Related Party Transactions: Red Flags in Indian Stocks

Money rarely leaves a company through the front door. It leaves through a related-party transaction — a sale to a promoter-owned entity at a soft price, a loan to a subsidiary that never comes back, a "brand royalty" paid to a parent. All of it legal. All of it disclosed in a note most investors never open. In India, where promoters typically own a large slice of the company and also run it, this is the single governance lever that separates a management treating you as a co-owner from one treating the listed entity as a wallet.

Here's the honest part most field guides skip: the same note that hides the leaks also records dozens of dealings that are perfectly fine. Two RPTs can look identical on the face of the disclosure and mean opposite things. Telling them apart is the whole skill, and getting it wrong in either direction costs you — flag every RPT and you'll never own a multinational subsidiary; flag none and you'll miss the one that matters.

What is a related-party transaction, and why is it built into Indian companies?

A related-party transaction (RPT) is any deal between the listed company and someone connected to it — the promoter, a promoter-owned firm, a subsidiary, a director, a key executive, or their relatives. Buying raw material from a promoter's trading company, leasing the head office from a family entity, paying a royalty to the foreign parent, lending to a group concern: all RPTs.

They exist because of how Indian companies are built. Most listed firms sit inside a larger promoter group with dozens of unlisted entities around them. Some inter-group dealing is genuinely efficient — a shared treasury, a captive supplier, a parent that ships you its R&D. The Companies Act and SEBI's LODR rules don't ban RPTs; they require them to be disclosed, approved in advance by the audit committee (SEBI's LODR Regulation 23 requires prior approval of the audit committee for all RPTs, with omnibus approval permitted for repetitive transactions), and — for material ones — put to a shareholder vote in which the interested promoter must abstain.

So the law's answer to the conflict of interest is sunlight, not prohibition. Which means the work falls to you: the disclosure exists, but reading it for what it reveals is the part nobody automates. The leak is legal. Spotting it is the analysis.

Which related-party transactions are routine, and which ones drain value?

The mistake is treating all RPTs as suspect. Most are mundane. The field-guide skill is telling the two apart, because they look nearly identical in the notes.

The unifying question is direction and pricing. Is value flowing into the listed company you own, or out of it toward an entity where the promoter's economic share is higher than their share in the listed company? A promoter who owns 50% of the listed firm but 100% of the supplier has a quiet incentive to let the supplier earn the fat margin. Every rupee shifted there is a rupee that belongs 100% to them instead of 50%.

The tell is rarely a single transaction. It's the trend: a royalty creeping from one-fifth of one percent of sales toward three-quarters of one percent over two years, advances to group companies that grow every year and never reverse, a captive supplier's share of procurement rising while the company's own gross margin slips. One year is a data point. A widening pattern is a policy.

A real case: what the Kennametal India royalty line actually does

Abstract rules slide off the mind. So take one real, disclosed RPT and read it the way you'd read it for a company you own. This is an illustration of how to read the disclosure, not a view on the stock — nothing here is a recommendation to buy or sell Kennametal India.

Kennametal India makes cutting tools and hard-metal products. Its ultimate holding company — its promoter — is Kennametal Inc. of the United States, which controls 75.00% of the equity (Kennametal India FY25 annual report, year ended June 30, 2025). The Indian arm pays the American parent a royalty for the technology and product designs it manufactures locally. That royalty is a textbook related-party transaction: a fee flowing from the listed company you'd own, to the promoter who owns three-quarters of it.

Now read the number across three years, all from the related-party note (Ind AS 24) in successive annual reports:

(Royalty and revenue figures: Kennametal India FY23, FY24 and FY25 annual reports, related-party note and statement of profit and loss; all amounts in ₹ millions as the company reports them.)

Put the two ends of that table far apart and feel the gap: revenue grew about 9% over two years, while the royalty paid to the parent grew from ₹20 million to ₹85 million — it more than quadrupled. Drill into the FY25 note and ₹71.4 million of that ₹85 million went specifically to Kennametal Inc., USA, the parent (Kennametal India FY25 annual report, related-party note). On the face of it, this is the exact shape the field guide warns about: a fee to the promoter scaling far faster than the business.

The twist that makes this a field guide and not a witch-hunt

Here is where most "red flag" lists would stop, point at the quadrupling, and call it value extraction. That would be lazy — and wrong on the facts. Because when an analyst asked management directly about the royalty agreement on the post-results call, the answer was specific, not evasive:

Read that twice. The rate came down, from 4.75% to 4.0% of the defined royalty base. The rupees paid to the parent went up, more than fourfold. Both are true at once. The headline rate, the thing a casual reader would check, improved for shareholders — while the absolute cash leaving for the parent jumped, because the agreement was refreshed and widened (a worldwide manufacturing licence, more parent technology transferred into the Indian plants). For a manufacturing subsidiary that lives off its parent's R&D, paying more in absolute rupees as it localises more products is not obviously a leak — it can be the cost of the thing that makes the business work.

This is the whole discipline in one example. The rate alone would have lied to you in the reassuring direction; the rupees alone would have lied to you in the alarming direction. You need both, plus the management explanation, before you decide which kind of RPT you're looking at. A royalty that quadruples while management refuses to explain it is a red flag. A royalty that quadruples while management walks you through a rate cut and a wider licence is a business decision you can choose to accept or reject on the merits — but it is not a smoking gun.

How do you read the RPT disclosure without a forensic-accounting degree?

You don't need to audit the company. You need to read three things and ask one question.

One — the related-party note in the annual report. Every annual report carries an RPT note (under Ind AS 24) listing related parties and the value of transactions with each, with a prior-year comparison. In Kennametal's note the royalty sits next to "professional fees (technical services)", "information technology services" and "purchase of goods" from the same parent — each a separate line, each with its own trend. Skim for the entries that are large, growing, or labelled vaguely ("other services", "advisory fees", "miscellaneous"). Vagueness in an RPT line is itself a small red flag. (For where this note sits in the wider document, see how to read an annual report like an analyst.)

Two — loans, advances, and guarantees to group entities. This is where value walks out most quietly. A loan or guarantee to an unlisted promoter entity is the listed company lending its balance sheet to the family. Check whether these balances grow year on year and whether they ever come back. A receivable from a group company that only ever increases is a polite word for a transfer.

Three — royalty and management fees as a share of revenue. Compute the fee as a percentage of revenue and track it across years, exactly as in the table above. But compute the absolute rupees too. The Kennametal case is the reason: a falling rate hid a quadrupling outflow. Watch both, because management will quote you whichever one flatters the story.

The one question, after all three: does the trend in RPTs match the story management tells on the concall? A management guiding for "improving capital efficiency" while quietly raising advances to group entities is saying one thing and doing another — and the disclosure note is where the doing is recorded, in numbers, on the record.

What does the concall add that the annual report can't?

The annual report tells you the RPTs happened. The concall is where you find out whether management will explain them under questioning — and that is the part that's hard to fake.

On the royalty, Kennametal's management engaged: a number, a date, a reason. Watch the same management on a different sensitive question — segment margins — and the posture changes. Pressed by an analyst to say merely whether locally manufactured products carried higher or lower margins than imported ones, no exact figure asked for, just the direction, the answer was a wall:

That is the texture worth learning to feel. The same management was forthcoming on the related-party royalty and closed on segment margins. The quality of the answer is the signal, question by question — not a verdict on the whole management. A team that walks you through the commercial logic of an RPT, gives a recovery timeline, and benchmarks the pricing is treating it as a defensible business decision; one that retreats to "all our transactions are at arm's length and audit-committee approved" without engaging the specifics is doing what evasive managements do — deflecting the topic that hurts. (For how to read that swerve, see how to tell when management is dodging.)

This is where tracking matters more than any single answer. Across the management commitments tracked on Inve, 35% of companies (534) have at least one piece of guidance that quietly went silent — never mentioned again on any later call (Inve data, as of 2026-06-12). "We'll wind down the group advances over the next two years" is exactly the kind of commitment that gets quietly dropped when it becomes inconvenient. The RPT note tells you the money is leaving; whether management's commitment to fix it survives contact with the next four concalls is what tells you who you're partnered with. Inve's Promise Tracker keeps that commitment-versus-delivery record so the dropped ones don't vanish from your memory the way they vanish from the call.

Where this read could be wrong

Be honest about the limits, because the inversion is where you get hurt. Take the same Kennametal royalty and argue the bear case as well as a sceptic would: a foreign promoter that controls 75% of a profitable Indian subsidiary has every incentive to extract cash through fees rather than dividends, because fees are paid before tax and are shared with no one, while dividends are split 75/25 with minority holders. A royalty that quadruples in two years is precisely how that extraction would look — and a rate cut from 4.75% to 4.0% on a widened base is exactly the kind of move that lets management announce a "reduction" while the cheque to the parent grows. The transparency on the call could be the price of the extraction, not evidence against it.

That bear case is coherent, and we can't fully refute it from outside — we can't see the contract that defines the royalty base, and we haven't independently benchmarked 4.0% against what an unrelated licensor would charge for the same technology. What we can see is direction, magnitude, and the quality of the explanation. Where this read fails is the company that gives a clean, specific, benchmarked answer on the call and routes the real leak through a line you weren't watching. The disclosure note shows you where to look; it does not guarantee the leak is on the line management chose to discuss.

When is a related-party transaction worth walking away over?

A field guide should end with a threshold, even an imperfect one. No single RPT is a verdict. The combination that should genuinely worry a minority shareholder is the convergence of three things at once on the same company:

Money flowing out of the listed entity (rising advances or purchases from promoter-owned firms), priced in a way no third party set (fees and royalties with no benchmark and no breakdown), and defended with evasion rather than explanation when analysts ask. Any one of these alone usually has an innocent reading — the Kennametal royalty had the first feature (rising rupees) but failed the third (management explained it). All three on the same company, trending the wrong way over several years, is the classic shape of value being quietly redirected — a pattern worth investigating closely rather than dismissing, since some of the governance blow-ups in Indian markets have, in hindsight, shown a version of this shape well before the auditors or the price caught up.

What must a five-year owner believe for the RPTs to be fine? That every rupee of inter-group dealing serves the listed company you own, not the wider family that owns more of the entity on the other side of the transaction — and that when you ask, management will show its working rather than wave you off. The disclosure note lets you check the first; the concall lets you test the second. Most investors never do either. That's the leak.

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