As market regulator SEBI looks into benefits and pitfalls of shares with differential voting rights, several experts and industry participants have flagged possible threats to the interest of minority shareholders and overall corporate governance due to certain persons getting ‘superior’ powers.
The Securities and Exchange Board of India (SEBI) initiated a public consultation process in March on whether the listed and to-be-listed companies in India can be allowed to issue DVR (Differential Voting Right) shares.
The proposal includes two types of such shares — ‘Fractional voting rights shares’ to be issued by companies already listed on a stock exchange for at least one year; and ‘Superior votes rights shares’ for IPO-bound companies.
The regulator had sought comments from all stakeholders till April 20 and is now in the process of collating the varied suggestions it has received. The current regulatory framework allows DVRs with lower voting rights, subject to certain conditions, but the DVRs with higher or superior voting rights are not permitted.
The start-up lobby has been pushing for DVRs to enable the companies to retain decision-making powers by retaining shares with superior rights and issuing shares with lower or fractional rights to the public investors.
They argue that DVRs can help start-ups raise funds without dilution of control and also act as a safeguard against hostile takeover bids.
According to officials and people associated with those who have submitted their suggestions, a large number of respondents have flagged concerns that “superior” voting right shares may adversely impact the interest of minority shareholders and also give “predatory” powers to promoters of IPO-bound firms and to powerful industrialists investing in start-ups as individuals.
Under the proposed mechanism, the ‘fractional right’ (FR) shares can be issued by companies already listed on a stock exchange for at least one year, while the shares would have a ratio of not less than 1 vote for every 10 shares held.
On the other hand, the ‘superior right’ (SR) shares would be reserved for companies seeking to list on a stock exchange. These shares would have a voting rights ratio of up to 10 votes for each share held (10:1). These shares would have an initial five-year period following an IPO, before reverting to ordinary shares, but could be extended at least for an additional five years.
Companies with SR shares would be allowed to issue FR shares one year post IPO.
Experts who have submitted their suggestions are of the opinion that the idea to protect young start-ups with visionary founders is laudable, but the proposal will also create a major disruption on the corporate governance front.
Glass Lewis, a leading independent provider of global governance services, said it has opposed the introduction of DVR structures in India.
Stating that Glass Lewis is strongly in favour of a ‘one-share-one-vote’ principle, it has submitted that shareholders should have the power to speak and the opportunity to be heard and effect changes if necessary.
It called the proposal a step in the wrong direction when India has made notable strides in the past years to improve its corporate governance practices.
Acknowledging possible benefits to foster innovation and enhance competitiveness, Glass Lewis said there are still distinct risks and drawbacks which may do more to harm investors interested in India and the wider Indian economy.
It cited the Asia Corporate Governance Association (ACGA) to flag that introduction of similar differential voting share classes has harmed the reputation of markets including Hong Kong and Singapore.
Commenting on the proposed policy, Shinoj Koshy, Partner at leading law firm Luthra & Luthra, said equal voting rights is generally accepted as the sine qua non (an essential condition) for corporate governance.
“Reform allowing for DVRs should ideally be accompanied by a package of other reforms which make corporate governance more robust and allow for effective and time bound mechanism for enforcement of contracts.
“For example, the DVRs should certainly not be allowed to be exercised for authorising related-party transactions. Also, they should be limited to asset light start-ups,” Koshy said.
He also pointed out that many private equity and pension funds’ charters prevent them from investing in shares if their shares hold less favourable rights than those held by other shareholders in the same company and this may make it difficult for such funds to invest in start-ups with DVRs.
Globally also, there has been a debate on DVRs. In a paper issued by the CFA Institute, corporate governance advocates have argued that in the absence of adequate investor protection, the permission to issue dual class shares could hurt the medium to long-term development of the market.
Though super voting rights shares are in existence in some developed economies, a few such as the UK have abolished the system.
Some of the recommendations to SEBI include limiting the range of companies which can exercise the right to issue DVR. It has also been suggested that the superior right shares be allowed only to start-ups incorporated in the last 7-10 years to facilitate promoters of new-age asset light technology companies.
It has also been recommended that superior voting rights should be allowed only to individual founders or promoters, and not to corporate shareholders.
Another suggestion is for allowing superior right shares only at companies with 100 percent stake held by individual founders or promoters.
It has also been suggested that major issues such as related-party and substantial transactions, changes to articles of association, appointment or removal of auditors and of independent directors should be always decided on ‘one vote one share’ basis.