can make assumptions about the value added by the promoter family member by way of the manner the company projects the person to outsiders/public as well as by way of the scope of the function/department said to be held by the promoter-family member.

Let us see some examples.

i) Sharda Motor Industries Ltd:

Sharda Motor Industries Ltd is one of the leading manufacturers of the automobile exhaust system, seat frames, seat covers and white goods parts in India.

While reading the FY2017 annual report, an investor notices that on June 2, 2016, the promoter of Sharda Motor Industries Ltd Mr. N. D. Relan expired and thereafter his wife Ms. Sharda Relan at the age of 81 years was appointed an executive director of the company on August 10, 2016.

An investor would notice that in FY2018, Sharda Motor Industries Ltd has paid a remuneration of ₹4.64 cr to Ms. Sharda Relan.

However, while going through the “Management Team” section of the website of the company, the investor notices that the name of Ms. Sharda Relan does not appear in the list of key management personnel. The “Management Team” section of the website highlights the following eight personnel:

1. Ajay Relan (Managing Director)
2. Aashim Relan (Chief Operating Officer)
3. Vivek Bhatia (CFO)
4. Sanjiv Kumar Yogi (Chief Purchasing Officer)
5. Sitangshu Goswami (President – Sales & Strategy)
6. Pradeep Rastogi (Legal & Strategic Affairs)
7. Nitin Vishnoi (Company Secretary & Compliance Officer)
8. Abinash Upadhayay (Chief People Officer)

The above assessment indicates that Sharda Motor Industries Ltd is not highlighting one of the highest-paid employees on its website as the key management personnel. This might seem in contrast to the principle of remuneration in proportion to the value added to the company. An investor may also interpret the above situation as a case where the company has merely shifted the remuneration, which was being paid to Mr. ND Relan to the account of Ms. Sharda Relan.

The total amount of remuneration taken by senior promoters (ND Relan, Sharda Relan and Ajay Relan) has increased consistently over the years.

While analysing the past annual reports of Sharda Motor Industries Ltd, an investor would notice that the promoters have been taking home the maximum possible remuneration allowed by the statutory limits.

In FY2010, the overall limit for remuneration to the directors was ₹36,382,914/- while the remuneration taken was ₹36,248,734/-. FY2011 annual report, page 47:

The above table also shows the method/calculation for arriving at the maximum permissible remuneration of promoters/directors for any company.

In FY2011, the overall limit for remuneration to the directors was ₹31,128,889/- while the remuneration taken was ₹31,433,330/-. FY2011 annual report, page 47:

In March 2014, Sharda Motor Industries Ltd proposed for paying minimum remuneration to promoters irrespective of low profits in the year by taking central govt. approval. FY2014 annual report, page 24:

RESOLUTIONS PASSED THROUGH POSTAL BALLOT:

Resolution No. 2 to 4 special Resolution under Section 198,269, 309 and other applicable provisions of Companies Act, 1956 for payment of Minimum Remuneration Shri N D Relan,Whole Time Director designated as Co-Chairman, Shri Ajay Relan, Managing Director and Shri Udayan Banerjee, Whole Time Director designated as Executive Director, with approval of Central Governments.

Thereafter, Sharda Motor Industries Ltd started paying remuneration higher than the stipulated limits by taking approval from central govt.

FY2015 annual report, page 36:

FY2016 annual report, page 40:

Based on the above discussion, an investor may observe that the promoters of Sharda Motor Industries Ltd have ensured that they receive remuneration, which is higher than the statutory limits by taking approval from central govt. approval irrespective of the business performance of the company.

Moreover, investors would observe that Sharda Motor Industries Ltd seems to have shifted the high remuneration being paid to Mr. ND Relan to the account of Ms. Sharda Relan after his demise. The company is not highlighting Ms. Sharda Relan as key management personnel on its website despite paying ₹4.64 cr as remuneration to her in FY2018.

Investors may keep these aspects in mind while analysing the promoters of any company.

An investor may read the complete analysis of Sharda Motor Industries Ltd here: Analysis: Sharda Motor Industries Ltd

ii) Ruchira Papers Ltd.:

While analysing Ruchira Papers Ltd., an investor notices that the senior vice president in charge of corporate social responsibility spending (Sr. VP-CSR), Ms. Praveen Garg, who is the wife of founder promoter of Ruchira Papers Ltd, is being paid a salary of ₹36.2 lakh, whereas the total CSR spending done by the company in FY2016 is ₹7.47 lakh.

An investor may analyse different sections of the annual report to verify these expenses.

CSR expense of ₹7.47 lac in FY2016:

Salary of Ms. Praveen Garg, Sr. VP-CSR of ₹36.22 lac in FY2016:

An investor may read the complete analysis of Ruchira Papers Ltd here: Analysis: Ruchira Papers Ltd

iii) Granules India Ltd:

Granules India Ltd is a Hyderabad-based Indian integrated pharmaceutical manufacturer, which focuses on making active pharmaceutical ingredients (API), pharmaceutical formulation intermediates (PFI) and finished dosages (FD) as primary business activities.

While analysing the remunerations of the promoter family for FY2016, an investor would notice that the promoter of the company, Mr Krishna Prasad Chigurupati (CMD) took home a remuneration of about ₹10 cr in FY2016 and his wife Ms Uma Devi Chigurupati (Executive Director), received a remuneration of about ₹8 cr in FY2016.

These salaries look very high from an industry benchmark perspective despite being in statutory limits. This is after considering that the net profit after tax of Granules India Ltd in FY2016 was about ₹118 cr. Salary of Krishna Prasad is about 8.5% of PAT and the salary of Uma Devi is about 6.8% of the PAT in FY2016.

Moreover, an investor would notice that the executive director, Ms Uma Devi Chigurupati does not seem to be dedicating her full-time attention to her role in Granules India Ltd. The annual report for FY2016 for the company mentions that she is also overseeing the operations of another business, which is a vineyard in Karnataka.

Mrs. Uma Devi Chigurupati has rich experience of 30 years in various fields. Mrs. Uma with Mr. Krishna Prasad Chigurupati had co-founded Triton Laboratories Private Limited in the year 1984, which was later amalgamated with Granules India Limited. Presently, she is spear heading CSR activities and HR initiatives. In addition, Mrs. Chigurupati is the Director of KRSMA Estates Private Limited, one of India’s premier boutique wineries. Under her tenure, she has established a vineyard in Karnataka and has been overseeing the ongoing operations at the site. Mrs. Chigurupati has a post-graduate degree in soil microbiology from Nagarjuna University.

If the vineyard operations require much of her time, then the high salary being paid out to her from Granules India Ltd might not be entirely justified. An investor should analyse it further to arrive at a final conclusion as high remuneration to family members might be one of the ways in which the promoters might be benefiting at the expense of the company.

An investor may read the complete analysis of Granules India Ltd here: Analysis: Granules India Ltd

E) When the salary of promoters increases despite losses/declining performance of the company:

An investor would appreciate that if the promoters of a company are working in the company full-time as employees, then like other employees of the company, they would also want to be rewarded with high salaries year-on-year. However, at the same time, an investor would note that increasing salaries of promoters year-on-year are justified only when the performance of the company is improving.

If an investor notices that the promoters of the company are taking higher salaries year after year when the business performance of the company is declining, then she may think that the promoters are keeping their own interests on priority than the business performance of the company. It might be a case where the promoters are treating the company as an avenue from where they need to extract the maximum amount of money possible instead of focusing on improving the performance of the company.

Therefore, in the cases where an investor notices that the remuneration of promoters is increasing despite losses/declining performance of the company, then she should be cautious and increase the level of her due diligence.

Let us see some examples.

i) Datamatics Global Services Ltd:

Datamatics Global Services Ltd is an Indian company providing Information Technology, business process management (BPM), engineering, data, and analytics services. The company provides IT products for robotics process automation (RPA), analytics, business intelligence, and automated fare collection (AFC). The company provides different products like TruBot, TruCap+, iPM, TruTest, Trade Finance, TruFare, TruBI, and TruAI.

While analysing the managerial remuneration of the promoters of Datamatics Global Services Ltd, an investor notices that in FY2015:

• Dr. Lalit S. Kanodia took an increase of remuneration of 21.4%
• Mr. Rahul L. Kanodia took an increase in the remuneration of 15.1%.
• Mr. Sameer L. Kanodia took an increase in remuneration of 27.5%

FY2015 annual report, page 34:

An investor may note that in FY2015, the operating profit of the company had declined to ₹86 cr from ₹91 cr in FY2014. Similarly, the net profit after tax (PAT) of the company in FY2015 had declined to ₹43 cr from ₹49 cr in FY2014.

This represents a curious case when the promoters of the company have taken a steep increase in their remunerations while the business performance of the company has declined.

An investor may read the complete analysis of Datamatics Global Services Ltd here: Analysis: Datamatics Global Services Ltd

ii) Globus Spirits Ltd:

While analysing the financial performance of the company, an investor notices that Globus Spirits Ltd has been facing financial challenges since FY2014 onwards. However, while analysing the remuneration of the promoters, an investor notices that the remuneration has been increasing almost consistently over the years.

The investor notices that Globus Spirits Ltd reported a net profit of ₹34.19 cr in FY2013. However, since then the profits have declined significantly. In FY2018, the company reported a net profit of ₹5.77 cr.

However, when an investor notices the remuneration of the promoters of the company, then she notices that their remuneration has been increasing almost consistently year on year. In FY2013, the promoters took home a salary of ₹0.82 cr, which increased to ₹1.89 cr in FY2018.

An investor would notice that the remuneration of promoters used to be about 1-2% of net profits in the earlier years, which has increased to 33% of net profits in FY2018.

An investor may read the complete analysis of Globus Spirits Ltd here: Analysis: Globus Spirits Ltd

F) When the profits of the company increase but only the salary of promoters increases whereas the salary of other employees decline:

An investor would notice that such cases might represent a situation where the promoters are only concerned about their own wellbeing without caring for other stakeholders of the company including employees who are the essential element for any business to succeed.

Investors need to assess such situations carefully because many times, the assessment of the quality of the management involves making subjective assessments.

Let us see an example.

i) Sreeleathers Ltd:

Sreeleathers Ltd is one of the leading footwear companies in India based out of Kolkata. Sreeleathers Ltd deals in the formal and casual footwear of men, women and kids as well as in leather accessories.

While analysing the remuneration of employees of the company, an investor notices that recently, year after year, the remuneration of the managing director who is the promoter of the company is increasing in line with increasing profits. However, the remuneration of many other employees is decreasing year on year.

As per FY2018 annual report, the remuneration of MD of the company increased by 60% due to the good performance of the company whereas remuneration of CFO decreased by 6%. The remuneration of employees declined by about 20%.

FY2018 annual report, page 8:

The % increase in the remuneration of each Director, Chief Financial Officer, Chief Executive Officer, Company Secretary or Manager, if any, in the financial year:

Satyabrata Dey (Managing Director) 60.00%

Bijoy Kumar Roy (Company Secretary) 9.52%

Sujay Bhattacharya (Chief Financial Officer) -6.10%

Moreover, when a person analyses the remuneration increases for the previous year (FY2017), then she notices that in FY2017, the remuneration of the MD/promoter of the company had increased by 150%, whereas the remuneration of other two key employees: company secretary and CFO had declined by 10% and 11% respectively.

The % increase in the remuneration of each Director, Chief Financial Officer, Chief Executive Officer, Company Secretary or Manager, if any, in the financial year:

Satya Brata Dey (Managing Director) 150%

Bijoy Kumar Roy (Company Secretary) -10.78%

Sujay Bhattacharya (Chief Financial Officer) -11.67%

Looking at the above data, an investor would sympathize with the situation of the CFO of the company, Mr. Sujay Bhattacharya who is working with the company with declining remuneration for two years in the row while the company is reporting highest-ever sales and profits.

Looking at the normal aspirational nature of human being, an investor may assume that:

• Either the workforce (with the CFO as an example) is subpar, who are not able to find better job alternatives, which may reward the hard work put in by employees in the company’s success. This does not seem to be the case as it is difficult for any company to grow its business without efficient hard work by its employees.
• Alternatively, the “additional incentives” other than the remuneration reported in the annual report, which are given by the company to its employees are good enough for them to stay with the company.

In any case, an investor needs to understand that she might have to do a deeper analysis of the remunerations paid by the company.

An investor may read the complete analysis of Sreeleathers Ltd here: Analysis: Sreeleathers Ltd

Consequences of promoters taking a high remuneration from the company

Whenever the promoters take a high remuneration from the company, then the future turn of events takes different shapes depending upon whether the remuneration has breached the statutory ceiling put by the Companies Act. This is because when the remuneration of promoters exceeds the ceiling put by the Companies Act, then the company and the promoters run the risk of contravening the law.

Let us see some examples where the companies breached the statutory ceiling on the remuneration put in by the Companies Act.

1) Promoters took home remuneration higher than the statutory limit and had to pay it back to the company:

In many cases, the companies paid a high remuneration to the promoters; but were directed to recover the excess remuneration from them.

A) National Peroxide Ltd:

National Peroxide Ltd is a Wadia Group company and the largest manufacturer of hydrogen peroxide (H2O2) in India.

While analysing the financial performance of National Peroxide Ltd, an investor notices that in the past, on many occasions, the company paid remuneration to its managing director, which was higher than the statutory limit in the Companies Act.

In FY2015, the company paid a remuneration of ₹2.59 cr to its managing director whereas the statutory limit was ₹0.93 cr.

FY2015 annual report, page 41:

Similarly, in FY2016, the company paid a remuneration of ₹2.29 cr to its managing director whereas the statutory limit was ₹1.66 cr.

FY2016 annual report, page 38:

In the past, there have been many instances where National Peroxide Ltd initially paid a higher remuneration/commission to its directors that it had to recover later on.

In FY2012 and FY2013, the company had to recover excess commission paid to its directors.

FY2016 annual report, page 63:

The reversal of excess commission paid to the directors continued in FY2014 and FY2015.

FY2015 annual report, page 89:

The next instance of such a reversal of excess commission to the directors appeared in FY2017.

FY2017 annual report, page 87:

An investor may note that in the case of National Peroxide Ltd, there has been an instance of senior management of the company prioritizing its interest over the interest of the shareholders when the employees of the company engaged in financial fraud.

In the FY2018 annual report, National Peroxide Ltd intimated its shareholders that it has come across a financial fraud of about ₹37 cr. by its employees including senior management employees. The company terminated the services of these employees and filed criminal complaints with the police.

FY2018 annual report, page 116:

Embezzlement of funds of the Parent Company: 1. During the current financial year, the Parent Company’s management has identified instances of embezzlement of its funds by certain employees of the Parent Company, including senior management employees, whose services have since been terminated. Based on the management’s scrutiny and the forensic investigation report, the amount of the embezzlement is ₹3,702.98 lakhs. The Parent Company has initiated criminal proceedings against these employees including filing of FIR and application for other appropriate action with the Joint Commissioner of Police, Economic Offences Wing.

Later on, from media reports, an investor gets to know that the police had arrested Mr. Suhas Lohokare (ex. MD) and an accountant of the company, Mr. Nipul Trivedi. The media report mentioned that these suspects siphoned off money, which was for the payments of sales tax and value-added tax (VAT) for over 10 years, from 2008-2017 (Source: Times of India)

Suhas Lohkare, who was brought from Pune and arrested

EOW had earlier arrested Nipul Trivedi (40), an accountant with the firm

The suspects siphoned off money for payment as sales tax and Vat over 10 years, from 2008. They claimed the ST receipts were pending with the government and they would get them later,” added an officer

After this fraud, National Peroxide Ltd acknowledged that its internal processes needed strengthening. As a result, the company changed its senior management team including the MD and the VP-Finance as well as its internal auditors.

Such an incidence indicates that when the management of any company starts to prioritize its own interests over the interests of the company and the shareholders, which might be visible in higher salaries, then the management might go to any extent, even frauds, to extract money out of the company. Investors should be very cautious while analysing companies with a high promoter/managerial remuneration.

An investor may read the complete analysis of National Peroxide Ltd here: Analysis: National Peroxide Ltd

B) India Glycols Ltd:

India Glycols Ltd is an Indian company manufacturing glycols, ethylene oxide derivatives using renewable raw material (alcohol, molasses), guar gum derivatives, alcohol & spirits, industrial gases, and nutraceuticals.

While analysing the remuneration of the promoters of India Glycols Ltd, an investor notices that during FY2015, the promoter-chairman took home the maximum remuneration permissible under the law while the company made losses because of poor business performance.

FY2015 annual report, page 34:

While reading the annual reports of the company, an investor also notices that at times, the company has paid remuneration to its promoters, which was higher than the statutory limit. As a result, the company had to seek approvals from the central govt. However, the central govt. refused to approve the full remuneration proposed by the company to its promoters (Chairman & Managing Director) and the Chairman had to refund the excess remuneration.

However, the company has requested the central govt. to reconsider its decision so that it can pay higher remuneration to its promoters.

FY2019 annual report, page 114:

During the FY 2017-18, Central Government (CG) approved remuneration for Chairman and Managing Director (CMD), which was lower than applied for by the Company, against which a representation has been made to reconsider the matter. During the FY 2018-19, pending any response from CG, as a good governance, a sum of ₹58.58 Lakh has been refunded by the CMD.

An investor may read the complete analysis of India Glycols Ltd here: Analysis: India Glycols Ltd

C) AksharChem (India) Ltd:

AksharChem (India) Ltd is an Indian manufacturer of dye intermediates (Vinyl Sulphone) and pigments (CPC Green and CPC Violet) based out of Gujarat.

While analysing the remuneration of the promoters, an investor notices that in FY2014, promoter management took a steep hike in its salary of about 17 times from ₹0.12 cr. in FY2013 to ₹2.12 cr. in FY2014:

However, it seems that AksharChem (India) Ltd had paid the remuneration in excess of the statutory limits and therefore, the company had to recover the excess remuneration in the subsequent year FY2015:

The Prior Period Adjustments of Rs.11,565,000/- shown in Statement of Profit and Loss represents the recovery of excess payment of Remuneration paid to the Managing Directors of the Company during the Financial Year 2013-2014.

One of the reasons leading to the recovery of excess remuneration might be that AksharChem (India) Ltd might have failed to get the central govt. approval for payment of remuneration to management, which is higher than the statutory limits.

Therefore, investors would notice that whenever the promoters take home a remuneration that is in excess of statutory limit, then they run a risk that they may not get the requisite approvals and in turn, may need to pay it back to the company.

However, investors face tricky situations where the promoters take salaries that are significantly high when compared to the financial strength of the company but unfortunately, are within the statutory limit prescribed by the Companies Act.

An investor may read the complete analysis of AksharChem (India) Ltd here: Analysis: AksharChem (India) Ltd

2) Promoters take high salaries but within the legal limits:

In such situations, the company, its business, its financial strength, and the minority shareholders have to bear the burden of the high salaries to the promoters. This, in turn, affects the financial health of the companies.

In many such cases, it becomes a vicious cycle as the high salary of promoters deteriorates the financial strength of the company making the banks reluctant to give it loans. In turn, the promoters then give loans to the company (from the high salary taken by them from the company) at a high-interest rate. An investor would notice that in such situations the company and the minority shareholders are left to the mercy of the promoters.

Let us see some examples.

i) PIX Transmissions Ltd:

While analysing the financial performance of PIX Transmissions Ltd, an investor would notice that the company did not generate sufficient cash flow from operating activities (CFO) to meet its capital expenditure (capex) and debt servicing requirements. Therefore, it has to raise an additional debt of ₹38 cr over FY2014-FY2017. The total debt of the company increased from ₹91 cr. at the end of FY2013/start of FY2014 to ₹129 cr. in FY2017.

Moreover, an investor notices that out of the additional debt of ₹38 cr. , the promoters/related parties have contributed ₹11 cr. and the outside lenders (banks/FIs) have contributed the balance ₹27 cr.

An investor may interpret that the related parties are supporting the company in times of liquidity stress. However, an investor needs to keep into account the important aspect of high remuneration taken by the promoters, discussed above in the article, before she makes any final opinion.

An investor would agree that one of the interpretations that can be assigned to such remuneration practices is that the related parties are taking high remuneration, which in turn is leading to the shortfall in cash generated by the company from its operations in comparison to its capital expenditure and debt servicing requirements. Then, the related parties are providing the cash received from the company, back to the company in the form of interest-bearing loans to bridge the same cash shortfall.

An investor would notice that the company is paying interest of about 12% on the loans from related parties. The following section of the FY2017 annual report, page 128, will help the investor to calculate the applicable interest rate:

• The loan outstanding at the start of FY2017/at the end of FY2016 = ₹18.5 cr.
• The loan outstanding at the end of FY2017 = ₹19.7 cr.
• Average loan outstanding during FY2017 = ₹19.1 cr. [(18.5+19.7)/2]
• Interest paid by the company on loans from related parties in FY2017 = ₹2.3 cr.
• The interest rate applicable to the loans from related parties in FY2017 = 12% (2.3/19.1)

An investor may interpret that contribution in the cash shortfall by high promoter remuneration and then bridging the shortfall by giving back the money by related parties as a loan to the company is a vicious cycle, which might have an effect of taking the economic benefit away from the non-promoter/public shareholders.

Therefore, we suggest that an investor should do her own in-depth due diligence before she makes any opinion about the managerial remuneration or the loans from related parties.

An investor may read the complete analysis of PIX Transmissions Ltd here: Analysis: PIX Transmissions Ltd

While analysing different companies, an investor will also find cases where the promoters wish to earn money from all possible avenues from the company. First, they take high salaries and then give this money to the company as a loan and then earn a high-interest rate on these loans from the company.

Let us see some examples.

ii) Bharat Rasayan Ltd:

While analysing the total cumulative financial performance of Bharat Rasayan Ltd over the last 10 years (FY2008-17), then an investor would notice that the company has a total cumulative CFO of ₹169 cr. whereas it had to meet a capital expenditure (capex) of ₹208 cr. and the interest expense of about ₹68 cr. indicating the total expenditure of about ₹276 cr. (=208+68). Bharat Rasayan Ltd had to meet the cash flow gap of ₹107 cr. (=276-169) by raising additional debt of ₹107 cr.

While analysing the company, an investor notices that the company has taken a significant amount of loans from related parties (primarily promoters). As per FY2017 annual report, page 89, the total loans outstanding from related parties is about ₹80 cr.

Upon analysing the past reports for the company, an investor would notice that the loans and advances from related parties started increasing significantly from FY2013 onwards. In FY2014, the loans from related parties increased to about ₹34 cr. from ₹5 cr. in FY2013. Overall, the investor would notice that during the period from FY2013 to FY2017, the loans from related parties have increased from about ₹5 cr. to about ₹80 cr. whereas during the same period the overall debt of the company has witnessed a net decline from ₹131 cr. to ₹115 cr.

The comparative analysis of total debt of Bharat Rasayan Ltd with its break-up into the related and outsider (banks etc.) parties shows the following picture:

In FY2013, the company completed its capex of about ₹125-150 cr. on the Dahej plant and it became operational. After FY2013, the company started its phase of high sales growth (sales increased from ₹98 cr. in FY2013 to ₹621 cr. in FY2017) and significant improvement in the operating profit margin (OPM).

The analysis of the breakup of the debt among the related parties and outside parties indicates that since the start of the Dahej plant, the promoters have been infusing more and more capital into the company in the form of loans and are replacing the outside lenders.

Related parties currently own 70% of the debt of the company in FY2017 up from 4% in FY2013.

It might be a case that that the promoters/related parties are flush with funds and are not finding opportunities to deploy those funds anywhere else at attractive rates of return. Therefore, they are replacing the outside lenders to Bharat Rasayan Ltd and in turn ensuring that they get interest income from Bharat Rasayan Ltd, which is higher than the interest income available to them outside.

While analysing FY2017 annual report of the company, page 88 & 89, an investor would notice that the company has disclosed the amount of the interest paid by it to all the related parties on the loans given by them to the company. An investor can use this data to find out the interest rate that related parties are charging to the company.

The following table shows the calculation of interest rate paid to four of the largest lenders from the related parties:

An investor would notice that the related parties are getting an interest rate of about 9.6% to 10.2% on their loans to Bharat Rasayan Ltd. Whereas, currently, the interest rate available for deposits in the banking system ranges from 5.25% to 7.25%.

Therefore, one interpretation to the infusion of funds by related parties might indicate that the related parties are getting an interest rate of about 10% from the money put in by them into Bharat Rasayan Ltd against the interest rate of about 6%, which they might get when they put money as deposits in the banks.

Therefore, an investor would notice that the act of related parties to infuse ₹75 cr. as loans into Bharat Rasayan Ltd to replace the outside lenders might indicate a situation where the company is facing cash flow constraints to run operations and repay outside lenders. On the other hand, if Bharat Rasayan Ltd has a strong cash flow position to run its operations smoothly and has the ability to repay all its outside debt on its own, then the loans from related parties might indicate an attempt by them to get higher interest rates on their money than the deposit rates from banks.

We would suggest that the readers/investors should do further analysis and arrive at their own conclusion regarding it.

An investor may read the complete analysis of Bharat Rasayan Ltd here: Analysis: Bharat Rasayan Ltd

Looking at all the examples discussed above, an investor would appreciate that she needs to be very cautious while analysing companies. This is because she may find a situation where the promoters themselves might have lost interest in running the company as owners, sell the business to others, and themselves act as employees.

An investor would appreciate that if the promoter decides to leave the company’s ownership and determines to take the assured benefits of a salary, then it may indicate that the business of the company is very difficult with little prospects of high profitability in the future. In such cases, the minority shareholders might not find the best investing opportunities. We believe that an in-depth analysis of the remuneration of the promoters and its trend over the years might alert the investor to such developments in the companies.

Let us see the examples of Kokuyo Camlin Ltd where Indian promoters have sold almost their entire stake a Japanese company and are happy working as a full-time paid employee of the company. Moreover, an investor would notice that after selling the business, the erstwhile Indian promoters of Kokuyo Camlin Ltd have found that their take-home benefits have become assured and are increasing year on year irrespective of the business performance of the company. The promoters of Kokuyo Camlin Ltd seem to have safely transferred the risks of business to the new Japanese owner and the minority shareholders.

When promoters sold their company and become employees of the company

Kokuyo Camlin Ltd:

Kokuyo Camlin Ltd is a leading manufacturer of stationery & related products owning brands Camel and Camlin. The company is now a subsidiary of Kokuyo Co. Ltd of Japan.

The analysis of the past business performance and related aspects of Kokuyo Camlin Ltd gives an investor interesting insights about the faith of Indian promoters in their ownership of the company founded by their elders about 75 years back. The investor finds that the Indian promoters of the company seem to have realized that the stationery and related business is too tough to make money as owners of the company.

The business performance of the company has been very challenging. Despite all efforts of the management, the company could not avoid losses. Despite a huge amount of investment in plant & machinery as well as in advertising & promotions, the company is not able to ensure consistent profitability.

Since FY2010, in the next eight years (FY2011-2018), Kokuyo Camlin Ltd spent an amount of ₹160 cr on advertisement and sales promotions. However, if the investor notices the result of this expense of ₹160 cr on the profits of the company, then she realizes that in concrete profitability terms, there is no value addition.

In FY2010, the company had reported a net profit after tax of ₹12 cr. After spending additional ₹160 cr on advertisement and promotions over the next eight years (FY2011-18), the net result was that Kokuyo Camlin Ltd.’s profits had declined to ₹10 cr in FY2018. In the meanwhile, the company also reported losses in FY2012, FY2013 and FY2014.

Our analysis of the company showed that the company suffers when raw material/commodity prices go up as it lacks the pricing power to pass on increased costs to customers. The company suffer again when the commodity prices go down as the already cutthroat competition intensifies further and the company has to reduce the prices of its products.

The company’s business has been consuming cash at a fast pace. Apart from entire business profits, the company consistently has to feed the business with additional funds from debt as well as equity just to maintain nominal growth of 8-9%. Despite such significant funds infusion, the business has not generated surplus cash for its shareholders.

During FY2009-18, the company had a cumulative cash flow from operations of ₹73 cr. However, during this period it did a capital expenditure (capex) of ₹198 cr. As a result, it had a negative free cash flow of ₹125 cr. (198 – 73).

Investors would appreciate that the phase of shareholders consistently putting in money in the company to generate growth due to lack of sufficient business profits seems justifiable in startup companies, which are yet to prove their business idea. This situation of consistent equity infusion seems strange for a business, which has a history of more than 85 years.

Without a doubt, this is a tough business to operate and the promoters seem to be happy to let the Japanese company Kokuyo take up majority stake when the opportunity came in FY2012. Kokuyo infused money in the company by preferential allotment as well as gave an opportunity for the promoters to sell a significant portion of their holding at a premium to the prevailing market price.

FY2012 annual report, page 15:

• On July 8, 2011, Kokuyo put in money in the preferential allotment of shares of the company (10% stake) at a price of ₹85/- per share when the prevalent market price of the company was ₹72.5.
• On October 13, 2011, Kokuyo purchased additional shares in the open offer (20% stake) and purchased 20.27% stake from Indian promoters at ₹110/- when the market price was ₹45.65.

However, the stake sale by the Indian promoters did not stop on October 13, 2011, when they sold their 20.27% stake to Kokuyo. The Indian promoters kept on selling their stake to Kokuyo year after year. During FY2014, when the company came out with the rights issue, then only the stake of Kokuyo Co. Ltd went up in the company from 50.5% in FY2013 to 65.8% in FY2014. During the year of the rights issue, the stake of Indian promoters declined from 13.4% in FY2013 to 9.2% in FY2014. It indicates that the Indian promoters did not participate in the rights issue.

It seems that the Indian promoters have decided to completely exit from the company as shareholders as they are continuously selling their stake to Kokuyo year after year and as disclosed below and their current stake in the company at meagre 0.6%.

An investor would appreciate that since the sale of the majority stake, the Indian promoters of the company have only earning salary/remuneration from Kokuyo Camlin Ltd as the company has not declared any dividend due to meagre profits.

Looking at the above table, the investor would notice that selling their stake in the company, the remuneration of the Indian promoter has been consistently on the rise. The total remuneration taken by the Indian promoters from Kokuyo Camlin Ltd has consistently increased year on year from ₹1.9 cr in FY2013 to ₹3.2 cr in FY2018.

This is despite the fact that the profitability of Kokuyo Camlin Ltd has been very fluctuating during these years. The company reported losses in FY2013 and FY2014 and the company reported a significant decline in profitability in FY2017. However, it seems that by selling a stake in the company and taking over the role of employees, the Indian promoters have ensured that their economic benefits stay healthy irrespective of the financial/business performance of the company.

Previously, when the Indian promoters were the largest shareholders of the company, then their payout from the company depended a lot on the business performance of the company. This is because payouts to promoters like dividend are determined by the board of directors based on the company’s financial performance. However, now as employees of the company, they seem to have ensured a healthy payout whether sufficient profits are there or not. In case of insufficiency of profits, the company took approval from the central govt. to provide them remuneration above the normal statutory limits.

FY2016 annual report, page 76:

Based on the records examined by us and according to the information and explanations given to us and as described in note 26 (d) to the financial statements, the managerial remuneration paid /provided by the Company to one of its directors is in excess of the amounts specified in section 197 of the Act read with Schedule V of the Companies Act. As described in the aforesaid note, the Company is in the process of applying to the Central Government for the necessary approval of the same.

FY2017 annual report, page 150:

Due to inadequacy of profits, the Company has filed an appication with Central Government for approval of revised Managerial Remuneration effective from 10February 2016 and is awaiting approval.

Based on the above discussion, it seems that the Indian promoters after running the business for about 80 years decided that they are better off being employees of the company and taking a healthy payout as salary/remuneration instead of being owners of the company and facing the uncertainty of dividends by taking the business ownership risks. As a result, after Kokuyo took a majority stake in the company in FY2012, the Indian promoters sold almost their entire shareholding in the company to Kokuyo over the recent years.

It indicates that the Indian promoters have lost faith in owning this business or find the ability to produce profits too uncertain that they have finally chosen the certain of paycheques over the uncertainty of dividend cheques from the company.

An investor may read the complete analysis of Kokuyo Camlin Ltd here: Analysis: Kokuyo Camlin Ltd

In light of the above discussion, an investor would appreciate that analysis of the remuneration taken by promoters becomes extremely essential. The assessment of promoters’ remuneration can indicate to an investor whether the promoters are putting their own interest above the interests of the company, the minority shareholders or other stakeholders like employees. The assessment of their remuneration can also indicate to the investor whether the promoters have lost interest in bearing the risks of running the business themselves and are seeking ways to get out of the business and shift to the safety of a monthly paycheque.

While analysing the remuneration of the promoters, an investor should focus on the auditor’s report section and the remuneration table in the extract of the annual report section. She should also compare it with the profits of the company, the salary of other promoters, the salary of other employees and the increments in the promoters’ salary over the years.

A deeper analysis of the trends in the promoters’ remuneration will bring out many helpful insights to the investor about the promoters’ attitude towards the business, their integrity, their shareholder friendliness etc. These traits of promoters are the major factors in determining the future returns on any investor’s investments in stocks.

One can only imagine that if an investor could have identified that during FY2011-FY2013, the promoter of Ess Dee Aluminium Ltd was increasing his salary continuously despite the declining profits of the company, then she could have avoided the subsequent poor experiences with the company. The hike in the promoter’s salary despite declining profitability in FY2011-FY2013 could have indicated that the promoters have their personal interest in mind instead of the interests of the company or the minority shareholders.

Later on, the company’s performance declined sharply and from FY2017 onwards, the company’s operating income stopped. It started reporting huge losses without any income. The debt levels of the company increased to very high levels of ₹1,166 cr in FY2019 from ₹214 cr in FY2011. With no income to support these debt levels and the continued remuneration of crores of rupees, charged by the promoter without any income in the company, the stock price of the company declined.

The stock price of the company declined from about ₹750 in Feb 2014 to ₹1.88 in 2020.

An investor can only wish that she could have caught on the early warning sign that the promoters are increasing their remuneration from the company despite declining profitability and exited the stock, then she could have saved on the huge losses that the company & its stock created for its shareholders.

Therefore, we advise investors to pay a lot of attention to the remuneration taken by the promoters from the company, the trend of increase of their remuneration and the accompanies circumstances of the business performance of the company. It may save them a lot of pain later on.

Readers’ Queries

What should be the ideal level of remuneration of promoters?

Advised Reading: Steps to Assess Management Quality before Buying Stocks (Part 1)

Good points, Sir. In the above article, you have mentioned that

“After analysing many companies as part of my stock selection process and for answering queries of readers, I notice that the usual salary range for promoter directors/management is about 2-4% of net profit after tax (PAT). The salary generally contains 2% commission on PAT and a fixed monthly component along with other perquisites.”

My query is that when you say 2-4% of net profits as remuneration of promoters, do you mean one key promoter? I have seen this figure to be a bit high for promoter directors and key management personnel. I referred Companies Act 2013, section V wherein remuneration of promoters details are mentioned, but I could not arrive at a conclusion.

What should be the permissible limit of remuneration of promoter directors and key management personnel? Can this salary include commissions/other re-reimbursement/sitting fees?

Thanks & Regards,

Author’s Response:

Hi

Thanks for writing to us!

The permissible limit of the remuneration of promoters is calculated as per section 197 of the Companies Act 2013 by making certain adjustments in the net profits of the company. Investors do not need to calculate it on their own. Companies provide the limit/ceiling value in the annual report in the section detailing the remuneration of key management personnel. Investors may use the data in the annual report to compare and make an opinion. In a few cases where due to any reason, the company has not provided the limit/ceiling value, then the investors may write to the company to get this data.

The above discussion relates to the legal provision. However, while doing our analysis, we compare the remuneration of promoters with the profit after tax (PAT), which is declared by the company in its P&L.

The assessment of remuneration of promoters is a subjective exercise and has many case-to-case based subjective interpretations.

We believe that the level of 2-4% is highly relevant for companies, which are run by a single entrepreneur/promoter. However, even in such cases the absolute amount of profits and the absolute amount of remuneration of the promoter is important before we arrive at any conclusion.

E.g. A company earns a PAT of Rs. 1 cr. and the promoter takes home Rs. 20 lac as salary, then even though the remuneration is 20% of PAT; still it is not a high salary as MBA graduates of tier-1 business school take a higher salary than Rs. 20 lac when they start their first job after graduation. Rs. 20 lac may be essential to living in a metro city while taking care of family and kids.

On the contrary, if a company has a PAT of Rs. 10,000 cr., then we do not expect the remuneration of promoters to be Rs. 200-400 cr. (considering 2-4% of PAT as an acceptable limit). We believe that remuneration levels of promoters should be lower in such cases and promoters should earn additional money through dividends, which are shared equally among all the shareholders.

The assessment of remuneration of promoters becomes a bit tricky when many members of the family are a part of the company’s senior management and each one takes a remuneration from the company. In such cases, we believe that an investor should assess the individual salaries of each of the promoter family members and then arrive at her conclusion about whether the salaries are appropriate or the salaries are being taken as a means of taking money out of the company by the promoters.

Moreover, an investor should always look for signs that may indicate to her whether the names of the promoter family members shown as employees/senior management of the company are merely on the rolls of the company in order to withdraw money from the company without adding any value to the company. OR these family members are truly working as value-adding resources/employees for the company.

An investor should go through the following analysis of Ruchira Papers Limited to understand more on the above point:

Advised Reading: Analysis: Ruchira Papers Limited

Therefore, the remuneration of promoters is a subjective assessment and the investor would be able to differentiate different cases from each other once she analyses the remuneration levels of many company promoters as a part of her analysis.

Hope it answers your queries.

All the best for your investing journey!

Regards

Dr. Vijay Malik

How to interpret statutory ceiling on managements’ remuneration?

Hello Sir,

There are some doubts in my mind, which I want to clear.

1. I came across an article in a finapp which says “The remuneration of any one Managing Director or Whole Time Director or Manager shall not exceed 5% of net profit. Where, there is more than one Managing Director or Whole Time Director, the overall limit is 10% of net profit.” Does it mean if there is more than one MD, we have to check the overall limit rather than the individual limit? And if one MD has 6% and other 4% salary, then also it is in the specified limit?
2. I have come across annual reports of good companies which have specified ceiling as per the act. Is that a correct number and we don’t need to calculate them individually?
3. After calculating these ceiling number, many companies use PBT instead of PAT. Why so? As it is mentioned in companies act that salary should be 10% (more than 1 MD) or 5% (one MD) of net profit, still, companies go ahead and calculate it in terms of PBT. Is it not a violation of corporate governance?

Author’s Response:

Hi,

Thanks for writing to us. We appreciate the time and effort being spent by you in the stock analysis.

1. Investors need to check both the individual as well as the overall limit.
2. Misstating the applicable limit would be a serious issue. Therefore, we believe that there would be a low probability that the companies would falsify the applicable limit to them.
3. The applicable limit is calculated on profits arrived as per specific sections of the companies act, which is different from the PBT and PAT of profit and loss statement. You may find many articles on the internet about calculating the profits as per those sections of companies act to arrive at the remuneration limits.

Further advised readings: Why Management Assessment is the Most Critical Factor in Stock Investing?

Hope it answers your queries.

All the best for your investing journey!

Regards

Dr. Vijay Malik

Related Query

Article: Analysis: Ruchira Papers Limited

Hello Dr Vijay,

I think the act says that the remuneration should be 10% of net profit before tax (and not after-tax) as per section 198 of companies act 2013. Can you please confirm?

Please refer to the article from EY on CSR spend guidelines.

According to this, the net profit is calculated as per section 198 of companies act 2013. Please refer to page 7. In there the income tax falls under “non-permissible deductions”. So income tax cannot be deducted from profit for calculation of net profit (this would increase the CSR spend required).

Hence, as per the act, net profit for calculating CSR and WTD remuneration is inclusive of tax.

Regards,

Author’s Response:

Hi,

Thanks for writing to me and point out to this explanation.

It seems that for managerial remuneration, income tax as well as the remuneration of managers need to be adjusted while arriving at the ceiling. The applicable section is 197 of companies act 2013:

“The total managerial remuneration payable by a public company, to its directors, including managing director and whole-time director, and its manager in respect of any financial year shall not exceed eleven percent of the net profits of that company for that financial year computed in the manner laid down in section 198 except that the remuneration of the directors shall not be deducted from the gross profits”

Also, apparently, the company has declared that it does not have adequate profits for payment of managerial remuneration under section 197 or schedule 5 of companies act 2013. At page 34 of the FY2016 annual report:

“During the Financial Year ended 31st March 2016, the Company did not have adequate profits for payment of managerial remuneration under section 197 and Schedule V of the Companies Act, 2013. The profitability has increased during the year but the remuneration proposed does not fall under the limits as specified under section 197 resulted inadequacy of profits during the F.Y. 2015-16. “

Anyway, by any means, the salary being paid to the promoter managers and the relatives is higher than reasonable levels.

All the best for your investing journey!

Regards,

Dr Vijay Malik

Do you use promoters’ remuneration as a parameter in your stock analysis? If yes, then what benchmarks do you use for your interpretations? What has been your experience of analysing promoters’ remuneration? Has it proved a helpful parameter to differentiate good companies from the poor ones and to differentiate good management from the poor one? It would be great if you could share your experiences with the author and the other readers in the comments section below.

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• We have used the financial data provided by screener.in and the annual reports of the companies mentioned above while conducting analysis for this article.

DISCLAIMER

Registration status with SEBI:

I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013

Details of Financial Interest in the Subject Company:

Currently, I do not own stocks of the companies mentioned above in my portfolio.