Thursday, December 3, 2009

The Debate over Multiple Classes of Shares

Currently, the issue of shares with differential rights as to voting and dividend is in a state of flux. While the Companies Act, 1956 and the Rules issued pursuant to that allow shares with differential rights, SEBI has proscribed the issue of shares with “superior voting rights” in listed companies, implicitly allowing shares with “inferior” voting rights. Finally, however, the Companies Bill, 2009 seeks to put all this to rest by banning shares with differential rights altogether. It is not clear if that intended result would ensue as there is still demand from industry to allow shares with differential voting rights as they provide tremendous flexibility to issuers and shareholders to structure rights on shares.

At a more general level, the topic of dual-class shares (with differential rights) has received some attention with Facebook’s proposal for a public offering with dual-class shares. The Economist has a report on the success of dual-class shares in the markets. Note that dual-class shares act as defensive mechanisms favouring holders of shares with superior control (voting) rights. Here is an extract:

Over the past 20 years firms with dual-class share structures have accounted for around 7% of IPOs, such as that of Visa, a credit-card company, last year. Studies by Chad Zutter and Scott Smart, economists at the University of Pittsburgh and Indiana University respectively, have found that dual-class IPOs tend to be priced at lower price-earnings and price-sales ratios than comparable single-class IPOs, suggesting that there is a penalty. But it is surprisingly small.

One likely explanation for this is that most public companies in America used to have powerful poison pills that protected management from hostile takeovers no matter what their share structure, says Jay Ritter of the University of Florida. They also had supine shareholders. Both of these things have changed in the past couple of years, however, as doughtier shareholders have agitated against poison pills. So perhaps Facebook will pay a higher price than it expects for its dual structure.
This seems to suggest that the way forward (even in the Indian context) would be to allow dual-class shares or shares with differential voting rights (along with predetermined checks and balances) and then leave it to the market to price these shares accordingly. That would be a more optimal approach than to ban these instruments altogether.


Raghav Sharma said...

The removal of shares with differential rights in the Companies Bill 2009 is certainly a retroactive move as developed markets like Canada, Australia, Delaware, UK and Hong Kong allow issue of such shares. The rights attached to shares should be a matter of contract between the member and the company (regulated by the company's charter documents)and the only justified restriction may be in case of shares with superior voting rights in case of listed companies to avoid prejudice to the public shareholders (SEC imposes such restriction like the SEBI). This would provide companies with flexibility in raising finance as per the needs of the investors.

Dipen Chatterjee said...

So once the Companies Act 2009 comes into force there should not be any shares with DVR existing. Therefore what happens to the existing shares with DVR. There is no clarification as such in the proposed Bill. Is it like companies have to undergo "arrangement" or "buyback and cancel" such shares. As of now there seems to be no formal methodology proposed under Companies Act 2009 which can purport to create uniformity amongst existing oridinary equity share capital and existing shares with DVRs.