It’s a divided house as supporters and opponents of DVR pitch their case. The ball is now in Sebi’s court. And the last word is yet to be heard.
Abhinav Prakash Singh
This is one issue that has split the market down in the middle.
No prizes for guessing as the issue of dual class shares (DCS) or differential voting rights (DVR) is fast becoming a hot-button topic, taking the market by storm.
The debate, involving mostly new technology companies, has turned shriller after regulator SEBI set in motion a public consultation process in March, trying to figure out whether listed and to-be-listed firms in India should be allowed to issue DVR shares with superior voting rights.
At present, the Indian regulatory framework allows DVR with lower voting rights, subject to some conditions, but those with higher or superior voting rights are still a no-no.
The core of the debate is all about assigning a higher percentage of voting rights to the promoter or founder of a new-age company so that he or she act freely and prevent a hostile takeover. Put another way, the stated intention of DVR is to enable startup founders to raise funds, take bold steps and be in-charge of things. It will also attract individual investors who are often not interested in the decision making power but higher dividends and capital appreciation
It can be effected through either superior voting rights for promoters, or lower or fractional voting rights for minority shareholders.
Of late, the issue has become more divisive in light of the fact that more and more Indian start-ups are eyeing unicorn status, that is with a valuation of more than $1 billion.
Agreed, DVRs may have their own proponents, but the underbelly just can’t be wished away.
The first and foremost concern is one of corporate governance. There has been a litany of issues Sebi is grappling with, pertaining to alleged violation of disclosure norms and corporate mismanagement.
DVRs may just open a can of worms and worsen the problem of moral hazard. It could as lead to subversion of shareholder interests, excessive compensation, lower dividend payout and management entrenchment.
Indian regulators are already bogged down by market manipulation and governance issues. So, does it make sense to further complicate the matter?
The fears have good reasons. For instance, a recent ICICI Securities report flagged the increase in ICD (inter-corporate deposits) to group companies in Britannia Industries, which sparked a fall in share prices.
It’s natural to believe that DVRs may encourage more such behaviour by the management, leaving the shareholders in the lurch.
That’s not all. The dual class share structure brings up agency costs that hurt common investors as insiders wield more power.
So, what remedy do minority shareholders have in case founders with superior voting rights fail to deliver? History is replete with instances. One such example is Facebook where minority shareholders are locked in a dispute with Mark Zuckerberg, but are powerless as the latter holds 51 percent voting rights with just 14 percent shares.
Well, such shareholders are between a rock and a hard place as shares with fractional voting rights are often illiquid.
Also, DVRs may act as a spoiler for institutional investors, who want to invest only in those shares that come with equal voting rights. In certain cases, their charters draw the line and say no to shares with inferior voting rights.
The argument in favour of DVRs that puts a premium on star value of a promoter or founder doesn’t always cut ice. That trust may very well be misplaced and can lead to turbulence, as seen in the case of Housing.com and its founder Rahul Yadav. The whole episode saw a sordid end as Yadav was forced out of the company amid ugly public exchanges.
Besides, DVR shares pose a big challenge when it comes to succession. It will ensure a new kind of hereditary control over the economic structure.There is no reason why the trust and confidence reposed in the founder should be inherited by the successors. DVRs can thus compromise market discipline.
Spare a thought for the legal slugfest that may follow in case DVRs kick in. And the legal cases could drag on for years. More importantly, is our judicial and legal system well-equipped to deal with the issues relating to DVRs?
When a few people control majority voting rights, the board of a firm is rendered inconsequential and can't take an objective decision independent of promoters or founders. That will create legal complications because the Business Judgement Rule — that the judiciary will not second guess the decision of the board of directors — will be difficult to poly in such scenarios.
This, while DVRs may look good on paper, but India should play its cards with care when it comes to adopting the model. The issue and the related complexities need a hard close look and supporting structures must be put in place before such a transition.
It goes without saying that interests of minority shareholders can’t be sacrificed at the altar of new fancy tech companies and their star founders. The consequences could be too hot to handle as these may have a long-term adverse impact on financial outreach and development of the market itself.
Abhinav Prakash Singh is assistant professor, Shri Ram College of Commerce, University of Delhi, Delhi. Views are personal.For more Opinion pieces, click here.
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