Do Transactions with Related Parties influence Firm Value and Firm Continuity: Four Case Studies of Large Listed Entities in India
CA. Binayak Datta
Fellow-Member of the Institute of Chartered Accountants of India. Contact: datta.binayak@icai.org
CA. Purva Hegde Desai
Professor, Goa Business School & Program Director, Goa University. Contact: eboard@icai.in
“The last two decades have seen several large corporate entities internationally as well as in India, failing unsuspecting non-promoter stakeholders, taking them completely by surprise. On investigations, it was most often found that corporate governance had failed. In most cases, especially in India, expropriations were alleged through a network of related parties, going undetected because of poor corporate governance practices. This article studies whether transactions with related parties could impact firm values and firm continuity. The four cases of leading corporates studied here do reveal an inverse relationship between volume of related party transactions and firm value and firm continuity. Read on…”
Introduction: Anatomizing Corporate Insolvencies & Expropriation
This empirical investigation examines the systemic effects of the volume of Related Party Transactions (RPTs) on firm valuation and corporate continuity. Over the past two decades (2001–2020), an unprecedented wave of massive corporate insolvencies caught institutional lenders, minority shareholders, and statutory regulators by complete surprise. A rigorous post-mortem of these collapses demonstrates a striking common denominator: the breakdown of internal corporate governance safeguards.
A crucial structural divergence exists between corporate failures in Western developed markets and the Indian economic landscape:
Corporate Failure Drivers in Western Economies
- Aggressive financial statement window dressing and revenue smoothing.
- Unapproved insider trading and concealed executive remuneration schemes.
- Creation and transfer of sub-prime structured toxic debt assets to balance sheets.
- Complex derivative speculation unhedged against interest-rate shocks.
Corporate Failure Drivers in Indian Listed Corporates
- Tunnelling & Siphoning: Expropriation of minority capital through a labyrinth of related entities.
- Round Tripping & Teeming-and-Lading: Artificial inflation of turnover through cyclical invoice discounting.
- Evergreening & Write-Offs: Rolling over aged inter-corporate deposits before formal write-offs or distressed mergers.
- Fraudulent Borrowings: Raising credit against fake Letters of Undertaking (LoUs) lacking underlying commercial goods.
- Capital Misallocation: Diverting low-cost bank loans into speculative, non-core promoter-owned ventures.
In response to these systemic vulnerabilities, Indian regulators instituted aggressive compliance frameworks—under the Companies Act 2013, SEBI (LODR) Regulations 2015, and Indian Accounting Standard (Ind AS) 24—imposing rigorous audit committee approvals, mandatory shareholder resolutions for material RPTs exceeding 10% of annual consolidated turnover, and exhaustive disclosures of Key Managerial Personnel (KMP) and Significant Beneficial Ownership (SBO).
Research Objectives, Categorization & Altman Z-Score Model
Core Research Objectives
- To examine whether high volumes of transactions with related parties should be subjected to heightened statutory scrutiny as primary conduits of corporate governance failure that erode Firm Value (Price-to-Book Ratio, Absolute Book Value) and destroy Firm Continuity (Altman’s Zed Score).
- To evaluate whether the impact of RPTs differs materially based on corporate ownership and governance structures: promoter-family driven versus professionally-managed enterprises.
Enterprises where family promoters exercise controlling business authority and the entity has defaulted on credit obligations (Company A1 and Company A2).
Enterprises where family promoters control management decisions with no historical record of debt default (Company B1).
Large conglomerates without promoter-family dominance, administered entirely by professional executives (Company C1).
Altman’s Zed Score (Zeta) Formulation & Distress Thresholds
Firm continuity is empirically quantified using Edward Altman’s multi-factor bankruptcy prediction model (Altman, 2018), weighting five fundamental parameters of operational discipline and balance sheet strength:
Case Study 1: Company A1 (Category A – Basic Manufacturing & Auto Steel Giant)
Company A1 was one of India’s premier new-age basic steel manufacturing champions catering to the automobile industry, reporting annual turnover of approximately Rs 13,000 crores with a robust 5-year CAGR of 10.3% (against the industry benchmark of 5.2% per IBEF). Notwithstanding a booming domestic automotive market, when asset valuation was conducted in FY 2017-18, an astonishing impairment of Rs 22,380 crores had materialized. Bizarrely, commercial banks had extended fresh credit lines of Rs 18,000 crores despite existing payment defaults exceeding Rs 6,000 crores. Creditors initiated CIRP under the IBC in 2016, and the entity was acquired by a competing industrial conglomerate under an NCLT resolution plan in 2017.
- Purchases from related parties jumped 65% within two years.
- Unsecured advances granted to related parties amounted to Rs 240 crores in a single year, when total operational cash flow generated across the entire enterprise was merely Rs 752 crores.
- Enterprise Value expanded not through organic earnings, but due to debt accumulation while market capitalization crashed by 70%, completely destroying shareholder equity.
Case Study 2: Company B1 (Category B – Family-Controlled Auto OEM Champion)
Company B1 represents India’s largest vertically integrated commercial manufacturing enterprise in its segment, recording standalone turnover exceeding Rs 43,000 crores. Like Company A1, Company B1 sits atop an intricate web of over 100 related parties, joint ventures, and subsidiaries. Crucially, while Company B1 has never defaulted on its banking obligations, its financial data reveals severe underlying distress driven by aggressive capital diversion.
Despite the Indian auto market enjoying unprecedented boom conditions from 2014 to 2018, Company B1 suffered relentless valuation degradation: Market-to-Book plunged from 11.30 to 2.87, and standalone Altman Zeta collapsed from 3.19 (Safe) to 0.84 (Distress) in 2019-20, well before COVID-19. In consolidated accounts, Altman Zeta remained trapped in the Distress Zone for five consecutive years. Despite maintaining zero bank defaults, Company B1 posted negative operational cash flow of Rs 1,455 crores and negative investing cash flow of Rs 4,718 crores—proving that its Rs 25,000 crore debt burden is fundamentally unsustainable.
Case Study 3: Company C1 (Category C – Professional E&C Conglomerate)
Company C1 is one of Asia’s largest vertically integrated Engineering & Construction (E&C) infrastructure conglomerates (spanning defence systems, heavy engineering, civil infrastructure, and industrial machinery). It reported annual turnover of Rs 82,000 crores on an asset base of Rs 1,41,000 crores, maintaining an extensive network of over 140 related entities and Special Purpose Vehicles (SPVs).
Unlike family-run entities where RPTs diverted liquidity into promoter pet projects, Company C1 deployed RPTs exclusively into core synergic SPVs (megaproject joint ventures, port/highway concessions). Although these infrastructure assets have long gestation cycles and high working capital intensity (depressing immediate standalone Altman Zeta), Book Value expanded relentlessly from Rs 36,404 crores to Rs 51,528 crores, and market capitalization rose by 30% over six years as related party exposure normalized.
Case Study 4: Company A2 (Category A – Blue-Chip Domestic Aviation Giant)
Company A2 was India’s iconic blue-chip private airline carrier, at its peak commanding over 400 scheduled daily flights across 70 destinations, generating annual revenues of Rs 23,000 crores on an asset base of Rs 12,000 crores. However, continuous RPT transactions with promoter-controlled overseas entities and subsidiary cross-subsidization rapidly precipitated severe distress. Currently, over 82% of its debt is in default; operations were suspended in April 2019, creditors filed under IBC in 2018, and a resolution plan was approved in October 2020.
Company A2 exhibited persistent, chronic RPT volumes with a median of 17.5%—substantially breaching the statutory 10% materiality ceiling established by SEBI LODR. Negative net worth was perpetual, and the Market-to-Book ratio deteriorated relentlessly. Standalone Altman Zeta plummeted to -3.24 in 2019-20, reflecting complete commercial insolvency.
Cross-Case Comparative Synthesis: What Was Common Across the Cases?
Across all three family-controlled entities (A1, A2, and B1), the retrospective 6-year volume of related party transactions expanded substantially faster than baseline operational revenue growth. Only in professional Company C1 was RPT growth strategically controlled.
RPT escalations failed to produce corresponding increases in consolidated earnings, margins, or market share. Related parties functioned not as operational catalysts, but as conduits for capital draining.
Default rates climbed from 3% to 11.3% in A1, and reached 82.6% in A2. In Company B1, despite having zero recorded defaults, operations consumed Rs 1,455 crores in operating cash and Rs 4,718 crores in investing cash—rendering its Rs 25,000 crore debt load unserviceable under distress.
In all four corporate cases, a conclusive inverse relationship was documented between RPT volume and the Price-to-Book (P:B) Ratio. Similarly, Book Value per share was systematically eroded in family-controlled entities whenever RPTs expanded.
In all three family-controlled firms, Altman’s Zed Score deteriorated continuously. Even the strongest family-controlled entity (B1) saw its Zeta plunge below the 1.81 threshold into the Distress Zone. In stark contrast, professionally managed C1 maintained a resilient, operationally sound consolidated Z-Score.
“Family-controlled companies have generally high levels of related party transactions, which when they increase disproportionately over a given period, can cause unsustainable financial health – in case of weaker ones, (with negative book values of equity) can result in even defaults and insolvency.”
Empirical Conclusions & Institutional Governance Imperatives
The cross-sectional findings from these four corporate empires yield four foundational conclusions for institutional investors, credit rating agencies, bank lenders, and insolvency professionals:
High levels of related party transactions that outpace core business revenue represent the most reliable pre-insolvency red flag. In entities with leveraged balance sheets, RPT surges inevitably culminate in negative book values, severe impairment write-downs, and commercial default.
While family promoters can artificially prop up distressed group entities through intra-group advances in the short run (as demonstrated in B1), this comes at crippling long-term costs to firm value, dragging the parent entity directly into the insolvency distress zone.
The qualitative nature of the related party is paramount. In professionally-run Company C1, RPTs were confined strictly to core, synergistic infrastructure SPVs with high-rated long-term cash flow visibility. In family-controlled entities, RPTs drained cash into speculative non-core ventures disconnected from core competencies.
Ultimately, long-term firm value and enterprise continuity cannot survive on market momentum alone. They require a rigorous, enforceable corporate governance framework—principally anchored on independent audit committee oversight, robust arm’s length validation, and strict materiality ceilings on related party transactions.
“It is ultimately firm value and firm continuity that a company works towards to sustain itself in the long run and it is important that it does so within proper and adequate corporate governance framework, particularly one of its most important drivers – that of transactions with related parties.”