Differential Voting Rights: Some Further References

In earlier posts (here and here), this Blog had covered the issue of differential voting rights by Indian companies.

A recent column by Srikanth Srinivas in the Business World examines the business rationale for the issuance of shares with differential voting rights and also the pros and cons of such instruments. The key objectives that companies seek to achieve through shares with differential voting rights are to guard against shareholder activism (e.g. the kind initiated by hedge funds in U.S. and U.K. companies) and against hostile takeovers (so as to protect the interests of the promoters and incumbents in management). However, the column also advocates the exercise of caution on this front:

“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.

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.”

Similar issues have also been identified in an investing column in the Business Standard.

What is peculiar with differential voting rights is the timing of its emergence in the Indian markets. While differential voting rights have been existent in other economies such as the U.S. and Europe for some time, there is now a conscious move in some of those economies (particularly in continental Europe) to shift away from differential voting rights and towards a “one-share one-vote” rule citing corporate governance and control concerns that arise in shares with differential voting rights. The trend appears to be exactly in the opposite direction as far as India is concerned; only time and experience will tell whether differential voting rights will benefit the investors in such shares or impose further risk to their capital.

Differential Voting Rights: A Markets Perspective

Economic Times carries the views and recommendations of various market participants about the feasibility and economics of issue of differential voting rights by Indian companies.

One interviewee notes:

“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.”

Differential Voting Rights as a Takeover Defence

Shares with differential voting rights (DVRs) have been permitted to be issued by Indian companies since 2001 when the Companies (Issue of Share Capital with Differential Voting Rights) Rules were issued. Not only have there been stringent conditions imposed with respect to issuance of shares with DVRs, but the rules themselves have given rise to several issues (particularly with reference to interpretation) due to which not many companies have actually availed of the benefits of DVRs.

DVRs can potentially be an effective tool to defend against hostile takeovers. For instance, promoters of a company may issue shares with DVRs to themselves, whereby they can hold a small number of shares, but still exercise a large number of votes. This will act as a resistance against hostile acquirers.

Today’s Livemint reports that a case pertaining to Jagatjit Industries that is currently pending before the Company Law Board may well clarify some of the existing ambiguities relating to DVRs and help determine their effectiveness as a takeover defence. The report also contains a discussion on several implications of issuance of DVRs, especially under the SEBI Takeover Code.