Corporate governance

KEY POINTS

·        A concern that many markets around the world share in relation to poor corporate governance is the abuse of related party transactions (RPTs).

·        Significant corporate frauds such as the Satyam scandal, Enron fiasco and WorldCom débâcle have happened connected to RPTs or similar arrangements.

Related-Party Transaction

·        A related-party transaction is a business deal or arrangement between two parties who are joined by a special relationship prior to the deal.

·        For example, a business transaction between a major shareholder and the corporation, such as a contract for the shareholder's company to perform renovations to the corporation's offices, would be deemed a related-party transaction.

Why it has to be regulated?

·        In India, RPTs assume even more significance due to the nature of Indian business houses, which are primarily promoter-led and consist of family business structures.

·        Given that the number of family-owned businesses is very high, it follows that they will have closer ties with other businesses owned by the same family or its relatives.

·        Not all RPTs are detrimental to the interest of the company or its shareholders. Some transactions can be legitimate and serve practical, commercial purposes.

·        But, the desire and opportunity to deal with a known party will be greater.

·        The tension between dealing fairly with a familiar party and exploiting shareholders’ resources for personal gain becomes magnified in family-owned businesses.

·        A RPT can present a potential or actual conflict of interest and might not be aligned with the best interests of the company and its shareholders.

·        It can result in situations where such transactions are used as a conduit to channel funds out of the company into another entity.

·         The absence of transparency exacerbates the problem by creating an environment in which attempts to siphon off resources go unchecked.

·        Abusive RPTs oppress small and retail investors, undermining confidence in the financial market and thereby adversely affecting the mobilisation of investment.

·        Hence, the corporate governance framework in India should emphasise monitoring/regulating connected transactions involving controlling shareholders and related entities.

·        India’s regulators are recognising that appropriate checks and balances in relation to related party transactions are crucial for good governance, and are improving safeguards and disclosures pertaining to them.