conservation of corporate finance

The conservation of corporate finance refers to the principle that the total value of a
company remains unchanged when it shifts the ownership of claims to its cash flows without
altering the total available cash flows. This principle is often associated with the
MillerModigliani Theorem, which states that a company's market value is unaffected by its
capital structure, assuming perfect markets.

Key Points
1. Value Conservation: The total value of the company is conserved when financial
decisions, such as substituting debt for equity or issuing debt to repurchase shares, do
not change the total cash flows.
2. Financial Engineering: Actions like financial engineering, share repurchases, or
acquisitions do not create value unless they improve cash flows.
3. Market Expectations: Movements in a company's share price reflect changes in
market expectations about performance, not just actual performance.
4. Best Owner Principle: The value of a business depends on its management and
strategy, not on the business itself.

Practical Implications
• Financial Decisions: When making financial decisions, companies should focus on
actions that genuinely improve cash flows to create value.
• Avoiding Value-Destroying Decisions: Companies should avoid decisions that do not
enhance cash flows, as these can erode value.
• Strategic Planning: Long-term strategic planning should consider the conservation of
value to ensure sustainable growth.

Regulation by Disclosure
Regulation by Disclosure is a critical aspect of corporate governance aimed at ensuring
transparency and protecting investors. It involves requiring companies to disclose pertinent
financial and operational information to the public, especially stakeholders such as investors,
regulators, and the general public. Here's an in-depth look at its importance, mechanisms, and
benefits:

Importance
• Transparency: Disclosure regulations ensure that companies provide accurate, timely,
and comprehensive information, promoting transparency in financial markets.
• Investor Protection: By mandating disclosures, investors are equipped with essential
information to make informed investment decisions.
• Market Efficiency: Transparent disclosure practices lead to more efficient markets
where prices reflect all available information.
 • Accountability: Regular disclosures hold companies accountable for their financial
practices and performance, deterring fraudulent activities.

Mechanisms
1. Periodic Reports: Companies must regularly publish financial statements, including
quarterly and annual reports, detailing their financial performance, position, and cash
flows.
2. Material Events Disclosure: Companies are required to promptly disclose any
material events or changes that could affect their financial status or operations, such as
mergers, acquisitions, or significant legal proceedings.
3. Prospectus: When issuing new securities, companies must provide a prospectus,
outlining financial details, risks, and the purpose of the capital raised.
4. Corporate Governance Reports: Detailed reports on corporate governance practices,
including board composition, executive compensation, and internal controls.
5. Compliance with Accounting Standards: Ensuring financial statements are prepared
in accordance with recognized accounting standards and principles.

Benefits
• Enhanced Investor Confidence: Transparent disclosure builds trust among investors,
encouraging investment.
• Risk Management: Regular disclosures help identify and mitigate potential risks
early on.
• Regulatory Compliance: Adherence to disclosure regulations ensures compliance
with legal and regulatory requirements, avoiding penalties and legal issues.
• Market Stability: Consistent and reliable information contributes to the stability and
predictability of financial markets.

Regulatory Bodies
In India, several regulatory bodies oversee disclosure requirements, including:

• Securities and Exchange Board of India (SEBI): Regulates securities markets and
enforces disclosure norms for listed companies.
• Ministry of Corporate Affairs (MCA): Governs corporate entities and enforces the
Companies Act, which includes provisions for disclosure and transparency.
• Stock Exchanges: Ensure listed companies comply with continuous disclosure
obligations.
Control on Payment of Dividends
Control on payment of dividends ensures that companies distribute profits to shareholders
in a manner that is fair, transparent, and sustainable, without jeopardizing the company’s
financial health. Let's explore how this is managed:

Key Aspects of Dividend Control

1. Legal Provisions o Companies Act, 2013: Governs the declaration and
payment of dividends by companies in India. o Section 123: Specifies the
conditions under which dividends can be declared, including the requirement
that dividends be paid out of profits or reserves.
2. Profit Criteria o Dividends can only be paid out of:
▪ Current Profits: From the company's financial year after providing
for depreciation.
▪ Undistributed Profits: Retained from previous years.
▪ Reserves: Transferred from the company's profits to the reserves,
under certain conditions.
3. Protection of Creditors o Ensures that the payment of dividends does not
impair the company’s ability to meet its long-term liabilities and obligations to
creditors.
4. Interim Dividends o Paid out of surplus in the profit and loss account or
from profits of the financial year in which such dividends are declared.
5. Dividend Declaration and Approval o Must be approved by the board of
directors and, in certain cases, by the shareholders at the annual general
meeting (AGM).
6. Dividend Payment Timeline o Once declared, dividends must be paid
within 30 days from the date of declaration.
o Failure to pay dividends within this timeframe can result in penalties for the
company and its directors.
7. Regulatory Oversight o Securities and Exchange Board of India
(SEBI): Ensures listed companies comply with disclosure norms related to
dividend payments. o Reserve Bank of India (RBI): Regulates the dividend
policies of banks and financial institutions.

Practical Example
Imagine a company, ABC Ltd., has made significant profits in the current financial year. The
board of directors decides to declare a dividend. They ensure:

• The profits are sufficient after accounting for depreciation.

• The company’s reserves are reviewed to ascertain additional available funds.
• A portion of the profits is retained for future investments and unexpected financial
needs.
• Approval is sought from shareholders at the AGM.
The dividends are then paid out within 30 days, ensuring compliance with legal and
regulatory requirements, and maintaining the company’s financial health.

Benefits
• Shareholder Satisfaction: Regular and transparent dividend payments build investor
confidence.
• Financial Stability: Ensures that the company remains financially sound while
rewarding shareholders.
• Regulatory Compliance: Adhering to laws and regulations avoids legal issues and
penalties.

Managerial Remuneration
Managerial remuneration refers to the compensation provided to the directors and key
managerial personnel (KMP) of a company for their services. Proper regulation of managerial
remuneration is crucial to ensure fairness, prevent excessive payouts, and align the interests
of management with those of the shareholders.

Key Components
1. Salary: The fixed portion of the remuneration, usually paid monthly.
2. Perquisites: Additional benefits like housing, transportation, medical insurance, and
club memberships.
3. Bonuses: Performance-based payments made based on the company's or the
individual's performance.
4. Stock Options: Grants employees the right to buy shares at a predetermined price,
often used to align management’s interests with shareholders.
5. Pension Plans: Retirement benefits provided to directors and key executives.

Regulatory Framework
• Companies Act, 2013: Governs the remuneration of directors and KMPs in India.
Specific sections of the Act provide guidelines and limits on managerial remuneration.
• Section 197: Specifies the limits on managerial remuneration, ensuring it does not
exceed 11% of the net profits of the company in a financial year without shareholder
approval.
• Schedule V: Details the conditions and approvals required for paying remuneration to
directors and KMPs, especially when the company has inadequate profits or no
profits.
Approvals Required
1. Board Approval: The remuneration package must be approved by the board of
directors.
 2. Shareholder Approval: In certain cases, remuneration exceeding specified limits
requires approval from the shareholders in a general meeting.
3. Central Government Approval: In some exceptional cases, approval from the
Central Government may be required.

Factors Considered
• Company’s Financial Performance: The overall profitability and financial health of
the company.
• Industry Standards: Benchmarking against remuneration practices in similar
companies within the industry.
• Individual Performance: Assessment of the contribution and performance of the
individual director or KMP.
• Regulatory Compliance: Adherence to legal requirements and corporate governance
standards.

Example
Imagine a company, XYZ Ltd., looking to set the remuneration for its CEO. The board of
directors considers the company’s financial performance, industry standards, and the CEO's
past achievements. They propose a remuneration package that includes a fixed salary,
bonuses tied to performance metrics, stock options, and other benefits. This package is then
presented for approval by the shareholders at the annual general meeting.

Importance
• Aligns Interests: Ensures that the interests of the management align with those of the
shareholders, promoting long-term value creation.
• Attracts and Retains Talent: Competitive remuneration packages help attract and
retain top talent.
• Incentivizes Performance: Performance-linked bonuses and stock options
incentivize managers to achieve better results.

Compliance and Transparency

• Disclosure Requirements: Companies must disclose the remuneration of directors
and KMPs in their annual reports to ensure transparency.
• Compliance with Laws: Adherence to the Companies Act, 2013, and other regulatory
requirements to avoid legal and financial penalties.
Payment of Commissions and Brokerage
Payment of commissions and brokerage involves compensating individuals or entities for
their roles in facilitating business transactions, such as sales or financing. This compensation
is usually a percentage of the transaction value. Here's a detailed look:

Commissions
Commissions are payments made to agents, brokers, or salespersons for their efforts in
securing business deals, generating sales, or facilitating transactions. They are typically
performance-based and vary depending on the nature of the deal.

Key Points:

1. Sales Commissions: Paid to sales personnel based on the sales they generate.
2. Brokerage Commissions: Paid to brokers for their role in negotiating and completing
transactions, such as real estate or stock trades.
3. Incentive Structure: Designed to motivate individuals to achieve higher sales or
close more deals.
4. Rate of Commission: Can be a fixed percentage or a sliding scale based on the
volume or value of transactions.

Brokerage
Brokerage refers to the fee charged by a broker for executing transactions, such as buying or
selling securities, real estate, or other assets. This fee compensates the broker for their
expertise and services.

Key Points:

1. Broker's Role: Brokers act as intermediaries between buyers and sellers, providing
valuable market insights and facilitating transactions.
2. Types of Brokerage Fees:
o Flat Fee: A fixed amount regardless of transaction size.
o Percentage-Based: A percentage of the transaction value.
3. Regulation: Brokerage fees are subject to regulatory oversight to ensure fairness and
transparency.

Legal and Regulatory Aspects

1. Companies Act, 2013: In India, the Companies Act governs the payment of
commissions and brokerage by companies. It outlines the conditions under which such
payments can be made.
2. Disclosure Requirements: Companies must disclose the payment of commissions
and brokerage in their financial statements to ensure transparency.
3. Approval: Payments often require approval from the board of directors and, in some
cases, shareholders.
Example
A real estate company hires agents to sell properties. Agents receive a commission for each
sale, typically a percentage of the property's selling price. The company discloses these
commission payments in its financial reports, adhering to regulatory requirements.

Importance
• Incentivizes Performance: Commissions and brokerage fees motivate agents and
brokers to achieve better results.
• Expertise and Facilitation: Brokers provide valuable services that facilitate
transactions and ensure smooth operations.
• Transparency: Proper disclosure and regulation of these payments maintain trust and
integrity in business operations.

Inter-Corporate Loans and Investments

Inter-corporate loans and investments refer to financial transactions between companies
where one company lends money or invests in the securities of another company. These
transactions are governed by specific regulations to ensure transparency and protect the
interests of stakeholders. Here are the key aspects:

Legal Framework
Companies Act, 2013 (India)

The Companies Act, 2013, regulates inter-corporate loans and investments in India. The
relevant provisions include:

1. Section 186: This section governs loans and investments by companies in other
bodies corporate.
o Loan Limitations: Companies cannot make loans or investments exceeding
60% of their paid-up share capital, free reserves, and securities premium, or
100% of their free reserves and securities premium, whichever is higher,
without special resolution approval. o Board Approval: Loans and
investments within the specified limits require board approval, while amounts
exceeding the limits need a special resolution passed by the shareholders.
o Disclosure Requirements: Companies must disclose details of the loans and
investments in their financial statements.
2. Exemptions: Certain transactions, such as those involving wholly-owned subsidiaries
or loans to employees, may be exempt from these provisions.

Purpose and Importance

1. Strategic Investments: Companies often invest in other businesses for strategic
reasons, such as expanding their market reach, acquiring new technologies, or
entering new markets.
 2. Synergies and Growth: Inter-corporate investments can create synergies, leading to
cost savings and enhanced growth opportunities.
3. Financial Returns: These investments can provide returns in the form of interest,
dividends, or capital appreciation.

Risks and Considerations

1. Financial Risk: Lending or investing in other companies carries financial risks,
including the potential loss of capital if the borrowing company defaults.
2. Regulatory Compliance: Non-compliance with regulatory requirements can result in
penalties and legal issues.
3. Due Diligence: Companies must conduct thorough due diligence to assess the
financial health and creditworthiness of the borrowing or investee company.

Example
Imagine Company A decides to invest in Company B to gain access to its innovative
technology. Company A's board of directors approves the investment within the limits
specified under Section 186. The details of this investment are then disclosed in Company A's
annual financial statements.

Procedure
1. Board Meeting: The board of directors of the lending or investing company convenes
a meeting to approve the transaction.
2. Special Resolution: If the transaction exceeds the specified limits, a special resolution
is passed by the shareholders.
3. Documentation: Proper documentation, including loan agreements or investment
contracts, is prepared and signed.
4. Compliance and Disclosure: The company ensures compliance with regulatory
requirements and discloses the details in its financial statements.

Benefits
• Access to Capital: Companies can access additional capital for growth and
expansion.
• Diversification: Investments in other companies can help diversify risk.
• Strategic Alliances: Forming strategic alliances can lead to new business
opportunities and market expansion.

Inter-corporate loans and investments are vital tools for corporate strategy and financial
management. They provide opportunities for growth, diversification, and strategic alliances
while requiring careful consideration of financial risks and regulatory compliance.
Pay-Back of Shares
Pay-back of shares, also known as share buyback or share repurchase, involves a
company buying back its own shares from the shareholders. This action reduces the number
of shares in circulation, often resulting in increased share value. Here are the key points:

1. Purpose of Share Buyback o Increase Share Value: Reducing the number

of outstanding shares can boost the value of remaining shares. o Return Excess
Cash: Allows companies to return surplus cash to shareholders.
o Optimize Capital Structure: Helps in adjusting the capital structure by
reducing equity. o Boost Financial Ratios: Improves metrics like earnings
per share (EPS) and return on equity (ROE).
2. Methods of Buyback o Open Market Purchase: The company buys shares
from the open market over an extended period. o Tender Offer: The company
makes an offer to buy back a specific number of shares at a premium price within a
certain time frame.
o Buyback from Reserves: Using company reserves to finance the buyback.
3. Regulatory Aspects o Companies Act, 2013: Governs the rules for buybacks
in India. Companies must comply with conditions like the buyback not exceeding
25% of the total paid-up capital and free reserves.
o Shareholder Approval: Buybacks often require shareholder approval through
a special resolution.

Other Corporate Spending

Corporate spending refers to the allocation of a company's financial resources towards
various operational and strategic initiatives. Key areas include:

1. Capital Expenditures (CapEx) o Investment in Assets: Spending on

acquiring, upgrading, and maintaining physical assets such as property, plant, and
equipment.
o Long-Term Benefits: CapEx is aimed at improving the company’s long-term
profitability and efficiency.
2. Operating Expenses (OpEx) o Day-to-Day Operations: Includes costs
associated with the daily running of the business, such as salaries, rent, utilities,
and administrative expenses. o Short-Term Focus: OpEx is necessary for
the company’s immediate operational needs and maintaining its current operations.
3. Research and Development (R&D) o Innovation and Growth: Investment
in R&D to develop new products, services, and technologies that can drive future
growth.
o Competitive Advantage: R&D spending is crucial for staying competitive
and advancing industry leadership.
4. Marketing and Advertising

o Brand Promotion: Investments in marketing and advertising to enhance

brand visibility and attract customers.
 o Revenue Generation: Effective marketing strategies can lead to increased
sales and market share.
5. Debt Repayment
o Financial Stability: Allocating funds to repay existing debts, reducing interest
expenses and improving the company's financial health.
6. Dividends o Shareholder Return: Distribution of profits to shareholders in the
form of dividends, ensuring a return on their investment.

Protection of Creditors
Ensuring the interests of creditors is essential for maintaining the company’s creditworthiness
and financial stability. Key measures include:

1. Adequate Reserves: Maintaining sufficient reserves to meet creditor obligations.

2. Debt Covenants: Adhering to the terms and conditions set by creditors, including
financial covenants and restrictions on further borrowing.
3. Disclosure and Transparency: Providing clear and accurate financial information to
creditors to facilitate informed decisions.

Protection of creditors is a fundamental aspect of corporate governance and financial

regulation, designed to ensure that creditors' rights and interests are safeguarded, especially in
the event of a company's financial distress or insolvency. Here are key mechanisms and
practices aimed at protecting creditors:

Legal and Regulatory Framework

1. Insolvency and Bankruptcy Code (IBC), 2016 (India) o Provides a robust
framework for the resolution of insolvency, ensuring the timely and orderly process
of asset liquidation or restructuring.
o Prioritizes the claims of secured creditors and other stakeholders in the
resolution process.
2. Companies Act, 2013 o Imposes stringent disclosure requirements and
governance standards to ensure transparency and accountability. o Enforces
regulations around the creation and maintenance of reserves, ensuring that sufficient
funds are available to meet creditor obligations.

Key Measures for Creditor Protection

1. Adequate Reserves and Provisions o Companies must maintain adequate
reserves to cover potential liabilities, ensuring that they can meet their obligations
to creditors.
o Regular audits and financial reporting help in assessing the adequacy of these
reserves.
 2. Debt Covenants o Specific terms and conditions agreed upon between the
company and creditors, such as maintaining certain financial ratios, restricting
further borrowing, or limiting dividend payments. o These covenants protect
creditors by imposing financial discipline on the company.
3. Security Interests and Charges o Fixed Charges: Secured against specific
assets, ensuring creditors have a clear claim on these assets if the company
defaults. o Floating Charges: General claims on the company's assets, which
crystallize into fixed charges upon certain trigger events, such as default or
insolvency.
4. Priority in Insolvency o Secured creditors generally have priority over
unsecured creditors in the event of liquidation, meaning they are more likely to
recover their claims from the company's assets.
5. Transparency and Disclosure o Regular and transparent financial reporting
ensures that creditors are aware of the company's financial health and any potential
risks.
o Disclosure of significant financial transactions, related-party dealings, and
contingent liabilities helps creditors make informed decisions.
6. Legal Recourse o Creditors have legal recourse to challenge fraudulent or
preferential transactions that unfairly disadvantage them. o Courts and regulatory
bodies provide mechanisms to resolve disputes and enforce creditor rights.

Practical Example
Imagine a manufacturing company, ABC Ltd., takes a loan from a bank to expand its
operations. The bank imposes covenants requiring ABC Ltd. to maintain a debt-to-equity
ratio below a certain threshold. ABC Ltd. must also provide regular financial reports to the
bank and ensure that specific assets are secured against the loan.

In the event of financial distress, the bank, as a secured creditor, has a priority claim on the
secured assets, ensuring it can recover its dues before other unsecured creditors.

Importance
• Financial Stability: Ensuring that companies can meet their obligations to creditors
contributes to overall financial stability and trust in the financial system.
• Risk Mitigation: Protecting creditor rights helps in mitigating risks, reducing the
likelihood of defaults and financial crises.
• Investor Confidence: Robust creditor protection measures enhance investor
confidence, facilitating access to capital and promoting economic growth