The Hindu Business Line : Reading between the lines

ASK a fund manager what he looks for in a company before investing in its stock and one of the first parameters he would pick is "management quality." Yet, this is a rather ephemeral concept. How does one really judge whether a company's management works in the best interests of its shareholders? Well, related party disclosures serve a useful purpose here. Shareholders can look for the following clues in reading related party disclosures:

Significant transactions with key management personnel (or their relatives or influenced by them) may indicate that the management is using its position in the company to undue personal benefit. The size of the transaction may be important to judge materiality. Second, look for a consistent pattern of such transactions before passing a judgement.

Large loans to entities controlled by the same management may serve as a warning signal of diversion of funds. But consistent outstanding balances and write-offs may be more worrisome than the actual fact that a loan has been advanced. Check if the auditors have verified the terms of the transaction.

Collaterals or guarantees extended to associates or other related parties can serve as advance notice of a large contingent liability looming over a company.

Sourcing or sale arrangements with a holding company or other group companies can demonstrate a company's dependence on its parent or group entities for business. This can help in assessing the impact on the company, if such a relationship is discontinued. For instance, one can gauge the impact on revenues if an MNC parent decides to sell its stake in the Indian arm to a third party.

In the same context, the reciprocity of transactions may help judge if a company is consistently at the receiving or giving end when it comes to transactions with group companies. For instance, if the sums a company receives from group companies towards services rendered roughly matches what it pays out towards shared services, there may be no real cause for concern.

Indian investors may find that details of relevant related party transactions are available in a few places other than the section on related party disclosures. The section on managerial remuneration, loans/advances due from directors and subsidiaries and the auditor's report (which may certify/qualify certain transactions) may provide important supplementary information.

In their present form, the related party disclosures (as detailed by Accounting Standard 18) may leave investors in public companies more enlightened about how the company is managed. However, there still appears to be considerable room for improving the present disclosures.

In general, the related party disclosures presented by companies to meet with the requirements of the US GAAP have been far more detailed than those presented to meet the requirements of AS-18. There are several gaps that need to be bridged:

Identity of related party: In their present form, the related party disclosures of Indian companies do not provide the identity of the specific party with whom a transaction has been made. Most companies carry lists for the various categories of related parties and then club together all transactions with a particular category, without identifying the specific counter-party to the transaction.

For instance, the Reliance Industries annual report says that it gave loans of Rs 14,000 crore to "associates" during the year. The annual report identifies 12 "associate" companies, which range from BSES and Reliance Infocomm to unincorporated oil and gas ventures. It is not clear which of the associates were the main borrowers. Most companies follow the same practice as Reliance.

What is a payment?: Nestle India's related party disclosures show a transaction of Rs.1.73 crore towards services received/rendered. It is not clear if the company received or paid this sum. Satyam Computer Services has gone a step further.

In its related party disclosures, the company has clubbed all its related party transactions (irrespective of the category) under different heads such as receivables/payables and outsourcing/payables. On reading this, one is none the wiser about whether the company paid or received money.

Terms of the transaction: A disclosure that a related party transaction was made during the year serves little purpose, unless one is apprised of the terms of the transaction. Madras Cements' related party disclosures set an example in this regard. In its annual report the company detailed all of its loans to associated and group companies. Not only did it separately identify each borrower, it also provided the rate of interest at which these loans were contracted.

But 2001-02 was the maiden year of related party disclosures for Indian companies. Hopefully, the disclosures will evolve over the years to provide better information to shareholders.

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