NEW DELHI: Five of India’s biggest listed companies, four of which are in the Nifty, have a Rs 40,000-crore decision to make in the next six months: what to do with the Rs 40,000 crore of their own shares they currently hold?
The urgency to make that decision arises from India Inc beginning its transition to International Financial Reporting Standards (IFRS), the global accounting architecture that is far more demanding than current Indian standards, from April 1, 2011.
IFRS invalidates a big reason why Indian companies prefer to hold their own shares or ‘treasury stock’ in accounting parlance. “Companies holding treasury stock for profit might now consider not having it at all,” says Jamil Khatri, executive director, IFRS, KPMG.
If these five companies, Reliance Industries, Mahindra & Mahindra , BPCL , Jaiprakash Associates and United Spirits , think similarly, it could lead to them offloading Rs 40,000 crore of their stock (See table: Stock Pile).
Emails to the five companies on their reasons for holding treasury stock and plans went unanswered.
To put that Rs 40,000 crore number in perspective, it is about 8.7% of the total Rs 4,60,000 crore market capitalisation of those five companies. “Share prices of companies with treasury stock might come under pressure,” says the research head of a leading brokerage.
A conclusive list of Indian companies with treasury stock, and their exact holding, is difficult to generate, as most of them hold such shares in a trust of a subsidiary. Because of the two degrees of separation, if not more, under Indian accounting rules, companies are not under compulsion to disclose the accounts of the trust. So, in most cases, treasury stock doesn’t show up in databases.
Treasury stock arises when a company merges a subsidiary into itself. For instance, Reliance Industries Limited (RIL), through four of its subsidiaries, held 46% stake in IPCL. When IPCL merged into RIL, all IPCL shareholders got RIL shares. RIL, being a shareholder through its subsidiaries, got its own shares.
In most developed markets like the US and the UK, companies extinguish their treasury stock on allotment itself. This has the effect of reducing a company’s equity, thus boosting its earnings per share (EPS). Theoretically, this should increase shareholder wealth. “Cancellation seems logical as it restates the correct position after merger,” says R Shankar Raman, senior vice-president (finance & legal), L&T, which has no treasury stock.
But several Indian companies have chosen to hold treasury stock. Promoters might want greater control over their stock or might feel their stock is undervalued. Or, they might want to sell treasury stock, boost their profit number, and use it to pay dividends or fund expansion. IFRS closes the profit and dividend-payout window.
Under this new accounting architecture, companies can’t show the sale proceeds of treasury stock as income. If they can’t recognise it as income, they can’t add it to profits. If they can’t add it to profits, they can’t distribute it as dividends.
In other words, such a transaction bypasses the profit and loss (P&L) account. The change gets reflected only in the balance sheet, with an increase in reserves. Thus, the sales proceeds can be used for expansion, but not to pay dividends. This reduces the incentive for companies to hold treasury stock with the intention of profiting from it.
L&T’s Raman says it’s difficult to say how companies will act
ROHIT KALIA
PGDM 1ST SEM
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