Shares with differential voting rights have attracted a great deal of controversy as they militate against a basic norm of shareholder democracy, one that requires each share to carry one vote. In DVR structures, different classes of equity shares may carry varied voting rights, thereby creating a disparity between the economic and control rights of shareholders in a company. While DVRs are advantageous in promoting entrepreneurship and capital raising, particularly in the new economy, they are accompanied by significant corporate governance concerns.
DVRs aren’t new for the Indian corporate sector. They entered the limelight in 2000 through amendments to the Companies Act. However, only a handful of companies adopted DVRs. This is partly attributable to regulatory constraints. In 2009, the Securities and Exchange Board of India prohibited companies from issuing shares with “superior voting rights” in order to avoid possible misuse of the structure by companies to the detriment of public shareholders.
This regulatory move effectively consigned DVRs into deep freeze mode.
Since then, global developments have elevated the popularity of DVRs. Market developments include mammoth DVR listings by companies such as Facebook and Alibaba in the United States. In their zeal to attract more listings, the stock exchanges in Singapore and Hong Kong too have recently permitted DVR structures after vehemently resisting them. Smartphone maker Xiaomi immediately followed by listing in Hong Kong using a DVR structure.
Caught in the winds of change and nearly a decade after DVRs entered their somnolent state in India, the SEBI chairman in December 2018 announced that the regulator has established a sub-committee to make recommendations regarding a possible reintroduction of DVR shares. This time the pressure appears to have come from new-age or technology-driven companies for whom DVR structures are an eminently attractive option. Such an arrangement allows for innovation and risk-taking by founders without facing the potential of short-term considerations that may be applied by activist investors or hostile acquirers.
As founders can enjoy the comfort of control that exceeds their financial stake, DVRs will enable technology startups to raise capital from public shareholders and list on the stock exchanges.
The Governance Concerns
At the same time, DVR structures face significant threats from a corporate governance perspective. The Indian corporate sector already experiences a considerable concentration of shareholding in public listed companies and the excessive influence of promoters. The DVR structure will help embolden a class of promoters known as “controlling minority shareholders” who may have a greater tendency to extract private benefits of control as they own disproportionately less equity in the company compared to the voting rights and control they exercise. Not only would this adversely affect the interests of minority shareholders who need greater protection, but the incumbent controllers are sheltered from possible hostile takeovers that operate as a governance mechanism to incentivise management to perform better.
They do have significant advantages and will likely benefit new age companies as well as the capital markets, but the SEBI-appointed sub-committee would be well-advised to take a cautious approach. This would involve balancing the benefits of the DVR structures with tight corporate governance measures that will prevent its abuse. The key measures are well worth discussing.
The Middle Path
First, it is necessary to set out criteria by which companies can be eligible to access the DVR route.
The Companies (Share Capital and Debentures) Rules, 2014 already provide that only profitable companies that have not committed any defaults can issue DVRs. SEBI ought to impose further conditions.
At the outset, the facility must be made available only to companies in the ‘new economy’ that are driven through technology and innovation.
Companies accessing this route must have a prescribed minimum market capitalisation at listing, thereby making it available only to players of substantial size. While SEBI does have an important role to vet each applicant against the eligibility criteria, the requirements must be set out in detail to ensure the necessary transparency. One must guard against a reversion to merit-based regulation of the capital markets whereby the regulator decides, rather opaquely, upon the eligibility of each issue to access such markets.
Second, DVR issuances must be limited to the issue of new shares.
Conversion of existing shares into DVRs by way of a recapitalisation would not pass muster, as the control of some current shareholders could be diluted. As is generally the case at present, the number of DVR shares must be capped as a proportion of the share capital of the company, and the number of votes per DVR share must not exceed a prescribed number; say, no more than ten votes per DVR share.
Moreover, given that DVRs fulfill the purpose of incentivising founders to list their companies, only founders and directors of companies must be permitted to hold DVR shares.
They must not be freely available for transfer or trading, for that would defeat the purpose of the DVR structure and also heighten governance concerns.
Third, companies taking advantage of the DVR structure must adhere to higher standards of corporate governance that SEBI would do well to prescribe.
These could include greater board independence requirements and stronger disclosures. For instance, Singapore has imposed more onerous requirements for independent directors in companies with DVR structures. Hong Kong has mandated the establishment of a corporate governance committee for such companies, which committee must be comprised entirely of independent directors and carries a whole host of functions and responsibilities for higher order governance in DVR listed companies.
Fourth, DVR structures cannot tantamount to effective disenfranchisement of shareholders holding ordinary shares with lesser voting rights.
In certain crucial matters such as an amendment to the memorandum and articles of association, variation of rights of classes of shares, appointment and removal of independent directors and winding up of the company, the shareholder vote must be obtained on a one-share one-vote basis and not on the basis of the DVRs.
While the DVR structure enables founders and promoters holding DVR shares to take long-term business decisions without hindrance from outside shareholders who are only interested in economic returns, the same cannot be said for governance matters where shareholder equality must be maintained.
On governance matters of the kind described above, the outside shareholders with inferior voting rights must have a say.
Finally, other jurisdictions have witnessed a strident debate on the need for sunset provisions.
By these, the DVR structure would meet its end after a pre-defined period of time or set of circumstances, and DVR shares would then automatically convert into ordinary shares to restore parity. Granted that it is hard to make a case for a time-bound sunset provision, as there would be considerable variation in the time taken for each company or industry to mature in rapidly changing market conditions. But, event-based sunset provisions would be most appropriate.
For instance, if a founder or director holding DVR shares were to exit the company or sell all their shares to outsiders, there is no reason for the DVR structure to continue.
These mechanisms ought to be built into the edifice of a DVR arrangement.
In all, SEBI has indeed capitalised on an opportune moment to reconsider the DVR structure. It may very well be an optimal route for companies in the new economy to access the capital markets. At the same time, it would be foolhardy to open up the sluice gates to DVR listings. Proponents of DVRs may scoff against significant curbs of the kind discussed above. It is, however, prudent to adopt a cautious approach, to begin with, and then relax the measures, lest corporate India suffers from further governance implosions driven by what has been a controversial capital markets instrument the world over.
Umakanth Varottil is an Associate Professor of Law at the National University of Singapore. He specialises in company law, corporate governance and mergers and acquisitions.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.
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