On March 20, 2019, the Securities and Exchange Board of India (“SEBI”) released a consultation paper (the “Paper”) that discusses the prospect of differential voting rights shares (“DVRs”) being made available to listed issuers in India. SEBI has sought input from stakeholders on DVR structures for both existing and newly-listed issuers.
According to the Paper, the key rationale for adopting DVRs in India are:
- To allow companies to fundraise without dilution of control to protect against hostile bids, which reduces the need to engage in debt financing. For Indian companies, this route of fundraising is seen as advantageous as technology firms often have smaller amounts of tangible assets, which may make debt financing challenging.
- To allow investors to participate in equity investing at more efficiently priced shares. This is as DVR shares can be priced lower for shares with lesser voting rights, without any dilution of their rights to dividend distributions (see page 2 of PMAC DVR Group’s Issuance of Equity Shares with Differential Voting Rights).
As envisioned, the adoption of DVR share classes could lead to existing listed companies and future IPO companies the ability to issue two different share classes to accompany ordinary shares.
The first class of shares would “fractional voting rights shares” (“FR Shares”). FR Shares could 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 (1:10). FR Shares could be issued one of three ways: (i) rights issue; (ii) bonus issue pro rata to all equity shareholders; or (iii) a follow-on Public Offer, which would be open to subscription by existing shareholders and other third parties.
The second type of DVR share class would be “superior votes rights shares” (“SR Shares”) and would be reserved for companies seeking to IPO on a stock exchange. The primary requirement for SR Shares is that companies would need to maintain such class of shares for more than a year prior to the filing of a draft offer document with SEBI, during which period only a company’s promoters or promoter group can hold such shares. The SR Shares would have a voting rights ratio of up to 10 votes for each share held (10:1). SR 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 after their IPO.
In our submission, Glass Lewis opposed the introduction of DVR structures in India. Foremost, Glass Lewis is strongly in favour of a “one-share-one-vote” principle. Shareholders do and should take a limited role in the operation of a company. Management, at the direction of the board, is there to operate the business. Yet, when it comes to governance and shareholder rights, we believe shareholders should have the power to speak and the opportunity to be heard and effect change if necessary.
We acknowledged that there may be some benefits associated with DVR structures for companies, particularly to foster innovation, enhance competitiveness, and to align the interest of managers and shareholders. Yet, where there may be some benefits, there are distinct risks and drawbacks which may do more to harm investors interested in India and the wider Indian economy. Indeed, as noted by the Asia Corporate Governance Association (“ACGA”), the introduction of similar differential voting share classes has harmed the reputation of markets including Hong Kong and Singapore. The issuance of DVR may do more to confirm ACGA’s broader fear of a race to the bottom, potentially encouraging additional Asian markets seek to issuance differential voting class shares.
Additional concerns include the entrenchment of promoters of Indian companies. This is particularly the case if a company with SR Shares were to list, then issue FR shares, which could lead to promoters having voting power up to 100 times that of FR Shareholders. Further, there are no envisioned limits on whether an existing listed company could de-list in order to re-list with SR Shares and thereafter, be able to issue FR Shares. Perhaps most worrisome are the lack of any proposed changes to corporate governance structures, beyond coat-tail provisions for SR Shares. Notably, there are no proposed changes to board structures, for instance, to make board committees solely independent, nor are there any limitations on promoter voting for proposals involving remuneration. On this point, as promoters – many of them being executive directors or non-executive directors –vote on their own remuneration, the entrenching of voting power in favour of promoters could lead to self-enriching remuneration packages.
Although Glass Lewis identified other shortcomings with the proposed DVR share structures, the underlying premise that DVR help companies fundraise and bolster the high-sector sector is tenuous at best. This is especially the case as there is no perceived eligibility testing for companies to issue either FR Shares or SH Shares. Taken together, we are concerned that the proposed rules would undermine the “one-share-one-vote” principle, potentially disenfranchising shareholders. As proposed, the DVRs would assist promoters in gaining and maintaining control, insulating their voting interests from those of other shareholders.
Overall, we view the prospect of DVR share structures being introduced as a step in the wrong direction, especially as India has made notable strides in the past years to improve its corporate governance practices.
You can download our submission below; for further information please contact us at info@glasslewis.com.