General Corporate Lawyer
Update – July 10, 2008: See also this column in the Hindu Business Line
“How worried should investors be about differential voting rights? Making voting power proportional to economic ownership serves several goals. First, economic ownership gives shareholders an incentive to exercise voting power well. Second, the coupling of votes and shares strengthens the framework for corporate governance. Third, the power of economic owners to elect directors is a basis for legitimacy of managerial authority.Similar issues have also been identified in an investing column in the Business Standard.
The evidence on corporate governance generally supports the importance of linking votes to economic interest. Voting rights are like property rights to cash flows of the company: decoupling economic and voting rights may benefit a controlling minority structure whose objectives may not quite coincide with that of the rest of the shareholders.
The issue also goes beyond just controlling minority structures. The derivatives revolution and other capital markets developments now allow both outside investors and insiders to decouple economic ownership of shares from voting rights. This decoupling — also called the new vote buying — is a worldwide issue. So before you endorse the idea of differential voting rights, think again.”
“We highlight ten key areas where reform is needed. In all likelihood, they areWhile the research paper does well to identify key concerns relating to growth and the areas to be addressed, it does pose some fundamental issues at a macro level. One of the criticisms that may be levelled against the paper is that it does not present any new findings or prescriptions, and all of those contained in the report are well-known and debated (with perhaps little concrete action being taken). But, this critique is more to do with the form and less with the substance of the matters covered.
not the only ten, but we consider them to be the most crucial:
1. Improve governance. Without better governance, delivery systems and effective implementation, India will find it difficult to educate its citizens, build its infrastructure, increase agricultural productivity and ensure that the fruits of economic growth are well established.
2. Raise educational achievement. Among more micro factors, raising India’s educational achievement is a major requirement to help achieve the nation’s potential. According to our basic indicators, a vast number of India’s young people receive no (or only the most basic) education. A major effort to boost basic education is needed. A number of initiatives, such as a continued expansion of Pratham and the introduction of Teach First, for example, should be pursued.
3. Increase quality and quantity of universities. At the other end of the spectrum, India should also have a more defined plan to raise the number and the quality of top universities.
4. Control inflation. Although India has not suffered particularly from dramatic inflation, it is currently experiencing a rise in inflation similar to that seen in a number of emerging economies. We think a formal adoption of Inflation Targeting would be a very sensible move to help India persuade its huge population of the (permanent) benefits of price stability.
5. Introduce a credible fiscal policy. We also believe that India should introduce a more credible medium-term plan for fiscal policy. Targeting low and stable inflation is not easy if fiscal policy is poorly maintained. We think it would be helpful to develop some ‘rules’ for spending over cycles.
6. Liberalise financial markets. To improve further the macro variables within the GES framework, we believe further liberalisation of Indian financial markets is necessary.
7. Increase trade with neighbours. In terms of international trade, India continues to be much less ‘open’ than many of its other large emerging nation colleagues, especially China. Given the significant number of nations with large populations on its borders, we would recommend that India target a major increase in trade with China, Pakistan and Bangladesh.
8. Increase agricultural productivity. Agriculture, especially in these times of rising prices, should be a great opportunity for India. Better specific and defined plans for increasing productivity in agriculture are essential, and could allow India to benefit from the BRIC-related global thirst for better quality food.
9. Improve infrastructure. Focus on infrastructure in India is legendary, and tales of woe abound. Improvements are taking place, as any foreign business visitor will be aware, but the need for more is paramount. Without such improvement, development will be limited.
10. Improve Environmental Quality. The final area where greater reforms are needed is the environment. Achieving greater energy efficiencies and boosting the cleanliness of energy and water usage would increase the likelihood of a sustainable stronger growth path for India.
Perhaps not all these ‘action areas’ can be addressed at the same time, but we believe that, in coming years, progress will have to be made in all of them if India is to achieve its very exciting growth potential."
(a) Commentators have argued that some level of restrictions and governmental regulation on economic and financial activity may be necessary in the context of developing economies. Joseph Stiglitz is a leading proponent of this view, as he strenuously makes his arguments in his book “Globalization and Its Discontents”.
(b) Similarly, as far as India is concerned, arguments have been made that it is India’s partially restrictive policies that have helped weather the recent global credit crisis or even the Asian financial crisis that swept the region over a decade ago (see an earlier post on this blog).
(c) It is also useful in this context to review Dr. Shankar Acharya’s critique of the Draft Report of the High Level Committee on Financial Sector Reforms headed by Dr. Raghuram Rajan, where the point has been made about the need for taking into accounting the realities in India while examining the nature of reforms.
“any certificate or instrument (by whatever name called), issued to an investor by any issuer being a special purpose distinct entity which possesses any debt or receivable, including mortgage debt, assigned to such entity, and acknowledging the beneficial interest of such investor in such debt or receivable, including mortgage debt, as the case may be;”Since the SCRA paved the way for creating a market for securitized debt, the recent regulations represent a step towards implementation of this regulatory intent. The Regulations set out the details of the SPV, the manner in which it can acquire receivables as well as the form of instruments it can issue. Unlike the regulations on debt securities which are more focused towards disclosures, the regulations relating to securitized debt are overarching and even govern several substantive issues pertaining to the transactions. This is perhaps explainable by the fact that the past experience of regulators the world over with securitisation markets has not entirely been positive. Securitisation, by its very nature, enables risk-holders to spread that risk over a wide array of investors (especially in the case of public offering of securitised debt), and this can result in a rapid spread of that risk among a larger group of people. This is precisely what occurred during the sub-prime crisis whereby sub-prime mortgage debt that originated in the U.S. was spread using securitisation and CDO (collateralised debt obligation) instruments.
“One of the main issues raised by the CSX case is whether, in calculating their beneficial ownership, investors are required to count shares in which they have an economic interest through swap or hedging transactions. In the CSX case, TCI held cash-settled “total return equity swaps” under which it obtained the economic risk of stock ownership, but no contractual rights in the underlying shares. While not contractually required under the swaps, the counterparty typically acquires some percentage or the full number of shares that are notionally covered by the swap.The relevant provisions of the Securities and Exchange Act Rules that the court relied on are as follows (as extracted from the Gibson Dunn memo):
The CSX ruling states that decisions by a person to enter into this type of swap arrangement or to terminate the swap can result in the counterparty buying or selling the shares that are notionally covered by the swap. The Court also stated that the counterparty may be likely to vote shares as its client would want in order to maintain a positive business relationship and to bolster the likelihood of obtaining business from the client in the future. …”
Rule 13d-3(a):While Rule 13d-3(a) deals with the question of beneficial ownership in securities for the purpose of disclosure, Rule 13d-3(b) is an anti-abuse provision that prevents the use of arrangements that avoid disclosure requirements. In this case, the court’s decision is largely based on an application of Rule 13d-3(b) to the facts of the case, whereby the court held that TCI shared voting or investment power over shares that its swap counterparties had purchased, on the theory that under the fact TCI had the ability to influence the counterparties’ actions. On this basis, it held that there was a failure by TCI to make appropriate disclosure of its shareholdings.
For the purposes of sections 13(d) and 13(g) of the Act a beneficial owner of a security includes any person who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise has or shares: (1) Voting power which includes the power to vote, or to direct the voting of, such security; and/or, (2) Investment power which includes the power to dispose, or to direct the disposition of, such security.
Rule 13d-3(b)
Any person who, directly or indirectly, creates or uses a trust, proxy, power of attorney, pooling arrangement or any other contract, arrangement, or device with the purpose of [sic] effect of divesting such person of beneficial ownership of a security or preventing the vesting of such beneficial ownership as part of a plan or scheme to evade the reporting requirements of section 13(d) or (g) of the Act shall be deemed for purposes of such sections to be the beneficial owner of such security.
“This is particularly galling in the light of the fact that the oil companies that are made to bleed are not wholly-owned by the government but are listed entities with a significant minority shareholding by the public. It is indeed possible for free market principles to co-exist with the just concerns for the welfare of the vulnerable sections of society. The role of a government that is concerned with the welfare of its citizens needs to be segregated from its role as the majority owner of listed commercial enterprises.This situation presents a classic conflict between the interests of consumers and the shareholders of a company – the type we have been considering earlier in the context of Dodge v. Ford Motor Company.
As a majority shareholder, the government needs to ensure that the listed companies function on sound commercial principles while it has to meet its social objectives by direct subsidies to the needy or by indirect subsidies through the oil marketing companies. However, they need to be used only as distributors of the subsidies and not as the providers of subsidies. We now have a situation where even the affluent sections of society get the same subsidy on petroleum products as the poor, even as the majority shareholder is severely compromising the tenets of good corporate governance by forcing the oil companies to run commercially-unviable businesses.
The government’s lack of concern to the basic principles of corporate governance that have been laid out through the listing agreement is not restricted to just the oil companies. Mandatory adherence to Clause 49 of the listing agreement, especially in relation to appointment of independent directors continues to be violated by the listed majority government-owned companies.
From a capital market viewpoint, the appropriate course of action for the government if it indeed wants to continue this way is to transparently make an open offer to the minority shareholders and proceed to delist these companies through the reverse book-building methodology.
Though this would amount to backdoor nationalisation — making a mockery of the gains achieved in the course of more than a decade-and-a-half of economic reforms — it is possibly a better option than destroying the trust of minority shareholders. It is about time the government takes the lead in setting high standards of corporate governance for India Inc., to follow.”
“In the latest issue of the Virginia Law & Business Review, we debate whether the classic case of Dodge v. Ford, and its claim that maximizing shareholder wealth is the proper purpose of a business corporation, deserves a place in the modern legal canon. Lynn argues that Dodge v. Ford is bad law, at least when cited for the principle that corporate directors should maximize shareholder wealth. As a positive matter, Lynn suggests, no modern jurisdiction follows this rule, and as a normative matter, advances in economic theory suggest that the goal of shareholder wealth maximization is at best inefficient and at worst incoherent. Jon argues that shareholder wealth maximization is both conceptually coherent and consistent with economic theory, and that Dodge v. Ford can be used to illustrate the fact that shareholder wealth maximization is both a valid goal for corporate law and an ethical requirement, even in contexts in which enforceability is practically impossible.Regarding the subject-matter of the debate, i.e. the Dodge v. Ford case, please see a previous post on this Blog pointing to Wikipedia.
The debate can be found here.”
“Differential voting rights can work every where in the world, and so also in India. These are ideally good instruments for passive investors, typically small investors, who seek higher dividend, and are not necessarily interested in taking a voting position. It is clear that no investor would agree to a sacrifice, which differential voting rights lead to, unless they are suitably compensated, and compensated in financial terms.
Since institutions are active investors, at least they are supposed to be so as per their charters, I do not think there would be any significant demand from them for such shares. Significantly, they invest primarily for capital gains, and not for dividends. There is one operational issue.
The law provides for issue of shares with differential voting rights. This means that a company may issue shares carrying voting rights with different weights, for example with weights of 100 and say 75 and say 50 and say 0. This, however, can lead to huge confusion.”
“Finally there is the National Academy of Legal Studies and Research (NALSAR), Hyderabad, which pulled off the impossible by toppling National Law School of India University (NLSIU), Bangalore, from the number one slot in the law stream.Rankings aside, observations in the survey clearly imply that legal education in India has a come a long way and has caught up with other streams of education.
NALSAR is a relative newcomer compared to its venerable Bangalore counterpart. Part of the reason for its triumph this year is its emphasis on providing world class infrastructure facilities that include virtual universal classrooms combined with outstanding faculty and consistency in training.
Perceptually, NLSIU may have scored top markets but it compared poorly with NALSAR in its factual ratings. So after years we have a new winner in the law category.”