The Suzuki problem

Need for a cap on royalty, higher tax on unlisted MNC arms

Maruti Suzuki's announcement that a proposed factory in Gujarat will be owned not by it but by a fully-owned subsidiary of Suzuki Motor Corporation gives rise to several questions related to corporate governance - and to larger questions about the regulation of multinationals in India. One, what is the price at which the new company, Suzuki Motor Gujarat, will sell cars to Maruti Suzuki? R C Bhargava, chairman of Maruti Suzuki, has said that these cars will be sold at cost price. But the books of Suzuki Motor Gujarat will not be open for scrutiny to Maruti Suzuki's shareholders; they have to take at face value the final cost charged to their company. Two, the land for the factory is owned by Maruti Suzuki. Will the new company buy it or pay it a lease rental that reflects the market price? Three, what happens in case there is a slowdown in the market? Will Maruti Suzuki curtail production at its plants at Gurgaon and Manesar, or will the burden fall on Suzuki Motor Gujarat?

Mr Bhargava has said that Maruti Suzuki's shareholders stand to gain because the company's cash reserves, on which it earns 8-9 per cent interest, need not be diverted into this investment. The assumption here is that the return on capital employed in the new venture will be less than 8-9 per cent. In other words, the opportunity cost of investing the reserves in a new factory is high for the company. That's perhaps the reason why the price of Maruti Suzuki's shares rose almost 8 per cent on Wednesday after falling 8.21 per cent on Tuesday, the day this announcement was made. Since Suzuki owns 56.2 per cent of Maruti Suzuki, this high interest income reflects on its profit in Japan. There, Suzuki earns as little as 0.3 per cent interest on its cash reserves. So, conserving Maruti Suzuki's cash is smart interest-rate arbitrage on its part. Suzuki's decision to have the Gujarat factory in a new company may also have something to do with the recurring labour trouble at Maruti Suzuki. Had it been under the same company, the labour unions would have found it easy to set up base in the factory. It will now be difficult for them to do so.

While the business logic appears to be strong, the development does not augur well for corporate governance. An element of opacity will now enter the operations of the country's largest car maker. That's why proxy advisory firms have raised their concern on the new arrangement and have asked minority shareholders to resist it. Suzuki is not the only multinational corporation to have listed as well as unlisted subsidiaries in India - there are many others. Several observers have raised their voice against this practice, especially against the distribution of profit and loss between the two subsidiaries. There are risks associated with every business, but these have to be borne by all shareholders. In the two-subsidiary arrangement, it has been found that the shareholders of the listed subsidiary often get the rough end of the stick.

That's where the government can help with its tax policy: Have a rate of tax for unlisted companies that is higher than what is currently levied on listed companies. The difference should be a strong deterrent for a multinational corporation to set up an unlisted subsidiary. The other issue that the government needs to look into for the sake of minority shareholders is royalty payment: Studies have shown that ever since the regime was liberalised, multinationals have squeezed significantly higher royalty from their listed Indian companies. The government needs to realise the regime is being misused and a correction is required.