Differential voting rights in India – a summary

What are DVRs?

Dual Class Shares (DCS) or shares with Differential Voting Right (DVR) as popularly known in India, simply mean that a company has issued more than one class of stocks with different voting rights. In other words, DVRs are shares that give the holder different voting rights compared to someone who owns ordinary shares of a company.
Globally, DVRs are of two types: a) Ones that offer superior voting rights b) Ones that offer lesser voting rights but higher dividends. Due to fewer voting rights, they usually trade at a discount to the ordinary shares.

Why are DVRs issued?

• Companies issue DVRs to raise capital without diluting the ownership structure.
• Another objective for the issue of DVRs is to prevent a hostile takeover.
  For investors, the benefit is that they get to own a part of a company at a lesser price since DVRs are usually available at a discount.
  
• It also helps those who are not interested in having a voting position.
  DVR structures are most commonly seen in founder-led companies where founders are considered to be critical for the success of the company; they have a high amount of pre IPO funding and are averse to any change of control.

History and recent trends in DVRs

Started in the US

Dual Class shares are not something new to the world; it got conceptualized in the U.S. way back in the 1800s but hit the limelight in the last two decades when many technology companies like Facebook issued these shares. Its founder, Mark Zuckerberg, has close to 54% voting rights in the company where he holds roughly 28% of class B shares; the class B shares have 10 votes per share. DVR listings in the US as % of total US IPOs have increased from around 2% in the early 80s to +25% by 2018. In comparison, India is nowhere near with just 4 companies having listed DVR shares

Asia Pacific region adapted eventually

There was a reluctance to list DCS IPOs by the stock exchanges in the APAC (Asia Pacific Accreditation Cooperation) region for a long time because they believed in the principle of one vote for one share. However, in 2018, both Singapore and Hong Kong amended their listing rules to allow DVR listing; possibly to create a more conducive environment for startups to unlock value and not miss the ship of listing multi-billion dollar IPOs! Recall, Alibaba had first gone to Hong Kong stock exchange but after it was denied a dual share listed, it went to NYSE. The Hong Kong stock exchange got its first DCS listing from Xiaomi Corporation.

Indian promoters and DVRs

In India, issuance of shares with differential voting or dividend rights has been around since 2000 and only few listed companies have issued shares with differential voting/dividend rights.

DVR shares have not been an attractive method of raising capital in India.
The discount between the DVR and an ordinary share is comparatively higher in India compared to the developed markets due to low liquidity.
In 2008, Tata Motors was the first company to issue DVRs. However, in 2009, the Securities and Exchange Board of India (SEBI) had banned the listed companies from issuing superior rights (SRs) in shareholding with respect to differential voting and higher dividend payment.

The Companies Act 2013 permits a company limited by shares to issue shares with differential voting rights. However, Section 47 of the same act requires that every shareholder should have a right to vote on every resolution placed before the company.

In order to promote technology/ promoter driven firms and match up to the global practice of issuance of dual class shares, SEBI, on June 27, 2019, approved and adopted a new framework on DVR Shares. Main goal was to clear the confusion surrounding DVRs in India

The list of companies that have issued DVR shares includes Tata Motors, Pantaloons Retail India (Future Retail group), Gujarat NRE Coke and Jain Irrigation. The trading volume in these is 75-90% less than in ordinary shares.

Positive response to SEBIs new framework for DVR

According to an article in ‘Economic Times’, Indian startups had welcomed markets regulator Securities and Exchange Board of India’s (Sebi’s) approval for issuance of shares with differential voting rights (DVRs).This approval was expected to allow startup founders to have a greater control over their ventures even after diluting a significant portion of their holdings, while raising multiple rounds of equity financing.

Before SEBIs approval, leading Indian entrepreneurs including ride-hailing company Ola’s Bhavish Aggarwal have tried taking greater control of their companies by reworking founder’s rights.

As the Indian startups believed, the way to allow Indian entrepreneurs some autonomous space for managing and growing their business without the suppliers of their capital breathing down their necks and offering advice they cannot refuse is to allow them to issue non-voting shares.
In a relief to the startups, in August 2019, the government relaxed norms for shares with differential voting rights, with the amended rules, companies can now have up to 74% Differential Voting Rights (DVR) shares of the total post issue paid up share capital. The limit has been revised from 26%.

Another key change brought about was the removal of the earlier requirement of distributable profits for 3 years for a company to be eligible to issue shares with DVRs.

Downsides of issuing DVRs

• The known downsides in several Western countries who have issued DVRs are clear. DVRs can mis-align incentives, be a tool for mismanagement and oppression of minority shareholders.
• As the company grows in size and public shareholding expands, the skew in control via voting rights starts to feel unfair.
• India has the highest number of family-owned companies and promoters owning close to 45% of the total shareholding. So, for family businesses in India with a DCS structure, it is much easier for major shareholders to abuse their position and take advantage of public shareholders, either through massive executive compensation packages or questionable consultancy arrangements.
  

In the past decade, India has seen a boom in new age companies, especially in the technology space. One of the key issues faced by founders is to raise funds for growth without diluting control. SEBI’s attempt to address this concern, by improving access to the Indian capital markets through a regulated DVR regime, is timely. However, its success rate would depend on the market’s acceptance of such instruments along with changes required to be made to other laws to operationalize these instruments. But, with poor investor rights and a complete lack of class action law suits, India simply doesn’t have the tools to manage even more power to the promoter class. Adopting Western standards directly and looking at the benefits without looking at the poor status of investor protection in India, could lead India on a race to the bottom

Views of CFA Institute on DVRs

Despite the recent developments in Hong Kong and Singapore, CFA Institute remains firm in the belief that “one share, one-vote” remains the fairest and most optimal market practice. They are concerned that allowing DCS structures will lead to an erosion of corporate governance standards.
To support their belief of “one share, one vote” they have stated the example of Australia. Despite Australia’s adherence to “one share, one vote”, it has won a number of cross –border technology IPO in the last few years from Singapore, New Zealand, Israel and the US.
Investors like Australia for its deep pension’s pool and sophisticated investor and analyst community, as well as its clear, transparent regulatory framework.

In addition to Australia, neither China nor Korea allows DCS structures and yet that hasn’t stopped these markets from being large and significant IPO markets over the last decade. This highlights an argument CFA institute has been making all along: there are many factors contributing to the selection of a listing venue, and DCS is not the magical ingredient that will provide a sustainable competitive advantage to startups of developing countries like India.

Unfortunately, given the number of commercial, for-profit stock exchanges in APAC, this trend is unlikely to stop at the Hong Kong and Singapore exchange. In it’s report on dual class shares CFA institute further states that, it is important to appreciate the implications of such changes as the single most important feature of DCS structures is that they give founders, entrepreneurs and other corporate insiders voting control of the listed entity, even though their equity stake may be reduced below a simple majority after successive rounds of financing. The important assumption here is that the potential gains associated with the founder’s expertise and vision would exceed the potential drawbacks associated with DVRs.
In conclusion, The CFA Institute study recommends that in markets where retail participation is significant, but legal recourse against rogue companies is not possible, exchanges and regulators need to create awareness for outcomes of dual class shares. Also, regulators must intervene in a timely manner when investors are taken advantage of or harmed, said the study.

References

Kpmg report – https://assets.kpmg/content/dam/kpmg/in/pdf/2019/06/aau-issue-35-june-2019-borrowing-costs-ind-as-23-differential-voting-rights.pdf
livemint – https://www.livemint.com/Money/kz7ZRbRMTkZVXONb7BQgzO/What-is-the-purpose-of-dual-class-shares.html
Explains DVR , scenario in US , views of CFA institute, and indian context as of 2018

SEBI guidelines -https://www.sebi.gov.in/sebi_data/meetingfiles/aug-2019/1565346231044_1.pdf

ET- learn with ET -https://economictimes.indiatimes.com/markets/stocks/news/learn-with- etmarkets-differential-voting-rights/articleshow/53972805.cms
Defn of DVR, purpose, DVR in India – article dated 2016

livemint – https://www.livemint.com/Money/kz7ZRbRMTkZVXONb7BQgzO/What-is-the-purpose-of-dual-class-shares.html
Explains DVR , scenario in US , views of CFA institute, and indian context as of 2018
Et -https://economictimes.indiatimes.com/small-biz/startups/newsbuzz/govt-relaxes-norms-for-shares-with-differential-voting-rights-to-boost-startups/articleshow/70702837.cms?from=mdr
CFA institute survey report – https://www.cfainstitute.org/-/media/documents/survey/apac-dual-class-shares-survey-report.ashx
CFA institute- https://blogs.cfainstitute.org/marketintegrity/2019/06/06/dual-class-shares-the-fear-of-missing-out/
ET – https://economictimes.indiatimes.com/markets/stocks/dvr-an-instrument-whose-time-hasnt-come/articleshow/69318711.cms