1

Non-Inclusion of Differential Voting Rights in the Companies Bill,

2009

Model Synopsis of the Project Work (Content wise)

1. Objectives of the Project Work

2. Introduction

3. Development of the Concept of DVRs and their current position

World over:

3.1 Unites States

3.2 Canada

3.3 France

3.4 Germany

3.5 New Zealand

3.6 United Kingdom

4. Issuing of shares with Differential Voting Rights in India

5. CLB Ruling on Superior Voting Rights Issue

6. Change in SEBI‟s Stand

7. Advantages and Disadvantages of issue of DVRs:

7.1 Advantages

7.2 Disadvantages

8. Conclusion

Bibliography

2

MODEL PROJECT WORK (TO BE FOLLOWED BY EVERY STUDENT)

3

DECLARATION

I hereby declare that the research project entitled “Non-inclusion of

Differential Rights in the Companies Bill, 2009” is a record of the

individual research carried out by me under the supervision of (Faculty

name). This has not been submitted by me for the award of any Diploma,

Degree or other similar title to this or any other University.

Date: Signature of the student

Place:

4

List of Cases referred in the work

(based on the cases referred alphabetically to be arranged)

5

1. Objectives of the Project Work:

(1). To examine the backgrounder under which the Bill has been

proposed.

(2). To examine the scope of the Bill and provide a critical evaluation.

2. INTRODUCTION:

Shareholding pattern has assumed great significance in the modern era

with a number of instrumental changes happening in the way issuing of

shares is being done. Company being a separate legal entity is

characterized by separation of management from the ownership.1 The line

of strict distinction between ownership and control has blurred over the

years and the shareholder has been gradually reduced from an owner in

the company to someone who is merely entitled to profits, i.e., dividends

and other consequential benefits. The right to vote is an inherent right of

the shareholders which signifies their overall supervisory powers and

ultimately, control over the actions of the company. It helps them steer

the management to act in the interest of the company. In India, the

Companies Act, 1956 classifies shares into two kinds: equity and

preference shares. Every member of a company limited by shares and

holding any equity share capital shall have a right to vote.2 This is

proportionate to the number of shares held. But the concept of One-

share, one-vote slowly began to undergo dilution with the management

wanting more control to ward off hostile takeovers, which were becoming

recurrent. The era of globalisation and privatisation led us into an era of

sweeping changes like never before. The urge to retain control demanded

innovative ways of handling issue of shares.

Keeping this objective in mind, an „Expert study on establishment of New

Stock Exchange‟ was set up in 1991 under the chairmanship of Mr. M.J.

1 Solomon v. Solomon & Co Ltd, [1895-99] All ER 33 (HL)

2 Section 87, Companies Act, 1956

6

Phewani. The Committee proposed that the dividend-paying companies

having a track-record of dividend payments in the preceding two years

and/or in four out of five years or five out of seven years can issue non-

voting shares (hereinafter referred to as NVS) i.e., certain shares without

the incidental right to vote.3

The provision for NVS found its place in the Companies Bill 1993 and

19974 with the condition that such shares shall not exceed 25% of the

issued share capital with voting rights.5 This was also made subject to

terms and conditions prescribed by the Central Government from time to

time. But these bills could not see the light of the day.

Unsuccessful attempts at enacting a new Companies Act forced the

government to amend the existing Companies Act, 1956 to incorporate

the concept of Differential Voting rights (hereinafter referred to as DVRs).

S. 2(46) A provides that shares may be issued with DVRs in accordance

with the provisions of s.86. The Companies Act Amendment of 2000

altered the s. 86 to now add a new class of equity shares which may be

issued with differential rights as to dividend, voting or otherwise in

accordance with such rules and subject to such conditions as may be

prescribed.

The inclusion of the aforementioned shares with DVRs meant that s. 88

which prohibited the issue of shares with disproportionate rights had to be

repealed.6 To give effect to the new provision of 86(a) (ii), the

Department of Company Affairs came up with the Companies (Issue of

Share Capital with DVRs) Rules, 20017. These rules govern the issue of

3 Roy, Souvik & Kumar, Akarshan, Differential Voting Rights:A Necessity or A Burden,

<http://www.taxmann.com/datafolder/Flash/flashart6-8-09_5.pdf> 4 Mukherjee, Arindam, No act of Corporate Democracy, Outlook India Online, September 1, 1997, <

http://www.outlookindia.com/article.aspx?204143>, (Last visited on September 14, 2009) 5 Shares minus voting, The Hindu Financial Daily, January 11, 2001,

<http://www.hindu.com/businessline/2001/01/11/stories/041118mo.htm>, (Last visited on 14th

September,

2009) 6 Vide the Companies (Amendment ) Act, 2000 (53 of 2000)

7 Notification SO 167(E) dated 09-03-2001

7

shares with DVRs and Rule 3 lays down the pre-conditions as well as the

duties of a company seeking to issue such shares. The rule lays down

that the total number of shares with DVRS cannot be more than 25

percent of the issued share capital.

3. Development of the Concept of DVRs and their Current

Position World over:

It is very interesting to find that the one share, one vote rule considered

as a norm now-days has not always been believed to be so in business

history. Reverting back in the sands of time to the days when the East

India Company came to India we find that voting rights to the

shareholders did not matter much. The Charters outlined the purpose of

the corporation. The shareholder was considered just a member of the

company rather than an owner, though individuality of shareholders was

protected by Anglo-American Common law.

The historical moment for One share, One vote rule came in the year

1781 when the Bank of North America‟s congressional charter

incorporated proportional voting and thus generated a huge controversy.8

But then, it was there to stay.

The development of the concept of DVRs began soon as companies

entered into the One share, One vote era. This can be traced back to

Alexander Hamilton, who in 1791, as the Secretary of the U.S. Treasury

thought that the proportionate voting was being misused by the majority

shareholders to connive and establish their control at the expense of the

interests of the small shareholders. 9To counter the same, he proposed

graduated voting rights which were to impose certain checks and balances

on unfettered power of landlords, family dynasties and governments, who

generally had the major shares. They soon became popular in the U.S. At

the same time, proportionate voting continued to make large strides and

8 Joshi V., Voting Rights and Corporate Governance, Chartered Secretary, January 2001, . 26-29

9 Ibid

8

became very popular.10 By the turn of the nineteenth century, One share,

One vote had become a rule world-over.

3.1 United States:

Differential voting rights came to be recognised and known as Dual-Class

shares with the passage of time in the U.S, though New York remained an

exception to this.11 American Stock Exchange (AMEX) and National

Association of Securities Dealers Automated Quotations (NASDAQ) have

been more forth-coming with respect to dual-class shares than New York

Stock Exchange (NYSE). For more than fifty years, starting from 1926 till

1980‟s the NYSE refused to list the companies which issued such shares.

It was only in 1989 that NYSE in fact changed its stand. Although AMEX

had a limitation cap of 1:10 in the favour of the class with superior shares

with respect to all matters except election of directors for which the

limited voting class of shared was given the ability to elect a minimum of

25% of the Board of Directors.12 AMEX also made sure that no further

shares could be issued which may have the effect of further reducing the

voting power of the existing shareholders with limited voting rights. The

NASDAQ Exchange is considered the most liberal of the three and chooses

not to discriminate between the different classes. The prevalence of

different regimes within the U.S. has led to a general consensus among

the experts about plutocratic nature of the American companies.

A dual-class company is generally characterised by the management and

other insiders holding the superior voting shares in higher proportion.13

This is also achieved in other ways, for e.g., by issue of one class of

10

Ratner, The Government of Business Corporations: Critical Reflections on the Rule of One Share, One Vote,

56 Cornell L.Rev. 1 (1970). 11

Gompers, et.al, Extreme Governance: An analysis of dual-class firms in the United States, The Harvard

Business School Rev Finance. Stud., 2009,< http://www.hbs.edu/units/am/pdf/dual.pdf> (Last visited on 19th

September, 2009) (hereinafter Gompers, Extreme Governance); La Porta,et.al, Legal determinants of external

finance, 52 J. Fin. 1131 (1997) 12

Sinhala, V.R. & Singh, V., Differential Voting Rights Shares: Tracing the Genesis of Chaos, SEBI and

Corporate Laws, April27- May 3, 2009, Vole 91, p.119a 13

Gompers et al, Incentives vs. Control: An analysis of U.S. Dual-class companies, December 2003,

<www.nber.org/papers/w10240>,(Last visited on 19th

September, 2009)

9

shares with no dividend but having very high voting rights. On other

hand, people holding the second type of shares are divested of their

voting rights in lieu of higher dividends.

The dual class companies are also said to be associated with agency costs

that have an adverse effect on the financial health of the company. Under

the “agency cost” theory, managers are 'agents' for the shareholders.14.

The relationship between the shareholders and managers of a corporation

perfectly fits the definition of a pure agency relationship.15

Because both parties are utility maximizers, the interests of each party do

not always correspond. The deviations in the utility functions create

agency costs, which have been defined as “the sum of the monitoring

expenditures by the principal,...the bonding expenditures by the agent,

[and] ....the residual loss....”16 Agency costs include contracting costs,

transaction costs, moral-hazard costs, and information costs.

Traditionally, agency costs have been contained through external and

internal monitoring mechanisms, such as the voting rights that attach to

certain common shares. Therefore, unbundling the voting rights and profit

claims has potentially significant consequences on the level of agency

costs.17

3.2 Canada:

Canada started issuing shares with differential rights towards the last

quarter of the 20th century.18 The issuing of shares with DVRs requires the

approval from minority shareholders in the sense that the resolution for

the same has to be passed by a simple majority of the shareholders who

14

Daniel, R. Fischer, the Corporate Governance Movement, 35 Vend. L. Rev. 1259,1262-65 (1982) 15

Michael Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and

Ownership Structure, 3 J. Fin. Econ. 305, 308 (1976). 16

Ibid 17

Douglas H. Blair et al., Unbundling the Voting Rights and Profit Claims of Common Shares, 97 J. Pol. Econ.

420, 422-23 (1989). 18

The Role of the Stock Market in Corporate Governance, The Fraser Institute,

<http://oldfraser.lexi.net/publications/books/gamble/chapter2.html>, (Last visited on 19th

September, 2009)

10

have less than 20% of the voting rights and only then the Toronto Stock

Exchange (TSE) lists the company‟s shares.

Despite having the essential safeguards, there has been active resistance

against the dual-share regime, led by the Canadian Coalition on Good

Governance that consists of a number of leading institutional investors

who have combined assets worth more than $400 billions. 19This impact

of this opposition is discernable from the fact that a number of companies

have done away with differential shares citing commitment to better

Corporate Governance practices that have come to guide the corporate

sector.

3.3 France:

Historically, it can be seen that corporate charters provided an upper limit

on the number of votes which can be vast by a shareholders and a lower

limit on the number of shares that can be held. In the early 20th century,

shares with more votes became prominent and were used as a tool of

defence against takeovers. As France was going through a bad phase

economically and there was shortage of capital, protectionism in the form

of insider control was used as an instrument to save the management

being passed to foreign hands.20 The provision has its negative impacts

too but it served the needs of the time. Multiple voting shares are

common in France today21 and the companies generally grant two votes

for every share, as long as they have been held for at least two

consecutive years and this period can be extended to four years for

19

Kai Li, et al, Do Voting Rights affect Institutional Investment Decisions: Evidence from Dual class firm,

August 2007, available on

<https://www.cicbv.ca/UserFiles/File/pdf/Do%20Voting%20Rights%20Affect%20Institutional%20Investment

%20Decisions.pdf>,(Last visited 19th

September, 2009) 20

Konczyk, Muriel, Big changes in ownership structures: Multiple votes in Interwar France, October 2006,

<http://papers.ssrn.com/sol3/papers.cfm?abstract_id=944808 > , (Last visited on 19th

September, 2009) 21

Adams R., Ferreira R, One Share-One Vote: The Empirical Evidence, Review of Finance (2008) 12: 51–91, <

http://www.business.uq.edu.au/download/attachments/18415929/AdamsFerreira_RofF.pdf>, (Last visited on

18th

September, 2009)

11

publicly trading these shares.22 They have become such an integral part

of the system in France that they are treated as ordinary shares and are

not classified under a special category.

3.4 Germany:

Germany has the normal One share-One vote regime since 1884 when

the Company Law underwent a complete overhaul in the country.23 But

this was not an absolute rule. An option was also given to companies to

issue shares limiting voting rights in the desired ways. But the option was

withdrawn when owing to long time demands and pressure for one vote-

one share rule, Germany abolished multiple voting shares in the 1998

Schroeder‟s KontraG Law.24

The European Council (EC) has long aspired for a European harmonization

of the field of takeovers, seeing it as a sine qua non for the attainment of

its broader objective, i.e. the creation of an integrated capital market by

2010. It has faced a stumbling block in the form of German opposition

for issuing a common “Takeover Directive” to members of the EC.

Germany wants a „one share one vote‟ system to create equal conditions

across the EU.25 Germany has argued that the „level playing field‟ would

be unfair as other members like France have shares with multiple votes.26

22

R. A. I. Van Frederikslust et al., Corporate governance and Corporate Finance: A European Perspective,

<http://books.google.co.in/books?id=XoD9J7QQ9dAC&pg=PA177&lpg=PA177&dq=france+%2B+dual+class

+shares&source=bl&ots=lJ52jndyKF&sig=onk6t3M1Ph0EMFTZ_A68s7KvM-s&hl=en&ei=Ja-

nSq7AKZTG6QOek5ShBg&sa=X&oi=book_result&ct=result&resnum=3#v=onepage&q=france%20%2B%20

dual%20class%20shares&f=false>,(Last visited on 18th

September, 2009) 23

Sinha V.R. and Singh V., Differential Voting Rights Shares: Tracing the Genesis of Chaos, SEBI and

Corporate Laws, April27- May 3, 2009, Vol 91, p.119 24

Ehrhard O. et al., Unifications of Dual-Class Shares in Germany - First Empirical Evidence on Liquidity

Effects of Share Class Unifications. Swiss Finance Institute Research Paper No. 06-12; 21st Australasian

Finance and Banking Conference 2008 Paper. Available at SSRN: <http://ssrn.com/abstract=677000>, (Last

visited on 19th

September, 2009) 25

New EU takeover Directive needs to address concerns before adoption, The Finance Magazine, September

2009, < http://www.finance-magazine.com/display_article.php?i=2389&pi=104> , (Last visited on 18th

September, 2009) 26

Cioffi, J. , Restructuring “Germany Including.”: The Politics of Company and

Takeover Law Reform in Germany and the European Union, Law & Policy , Vol. 24, No. 4, pp. 355-402

(2002),

12

Germany wants to prevent hostile takeover of its giant corporations, and

feels particularly vulnerable having abolished multiple voting shares.27

3.5 New Zealand:

The law in New Zealand as regards to the differential voting shares is

quite similar to Germany. S. 37 of the New Zealand Companies Act, 1993

allows companies to issue different kinds of shares carrying special limited

or conditional voting rights subject to the constitution of the company.

3.6 United Kingdom:

The London Stock Exchange permits the issue of shares with differential

voting rights like that of other European nations like France, Italy, etc.

The options available to the entrepreneur explain for a number of

companies with varying capital and voting structures.28 The shareholder

voting rights are undergoing a rethink wherein the U.K. minister

responsible for London's financial centre, Paul Myners, has suggested that

shareholders should be able to buy and sell their voting rights which

according to him, would elevate them to the owners of the company and

not just traders. The proposal has been criticised vehemently by asset

managers as opposed to democracy and the principles of corporate

governance.29

4. Issuing of shares with Differential Voting Rights in India

After the amendment of s.86 of the Companies Act in 2000 to include the

provision for DVRs, they were issued in India, by TATA Motors in

Clift, Ben, The Political Economy of the Market for Corporate control in France and the Hamstrung

Harmonisation of European (and French) Corporate Governance, GARNET Working Paper: No 3008 ,January

2008, < http://www.garnet-eu.org/fileadmin/documents/working_papers/3008.pdf> , (Last visited on 18th

September, 2009) 28

Brecht, M. & Mayer, C., Corporate Governance in Europe: Competition versus Harmonization,

<http://www.sbs.ox.ac.uk/NR/rdonlyres/0B017B7F-BAE4-4242-BA9E-

941954BEEF29/2961/CorporateGovernanceinEurope4.pdf> , (Last visited on 17th

September, 2009) 29

Shareholder Voting Gets Rethink in U.K, The Wall Street Journal, August 10, 2009,<

http://online.wsj.com/article/SB124984880909817763.html> , (Last visited on 17th

September, 2009)

13

November, 2008 for the first time ever by a listed company. TATA had

issued 6.4 crore such shares as per a part of the repayment of its loan for

Jaguar-Land Rover acquisition.30 The DVR shares were priced at Rs. 305

per share as against Rs. 340 for an ordinary share. Moreover, the

dividend paid on the DVR shares was to be 6% which was much more the

1% payable on the ordinary shares.31

Pantaloons Retail also issued DVR shares with their bonus issue in

February, 2009 but they made a very innovative use of a provision for the

shares with differential shares by not issuing these shares differently but

by offering one bonus share for every ten ordinary equity shares.32 It can

be seen that the DVR shares were used here to attract more capital from

the public by using such shares as sops rather than an instrument of

consolidating power by the insiders.

Even a cursory glance at the stock market trading of such shares shows

that the investor community lacks the knowledge about DVRs at present.

They do not seem to have the sufficient maturity or vision to appreciate

them. The fact that only 5427 shares with DVRs issued by TATA Motors

were traded on BSE of the huge numbers issued33 is an indicator of that

they were not be popularised so that they could have been used more

often by the investor community for their good. On the other hand,

Pantaloons saw hectic trading of its shares with DVRs which stood to the

tune of 23.05 lakhs in 2009.34 But as mentioned above, this is due to the

fact that they were not traded separately from the ordinary shares. They

30

Tania Kishore Jaleel, IFCI offloads 4% Tata Motors DVR shares, The Hindu Business Line, Mumbai,

September 1, 2009, < http://www.thehindubusinessline.com/2009/09/01/stories/2009090151701000.htm> ,

(Last visited on 14th

September, 2009) 31

S. Hamsini Amritha, Differential Voting Rights, The Hindu Business Line, October 5, 2008, <

http://www.thehindubusinessline.com/iw/2008/10/05/stories/2008100550501300.htm>, (Last visited on 14th

September, 2009) 32

Pantaloon Offers bonus DVR shares, The Indian Express, Bombay, July 25, 2008, available on

http://www.indianexpress.com/news/pantaloon-offers-dvr-bonus-shares/340185/ 33

Tania Kishore Jaleel, Differential Voting Rights trading remains dull, The Hindu Business Line, Mumbai,

July 2, 2009, <http://www.thehindubusinessline.com/2009/07/02/stories/2009070251771200.htm >, (Last

visited on 14th

September, 2009) 34

Ibid

14

were offered as a bonus instead and hence this does not reflect the

voluntary trading based on sufficient

knowledge/information/willingness/foresight of the buyer and cannot be

used to base any conclusion about the impact of shares with DVRs on the

Indian market. This can also be partially attributed to disinterest of the

institutional shareholders in such shares who institutional investors care

more about the capital gains. Even otherwise, they have not been able to

buy such shares even otherwise, because of restriction clause on trading

such shares in their charters. Until that clause is removed, they can‟t buy

such shares.35

Also, the companies with sound business ethics and a pre-existing control

over the management generally confident of taking decisions on its own

and without any threat of takeover will be very reluctant to use such

instruments that may be detrimental to the hard-earned goodwill in the

economy and drive away institutional investors.36

5. CLB Ruling on Superior Voting Rights Issue:

The use of shares with DVRS to exercise control has already begun in

India. In Anand Pershad Jaiswal and Ors v. Jagatjit Industries Ltd. and

Ors37 the first case of its kind, before Company Law Board, the

promoters were issued shares with 20 voting rights per share which

enabled them to exercise complete control over the company. The

preferential allotment of new shares with superior voting rights had

increased their voting rights to around 64% though the economic stake

increased merely by a little more than 8 percent from 23.59% to around

32% . This was initially challenged before SEBI by the rival groups

35

Will Differential Voting Rights Work in India, Economic Times, May 30, 2008,<

http://economictimes.indiatimes.com/Markets/Stocks/ViewsRecommendations/Will_differential_voting_rights_

work_in_India/articleshow/3084229.cms > 36

Carleton Willard T et al., The Influence of

Institutions on Corporate Governance through Private Negotiations: Evidence from

TIAA-CREF, Journal of Finance 53, 1998, 1335-1362. 37

MANU/CL/0002/2009; Order No. WTM/TCN/01 /CFD/ APRIL /08, April 8, 2008, also available on

<www.sebi.gov.in/cmorder/jagatjitorder.pdf >, (Last visited on 17th

September, 2009)

15

contending foul play in pricing of shares and the fact that approval for the

same was not acquired from the stock exchanges. SEBI found itself

incompetent to decide the matter citing the fact that Section 86 of the

Companies Act does not come under Section 55A which enumerates the

powers exercisable by SEBI on companies.

The petitioners then moved the Company Law Board praying for

declaration of the resolution approving such differential voting rights as

bad in law and hence null and void. The contention was negated by the

CLB. The issue of shares with DVRs was upheld as valid as being in

accordance with the Articles of Association of the Company and provisions

of the Companies Act. The Company was directed to buyback the entire

shareholding of the two petitioner groups for a total consideration of Rs.

36, 50, 00,000/- to be paid to each Group. The said shares were ordered

to be converted into physical form and tendered to the Company for buy

back as a consequence thereof the share capital of the company stood

reduced and the Company was exempted from compliance under Section

100 of the Companies Act, 1956. The CLB also observed that since the

shares were being bought back by the Company from the existing

promoters as part of a settlement between them, in the circumstances,

the parties were exempted from complying with the provisions of Section

77A, the provisions of SEBI (Buyback of Securities) Regulations, 1988,

SEBI (Substantial Acquisition of Shares & Takeovers) Regulations, 1997

and any other applicable Regulations and provisions of the Companies

Act.

6. Change in SEBI’s Stand:

As a counter measure to disable companies to imitate the above model by

changing share structure, SEBI prohibited public listed companies from

issuing shares with superior voting rights or dividends by letter dated July

21, 2009 addressed to all stock exchanges. The letter entails the

amendment of the Listing Agreement ensuring compliance with the

16

directions of SEBI. This has created more uncertainty as a deadline for

bringing the shares with DVRs on par with other shares has not been

provided. The companies which have already issued such shares may in

fact also contend only prospective operation of the direction since it does

not address this point. The SEBI should clarify its position.

With its latest move, SEBI has come a full circle on this matter. Earlier

this year in February, SEBI had inserted clause 8.3.5.238 in SEBI

(Disclosure and Investor) Protection Guidelines, 2000 popularly known as

DIP Guidelines which allowed listing of equity shares with differential

rights without making an initial public offer for the same.

This did not last long. Then came the CLB ruling in March. The SEBI‟s

move to ban issue of votes with superior rights has been seen as a

response to the CLB ruling in Anand Pershad Jaiswal case. The said letter

dated 21st July was written in pursuance of SEBI Board Meeting on

Primary Market reforms chaired by Mr. M.S. Verma on June 18, 2009

which had decided to do away with different class of equity shares in light

of the increased focus on corporate governance of late. SEBI has also

issued the new SEBI (Issue of Capital and Disclosure Requirements)

Regulations, 2009 replacing DIP Guidelines, 2000 this September. The

new regulations do not have an analogous provision to Clause 8.3.5.2

that had allowed a company to list equity shares with DVRs. This has

followed SEBI (Delisting of Equity Shares) Regulations 2009 that replaced

Delisting Guidelines in June.

38

8.3.5.2 Application by a listed company for listing of equity shares with differential rights as to dividend,

voting or otherwise.

8.3.5.2.1 A listed company may make an application to the Board for relaxation from applicability of clause (b)

to sub-rule (2) of Rule 19 of the Securities Contracts (Regulation) Rules, 1957 for listing of its equity shares

with differential rights as to dividend, voting or otherwise, without making an initial public offer of such equity

shares, if it satisfies the following conditions:

i. issue of such equity shares are made to all the existing shareholders as on record date by way of rights or

bonus;

ii. the issuer is in compliance with the conditions of minimum public shareholding requirement with reference to

the equity shares already listed and the equity shares with differential rights proposed to be listed;

iii. the issuer undertakes to disclose the shareholding pattern of the equity shares with differential rights

separately under clause 35 of the Equity Listing Agreement.

17

Barring the decision to insert clause 8.3.5.2 in DIP Guidelines, 2000 the

other moves seem to be compatible with the Companies Bill, 2000

introduced in Lok Sabha on 3rd August, 2009. The current bill i.e.

Companies Bill, 2009 akin to the Companies Bill, 2008 that lapsed after

dissolution of Lok Sabha before General Elections, 2009 does not

contemplate different class of shares with varying votes or dividends. 39

7. Advantages and Disadvantages of issue of DVRs:

7.1. Advantages:

Experts have not come to a consensus on a single motivating factor

world-wide40, which prompted the move to come up with this concept,

though the „control‟ factor is generally believed to be the driving force.41

The fact that attempts of hostile takeover can be checked through the

shares with disproportionate votes us one of the prime reasons42 for

enacting such a provision as acquisition, merger and takeover activities

began to dominate the corporate sector post 1991.

When a company issues shares without voting rights, it tries to balance

the negation of suffrage by offering them shares at a discounted price

with higher dividends.43 This has a positive impact on the minority

shareholders. As an implication, voting rights also get accumulated with

fewer shareholders thereby making the supervision of voting simpler and

easier to monitor. The responsibility of the management‟s actions can be

39

Clause 37 of The Companies Bill, 2009 laying down the different kinds of share capital does not make a

provision for issuing of shares with Differential Rights unlike S.86 of the Companies Act, 1956. 40

Mandelbaum A., Departure from One Share- One Vote Rule: An Overview and Some Lessons from New

Zealand, (1995) 10 (2) Journal of Int’l Banking Law 56-61 [hereinafter Mandelbaum, Departure from One

Share-One Vote Rule] 41

Bennedsen, M. and Nielsen, K. The principle of proportional ownership, investor protection

and firm value in Western Europe, ECGI Finance Working Paper No. 134/2006. ((2007) 42

H. De Angelo and L.De Angelo, Managerial Ownership of Voting Rights: A Study of Public Corporations

with Dual Classes of Common Stock, Journal of Financial Economics 33-69 (1985) [ hereinafter H. De Angelo,

Managerial Ownership of Voting Rights]

43

Pandya Arnav, Change in Voting Rights, Business Standard, July 9, 2009, <http://www.business-

standard.com/india/storypage.php?autono=326742 >

18

fixed on this group of shareholders as they have added accountability

which flows from their right to vote.44 It allows the management to

leverage the capital structure in a better way as the obligation to pay

back the investors is not immediate as compared to the debt

instruments.45 It also attracts people to invest in a company as the shares

with DVRs have more liquidity in the market than normal shares.46

The structure of the company, at present, generally comprises of widely

dispersed shares wherein the minority shareholders do not have a voice.

To add to this, there is a general sense of apathy and disinterest

prevalent amidst them towards the affairs of the company or

management.47 Since the return is low on the meagre investment by

them, the desire to probe into the actions of the management is generally

missing. The average shareholder also does not have the requisite

knowledge and understanding of the issues to take an informed decision

so as to really contribute towards a healthy development of the

company.48 This may be due to various factors like disinterest and

disinclination, as mentioned above, and also because of paucity of time,

other engagements, etc. The costs and the cumbersome process involved

in attending the Annual General Meetings outweigh the benefits and thus,

such an exercise is not worth the effort for a small shareholder. Though

proxy voting and postal ballots are options available in the alternative,

the lack of knowledge about the same as well as a general reluctance to

use them coupled with associated expenses ensure that such

shareholders maintain a general attitude of indifference. In this light, the

issue of shares with differential rights is aimed to entice small prospective

investors to buy such shares.

44

Mandelbaum, Departure from One Share-One Vote Rule, supra note 42 45

Chandra Shekhar Y., Differential Shares: More Room for maneuver, Corporate Finance, Vol IV, ICFAI

University Press, , p.11 46

Forester S.R. & Porter D.C., Dual Class shares: Are there return Differences, 20(6) Journal of Business

Finance and Accounting 893-903 (1993) 47

Supra note 20 48

Srinivas, Srikanth, Changing Voting Rights, Business World, (June 13, 2008), available on

<http://www.businessworld.in/index.php/Columns/Changing-Voting-Rites.html >

19

7.2 Disadvantages:

The creation of a group of shareholders with no powers to interfere in the

working of the management renders the promoters and directors more

likely to misuse the powers conferred on them to further their vested

interests. This has been the major reason for opposition for the

disproportionate shares.49Critics have labelled such a provision validating

disproportionate powers to different shareholders as a major hindrance to

Corporate Governance,50 which has come to dominate the subject today

catapulted by a string of scams like Enron, Worldcom ,Satyam etc. that

has dented the confidence of shareholders like never before.

The existing shareholders are placed at a disadvantage in terms of

dividends. Moreover, since the shareholders cannot be assumed to be

rational, this also brings confusion and uncertainty in the market which

may disturb the equity shareholding. The existing shareholders are forced

to undertake exercises to keep themselves informed about the different

capital structures the company may adopt.

The institutional investors are also subjected to prudence standards unlike

individual investors51 and are generally not able to buy such shares owing

to prohibition on restrictions on such shares in their charters.

The Agency costs in the case of companies which go for differential shares

have been found to be in great excess to those companies which do not.

The studies conducted based on U.S. Companies as discussed above

elucidate such hypothesis and provides a rational for the same.

49

Mandelbaum, Departure from One Share-One Vote Rule, supra note 42 50

La Porta, R.,et al.. Investor protection and

Corporate Valuation, Journal of Finance, 57, 1147–1170 (2002); Morck, R.,Wolfenzon, D. & Yeung, B,

Corporate governance, economic entrenchment, and growth, Journal of Economic Literature 43, 657–722.

(2005); Davies Arnold Cooper LLP, To vote or not to vote - Lord Myners' latest suggestion to break out of the

current approach to shareholder engagement, Digest, 28 August 2009,

<http://www.dac.co.uk/documents/resources/newsletters/To_vote_or_not_to_vote_-

_Lord_Myners%27_latest_suggestion_to_break_out_of_the_current_approach_to_shareholder_engagement_-

_Digest> 51

Del Guercio, Diane, The distorting effect of the prudent-man laws on institutional equity investments, Journal

of Financial Economics 40, 31-62. (1996)

20

Hostile Takeovers, though considered parasitic and negative to the

shareholders of the target company, may sometime prove to be a

blessing in disguise. The increase in power and autonomy of the

management may cause the company in becoming complacent or

inefficient which might in turn lead to poor utilisation of resources of the

existing management and hence the company can use the threat of

hostile takeover as a garb to hide its own inefficiency, corruption,

collusion and other vested interests, detrimental to the interests of the

general well-being of the company. In such instances, hostile takeover

will serve as a welcome change that can turn the fortunes of the company

for the better, freeing-up the locked assets in the target company through

efficient management of resources ultimately benefitting the

shareholders.52

There seems to be a prolonged holding of shares of the superior class by

the group that acquires them initially. Empirical evidence shows that dual

class shares especially those with superior voting rights are less traded,

.Gompers et al. find that about 85% of firms in their dual-class sample

have at least one class of shares that is not traded.53 This is because of

the fact that once the people buy such shares, generally the management

and promoters, they tend to sit with them.

8. Conclusion:

The move towards abolishment of the system of differential voting lines in

the Companies Bill, 2009 is conspicuous from its absence in clauses

37and 41(1)(b) that provide for the kinds of share capital and voting

power respectively. The interest of the minority and outside shareholders

is one of the biggest concerns driving the move for the removal of shares

with differential rights. But the DVRs do not go against the minority

shareholders in all cases. As explained above in detail, the concept of

52

H. De Angelo, Managerial Ownership of Voting Rights, supra note 44 53

Gompers, Extreme Governance, supra note 13

21

differential voting rights has been used in a positive manner to better

Corporate Governance in countries like Germany and France.

Shares with DVRs has not been frequently issued by listed companies

ever since the provision was inducted through an amendment to Section

86 of the Companies Act in 2000. The two listed companies, namely Tata

Motors and Pantaloons, have not resorted to issuing shares with superior

voting rights that may due to the apprehension that shares with superior

voting rights may adversely impact on its corporate governance ratings

and as a mark of commitment to business ethics. The companies may

also feel that such a move might create confusion in the market and drive

away prospective investors and hence discourage investment from

general public, institutional investors, creditors alike.

The reasons for the listed companies for not issuing DVRs is general may

vary from lack of knowledge about such innovative use, less expectations

for investment from public as exemplified by the meagre trading of such

shares of Tata Motors that has been attributed to the immaturity of the

market, widespread ignorance and disinterest in complex instruments

amidst the common investor; and reluctance to change the present

capital structure.

Post-Satyam there is an increased debate on corporate democracy with

renewed focus on accountability and transparency in the affairs of the

Companies. But to impose a blanket ban on DVRS will send a message

that the Indian economy is inflexible and does not adapt itself with

changing times and needs. The shares with superior voting right of course

present a great challenge to the corporate governance ideals and have

been rightly prohibited. It is imperative that the Companies Bill, 2009

should not in entirety ban the issue of shares with differential votes but

improvise upon the same. Different measure have been adopted as

checks and balances in countries like Canada and the U.S. to make sure

that these do not become an instrument for abuse and circumvention of

22

the provisions safeguarding the interests of the mass investor community.

On the lines of Canada, the issuing of shares with DVRs may be made

subject to approval from minority shareholders and in this way, the

smaller shareholders will also have a say in the issue of such shares.

Even the superior voting rights can be retained with a cap on the total

number of votes per share and the number of shares that can be issued in

proportion to the number of equity shares which may be five in both

cases. The provision could also debar the persons who are already holding

shares in excess of say, 20 per cent, of the existing share capital from

subscribing to shares with superior votes. Such a provision will check the

ulterior motive behind issuing such shares as it includes the Rawlsion

concern for maximum advantage to the least privileged.

The inclusion of shares with DVRs vide an amendment in 2000 was a step

in the right direction. It indicates progress and maturity of the securities

market and should not be undone by putting a total prohibition on shares

with DVRs as is indicative from the Companies Bill, 2009. The lacunae can

be rectified by making changes on the lines suggested above that shall

serve the purpose of plugging the gaps that exist at present. Removal of

a forward-looking concept itself in its entirety rather than facing the

resultant consequences and challenges that stand in its way to success is

reflective of the lack of will and hesitation on the part of the lawmakers.

The position needs to be reappreciated with changes to the relevant

clauses of the bill to include differential voting rights qualified in a way so

as to extend maximum benefits and choice to the shareholders without

leaving a scope for misuse/abuse.

23

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