SEBI to reintroduce DVRS: The instrument can become useful for companies and investors alike

Differential voting rights shares – DVRS – are in the news with SEBI forming a committee to review the scattered, confusing and near prohibitive law relating to the issue of such shares by listed companies. Their report will hopefully help decide whether and how such shares can be issued. DVRS are a form of equity shares. In the ordinary course, equity shares come only in one flavour. Each equity share carries one vote. Each equity share is also entitled to the same dividend. DVRS, however, create variants of equity shares. They give more/less voting rights or more/ less dividends. Thus, one variant of DVRS could give a mere 1/10th of a vote as compared to an ordinary equity share. Or it could give 10 votes per DVRS as compared to an ordinary equity share. The dividend on DVRS could be higher (or lower) than ordinary equity shares. DVRS are useful both to promoters/founders of a company and other shareholders. DVRS that carry more votes can help promoters control a company without investing higher capital. Minority/small shareholders know that with their very small quantity of shares, they cannot influence corporate decisions. They may be willing to trade in their voting rights for higher dividends. Thus, other things being equal, this could be a win-win affair for both. [caption id=“attachment_4332599” align=“alignleft” width=“380”] Representational image. Reuters.[/caption] However, concerns and even strong opposition have been expressed about DVRS. It is said that this will result in promoters being able to control companies without putting in proportionate capital or risk. Another concern is that till now DVRS have generally been unsuccessful. Barely 5 companies have issued them. All except one trade at a huge discount over the price of their corresponding ordinary equity share. The trading volumes of such DVRS are low too. Presently, the law does permit the issue of DVRS but with several restrictions. Approval by way of special resolution is required. Existing ordinary equity shares cannot be changed into DVRS. DVRS carrying more dividend/voting rights than existing shares cannot be issued. DVRS have to be issued to all shareholders and not to any select group. DVRS should constitute not more than 26% of the total equity capital. Approval of SEBI is required which can be time-consuming and discretionary. However, I think that the concerns about DVRS are exaggerated and even misplaced. A ban or severe restrictions on issue of DVRS deprive companies and shareholders in structuring their capital in a manner they desire by mutual consent. In the end, dealing in shares is about proper valuation taking into account their rights, risks and rewards and the needs of each party. Informed shareholders and markets can value DVRS taking into account the lesser voting rights/higher dividends. A small shareholder who in any case does not find his small voting of much use may not put much value on voting rights. Companies issuing DVRS would thus have to factor this in the issue price. If they present shares with too much risk and too little reward/rights, they will be hugely underpriced or not even sold. If needed, in the initial period, SEBI can provide safeguards like minimum pricing as it does in several other contexts. It could, for example, take into account the fair value of DVRS, the six-monthly average of prices, etc. and require a minimum price be charged particularly for DVRS with higher voting rights. Needless to add, rights of existing shares should not be allowed to be changed except by specific consent of each shareholder. DVRS do suffer from certain challenges. Initially, there would have to be education to investors on what they are and how they can be valued. DVRS can come in many variants, and the same company may issue different series of DVRS with different rights of voting/dividends. Thus there may be one series with 1/10 voting rights and 25 percent more dividends. Another series may give 1/5th voting rights but 20 percent dividends. And so on. However, this should not matter as each series can be valued independently. Approval of regulators should not be required at all. Such approvals are time-consuming, non-transparent and even arbitrary. There should, of course, be due provisions to ensure controlling shareholders cannot take decisions that very significant decision or expropriate the wealth of other shareholders or otherwise abuse such control. These decisions may include change or sale of a business, issue of fresh capital, etc. Today, there are several safeguards generally existing protecting minority rights and ensuring good corporate governance generally. Independent directors, regulation of related party transactions, audit and other committees, postal ballot, electronic voting, etc. are some such provisions. Thus, the situation has changed considerably since the last time the law relating to DVRS was reviewed. Another concern raised is that if the promoters hold majority voting control with a small amount of capital, the other shareholders would not be able to remove them. Here too, I feel that the concerns are exaggerated. So long as an investment is made in DVRS with eyes open as to the rights, parties should be allowed to have such structure. The faith in the promoters/management will decide the issue price – lower the faith, lower the price that would be offered and higher the rewards demanded. It is also lost sight that pricing of issue of shares is in any case in the hands of the company. If a company can ask for high price at its discretion, it should be allowed to offer a lower price but with lesser voting rights. In appropriate cases, the DVRS will command a lesser price or even no buyers. The issuing company may have to put in more sweeteners. Effectively the risk inherent in an instrument would have to be compensated by adequate reward. The law presently is badly drafted too. A provision, for example, restricts the issue of DVRS upto 26 percent of the total equity capital. However, this is meaningless since it considers the amount of paid-up capital and not the voting rights. If the DVRS have, say, 100 times the vote of other ordinary equity shares, a 26 percent holding may give 90 percent+ of the total voting rights. DVRS are fairly prevalent and widespread in the West. The discounts of prices of DVRS over ordinary equity shares are not disproportionately high. If DVRS are issued transparently, there may become a useful instrument both for companies and investors. To conclude, the time of DVRS has come. Companies and their shareholders should be given the flexibility to structure their capital as per their needs. The company, of course, may have to bear the cost of giving higher dividends and obtaining a lesser value of shares that have lower voting rights. A regulator playing all-knowing big brother who straightaway bans such instruments creates inefficiencies and hurdles that ultimately results in costs to the market.