DVRs - an instrument whose time has not come
In the old adage ‘put your money where your
mouth is’ the mouth may be moving away from the money. SEBI’s recent move
seeking to amend differential voting rights is a move whose time has not come.
Differential voting rights are essentially certain shareholders having
different number of votes. So a promoter may have say 10 votes per share, while
a mortal shareholder may be lucky to have only one per share. While DVRs have
been around for some time under the old Companies Act as also under the 2013
version, SEBI has permitted them for over a decade with the restriction that no
company may provide shares with superior voting rights, though it may issue
shares with inferior voting rights. This follows a nearly century old
jurisprudence, where a shareholder once issued shares cannot be diluted,
because he or she never bargained to be short-changed in the future with the
promoter getting say ten votes per share.
Lack of
demand for DVRs: The
popularity of DVRs among investors has not picked up in the Indian securities
market. Even though a handful of listed companies have issued DVRs in the past
as highlighted in the Consultation Paper itself, they continue to be traded at
a steep discount and they are barely liquid even at that price. This goes to
show that Indian investors continue to value their voting rights/powers and are
not keen on trading it for higher dividends or other benefits. Because of their unpopularity, domestically
there is little empirical evidence with respect to such companies.
Inherent disadvantages of
issuing DVRs:
The known downsides in
several western countries are clear. DVRs can mis-align incentives, be a tool
for mismanagement and oppression of minority shareholders, encourage
entrenchment of promoters with little skin in the game, result in excess
compensation and typically companies with DVRs lag other companies in
performance if you take out a handful of the super-successful companies like
Facebook from the equation. However, they have been allowed on the premise that
providing such flexibility would encourage companies where promoters don’t want
to give up control, to come to public markets. There is also an argument that
promoters would act in the long term interest of the company without regard to
the outcome of the next quarter.
SEBI proposes: Now SEBI proposes to introduce superior voting
rights (SR). Under the proposed
paper of SEBI, superior rights can be issued to promoters before an IPO. SEBI
has introduced several dis-incentives so that these are not mis-used. The
dis-incentives include lock in of shares, inability to trade them in the
market, a sunset or expiry clause on superiority, inability to pledge them, cap
on number of votes and DVRs becoming ordinary shares in certain kinds of
resolutions.
Dis-enfranchisement: SR shares are just a
euphemism for dis-enfranchisement. It is unclear how having superior voting
rights and ignoring the votes of the many would improve long term strategy. SEBI
should implement evidence based laws and there is no evidence world-wide that
providing SR shares improves firm value. In fact, the evidence clearly shows
that over the medium and long term they are value destructive. The most
comprehensive academic study on
dual-class shares published in 2010 by three professors from Harvard, Stanford
and Yale found evidence that dual
class shares reduce firm value in US companies, result in weakened takeover and
market checks, diminished board independence and effectiveness, and reduced
institutional investor oversight. Such boards have been shown to be
statistically less independent and consequentially more deferential to management.
Further, as per the Asia Corporate Governance Association, the introduction of
DVRs in Hong Kong and Singapore have adversely impacted the reputation of their
securities market. The introduction would take us on a regulatory race to the
bottom.
Poor investor protection
standards in India: Adopting western standards directly and looking at the
benefits without looking at the poor status of investor protection in India,
begs the question whether we should transplant a western standard without the investor
protection means available to the western investor. Charles Elson,
director of the Weinberg Center for Corporate Governance at the University of
Delaware, says that “when you have dual-class shares, what you are
doing is exporting the monitoring function to third parties - to the
government, the courts, the regulators. This is because dual class shares will
severely inhibit the role of directors, shareholders and markets in corporate
governance.” Issuance of DVRs in this governance vacuum may be detrimental
to the interest of the minority shareholders of companies.
India IS different: Usually the statement that India is different,
should always be taken with a fistful of salt, but in the case of DVRs, that is
indeed the case. With poor investor rights, mis-management rife 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. Already, promoters in India own 45% of
listed company shares on average. Give both the dominance of promoters and poor
minority rights in fact, India is simply not ready to give another tool to
corporate India to shortchange regular investors like you and me. Giving the
investors a Hobson’s choice of a good company with poor governance is not a
standard we should adopt.
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