Notification No. F. No. SEBI/LAD-NRO/GN/2025/239; Dated: 27.03.2025

The Securities and Exchange Board of India has introduced significant amendments to the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. These changes aim to strengthen corporate governance, enhance transparency, and enforce stricter compliance norms, with a special focus on High-value debt-listed entities (HVDLEs).

Further, the SEBI has significantly expanded the compliance framework for SME-listed entities by making Regulation 23 of the LODR Regulations, which governs “Related Party Transactions,” applicable to them. Regulation 23 shall apply to a listed entity that has listed its specified securities on the SME Exchange and has either a paid-up equity share capital exceeding Rs 10 crore or a net worth exceeding Rs 25 crore, as on the last day of the previous financial year. Once an SME entity crosses either of these thresholds, it is required to adhere to RPT compliance norms within six months.

Further, SEBI has also introduced stricter governance rules for High-Value Debt Listed Entities (HVDLEs). A High-Value Debt Listed Entity (HVDLE) refers to a listed entity that has only non-convertible debt securities listed with an outstanding value of Rs 1000 Crore and above and does not have any listed specified securities.

If the value of outstanding listed non-convertible debt securities equals or exceeds Rs. 1,000 crore during a financial year, the entity must comply with the provisions within six months from the trigger date. Additionally, disclosures regarding such compliance may be included in the corporate governance compliance report. This move aims to enhance governance and transparency for HVDLEs.

Click Here To Read The Full Notification

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SEBI Report; Dated: 27.03.2025

SEBI has proposed limiting the expiries of all equity derivatives contracts on an exchange to one of either Tuesday or Thursday. This is aimed at providing optimal spacing between expiries across exchanges, while avoiding the choice of either the first day of the week or the last day as an expiry day. Further, every exchange will continue to be allowed one weekly benchmark index options contract on their chosen day, i.e. Tuesday or Thursday.

Besides benchmark index options, all other equity derivatives contracts, viz., all benchmark index futures, non-benchmark index futures / options, and all single stock futures / options will be offered with a minimum tenor of 1 month, and the expiry will be in the last week of every month on their chosen day (that is last Tuesday or last Thursday of the month).

SEBI has invited comments and suggestions, supported by rationale, from all stakeholders—including individual investors, market participants, intermediaries, investor associations, and academic institutions.

Click Here To Read The Full Update

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LLP Agreement is a written agreement between the partners of a Limited Liability Partnership (LLP) or between the LLP and its partners. It outlines the mutual rights, duties, and obligations of the partners as well as their rights and duties in relation to the LLP.

Table of Contents

1. Agreement Among Partners
2. Standard Conditions of LLP
3. When to Execute Agreement
4. General Comments on LLP Agreement
5. Various Clauses of Agreement
6. Model Draft of LLP Agreement

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1. Agreement Among Partners

LLP Act, 2008 provides great operational flexibility. In many cases, provisions as contained in LLP Agreement prevail.

LLP Agreement is comparable with ‘Articles of Association’ under Companies. Such agreement is not mandatory but highly advisable. In absence of LLP Agreement, general provisions as specified in First Schedule to LLP Act apply.

After incorporation, LLP may have Limited Liability Partnership Agreement. This agreement will govern mutual rights and duties of partners of LLP and mutual rights and duties of LLP and its partners. The agreement can be changed and details should be filed with ROC [Section 23 of LLP Act, 2008].

‘Limited liability partnership agreement’ means any written agreement between the partners of the limited liability partnership or between the limited liability partnership and its partners which determines the mutual rights and duties of the partners and their rights and duties in relation to that limited liability partnership [Section 2(1)(o) of LLP Act].

Interestingly, LLP agreement and its extracts as given in e-form 3 are not available for public inspection.

1.1 Relationship of Partners As Apecified in LLP Agreement

Save as otherwise provided by LLP Act, the mutual rights and duties of the partners of a limited liability partnership, and the mutual rights and duties of a limited liability partnership and its partners, shall be governed by the limited liability partnership agreement between the partners, or between the limited liability partnership and its partners – section 23(1) of LLP Act.

Agreement has to be ratified by all the partners – An agreement in writing made before the incorporation of a limited liability partnership between the persons who subscribe their names to the incorporation document may impose obligations on the limited liability partnership, provided such agreement is ratified by all the partners after the incorporation of the limited liability partnership  – section 23(3) of LLP Act.

Matters in Schedule to LLP Act apply if no agreement – In the absence of agreement as to any matter, the mutual rights and duties of the partners and the mutual rights and duties of the limited liability partnership and the partners shall be determined by the provisions relating to that matter as are set out in the First Schedule to LLP Act – section 23(4) of LLP Act.

Many of the standard clauses in first schedule to LLP Act will not be acceptable in majority of the cases. Further, fees payable for filing a document depend on ‘contribution’ of partners.

Hence, practically, each LLP will be required to have LLP Agreement.

The provision of rules are such that the agreement can be signed and executed either before incorporation or after incorporation of LLP.

1.2 Filing of LLP Agreement and Changes

The agreement and any change in the agreement shall be filed with ROC [Section 23(2) of LLP Act].

The limited liability partnership agreement and any changes, if any, made therein shall be filed with the Registrar in such form, manner and accompanied by such fees as may be prescribed – section 23(2) of LLP Act.

Information with regard to LLP Agreement shall be filed in form 3 with ROC within 30 days from date of agreement with prescribed fees. Change shall also be informed within 30 days with fees, in form 3 within 30 days of ratification by all members [Rule 21 of LLP Rules, 2009].

The prescribed details are to be given in form 3 and copy of LLP agreement is required to be attached.

Same procedure is to be followed for change in LLP agreement.

1.3 Pre-incorporation Contracts

Pre-incorporation contracts (i.e. agreements made before formation of LLP) by subscribers to incorporation document may impose some obligations on LLP. Such agreement is binding on LLP if ratified by all partners after incorporation of LLP [section 23(3) of LLP Act].

Such ratification shall be done immediately after incorporation and shall be informed to ROC in form 3 within 30 days from date of incorporation of LLP with prescribed fees [rule 21(2) of LLP Rules, 2009].

2. Standard Conditions of LLP

Following provisions relating to mutual rights and duties of partners apply to each LLP in absence of any agreement to contrary [First Schedule to LLP Act, read with section 23(4) of LLP Act].

• The mutual rights and duties of the partners and the mutual rights and duties of the limited liability partnership and its partners shall be determined, subject to the terms of any limited liability partnership agreement or in the absence of any such agreement on any matter, by the provisions in this Schedule.
• All the partners of a limited liability partnership are entitled to share equally in the capital, profits and losses of the limited liability partnership.
• The limited liability partnership shall indemnify each partner in respect of payments made and personal liabilities incurred by him –

1. 1. in the ordinary and proper conduct of the business of the limited liability partnership; or
   2. in or about anything necessarily done for the preservation of the business or property of the limited liability partnership.

• Every partner shall indemnify the limited liability partnership for any loss caused to it by his fraud in the conduct of the business of the limited liability partnership.
• Every partner may take part in the management of the limited liability partnership.
• No partner shall be entitled to remuneration for acting in the business or management of the limited liability partnership.
• No person may be introduced as a partner without the consent of all the existing partners.
• Any matter or issue relating to the limited liability partnership shall be decided by a resolution passed by a majority in number of the partners, and for this purpose, each partner shall have one vote. However, no change may be made in the nature of business of the limited liability partnership without the consent of all the partners.
• Every limited liability partnership shall ensure that decisions taken by it are recorded in the minutes within thirty days of taking such decisions and are kept and maintained at the registered office of the limited liability partnership.
• Each partner shall render true accounts and full information of all things affecting the limited liability partnership to any partner or his legal representatives.
• If a partner, without the consent of the limited liability partnership, carries on any business of the same nature as and competing with the limited liability partnership, he must account for and pay over to the limited liability partnership all profits made by him in that business.
• Every partner shall account to the limited liability partnership for any benefit derived by him without the consent of the limited liability partnership from any transaction concerning the limited liability partnership, or from any use by him of the property, name or any business connection of the limited liability partnership.
• No majority of the partners can expel any partner unless a power to do so has been conferred by express agreement between the partners.
• All disputes between the partners arising out of the limited liability partnership agreement which cannot be resolved in terms of such agreement shall be referred for arbitration as per the provisions of the  Arbitration and Conciliation Act, 1996.

Some standard conditions not practicable – Some of the standard conditions specified are not practical. Hence, practically, every LLP will be required to have a written LLP agreement.

3. When to Execute Agreement

Normally, any agreement by or with LLP can be executed only after incorporation of LLP. However, the LLP agreement is not by or with LLP. It is agreement among partners of LLP about LLP. Hence, it can be executed before incorporation of LLP, though it can as well be executed after incorporation of LLP.

The agreement can be amended any number of times. Any amendment has to be filed with Registrar of Companies with filing fee.

3.1 Stamp Duty Payable on LLP Agreement

Since LLP Agreement is a new instrument, obviously, it will not find place in any schedule of State Stamp Act. If the entry in schedule simply reads ‘Partnership Deed/Agreement’, then LLP Agreement can fall under that entry. However, if entry reads ‘Partnership deed/agreement under Indian Partnership Act’, then obviously LLP Agreement will not fall in that heading. In that case, it should fall under residual entry i.e. ‘Any other agreement’, and stamp duty will be payable accordingly.

Of course, in due course, Stamp Acts of all States will be amended.

e-payment of stamp duty – Provision for e-payment of stamp duty has been made under Companies Act. Till parallel provision is made under LLP Act, the existing provision of physical stamps and physical submission of documents will continue.

4. General Comments on LLP Agreement

Just as a shirt cannot fit all persons, there cannot be a standard LLP agreement which will fit requirements of all types of LLPs.

LLP can be of different sizes and for different purposes. Some LLPs may have few partners while some may have huge number of partners. Some LLPs may be in form of family partnerships while some may be in form of Joint Ventures.

Flexibility in agreement – These aspects have to be kept in mind while drafting LLP agreement. The agreement should not be rigid and should provide as much flexibility as possible. More the rigidity, more the problems of operations.

Interests of all parties should be kept in mind. Chances of oppression and mismanagement by some partners cannot be ruled out. There can be oppression of majority. These factors should be considered and proper care should be taken.

Rules are for gentlemen – Of course, ultimately, the fact remains that all rules and regulations are for gentlemen (who really do not need them). Crooks will always find ways and means to hoodwink the system.

4.1 Types of Partners

Under LLP, authority of a partner can be restricted by way of LLP agreement. Such restriction may not be required in case of small family managed LLP but should be provided in large firms.

LLP Agreement can provide for different categories of partners. Some may be termed as Senior/Managing/Executive Partners, some may be termed as ‘Partner’ and some may be even ‘Junior Partner’.

Veto powers to one or more partners – If one or more partner/s intend to control LLP, the agreement can provide them veto power i.e. LLP agreement can provide that in any meeting of Partners or Senior/Managing/Executive Partners, there will be no quorum if they are not present and no resolution can be passed without their affirmative note.

4.2 Executive/Managing Committee in Case of Large LLP

In case of LLP with large number of partners, it is unworkable to give executive or operational powers to all partners. Hence, it may be advisable to form a committee of senior partners which may be termed as Executive/Managing Committee. In my opinion, the number should not exceed five or seven to make it manageable.

4.3 Number of Partners to Execute LLP Agreement

Two persons are sufficient to incorporate LLP. If number of partners are expected to be large, it may be advisable to incorporate LLP with two partners and then increase the number of partners later on. This will be more convenient than to incorporate LLP with large number of partners.

In such case, Incorporation document and LLP Agreement may be executed by two partners. Of course, legally, there is no limit on number of partners who can sign Incorporation document and LLP agreement.

5. Various Clauses of Agreement

Considering the flexibility required in LLP, comments on various clauses are given in following paragraphs. LLP agreement should be drafted considering the requirements and business model of proposed LLP. In following discussions, XYZ is taken as name of LLP. This should be replaced with the name of LLP under formation.

5.1 Main Clauses of LLP Agreement in Form 3

Columns 7 to 20 of Form 3 are in respect of information with regard to LLP agreement. It is highly advisable to draft LLP Agreement in same sequence as far as possible, so that filling form 3 and its checking by Registrar will be easy.

5.2 Model LLP Agreement

Model draft of agreement is given in Annex 4.1. This may be suitably amended to meet requirements of individual LLP.

5.3 Sample Amendment to LLP Agreement to Admit Partner

Sample amendment to LLP Agreement to admit partner is given in Annex 4.2

If there are more than one amendments to LLP Agreement, serial numbers of amendments should be given and each amendment should give brief reference of previous amendments made to LLP Agreement.

6. Model Draft of LLP Agreement

XYZ LLP Agreement

This LLP Agreement made at _________ (place) on _________ (date) between the following (hereafter collectively referred to as ‘parties to LLP agreement’) –

1. A
2. B
3. C

Notes –

1. If partner is LLP or body corporate, that name should be mentioned and not of authorised signatory who is signing the LLP agreement.
2. The agreement will be signed by nominee/authorised representative of such company. It is advisable that in opening paras of the agreement, the person who is signing on behalf of such company/LLP and authority under which he is signing should be mentioned).
3. In case of partners who are individuals, their full name, full name of father/husband, full address with PIN code, age, PAN number (and DIN number if available) should be given. If partner is company, LLP, foreign company or foreign LLP, its name address of registered office, law under which it is incorporated, its registration number should be given.

Effective Date of LLP Agreement – This agreement shall be effective from date of incorporation of the LLP and without need of any further ratification or adoption by the signatories to this agreement (If executed before incorporation) or

This agreement will be effective from date of execution of this agreement (if executed after incorporation of LLP).

Whereas –

1. The parties to LLP Agreement have decided and agreed to incorporate a Limited Liability Partnership to be known as ‘XYZ LLP’.
2. The proposed name has been reserved by Registrar of Companies, __________ vide his letter No. __________ dated __________.
3. The Incorporation Document for LLP has been executed by all the parties to LLP agreement.
4. The Incorporation Document and other connected papers are being submitted to Registrar of Companies with necessary filing fees.
5. Mr. J has been authorised by Y Company Ltd. to sign this LLP agreement on its behalf vide its Board resolution dated __________.
6. Mr. K has been authorised by X LLP to sign this LLP agreement on its behalf vide resolution of its executive committee dated ________.

(If the LLP Agreement is executed after incorporation, the aforesaid preamble may be altered suitably)

Now, therefore, it is decided and agreed by all parties to LLP agreement as follows –

1. Name of LLP – Name of LLP shall be XYZ LLP.

1.1 Business of LLP – The business of LLP will be as specified in the Incorporation Document. The business shall commence on from date of incorporation of LLP.

1.2 Incidental or Ancillary Powers – Following powers shall be incidental or ancillary to attainment of main business of LLP as indicated in Incorporation Document. LLP can exercise those powers as and when required.

(a) Obtaining rights, privileges, contracts, licenses, intellectual property rights, authorisations, permissions from Government or any other authority, company or person to carry out the business of LLP.

(b) Take over any running firm, concern, LLP or body corporate carrying on similar business at a price mutually agreeable or to amalgamate with any other LLP or company or body corporate having objects similar or compatible to those of the LLP

(c) Become partner of another LLP or member of any company

(d) Enter into compromise with any person.

(e) Enter into arrangement for sharing profits, union of interest, cooperation or joint venture with any person, LLP or Company or body corporate.

(f) Appoint, deal with or act as agents, sub-agents, dealers, sub-dealers, distributors for selling or purchasing or dealing with the products or services related to the business of LLP.

(g) Acquire or dispose of movable and immovable property, enter into agreements for purchase, sale or disposal of movable or immovable property.

(h) Open, operate and close bank accounts, give and obtain guarantees, borrow from banks, financial institutions or any other person on providing security or without security, invest surplus funds of LLP in appropriate avenues.

(i) Appoint, promote remove or suspend employees and workmen, to take disciplinary actions and impose punishments on workmen and employees, to represent before labour courts, industrial tribunals, High Court and Supreme Court in labour matters.

(j) To institute or defend any suit or show cause notice before any adjudicating authority, appellate authority, Tribunal or Court, to appoint consultants, advocates and authorised representatives for representing LLP.

(k) To grant general or special power of attorney to any person for purpose of business of LLP.

(l) Do all such acts and things as may be necessary to carry out businesses of the LLP.

1.3 Change, Suspension or Modification in Nature of Business – The nature of business can be changed or new business can be commenced or existing business can be suspended or modified or business can be completely closed with –

• consent of all partners
• consent of 75% of partners
• consent of 75% of Senior/Executive/Managing Partners

(keep as appropriate).

1.4 Registered Office of LLP

The registered office of LLP shall be at the following place –

_______________________________

_______________________________

_______________________________

The registered office can be changed as provided in subsequent clauses of this agreement.

1.5 Place of Business – LLP can conduct business and have place of business anywhere in India.

1.6 Liability of Partners – Liability of each partner towards LLP shall be limited to his contribution to LLP.

1.7 Categories of Partners – There shall be following categories of partners – Senior/Managing/Executive Partners, ‘Partner’ and ‘Junior Partner’. Keep as appropriate. Omit the clause if such categories are not envisaged or not required]

2. Designated Partners – Following are presently designated partners

They have given their consent to act as designated partners.

The designated partners may be changed and new partners may be appointed as Designated Partners with their consent. It will not be necessary to amend the LLP Agreement for this purpose.

2.1 Acts To Be Done By Designated Partners – The designated partners shall be responsible for all acts specified in section 8(a) and all other statutory requirements of Limited Liability Partnership Act and other provisions. The designated partners shall be responsible for authenticating and signing of Statement of Account and Solvency as required under LLP Act and LLP Rules.

2.2 Other Powers As Per LLP Agreement – The designated partners will exercise other powers relating to management of LLP only as per provisions of this agreement and subject to powers as given to executive/managing partners and general body of partners as specified in this LLP agreement.

2.3 Appointment/Removal of Designated Partners – Designated partners will be appointed and/or removed

• Unanimously by all partners.
• By executive/managing committee of LLP.

(keep as appropriate)

3. Contribution

The total monetary value of contribution of LLP shall be Rs. ___________ (state as specified in Incorporation Document). Obligation of each partner to contribute is as follows –

Persons, who have consented to be the partner of LLP, shall be bound by the terms of this LLP agreement, as may be amended from time to time. They shall be bound to contribute as specified above.

(Note – If number of partners is large, this clause will require amendment every time a new partner is added or a person ceases to be a partner. Hence, in such cases, this clause may be suitably redrafted e.g. on basis of categories of partners).

3.1 Increase or Reduction in Contribution – The Contribution can be increased or reduced with consent of –

• all partners
• 75% of partners
• 75% of Executive/Managing Partners
• Resolution of Executive/Managing Committee

(keep as appropriate).

The increase in contribution shall be in the existing ratio of the contribution, unless all other partners agree for different proportion. Contribution of any partner shall not be increased without his express consent.

Share of each partner in contribution in case of subsequent increase – The share of each partner in the Contribution will be as decided with consent of all partners/consent of 75% of partners/consent of 75% of Executive/Managing Partners (keep as appropriate).

No Interest on capital contribution – Interest shall not be paid on capital contribution.

3.2 Other Provisions Relating to Contribution

Share of profit of each year shall not form part of contribution – Share of profit of each partner shall not form part of contribution of the partner. The amount will be credited to a separate account of the partner.

Refund of Contribution – The contribution of partner will be fully refundable in the following situations –

• in case of death, resignation, expulsion or cessation for any other reason of the partner.
• winding up of LLP.

The partner’s contribution may be partly or fully refunded if –

• at least 75% of the remaining partners
• with consent of Executive/Managing Committee of LLP

(keep as appropriate).

Refund of contribution in case of closure of business – When it is decided that business of LLP be closed, all secured and unsecured creditors should be first paid. All liabilities of LLP shall be cleared. Balance, if any, shall be distributed among partners in the ratio of their contribution at the time of closure of business.

4. Partners’ Powers and Duties

4.1 Types of Partners

Partners shall be of following types –

• Executive/Managing Partner
• Salaried Partner
• Non-Executive Partner
• Partner

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Effectiveness of independent directors refers to how well these external board members perform their core duties—ensuring transparent governance, mitigating risks, safeguarding minority shareholder interests, and maintaining accountability. They bring objectivity and fresh insights to decision-making processes, free from the personal or financial connections that may influence executive directors. An effective independent director actively questions corporate strategies, demands comprehensive disclosures, and promotes ethical practices. They also help shape company policies by offering diverse expertise and driving robust discussions in board meetings. Ultimately, when independent directors are truly effective, they bolster stakeholder confidence, maintain regulatory compliance, and foster a culture of responsible governance.

Table of Contents

1. Effectiveness of Independent Directors
2. Board Duality

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1. Effectiveness of Independent Directors

The major role that independent directors play in a company broadly includes improving the overall corporate governance framework and risk management processes of the company. The empirical evidence in different jurisdictions point out a significant improvement in the corporate governance standards with the induction of independent directors. In the boards especially in family controlled and concentrated shareholding companies the presence of independent directors has ensured structured agenda, deliberate discussions, and compliance regarding board processes. One of the important roles of board is to oversee and ensure compliance of the company with the rules and regulations. Independent directors are legally liable for negligence and are required to exercise utmost due diligence over all the financial and executive decisions of the company they are associated with. They are expected to bring out, misappropriation, non-compliance with legal provisions, malpractices etc. in the company.

In case of Satyam computer scam the court imposed hefty fine on the independent directors. There are many cases including Enron, WorldCom, Dewan Housing Finance, IL&FS wherein independent directors not only came under scrutiny, but they dented their reputation also.

Independent directors act as monitor of controlling shareholders. Independent directors prevent business decisions that are unfair to minority shareholders and other stakeholders. The audit committee headed by an independent director monitors all the related-party transactions, engage with the statutory auditors, and ensure integrity of financial reports. There are many instances wherein independent directors have blocked decisions which are not in the interest of the companies. There is no dearth of cases of independent directors asking tough questions and taking tough decisions despite pressure from the promoters or controlling group of shareholders. In fact, the institution of independent directors is well established and respected all over the world.

However, questions are often raised about the ‘genuine independence’ and effectiveness of independent directors. This is because these are appointed by the controlling group of shareholders or the promoters in most companies in Asia marked by domination of families. As independent directors are dependent on the families or the controlling group of shareholders for their appointment and continuation of appointment, it may impair their independence. In widely held big corporations of the US and UK, nomination process of independent directors is tilted more in favour of executives of the company particularly the CEOs of the companies who suggest the names of potential directors and finally the appointments are carried through the ‘nomination committees’ of the boards before approved formally by the shareholders in the annual general meetings. The independent directors may thus become dependent on the CEOs or chairman of the companies for their continuation/re-election.

Despite the prescribed independence criteria, some independent directors may have past or ongoing associations with the company’s promoters or management. While these relationships may not be classified as “material” under the legal definition of independent director, in many cases it impacts judgment and decision-making of the independent directors. In state run public enterprises wherein political workers or persons loyal to the political party in power are obliged by offering them independent directorships in the companies, subconscious biases, affiliations, and loyalties, or undue familiarity sway judgment diluting the rigour and neutrality expected of their role. It gives rise to a fundamental issue of independence in fact (real independence) and independence in appearance (perceived independence).

Leaving the issue of ‘independence’ aside, doubts are also expressed on the efficacy of independent directors. As independent directors may be engaged in activities other than directorships in companies, they have limited time at their disposal to participate in board processes effectively. When making decisions, these directors have to rely on the information presented to them by the executives of companies. In some jurisdictions, directors have a legal right to inspect records of companies. Yet time constraints generally render this right ineffective. Many a times, independent directors lack proper training and orientation to influence board decisions. Given these constraints, independent directors can hardly initiate much of the corporate strategies or policies or bring to fore ‘independent and objective judgments’ to ensure that corporate decisions are made in the best interests of all the shareholders.

Failure of board of directors especially independent directors is the most common governance failure noticed in various corporate failures whether it is Enron or WorldCom or Parmalat or the Satyam. Some of the cases are as under –

1. Enron Corporation was an American energy, commodities, and services company based in the USA collapsed in 2001. On paper, Enron had a model board of directors comprising predominantly outsiders with significant ownership stakes and an talented audit  committee. In its 2000 review of best corporate boards, Chief Executive included Enron among its top five boards. Collapse of Enron may be construed as failure of corporate governance in particular the board of directors of Enron. The board failed miserably in its oversight responsibilities. The board had no clue of what the executives were doing. The directors failed to understand the related party transactions between Enron and SPEs. The board flawed in implementing proper systems of control and risk management.
2. The non-executive directors on the Maxwell Communication board, all reputed persons, did little in discharging their responsibilities. Unrestricted movement of funds across group companies, pledging shares of a company to raise funds for another company, excessive borrowings took place under the nose of the board. It appeared that the board was helpless in the face of larger-than-life personality of Robert Maxwell.
3. WorldCom had the board of directors consisting of 11 directors, eight of whom were independent. The board failed to fulfil its basic responsibilities. Acquisitions made by the company with the approval of the board, in many instances appeared to be opportunistic rather than part of the long-term strategic plan. The board’s review of acquisitions was not comprehensive and left the company highly levered. These strained the financial structure of the company and complicated the analysis of the financial performance measurement. The board neglected in every aspect of the monitoring and oversight over the executives. The board failed to act or ignored accounting irregularities besetting the company more than 12 months before the company collapsed ultimately.
4. The debacle of Satyam Computer in 2009 demonstrated the ineffectiveness of independent directors. The board of directors of Satyam had well acclaimed persons as the members. The board failed miserably in its prime duty of oversight. The fraud had been cooking in Satyam for years together. On the behest of the promoters the board cleared the deal of acquiring family concerns of the promoters even though it was a major departure from the normal activities and expertise of Satyam. The high-profile independent directors chose to remain silent spectators to the pranks of the chairman of the company reducing themselves to the ‘passive observers’. The board of directors of Satyam composed of a majority of independent directors, and the ‘independent’ Audit Committee of the Company miserably failed to exercise the important ‘oversight’ role and remained either ignorant of the whole scam or turned a blind eye to wrong practices ostensibly in fear of losing continuance of their job in the company from which they were getting hefty remuneration. The Central Bureau of Investigation report stated “The members of the Board of Directors had acted as “rubber stamps”, unwilling to oppose the fraud. Not a single vote of dissent has been recorded in the minutes of the Board meetings¹”.
5. One of the important roles assigned to independent directors is overseeing policy implementation and ensuring that the business is carried on in the interest of the company. Infrastructure Leasing & Financial Services Ltd. (IL&FS) became highly levered and started making default in debt repayments in 2018. IL&FS had a board of directors consisting of eminent persons as independent directors and nominee directors from SBI, LIC and CBI. It seems that the directors in the company were either negligent or they lacked expertise in managing a complex infrastructure financing NBFC. The board failed miserably in managing the liquidity crisis that was brewing over the last four years. It is no wonder that, with such poor board oversight, IL&FS had ventured down a path of misgovernance, resulting in the company defaulting on its financial obligations.

1.1 Enhancing the Effectiveness of Independent Directors

• Strengthening the Selection Process – Policymakers and regulators should establish robust criteria for determining the independence of In India there is an online data bank of the independent directors and the requirement to pass online proficiency test, but generally directors are hand-picked by promoters. The role of nomination committee of the board is important in setting standards for nomination of directors and screening the probable candidates.
• Promote diversity on Boards – Independent directors should be appointed with a diverse range of expertise and professional Companies should appoint directors from diverse backgrounds including gender and region. This will ensure that boards have a range of perspectives and experiences which can lead to better decision-making.
• Enhancing the authority of Independent Directors – The authority granted to independent directors does not commensurate with their responsibility. There is a need to augment the authority granted to A comprehensive board charter outlining the roles, responsibilities, and authority of independent directors should be established. The company needs to ensure that independent directors have timely access to accurate and relevant information about the company’s operations, financials, risks, and performance. This will empower them to make informed judgments and actively participate in discussions.
• Induction, Training and Development of Directors – A newly appointed director needs to undergo an induction programme to obtain essential knowledge about the company and its industry. For incumbent directors, continuous updating and professional development has become more important in the wake of growing complexities of the business and rapid acceleration of new regulations and legal requirements for directors. These programs should cover corporate governance best practices, legal and regulatory requirements, risk management, ethics, and Companies should invest in continuous training and development programmes for independent directors to keep them updated on industry trends, best practices, and changing regulatory landscapes.
• Performance Evaluation – Regular evaluation of independent directors’ performance, both individually and collectively should be undertaken by the entire board. This will identify potential conflicts of interest or shortcomings in fulfilling their responsibilities. The peer review can consider the constructive and less constructive roles individual directors play in discussions, the value and use of various board members’ skill sets, interpersonal styles, individuals’ preparedness and availability, and directors’ initiative and links to critical stakeholders. This process should be driven by a board committee such as a nominating or governance committee. The continuation of independent directors should depend on satisfactory evaluation report. Absence of evaluation has often led to the situation of independent director being a ‘puppet independent director’ who are unable to perform the duties of directors as they lack skills inside the board rooms.
• Promote greater engagement between directors and other stakeholders, including shareholders, employees, and customers. This will help ensure that directors have a better understanding of the concerns and perspectives of the stakeholders. It will facilitate the directors to deliberate effectively in the boardrooms.
• Appointment of Lead Independent Director – When the Chairman of the board of directors is not independent or serves as CEO of the company also, there is a practice in some jurisdictions² to designate an independent director as the ‘Lead Independent Director’ or Senior Independent Director’ to serve in a lead capacity to coordinate the activities of the other independent directors and to perform such other duties and responsibilities as the board of directors may determine. Lead independent director serve as liaison between chief executive office, senior management of the company and the independent directors. Such director also chairs the meetings of the independent directors without the presence of executive directors. This practice should be adopted by the companies to enhance the effectiveness of independent directors.

2. Board Duality

CEO duality is a governance structure where the CEO of a company also serves as the chairman of the board of directors. While CEO is liable for the performance of the company and for safeguarding the stakeholders’ interests, the role of the chairman in a company is to run the board and ensure effectiveness of the board in implementation of the strategies. Both positions are equally important top-level leadership in a company responsible for the success and sustainability of the firm.

One of the most contentious issues in corporate governance is whether the positions of CEO and chairman may be combined in the same person or separated. The reforms in corporate governance which came largely in the wake of the corporate scandals all over the world, prescribe persistently a clear division of responsibilities between chairman and CEO of the company. Sir Adrian Cadbury, chairman of the Committee in the U.K. which investigated corporate governance issues in the early 1990s emphasised that ‘the jobs of chairman and chief executive demand different responsibilities and perhaps temperaments. It is very much in shareholders’ interests to ensure they are performed by different people’. The Cadbury Committee clearly recommended that “there should be a clear division of responsibilities at the head of the company between the running of the board and the executive responsibility for the running of the company’s business. No one individual should have unfettered powers of decision”. Asserting chairman and CEO as two jobs and not one, many corporate governance codes and guidelines seek to institute independent chairman of the board of directors.

The primary role of a board of directors is to monitor and supervise the operations and ensure that the CEO and other executives run the company in the best interest of the shareholders. The CEO heads the management to implement the policies and strategies laid down by the board of directors. When CEO is also the chairman, he/she monitors her/himself, which may lead to abuse of power and position. This has given rise to many corporate scams and frauds.

The preference for the separate CEO-Chairman is largely grounded in the agency theory of corporate governance concerning the potential for managerial abuse. Cadbury Committee, 1992 and many codes of corporate governance strongly advocate that CEO of the company should not serve simultaneously as chairperson of the board. If chairman and CEO is the same person, it becomes more difficult for the board to provide an independent oversight of management or to evaluate the CEO or to express independent opinion on the management. An independent structure of the chairman is prescribed to facilitate objective assessment of the company and the top management of the company.

On the other side, the practicing managers rarely adopt the view that separation of the two positions is the superior structure. The CEO and the board chairman are two of the most positions in a company. Since CEO duality combines the responsibilities of both positions into one person, it cultivates a stronger and unified leadership at the top. The stewardship theory also suggests that the duality of the CEO and chairman joint structure provides unified firm leadership and removes any internal or external ambiguity regarding who is responsible for firm processes and outcomes. Duality offers the clear direction of a single leader, and a faster response to external events. The CEO-cum chairman is expected to have a greater knowledge of the company and the industry and have greater commitment to the company than a separate chairman.

CEO duality is more common in the U.S.A. than other part of the world. Although the current U.S. reforms do not mandate the separation of the roles of Chairman and CEO, they certainly reflect a desire to shift the power centre of the corporation away from the CEO to the Board. While Sarbanes-Oxley Act (SOX) addresses issues of managerial and board integrity through a number of provisions, listing rules of the NYSE and NASDAQ call for the boards to be comprised of a majority of independent directors.

In the UK on the other hand, the corporate governance code prescribes that the roles of chairman and chief executive should be split and further a chief executive should not go on to become chairman of the same company. There is a high level of compliance in the U.K., particularly among larger listed companies of the principle of separation of the two roles.

The Indian codes of corporate governance viz. CII code, Clause 49 of the Listing Agreement, Revised Clause 49 while silent on the issue of separation of chairman and CEO, linked independent (non-executive) chairman with the component of independent directors in the board of directors of company. The CII report recommended that if the chairman and CEO (or Managing Director) is the same person, independent directors should constitute 50% of the board, and 30% of the board in case the two positions are separate. The Kumar Mangalam Birla Committee’s views on the subject were quite ambiguous. The committee believed the chairman’s role should in principle be different from that of the chief executive, though the same individual may perform both the roles.

In the mandatory category of recommendations, the committee dittos the CII recommendations of linking non-executive chairman with the composition of board of directors of the company. The same provision was incorporated in Clause 49 as well reiterated in the Revised Clause 49 of the Listing agreement by the SEBI.

Based on the recommendations of the Uday Kotak Committee on Corporate Governance, the Securities and Exchange Board of India (SEBI) amended the SEBI (Listing Obligations and Disclosure Requirements (LODR)) Regulations, 2015. The amendment requires the split of the positions of the Chairman and Chief Executive Officer (CEO). In addition, the LODR Regulations provide that the chairman and CEO must not be related to each other. The amendment also requires that the position of chairman be held by a non-executive member. This regulation was to be applicable to the top 500 listed entities by market capitalisation from April 1, 2022. However, on the persistent demand of the corporate sector, SEBI made the rule of separation of CEO and Chairman voluntary.

2.1 Gender Diversity in Boards

In recent years board diversity has caught the attention of policy makers and practitioners, primarily driven by a concern for greater equality for men and women at the level of the board. It is also strengthened by the belief of behavioural difference in core values of female directors who would bring a different perspective in the board room.

The gender diversity in the board is advocated worldwide either through quota regulations or codes. The regulations in developed economies like Norway, Germany, Belgium, Iceland, and France pose a requirement of at least 40 per cent women on the boards of publicly traded firms. The governments of many other countries, like Australia, Britain and Sweden desire the listed entities to appoint an appropriate mix of women directors on the boards.

In quite a few European countries and in India, board gender diversity was introduced in listed firms by the legislation. A sustained pressure also came from national and international bodies.

In India, section 149(1) of the Companies Act, 2013 requires that the following class of companies must appoint at least one woman directors on the board –

• Every listed
• Every other public company having paid up capital of ` 100 crore or more, or turnover of ` 300 crore or more.

The Securities and Exchange Board of India (SEBI) Regulations, 2015 (LODR) also requires the boards of the top 1000 listed entities to appoint at least one independent woman director.

Presently, the composition of female members in the Indian boards is just 13.8 per cent which is much below the worldwide average. With Norway on the top with 41 per cent, France 37.2 per cent, South Africa 26.4 per cent, the global average is 16.9 per cent (Deloitte, 2018).

There are few theories which provide a strong rationale of women directors in the boardrooms. Resource Dependence theory posits the board’s role to connect the firm with the external environment and bring various resources to expand the boundaries. It is argued that female directors bring a different set of knowledge, skills, and experience. A study of Bank of America Merrill Lynch (2018) also opines that gender diversity may provide a heterogeneous opinion in the boardrooms enabling the company to compete and adapt to changes in the industry. It has been pointed out that women bring ‘competitive advantage’ to the firm by dealing with the labour and product market efficiently. There is evidence which shows the experience of women in the boardroom valuable as they may understand consumers in some markets better than men. Thus, gender diversity on the round table enhances creativity and innovation.

The study of Forbes also advocated that a ‘diverse board is better positioned to understand its customer base and the business environment in which it operates’ (Forbes, 2018). Women directors make the board diversified to represent diverse customer base (The Economist, 2014). There are various psychological studies which state that women in leadership position enhance communication between different stakeholders and hence improves firm chance to perform better.

Gender role theory links gender with the behaviour and effectiveness of the individual. Women are regarded as risk-aversive and are less willing to take extreme risk to earn phenomenal returns. There are many research studies which postulate the risk-averse nature of women. These studies concluded that firms which had more females in the top management team exhibited lower risk and better performance.

Many studies both by the researchers and consultancy firms have been undertaken to explore relationships between women directors and corporate financial outcomes. Many of these (Credit Suisse Research Institute, 2019, Bank of America Merrill Lynch, 2018, and Deloitte, 2018) unequivocally pointed out diversity as not only the right thing to do but also leading to ‘smarter decision-making’ impacting earnings significantly.

1. Satyam CBI Report (http://www.topnews.com.sg/content/22973-satyam-scam-board-directors-also- party-fraud)
2. The practice is mandated by the codes of corporate governance of the quite some countries.

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Shareholder Activism is when shareholders leverage their ownership in a company to influence its policies and decisions. By engaging with management—through voting, meetings, and other strategic actions—shareholders aim to enhance transparency, accountability, and ultimately the firm’s long-term value.

Table of Contents

1. Shareholder Activism
2. Class Action Suits
3. Institutional Investors

Check out Taxmann's Corporate Governance – UGCF | NEP which is is comprehensively aligned with the NEP-based B.Com. curriculum and offers a rigorous and practical exploration of corporate governance principles and frameworks across Indian and global domains. From analysing landmark corporate failures (Enron, Satyam, Kingfisher) to illustrating legal regulations (Companies Act, 2013; SEBI LODR, 2015), it underscores the pivotal role of robust governance in averting crises. Engaging case studies and research-backed discussions provide a 360-degree view of corporate ethics, board structures, and emerging issues like insider trading and shareholder activism. Each of the eleven chapters includes end-of-chapter questions, references, and previous years' questions to reinforce learning.

1. Shareholder Activism

1.1 Introduction

Increasingly worldover, the shareholders influence the management in governing the company. Greater shareholder involvement in corporate governance is considered necessary to ensure transparency and accountability in organisations. Such involvement is called shareholder activism.

1.2 Definition

According to E. Sjöström (2008),

“Shareholder activism refers to the active influence on firm policy and practices through the use of ownership position.”

1.3 Features

• Shareholder activism can be through different types of ownership position it can be minority shareholders; institutional investors (insurance companies, development banks, private equity funds and hedge funds); or labour unions.
• Shareholder activism may range from financial reasons such as dissatisfaction with corporate financial results, disapproval of financing structure, to non-financial reasons, e.g. adoption of environmentally friendly policies; the constitution of Board of Directors to meet their good governance expectation; and investment in or disinvestment from certain countries.
• Regulatory support is important for its effectiveness.
• Proxy battles, shareholder resolutions, litigation and publicity campaigns are some of the forms shareholder activism can take.

1.4 Advantages

The increased involvement of shareholders in the company’s affairs results in many advantages. Some of them are listed below –

• Reduces agency problem between the management and shareholders – Shareholder activism results in closely monitoring action of corporate management. This helps the shareholders to trust the decisions made by management. The agency problem, thus, gets reduced.
• Creating shareholder value – Activism by the shareholders has become a very significant way through which shareholders are able to influence the management of underperforming companies to step up the company’s performance and create shareholder value.
• Sharpens the company’s strategy – Shareholders have access to timely and accurate information since they are involved in decision making They, especially the institutional investors, can actively provide expert guidance to company on policy matters and improving upon its strategy.
• Improves corporate governance – Shareholder activism helps in enforcing accountability and transparency of decisions made by This results in better corporate governance which, in turn, can prevent corporate failure and promote corporate sustainability in the long run.

Thus, shareholder activism helps the organisation as well as the investors.

1.5 Disadvantages

It has been argued by some people that shareholder activism is detrimental to corporate values because of the following reasons –

• It undermines Board authority – Bainbridge (2002) has argued that shareholder activism results in erosion of the Board’s authority. Some (majority) shareholders may use their power to further their interests at the cost of (minority) others.
• Informational asymmetry and lack of expertise – Lipton and Rosenblum (1991) contend that shareholders do not have time and expertise to gather information, nor do they have complete access to sensitive financial and non-financial information of the Hence, options proposed by shareholders will lack substance and insight.
• Short-termism – It is argued that some shareholders might push decisions that may result in short-term gain for them but damage the long-term value of the corporation.
• Ignore stakeholders – Good corporate governance principles emphasise the furtherance of interest of all the stakeholders, including sharehold While shareholder activism’s basic assumption is that shareholders involve themselves in affairs of the corporate to protect their interest.

A keen interest from institutional investors and focus on long-term growth of corporations by shareholders will mitigate the disadvantages of shareholder activism.

1.6 Shareholder Activism in India

The Companies Act, 2013 and certain regulatory changes introduced by SEBI have ushered a new era of corporate governance in India. Shareholder activism, an important aspect related to corporate governance, has taken the form of institutional shareholder activism as well as minority shareholder activism in India. According to a BNP Paribas Asia Strategy Report released in September 2014, the incidences of shareholder activism in India was more than that in other Asian country since year 2000¹.

Shareholder activism is coming of age in India. Minority shareholders have successfully opposed resolutions regarding increased remuneration for key personnel, related party transactions, and the reappointment of directors. For example, shareholders of Eicher Motors Limited, KRBL Limited, Max Financial, and Sobha Realty voted against special resolutions aimed at raising the remuneration of top executives. Additionally, in September 2023, shareholders of Godfrey Phillips India rejected the company’s proposal for a related party transaction to annually export unmanufactured tobacco worth up to ` 1,000 crore to Philip Morris².

Ways of Participation in Shareholder Activism in India³

There are several ways available to shareholders to participate in shareholder activism. Some of these are as follows –

• Interaction with the Board – Shareholders can regularly express their concerns by engaging with the Board either at AGMs or EGMs, fostering awareness of shareholder issues. This interaction helps build rapport and goodwill between shareholders and Board members, which can facilitate the resolution of disputes.
• Right to requisition an EGM – According to section 100 of the Act, 2013, shareholders have a right to requisition the convening of an EGM to discuss specific matters. In a recent case, Zee Entertainment Enterprises Private Limited (“Zee”), a publicly traded company declined to schedule a shareholders’ meeting in response to a requisition notice from Invesco, an institutional investor, regarding the appointment of independent directors. The Bombay High Court held that failing to call the requisitioned meeting would undermine shareholders’ democracy as a consequence of the restrictive behaviour of the Board. Zee was ordered to convene the meeting.
• Utilising the Stakeholders Relationship Committee – Publicly traded companies or those with more than 1,000 shareholders, debenture holders, deposit holders, or other security holders must establish a Stakeholders Relationship Committee to address security holder grievances. This Committee provides shareholders with a platform to voice their concerns.
• Making public announcements – When issues cannot be resolved privately, shareholders have the option to publicly express their grievances, which can place pressure on the Board. Cyrus Mistry, a key shareholder in Tata Sons through his family’s company, Shapoorji Pallonji Group, which owns around 18.4% of Tata Sons, was unexpectedly ousted as Chairman in 2016. After his removal, Mistry raised concerns about the company’s governance through an open letter to the Board, which quickly became public. In this letter, he highlighted issues with corporate governance and questionable business decisions. The public nature of these revelations garnered significant media attention, putting pressure on the Tata Sons board and raising alarm among stakeholders. This situation led to a drawn-out legal dispute, with Mistry alleging oppression and mismanagement, citing his role as a major shareholder [Tata Sons vs. Cyrus Mistry (2016)].
• Approaching the National Company Law Tribunal – Shareholders may file a claim with the National Company Law Tribunal (NCLT) for oppression or mismanagement, arguing that the company’s affairs are being conducted in a manner detrimental to the interests of its members. In Fortis Healthcare vs. Singh Brothers (2018), shareholders of Fortis Healthcare filed cases against promoters Malvinder Singh and Shivinder Singh, alleging mismanagement of company funds and diversion of resources to related parties. They approached the NCLT to protect their interests and rectify the company’s affairs, resulting into a legal investigation of Fortis Healthcare’s financial transactions.
• Making an application to the Serious Fraud Investigation Office (SFIO) – If shareholders suspect serious mismanagement potentially involving fraud, they can notify the Central Government, which may instruct the Serious Fraud Investigation Office to conduct an investigation. In 2018, IL&FS, a prominent infrastructure development and finance firm, faced a severe financial crisis revealed fraud and mismanagement of funds, due to weak corporate governance. Shareholders and creditors expressed their concern about the company’s deteriorating financial situation, prompting the Central Government to order an investigation by SFIO. The ensuing inquiry revealed substantial financial irregularities and mismanagement, ultimately leading to a significant restructuring of the company.
• Acting as per proxy advisory firm’s advice – Proxy advisory firm’s advice the shareholders on various issues based on their For example, they advise the shareholders as to how to vote on various corporate matters, including board elections and executive compensation. Institutional Investor Advisory Services (IiAS) and Institutional Shareholder Services (ISS) recently recommended that shareholders vote against the appointment of Anant Ambani to the board of Reliance Industries Ltd. (RIL). They cited his young age of 28 years as a reason for opposing his non-executive director position, noting that it did not conform to their voting guidelines. In contrast, they endorsed the appointments of his older siblings, Isha and Akash, both 31 years of age⁴.

Besides the above, ways individual motivation to be a vigilant shareholder may lead to improvement in corporate governance.

The role played by Mr Arvind Gupta as a ‘shareholder and stakeholder activist’ in unearthing ICICI scam is the best example of explaining how a single shareholder can make a difference.

1.7 Important Changes Introduced by the Companies Act, 2013

The Companies Act, 2013 has pushed shareholder activism introducing various regulations –

• Introduction of electronic voting – E-voting was made mandatory in 2013 for certain classes of This has resulted in greater retail investor participation as physical presence in a general meeting is no longer required and voting can be done from any location.
• Class action suits – On June 1, 2016, the Ministry of Corporate Affairs (MCA), notified section 245 of the Companies Act, 2013, which contains provisions related to class action suits in India. It has given minority shareholders the confidence to raise voice against company if a situation demands so.
• Approval of related party transactions – An ordinary resolution is required to approve or disapprove related party transactions, and the promoters/directors interested in the transaction are ineligible to Thus, the minority or public shareholders can play a decisive role in approving or disapproving related party transactions now.
• Small shareholders director – Section 151 of the Companies Act, 2013 requires listed companies to appoint at least one director elected by small shareholders⁵.

The recent changes in regulations have certainly given the desired push to shareholder activism. In 2014 minority shareholders of Tata Motors did not give consent to the proposed executive compensation package for some of the company’s directors as the company reported a net loss for the year. In the same year, minority shareholders of Siemens rejected the initial offer, and it was forced to raise the offer price at which it wanted to buy out the metal technologies business of its listed Indian subsidiary. These examples and many more such instances are testimonials to rising shareholder activism in India.

 2. Class Action Suits

2.1 Introduction

Class action lawsuits, which originated in the U.S., have been used by millions of Americans and Europeans successfully since long. Such lawsuits have been brought against the Government or Corporates to claim compensation for damages and/or injuries caused by defective products, environmental disasters, employment discrimination, securities fraud, false advertising or any other discriminative or manipulative business practices.

2.2 Definition

“A class action is a type of lawsuit in which one or several persons sue on behalf of a larger group of persons, referred to as the class⁶.”

The common features of class action suits are as follows –

• The issue in dispute is such that a large number of individuals have been made to suffer or have been wronged in a similar manner by the defendant.
• The number of persons affected by the wrong is large and, therefore, it is impracticable for all of them to appear before the court together.

2.3 Advantages of Class Action Suits

• Streamlines the litigation process – Class action lawsuits streamline the process by allowing shareholders to bring their claims to a single court. This is particularly beneficial in a vast country like India, where shareholders may be spread across various Companies can avoid defending multiple lawsuits in different states, while shareholders gain stronger collective representation.
• Lowers the cost of litigation – The financial burden of litigation is divided among all shareholders involved, making it more This is especially important in India, where high litigation costs often deter individuals from filing suits. Shareholders with limited financial means can collectively hold companies accountable without bearing the full cost alone.
• Uniformity in legal decisions – Class actions ensure that all shareholders receive the same treatment and avoid the inconsistency that could arise from multiple courts issuing conflicting rulings.
• Strengthened negotiating position – Companies often prefer settling class action lawsuits rather than waiting for a court verdict. With the collective bargaining power of shareholders, settlements tend to be larger than those achieved in individual lawsuits.
• Boosts shareholders’ awareness and activism – Class action lawsuits attract more media coverage and public attention than individual cases, which increases awareness among shareholders and motivates them to assert their rights.
• Deter companies – Although the primary goal of class actions is not to punish companies, they do serve as a financial deterrent. Large settlements can impose significant costs on companies, encouraging them to act more responsibly in the future. For example, if Satyam Tech had faced a class action suit in India like it did in the U.S., it might have deterred similar corporate misconduct.
• Increases judicial efficiency – In a country like India, where backlog of legal cases in courts is a serious matter of concern, class actions save valuable time and reduces their burden.

2.4 Disadvantages of Class Action Suits

Some of the disadvantages of class action suits include –

• Delay in resolution – In case of a class action lawsuit, it takes time to build a consensus among The procedural complexities result in longer time in resolution of class actions as compared to conventional cases.
• Lack of control – These suits are representative by their very The representative parties only have authority to agree to a settlement or take any other decision. Aggrieved party has no control.
• Limited forms of compensation – Compensation in class action suits is, generally, limited to pecuniary No other form of relief, such as employment in the entity, is not available to the plaintiffs.
• Litigation financing – In the United States and elsewhere, class action movement has been boosted by third-party funding and contingency fees, which allow plaintiff lawyers to take the risk of litigation while ensuring windfall profits in the event of a success. There is absence of similar regulation in India and lawyers cannot get contingent or success fees.

To ensure mitigation of these problems, law in many countries requires an option to be given to members to opt out of settlement.

2.5 Class Action Suits in India

• Class action suits and Satyam – Satyam scam, which broke out in 2009, brought many corporate governance issues in the One of these was the need for regulations related to class action lawsuits. Indian investors of Satyam were not successful in taking a legal recourse while company’s U.S. investors filed class action suit against the company and its auditors.
• First class action suit– Interestingly, Department of Consumer Affairs under the Ministry of Consumer Affairs, Food & Public Distribution filed a class action suit against Nestle recently citing the Consumer Protection Act, 1986. It is the first instance of such a case in India.
• Section 245 of the Act – This section empowers members or depositors of a company to file a class action suit if they believe that the company’s affairs are being conducted in a manner detrimental to their interests. It allows them to collectively bring a lawsuit against –

1. 1. the company,
   2. its directors,
   3. auditors, or
   4. other relevant parties such as experts, advisors, or

Eligibility for Filing

• • • For companies with share capital, at least 100 members or 10% of the total number of members, whichever is less, can initiate a suit.
    • For unlisted companies, members holding at least 5% of the issued share capital can file.

• • • For companies without share capital, at least 1/5th of the total number of members is required.

Process of Filing

• • • The suit must be filed in the National Company Law Tribunal (NCLT) and must specify the grounds for action and the relief Upon admission, the NCLT issues public notice to all affected parties.

Deterrence to Frivolous Litigation

Sub-section (8) of Section 245 of the Companies Act, 2013 states that if the Tribunal finds an application filed by members or depositors to be frivolous or vexatious, it can reject the application:

• • • The Tribunal must record its reasons for rejection in writing.
    • The Tribunal must order the applicant to pay costs to the opposite party, not exceeding ` 1,00,000.
• Reimbursement of legal expenses – The company can reimburse expenses incurred for pursuing class-action suits under Sections 37 and 245 of the Act by debenture-holders, members, or depositors and sanctioned by the National Company Law Tribunal out of Investor Education and Protection Fund.

Two separate class action suits are subjudice at present: one filed by some shareholders of Jindal Poly Films Ltd. against promoter B. C. Jindal Group; and the other filed by minority shareholders of ICICI Securities Ltd. against the company and its promoter, ICICI Bank Ltd. The future of corporate governance in India may largely depend on the jurisprudence established while resolving these issues.

3. Institutional Investors

3.1 Introduction

Institutional investors are key players in the governance mechanism of a corporation. They hold significant stake and voting power which can potentially influence company’s decisions and promote good governance practices. Their sheer voting power allow them to act as stewards of good governance, ensuring transparency, and thereby contributing to overall market stability.

3.2 Definition and Types

NASDAQ defined institutional investors as:

“Organisations that invest, including insurance companies, depository institutions, pension funds, investment companies, mutual funds, and endowment funds⁷.”

Griffin (1993) defined institutional investors as:

“Institutions which have as their primary role the professional investment and management of any fund established for the purpose of pooling monies paid by individual investors and invested in financial and non-financial assets⁸”.

In simple words, institutional investors are organisations that pool large sums of money and invest it on behalf of their clients or members. These include mutual funds, insurance companies, pension funds, Foreign Institutional Investors (FIIs), banks, and other financial institutions. The primary goal of institutional investors is to maximise the returns for their clients or beneficiary members while maintaining a long-term view of corporate performance and sustainability.

For instance, LIC is the largest institutional investor in India. As of June 2024, LIC has invested in stocks of 282 companies, the value of whichwas estimated at ` 15 trillion. The total Asset Under Management (AUM) of LIC stood at ` 53.59 trillion by end of June 2024⁹.

In India, institutional investors can be broadly classified into two types –

• Domestic Institutional Investors (DIIs) – These include Indian mutual funds, insurance companies like LIC, pension funds such as Employees’ Pension Fund (EPF), and domestic financial institutions such as
• Foreign Institutional Investors (FIIs) – These include foreign hedge funds, private equity funds, foreign pension funds, and others that invest in Indian For example, KKR is a global investment firm having invested $190 Billion as private equity in companies across the globe by the end of September 2024¹⁰. Such firms are FIIs for Indian companies.

Types of Institutional Investors

1. BNP’s report mentioned six instances in India, four in Japan since 2000, two in China and one in Thailand
2. https://iclg.com/practice-areas/corporate-governance-laws-and-regulations/india
3. https://www.barandbench.com/law-firms/view-point/shareholder-activism-in-india
4. https://indianexpress.com/article/explained/everyday-explainers/proxy-advisory-firms-oppose-anant-ambani-appointment-8990115/
5. Small shareholders for this purpose means shareholder holding shares of nominal value of not more than twenty thousand rupees or such other sum as may be prescribed.
6. https://www.lieffcabraser.com/about-us/class-action-faq/
7. https://www.nasdaq.com/glossary/i/institutional-investors
8. https://www.austlii.edu.au/au/journals/JCULRev/1996/4.pdf
9. https://www.business-standard.com/companies/news/lic-to-invest-around-rs-1-30-trillion-in-stock-market-in-fy25-md-ceo-124081100292_1.html
10. https://www.kkr.com/ accessed on October 28,

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Notification No. S.O. 1376(E) Dated: 25-03-2025

The Central Govt. has directed all Companies receiving goods or services from micro and small enterprises to submit a half-yearly return to the MCA if payments exceed 45 days from the acceptance or deemed acceptance date. The return must include:

(a) the outstanding payment amounts and

(b) reasons for the delay.

Click Here To Read The Full Notification

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Editorial Team – [2025] 172 taxmann.com 680 (Article)

World Corporate Law News provides a weekly snapshot of corporate law developments from around the globe. Here’s a glimpse of the key corporate law updates this week:

• Singapore’s Ministry of Law seeks feedback on recommendations to enhance the Corporate Restructuring & Insolvency Regime; and
• SEC extends Compliance Dates for amendments to Investment Company Name Rules

Click Here To Read The Full Article

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PR No. 16/2025; Dated: 24.03.2025

Earlier, SEBI issued directions to stock exchanges with a commodity derivatives segment to suspend trading in derivative contracts for 7 agro commodities for one year. Subsequently, the suspension was extended for an additional year until December 20, 2023, and then again until December 20, 2024. The suspension was again extended until January 31, 2025, and subsequently for an additional two months until March 2025. Now, SEBI has extended the suspension of trading in these contracts to January 31, 2026.

Click Here To Read The Full Press Release

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PR No. 15/2025; Dated: 24.03.2025

SEBI, in its 209th Board Meeting, approved a series of amendments. The key highlights include:

(a) an increase in the FPI disclosure threshold to Rs 50,000 crore,

(b) a review of provisions related to the appointment of Public Interest Directors (PIDs), a cooling-off period for KMPs and Directors, and the appointment process for specific KMPs in MIIs, and

(c) the charging of advance fees by Investment Advisers and Research Analysts.

Click Here To Read The Full Press Release

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Discounted Cash Flow (DCF) Method is a valuation approach used to estimate the value of an investment, business, or asset based on its expected future cash flows. These future cash flows are projected and then discounted back to their present value using an appropriate discount rate, typically reflecting the cost of capital and risk involved.

Table of Contents

1. Introduction
2. Free Cash Flows
3. When to Apply the Discounted Cash Flow Method
4. Steps in Valuation Using Discounted Cash Flow Method
5. Free Cash Flow to the Firm (FCFF)
6. Employee Share-Based Payments (Stock Options)
7. Capital Expenditure (Capex) Including Acquisitions

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1. Introduction

The value of an asset is the present value of the cash flows associated with it, discounted at an appropriate discount rate. The Dividend Discount Model (DDM) helps in valuing a company from a minority shareholders’ perspective. For a matured company, dividends serve as a proxy for cash flows for minority shareholders. The Free Cash Flow (FCF) approach is the most preferred Discounted Cash flow method for determining the current value of a company using future cash flows adjusted for time value. Whereas dividends are the cash flows actually paid to stockholders, free cash flows are the cash flows available for distribution to shareholders. The investors and stakeholders are concerned with the amount of cash (and not book profits) that will be left behind for them. There are two forms of Free Cash Flow – Free Cash Flow to Equity (FCFE) and Free Cash Flow to Firm (FCFF).

2. Free Cash Flows

A firm receives cash through revenue or collections from customers, while it pays cash towards operating expenses, such as purchases, cost of materials, salaries, and taxes. Interest expenses are not considered operating expenses, and depreciation is excluded since they are not cash expenses. The remaining cash is used for short-term net investments in working capital, like inventory and receivables, and long-term investments in property, plant, and equipment (PP&E). The cash left over after these activities is free cash flow to the firm (FCFF), which is available to pay the firm’s debt-holders and equity shareholders. This FCFF can borrow more funds, repay existing debt, and make interest payments. After settling these obligations, the residual amount is referred to as Free Cash Flow to Equity (FCFE).

Valuers use free cash flow as the return (either FCFF or FCFE) whenever one or more of the following conditions is present –

The company does not pay dividends –

• The company pays dividend but these dividends are significantly different from the company’s capacity to pay dividends.
• Free cash flows align with profitability within a reasonable forecast period with which the valuer is comfortable.
• The valuation is done from a “control” With control comes discretion over the uses of free cash flow. If an investor can take control of the company, dividends may be changed substantially; debt could be repaid and investments can be tweaked.

Free cash flow to the firm (FCFF) is the cash flow available to the company’s suppliers of capital after all operating expenses and taxes have been paid and necessary investments in working capital (e.g., inventory) and fixed capital (e.g., fixed assets) have been made. FCFF is the cash flow from operations, less, capital expenditures. A company’s suppliers of capital include equity shareholders, lenders, bondholders, and, sometimes, preference shareholders. The FCFF equation depends on the accounting information available.

Free cash flow to equity (FCFE) is the cash flow available to the company’s equity shareholders after all operating expenses, interest, taxes, and principal payments have been paid and necessary investments in working and fixed capital have been made. FCFE is the cash flow from operations, less, capital expenditures less, payments to (plus receipts from) debtholders.

The advantage of FCFF and FCFE over other cash-flow concepts is that they can be applied directly in Discounted Cash Flow method to value the firm or to value equity. Other cash flow or earnings-related measures, such as Cash Flow form Operations (CFO) from Cash Flow Statement, Profit After Tax (PAT), EBIT, and EBITDA, cannot be applied in the same way because they either double-count or omit cash flows in some way. For example, EBIT and EBITDA are before-tax measures, and the cash flows available to investors must be after tax. From the shareholders’ perspective, EBITDA and similar measures do not account for differing capital structures (the after-tax interest expenses or preferred dividends) or for the funds that bondholders supply to finance investments in operating assets. Moreover, these measures do not account for the reinvestment of cash flows that the company makes in capital assets and working capital to maintain or maximize the long-run value of the firm.

3. When to Apply the Discounted Cash Flow Method

The free cash flow method can be applied to most types of companies regardless of their dividend policies and capital structures. However, companies that have significant capital requirements (or investments) may have negative free cash flows for years into the future. This negative free cash flow complicates the Discounted Cash Flow method and makes less reliable.

The board of directors has the authority to decide how much of the profits to distribute as dividends to shareholders and how much to retain for reinvestment. If the firm identifies significant investment opportunities that are expected to boost share prices more than paying dividends, it will keep more funds for reinvestment and distribute less as dividends. Nonetheless, because “cash is king,” shareholders value companies that provide stable dividends. Another reason the board might choose not to distribute all available funds as dividends is to ensure they can maintain consistent dividend payments even if the amount available for distribution is lower the following year by using the current year’s surplus.

The free cash flow approach highlights the perspective of a potential acquirer who seeks control over the firm and the ability to alter its dividend policy. This contrasts with the viewpoint of minority investors, who cannot influence the dividend policy and thus assess the firm based on its existing dividend practices. If an investor is willing to pay a control premium for the firm, there might be a discrepancy between the valuations derived from these two perspectives.

The Discounted Cash Flow method attempts to assess the intrinsic or fair value of a business. While valuers should ensure that the forecasted free cash flows are always realistic, the discount rate should normally assess the risk involved in the business. However, if the valuation is being done from a control perspective of the Discounted Cash Flow method, valuers often add a control premium in the discount rate, this makes the value of the company not fair from a market participant perspective. An alternative, and indeed a better approach, is to assess the fair value of the company from a market participant perspective and add a control premium to the fair value to make it aligned for a full control acquisition.

Free cash flow method is most appropriate –

• For companies that do not pay dividends or whose dividend policies are unrelated to earnings.
• Since dividends are paid at the discretion of the board of directors, it may reflect poorly on the firm’s long-run profitability.
• For companies whose free cash flow is related to their profitability
• Valuation is done from the viewpoint of controlling shareholders.

4. Steps in Valuation Using Discounted Cash Flow Method

1. Value the company’s operations by discounting free cash flow at the Weighted Average Cost of Capital (WACC).
2. Identify and value non-operating assets, such as excess cash and marketable securities, non-consolidated subsidiaries, and other assets not included in free cash Summing the value of operations and non-operating assets gives gross enterprise value.
3. Identify and value all debt and other non-equity claims against the enterprise value. Debt and other non-equity claims include fixed-rate and floating-rate debt, debt equivalents such as unfunded pension liabilities and restructuring provisions, employee options, preference shares, and others.
4. Subtract the value of debt and other non-equity claims from enterprise value to determine the value of common To estimate value per share, divide equity value by the number of current shares outstanding.

The value of equity can also be estimated directly by discounting FCFE at the required rate of return for equity (because FCFE is the cash flow going to common stockholders, the required rate of return on equity is the appropriate risk-adjusted rate for discounting FCFE).

Additional adjustments may include Cash (Add), Non-Operating Assets (Add), Assumption of external funds infused in projections (reduce).

The two free cash flow approaches for valuing equity, FCFF and FCFE, theoretically should yield the same estimates if all inputs reflect identical assumptions. A valuer may prefer to use one approach rather than the other, however, because of the characteristics of the company being valued. For example, if the company’s capital structure is relatively stable, using FCFE to value equity is more direct and simpler than using FCFF.

The FCFF model is often chosen, however, in two other cases –

• A levered company with negative In this case, working with FCFF to value the company’s equity might be easiest. The valuer would discount FCFF to find the present value of operating assets, adding the value of excess cash (“excess” in relation to operating needs) and marketable securities and of any other significant non-operating assets to get total firm value. He or she would then subtract the market value of debt to obtain an estimate of the intrinsic value of equity.
• A levered company with a changing capital structure. First, if historical data are used to forecast free cash flow growth rates, FCFF growth might reflect fundamentals more clearly than does FCFE growth, which reflects fluctuating amounts of net Second, in a forward-looking context, the required return on equity might be expected to be more sensitive to changes in financial leverage than changes in the WACC, making the use of a constant discount rate difficult to justify.
• If the company is not expected to borrow more funds, and is going to generate profits on one hand and will repay the loans on the other This will lead to higher equity in the future periods and lower Debt, leading to a changing D/E Equity Ratio.

5. Free Cash Flow to the Firm (FCFF)

Free cash flow to the firm, as described above, is used to value the firm as a whole (including shareholders and bondholders). Using the FCFF approach, the firm’s value is defined as FCFF discounted at the Weighted Average Cost of Capital (WACC).

WACC is the required return on the firm’s assets. It’s a weighted average of the required return on common equity and the after-tax required return on debt, defined as –
WACC = Wd × Kd + We × Ke
Please refer to the “Cost of Capital” section for details on WACC.

Value of the Firm = FCFF Discounted at WACC.

The FCFF discounted at WACC gives us the value of the firm’s operating assets. Although this is what matters most to investors, and non-operating assets are generally negligible, we can still find out the total value of the firm by adding non-operating assets such as land held for investment, excess cash, and marketable securities (this is not the total cash on the balance sheet). These should be found in the notes or management information.

FCFF can be obtained by either Net Income (profit after tax—PAT), EBIT, EBITDA, or Cash Flow from Operations.

5.1 Calculating FCFF from PAT

Net Profit After Tax (PAT) or Net Income available to common shareholders— usually, but not always, the bottom line in an income statement. It represents income after depreciation, amortization, interest expense, income taxes, and the payment of dividends to preferred shareholders (but not payment of dividends to common shareholders).

FCFF is calculated from PAT as follows –

FCFF = PAT + NCC + Interest (1 – t) – FCI – WCI

PAT = Profit After Tax (or Net Income)

NCC = Non-Cash Charges, E.g., Depreciation, Provisioned Expenses t = Marginal Tax Rate

FCI = Fixed Capital Investment (Net Capital Expenditure)

WCI = Working Capital Investment (Changes in Non-Cash Working Capital)

5.2 Non-cash Charges

To derive cash flow from PAT, it is necessary to make adjustments for any items that involved decreases and increases in net income but did not involve cash inflows or outflows. These items are referred to as non-cash charges (NCC). Non-cash expenses must be added back to the Profit After Tax since they lower the company’s profits even though there isn’t a cash outflow.

Non-cash charges that typically need to be added back include the following examples –

• Depreciation and amortisation – The two most prevalent non-cash charges in any business are amortization (on intangible assets) and depreciation (on tangible assets), which must be added back.
• Provisions – Expenses that show up as a write-down of profits for anticipated expenses include provisions for warranty costs and bad debts. These are liabilities that could be added back in the future.
• Restructuring expenses – Loss on sale of assets needs to be added back and Gain on sale of assets is to be subtracted.

5.3 After Tax Interest Expense and Preference Dividend

Interest expense net of the related tax savings was deducted in arriving at PAT, but interest is a cash flow available to one of the company’s capital providers (i.e., lenders). Interest expenses appear on the Profit & Loss Statement and is often paid in cash to the company’s lenders and bondholders. The after-tax interest tax is added back, nevertheless, because it serves as a financing cash flow to bondholders that the company has access to before paying any of its capital sources, the shareholders. Since paying interest lowers the tax owed, interest expense after taxes is added. For instance, the net effect of interest on free cash flow is an increase in after-tax interest cash outflow of INR 100 × (1 – 30%) = INR 70 if interest payments total INR 100 and the marginal tax rate is 30%.

Note that FCFF is discounted using after tax cost of capital (i.e., WACC considered after-tax). For consistency, FCFF is also computed by using the after-tax interest paid. It is still possible to compute WACC on a pretax basis and compute FCFF by adding back interest paid with no tax adjustment. Whichever approach is adopted, the valuer must use mutually consistent definitions of FCFF and WACC.

For the same reason as after-tax interest, Preference Dividend paid is also deducted while arriving at Free Cash Flow for the Firm. However, preference is usually not tax-deductible so no tax adjustment is required.

5.4 Deferred Taxes

Deferred taxes result from differences in the timing of reporting income and expenses in the company’s financial statements and the company’s tax return. The income tax expense deducted in arriving at net profit for financial reporting purposes is not the same as the amount of cash taxes paid. Over time, these differences between book profit and taxable profit should offset each other and have no impact on aggregate cash flows.

Generally, if the valuer’s purpose is forecasting and, therefore, identifying the persistent components of FCFF, then the valuer should not add back deferred tax changes that are expected to reverse in the near future. In some circumstances, however, a company may be able to consistently defer taxes until a much later date. If a company is growing and can indefinitely defer its tax liability, valuer should add back deferred taxes to net profit. Nevertheless, a valuer must be aware that these taxes may be payable at some time in the future.

5.4.1 Deferred Tax Asset

Companies often record expenses (e.g., restructuring charges) for financial reporting purposes that are not deductible for tax purposes or record revenues that are taxable in the current period but not yet recognized for financial reporting purposes. In these cases, taxable profits exceed financial statement profits, so cash outflows for current tax payments are greater than the taxes reported in the P&L. This results in a deferred tax asset (DTA) and a necessary adjustment to subtract that amount in deriving operating cash flow from net profit. If, however, the deferred tax asset is expected to reverse in the near future, to avoid underestimating future cash flows, the valuer should not subtract the deferred tax asset in a cash flow forecast. If the company is expected to have these charges on a continual basis, however, valuer should subtract DTA that will lower the forecast of future cash flows.

6. Employee Share Based Payments (Stock Options)

Companies record an expense for options provided to employees in the P&L. The granting and expensing of options themselves do not result in a cash outflow and are thus a non-cash charge; however, the granting of options has long-term cash flow implications. When the employee exercises the option, the company receives some cash related to the exercise price of the option at the strike price. This cash flow is considered a financing cash flow. Also, in some cases, a company receives a tax benefit from issuing options, which could increase operating cash flow but not net profit. Accounting regulations may require that a portion of the tax effect be recorded as a financing cash flow rather than an operating cash flow in the statement of cash flows. Valuers should review the statement of cash flows and footnotes to determine the impact of options on operating cash flows. If these cash flows are not expected to persist in the future, valuers should not include them in their forecasts of cash flows. Valuers should also consider the impact of stock options on the number of shares outstanding. When computing equity value, valuers may want to use the number of shares expected to be outstanding (based on the exercise of employee stock options) rather than the number currently outstanding.

7. Capital Expenditure (Capex) Including Acquisitions

As a business expands, in the long run, it would need additional fixed assets. These fixed assets may be new assets (new capex) or replacement of existing assets (replacement or maintenance capex).

Since PAT serves as the foundation for computing the FCFF, even though fixed capital investments are not shown on the Profit & Loss Statement, fixed capital investments should be deducted from PAT since they represent cash outflows for the firm –

• Investment in tangible assets to support business This may also be required to replace existing depleting assets. Note that sale of assets will reduce capital expenditure.
• Investment in intangible assets such as trademarks or These are required to gain or protect competitive advantages.
• Acquisitions of other companies to expand their operations is also a part of capex. In the case of large acquisitions (and all non-cash acquisitions), valuers must take care in evaluating the impact on future free cash For acquisition based on stock, there should be no difference than cash based acquisitions. While there may be no cash spent by a firm in the latter case, the firm is increasing the number of shares outstanding. In fact, one way to think about stock-funded acquisitions is that the firm has skipped a step in the funding process. It could have issued the stock to the public, and used the cash to make the acquisitions.

The company’s statement of cash flows is an excellent source of information on capital expenditures as well as on sales of fixed capital. Valuers should be aware that some companies acquire fixed capital without using cash—for example, through an exchange for stock or debt. Such acquisitions do not appear in a company’s statement of cash flows but, if material, must be disclosed in the footnotes. Although non-cash exchanges do not affect historical FCFF, if the capital expenditures are necessary and may be made in cash in the future, valuers should use this information in forecasting future FCFF. Alternatively, Capex can be assessed using Balance Sheet and Profit & Loss Statement.

The difference between capital expenditures, or long-term fixed asset investments, and the returns from the sale of fixed assets is known as fixed capital investment.

Capex = Purchase of Long-Term Assets – Proceeds from Sale of Long-Term Assets

Both the purchase of long-term assets and proceeds from the sale of long-term assets are generally reported on the Cash Flow Statement (Cash Flow from Investing Activities).

Without information, we can calculate fixed capital investment (or net capital expenditure) as the difference between closing and opening gross fixed assets, as the sales and purchases are incorporated in the gross fixed assets. Note that if long-term assets were sold during the year, any gain or loss on the sale is treated as a non-cash item (restructuring charges), as discussed above.

7.1 Classifying Operating Expenses as Capex

Some new age businesses derive a significant portion of their value through intangibles. These intangibles come from investment in their Research & development (R&D) or Advertisement expenses. Although accounting regulations require most of these to be expenses into P&L, valuers may treat them as capital expenditures as their benefits would likely accrue over a longer period. In such cases, P&L should be normalised to reduce these expenses (i.e., increase PAT) and treat them as capital assets. Note that if these are treated as fixed assets, depreciation would have to be charged and FCF is calculated accordingly.

There should also clearly be an impact on the estimates of capital expenditures, depreciation, and, consequently, net capital expenditures. If the valuer decided to recategorize some operating expenses as capital expenses, the current period’s value for this item should be treated as a capital expenditure. For instance, if R&D expense is capitalised, the amount spent on R&D in the current period has to be added to capital expenditures.

Adjusted Capex = Capex + R&D Expense

Since capitalizing an operating expense creates an asset, the amortization of this asset should be added to depreciation for the current period. Thus, capitalizing R&D creates a research asset, which generates an amortization in the current period.

Adjusted Depreciation & Amortisation = Depreciation & Amortisation + Amortisation on R&D Asset

The net capital expenditures of the firm will increase by the difference between the two –

Adjusted net Capex = Capex + R&D Expense for the period – Amortisation on R&D Asset

Note that the adjustment that made to net capital expenditure mirrors the adjustment made to operating income. Since net capital expenditures are subtracted from after-tax operating income, in a sense, the impact on cash flows of capitalizing R&D is nullified.

7.2 Working Capital Investment (Changes in Non-Cash Working Capital)

As a business expands, it needs to invest into working capital. For example, let’s say for generating INR 100,000 of revenue, if a company needs INR 20,000 of inventory. If the company’s revenue are expected to enhance to INR 200,000, it would need to invest into a higher amount of inventory (say INR 40,000). This higher inventory would have to be kept from setting aside a portion of existing profits. Thus, a growing business needs to invest into working capital. Similarly, if the revenues are falling, the working capital may be released and thus, investment in working capital may be negative.

Working capital is often defined as current assets minus current liabilities. However, working capital for cash flow and valuation purposes is defined to exclude cash and short-term debt (which includes short-term borrowing and the current portion of long-term debt). When finding the net change in working capital for the purpose of calculating free cash flow, working capital excludes cash and cash equivalents as well as notes payable and the current portion of long-term debt.

Cash and cash equivalents are excluded because the final objective of free Cash flow is to assess the change in free cash during the period. Also, since Discounted Cash Flow Method is assessed from a control perspective, the cash and bank balance as on the date of valuation is included back on the date of valuation. The rationale is that the acquirer will pay an amount to acquire the company but will ultimately get access to the company’s cash in terms of the Discounted Cash Flow method.

Short-term borrowing and the current portion of long-term debt are excluded because they are liabilities with explicit interest costs that make them financing items rather than operating items. Although working capital impacts the company’s cash flow, it does not affect its accounting income. The study must take the variations in working capital into account. Overestimating after-tax cash flows is the result of ignoring working capital requirements. The project’s working capital fluctuations will result in a negative present value of cash flows even if the working capital is recovered. Therefore, the project’s net present value will be inflated if working capital requirements are left out of the study. We remove cash, cash equivalents, notes payable, and the current part of long-term debt from our calculations for free cash flow.

Non-Cash Working Capital = (Inventory + Accounts Receivable) – (Accounts Payable + Taxes payable)

Further, working capital investment would be the difference between current year working capital and prior year working capital subject to adjustments above.

Example – A simple balance sheet for two years and calculate the working capital for FCFF.

* Working Capital for FCF (in this case) is Accounts Receivable + Inventory – Accounts Payable

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