Differential Voting Rights : A necessity or a burden

Souvik Roy and Kumar Akarshan 1

This article is an attempt at analyzing the issue of shares with differential rights as to voting, dividend etc. by the companies. In furtherance of that objective, the authors have analyzed the provisions of The Companies (Issue of Share Capital with Differential Voting Rights) Rules, 2001. It is an attempt to understand the various advantages and disadvantages of differential voting shares and to explore the implications of the same in corporate sector. They have tried to put forth the potential benefits and harm of these instruments and discussed the performance of the companies having dual class shares of different countries. The authors argue that the role of regulator and the government should be to ensure that public shareholders are not exploited. There should be transparency and accountability in corporate governance practices and management should ensure that activities are being done in the best interests of the company and its owners instead of expropriating personal profits by having more controlling power. __________________________________________________________________

Introduction: Due to a growing trend in the corporate activities since the last decade, corporate governance practices were considered to be a major impact on the companys performances. One of the prime features of a public company is the separation of ownership and controlling management. The management of a company acts as an agent of the owners i.e. shareholders in managing the day-to-day functions of the company. 2 The equity shareholders are usually given voting rights in the affairs of the company which acts as one of the efficient means to control the activities of management. The Government of India, in the year 2000, brought in significant changes in the voting rights of the shareholders thus giving more power to control the management and to ensure meaningful shareholders democracy in working of a

1 2

Students of 4th year, The West Bengal National University of Juridical Sciences, Kolkata. SEE Gry, Tara, Dual Class Share Structures and Best Practices in Corporate Governance, (August 18, 2005) available on www.parl.gc.ca/information/library/PRBpubs/prb0526-e.htm (last accessed on 27.07.2009)

company. The Companies Act, 1956 (hereinafter referred to as the Act) was amended in the year 2000, with effect from 13.12.2000, 3 whereby issuance of shares with differential voting rights was introduced by Section 86. Moreover, Section 2(46A) was also introduced in relation to shares with differential rights. The amended provisions stand as follows: 2(46A). Share with differential rights means a share that is issued with differential rights in accordance with the provisions of Section 86. 86. New issues of share capital to be only of two kinds- The share capital of a company limited by shares shall be of two kinds only, namely:(a) equity share capital(i) with voting rights; or (ii) with differential rights as to dividend, voting or otherwise in accordance with such rules and subject to such condition as may be prescribed. Simultaneously, Section 88 of the Act was repealed which prohibited issue of equity shares with disproportionate rights as to voting, dividend, capital or otherwise which applied to public companies only. Basically, the amendment entitled a public as well as a private company to issue shares with different voting rights. Prior to the Amendment in the year 2000, a Committee headed by Mr. M.J. Pherwani on Expert Study Group into establishment of new stock exchange in the year 1991 also mooted for the proposal of non-voting shares by dividend paying companies which had a track record of dividend payment in the past two years and/or in four out of five previous years or five out of seven years. 4 Moreover, The Companies Bill, 1993 also made provision for issuance of non voting shares and Clause 78 of Companies Bill, 1997 also provided for issue of equity shares with differential rights as to voting, dividend or otherwise, not exceeding 25% of the issued share capital with voting rights and subject to the terms and conditions as prescribed by the Central Government. 5

The Companies (Issue of Share Capital with Differential Voting Rights) Rules, 2001:

3 4

SEE The Companies (Amendment) Act, 2000. Shares Minus Voting, Business Line (January 11, 2001) available on http://www.hindu.com/businessline/2001/01/11/stories/041118mo.htm (last accessed on 27.07.2009) 5 Ibid.

Subsequently, the Central Government notified The Companies (Issue of Share Capital with Differential Voting Rights) Rules (hereinafter referred to as Rules) in the year 2001 6 in pursuant to the powers conferred by sub-clause (ii) of clause (a) of Section 86 read with clauses (a) and (b) of sub-section (i) of Section 642 of the Act. Rule 3 of the Rules prescribes certain terms and conditions for a company to issue shares with different rights as to dividend, voting or otherwise. The conditions are: 1. The company has distributable profits in terms of Section 205 of the Companies Act, 1956 for preceding three financial years preceding the year in which it was decided to issue such shares. 2. The company has not defaulted in filing annual accounts and annual returns for three financial years immediately preceding the year in which it was decided to issue such share. The period of three financial years prescribed will be reduced proportionately where the companies are in existence for less than three financial years. And in circumstances where the default of the company has been condoned, it will not be liable under the abovesaid rule. 7 3. The company has not failed to repay its deposits or interest thereon on due date or redeem its debentures on due date or pay dividend. 4. The Articles of Association of the company must authorize the issue of shares with differential voting rights. If the Articles do not authorize, they have to be altered before the issuance of such shares. 5. The company has not been convicted of any offence arising under Securities Exchange Board of India Act, 1992, Securities Contracts (Regulation) Act, 1956, Foreign Exchange Management Act, 1999. 6. The company has not defaulted in meeting investors grievances. 7. The company has obtained the approval of the shareholders in general meeting by passing resolution as required under the provision of sub clause (a) of subsection (1) of Section 94 read with sub-section (2) of Section 94 of the Act. 8. The listed company has obtained the approval of the shareholders in a postal ballot.

6 7

Vide Notification No. GSR. 167(E) dated 9.03.2001 Differential Voting Rights, (September 5, 2008) available on http://lawmatters.in/content/differential-voting-rights-170 (last accessed on 27.07.2009)

The Companies (Passing of Resolution by Postal ballot) Rules, 2001 will govern the aforesaid condition. 9. The notice of the meeting at which resolution is proposed to be passed is accompanied by an explanatory statement stating(a) the rate of voting rights which the equity share capital with differential voting right shall carry; (b) the scale or in proportion to which voting rights of such class or type of such shares will vary; (c) the company shall not convert its equity capital with voting rights into equity share capital with differential voting rights and the shares with differential voting rights into equity share capital with voting rights; (d) the shares with differential voting rights shall not exceed 25% of the total share capital issued; (e) that a member of the company holding any equity shares with differential voting rights shall be entitled to bonus shares, rights shares of the same class; (f) the holders of equity shares with differential voting rights shall enjoy all other rights to which the holder is entitled to excepting the right to vote as indicated in (a) above. Hence, a company can issue shares with higher or lower voting rights. For example, it can issue shares where the voting right is one for every three shares. Again, it is also capable to issue shares where the voting right is five votes per share. The management of the company generally issues such shares where the capital is raised without much dilution in the voting power. In a way, the controlling management can have fewer shares but a greater effective control in managing the company. 8 Also, if the shares are issued with reduced voting rights, they are likely to be available at a lower price as well. 9 Advantages of Differential Voting Shares: One of the biggest advantages of having differential voting shares is the benefit to ward off hostile takeover threats. Regulation 21 of The Securities and Exchange

SEE Pandya Arnav, Change in Voting Rights,Business Standard, (July 9, 2009), available on http://www.business-standard.com/india/storypage.php?autono=326742 (last accessed on 27.07.2009) 9 Ibid.

Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 10 requires a public offer to be made to the shareholders of the target company by the acquiring company for a minimum of twenty percent of the voting capital of the company. If the controlling management or the promoters have higher voting rights than the shares held by them, they have a complete liberty to accept or reject the offer made by acquiring company. In furtherance to it, they can add high premium to the value of those shares with higher voting rights, thus making the acquisition process more cumbersome. With no takeovers to worry about, the promoters also are more likely to remain in charge and benefit shareholders with their skills and expertise. Entrepreneurship is encouraged by ensuring that promoters reap future benefits from their efforts, instead of having subsequent shareholders capture the companys gains. 11 It is highly likely that controlling shareholders have an interest in maintaining a good reputation among investors in case they need to raise additional equity. 12 Another advantage pertaining to issue of differential voting shares is the benefit accrued to retail investors. Small investors generally are not concerned much about the voting rights in the company. They are much more concerned about the capital gains in the shares they own and receiving dividends. 13 So, if the shares with less voting rights are issued to them at a discounted price, these shares will be much more attractive to these investors than shares with higher voting rights, thus making the shares more tradable.

Disadvantages of Differential Voting Shares: One of the major disadvantages of these types of shares is the possible misuse of voting power by the promoters. The management may act against the interests of the other shareholders since they have voting power disproportionate to the economic ownership in the company like expropriating funds from those holding lesser voting

As Amended upto 13.02.2009, available on http://www.sebi.gov.in/Index.jsp?contentDisp=Section&sec_id=1 (last accessed on 27.07.2009) 11 SEE Gry, Tara, Dual Class Share Structures and Best Practices in Corporate Governance, (August 18, 2005) available on www.parl.gc.ca/information/library/PRBpubs/prb0526-e.htm (last accessed on 27.07.2009) 12 Ibid. 13 Srinivas, SrikanthChanging Voting Rights, Business World, (June 13, 2008), available on http://www.businessworld.in/index.php/Columns/Changing-Voting-Rites.html (last accessed on 27.07.2009)

10

shares, unnecessary expenses, stock option plans etc. 14 Making voting power proportional to economic ownership helps to achieve several goals. Firstly, economic ownership gives shareholders an incentive to exercise voting power in the interests of the company. Secondly, the coupling of votes and shares solidifies the framework for corporate governance. Finally, the authority of economic owners to elect directors is a basis for legitimacy of managerial authority. 15 Thus, the common shareholders may be sidelined if the promoters tend to behave as utility maximizers, only serving their own goals. Next comes the issue of accountability of the management with superior voting rights. The controlling shareholders can tend to preclude the ordinary shareholders from taking action against them, thus making them unaccountable for their actions. This will ultimately result in lack of transparency vis--vis day-to-day affairs of the company. Moreover, the institutional investors might not find it very lucrative to invest in companies where the promoters own superior voting rights due to the apprehension that the promoters will tend to act contrary to the companys interests thus making the appreciation of share prices more difficult. Since institutional investors are more concerned about capital gains, these shares can act as a highly negative incentive for them to invest. Issue of Differential Voting Shares in different countries: Many countries have issued shares with differential rights as to voting, dividend etc. The implications of these shares in the corporate sector as well as the performance of the companies with different voting rights as issued in some countries are discussed here. U.S.A: Shares with differential rights is common in U.S.A. It is more commonly known as dual-class shares. 16 A typical dual-class company offers one class of common stock with superior voting rights and another class with inferior voting rights. The management and other insiders often hold the superior voting class in

SEE Gry, Tara, Dual Class Share Structures and Best Practices in Corporate Governance, (August 18, 2005) available on www.parl.gc.ca/information/library/PRBpubs/prb0526-e.htm (last accessed on 27.07.2009) 15 SEE Srinivas, SrikanthChanging Voting Rights, Business World, (June 13, 2008), available on http://www.businessworld.in/index.php/Columns/Changing-Voting-Rites.html (last accessed on 27.07.2009) 16 Paul A. Gompers et al, Incentives vs. control: An analysis of U.S. Dual-class companies, (December 2003), www.nber.org/papers/w10240 (last accessed on 27.07.2009)

14

greater proportion. 17 Some companies issue differential shares where one class of shares has control rights with no dividend and the other class yield dividend with no or much lesser voting rights. Since the insiders have nearly absolute controlling rights, it gives birth to the problem of agency cost 18 , thus the company not being able to reach its efficient output. Empirical studies have shown that the agency costs borne by the companies issuing dual class shares are much higher than the companies where the voting rights are proportional to the economic ownership. 19 Studies have also shown that more voting ownership has a negative relationship with the firm valuation resulting in low sales growth, net profit margin and return on equity. 20 France: During the 1920s, the phenomenon of multiple voting shares popularized all over France. 21 The multiple voting shares were considered as a tool of corporate finance, thereby making the takeover of firms in difficult times much easier. When a firm was suffering enough cash loss and raising capital through issue of shares or debt instruments was not possible, many businessmen would bring in capital and in turn, owned the shares with multiple voting rights. In this way, they could ensure total management control over the company. 22 Moreover, multiple voting shares were also considered tools for corporate governance and it paved the way for the insiders or management of the company to run the affairs in an efficient manner using their skills and expertise since ordinary shareholders didnt possess the same. In the years around 1926, a consensus existed in France considering the importance of multiple voting shares to defend French firms against foreign takeovers since the French currency had weakened considerably. 23 Though there were some disadvantages, multiple voting shares were advocated widely throughout France.

Ibid. Agency costs can be defined as the costs which generally arise due to divergence between agents decisions and the decisions which would maximize welfare of the principal. [ Jensen, Michael and William Meckling, Theory of the Firm, Journal of Financial Economics 305 (1976) ] 19 SEE Paul A. Gompers et al, Incentives vs. control: An analysis of U.S. Dual-class companies, (December 2003), www.nber.org/papers/w10240 (last accessed on 27.07.2009) 20 Ibid. 21 Konczyk, Muriel, Big changes in ownership structures: Multiple votes in interwar France, (October 2006), available on http://papers.ssrn.com/sol3/papers.cfm?abstract_id=944808 (last accessed on 27.07.2009) 22 Ibid. 23 Ibid.
18

17

Canada: Since the past thirty years, Canadian companies have been issuing shares with differential rights. 24 Though these types of shares provide some benefits, the investor opposition is growing in Canada. Empirical research has suggested that investment by institutional investors has been much lower in firms issuing dual class shares than in firms issuing single class shares. 25 Many regulatory changes emphasizing on better corporate governance practices has led many companies to do away with dual class shares. The Canadian Coalition on Good Governance, formed by 23 of Canadas leading institutional investors with a combined $400 billion in assets, is also opposed to dual-class share structures.26

Issue of Shares with Differential Voting Rights in the Indian market: Issue by Tata Motors Ltd.: The issue of these types of shares has not been too popular in India. In 2008, seven years after the Rules were notified by the Central Government, Tata Motors became the first company to issue equity shares with differential voting rights.27 Tata Motors had issued 6.4 crore shares with differential voting rights in November 2008 as part of its Rs. 4145 crore rights issue to pay back the loan taken for its acquisition of JaguarLand Rover. The ordinary rights issue was priced at Rs. 340 per share, Rs. 35 higher than the differential voting shares. However for a 1 per cent dividend on ordinary shares, Tata Motors agreed to give 6 percent dividend on differential voting shares. Hence the shares with differential voting rights carried lesser voting rights than the ordinary shares. 28 One of the primary reasons it issued these shares is due to growing nature of shareholder activism. In order to thwart the hostile takeover threats, the Government,
Gry, Tara, Dual Class Share Structures and Best Practices in Corporate Governance, (August 18, 2005) available on www.parl.gc.ca/information/library/PRBpubs/prb0526-e.htm (last accessed on 27.07.2009) 25 SEE Kai Li, et al, Do Voting Rights affect Institutional Investment Decisions: Evidence from Dual class firms, (August 2007), available on https://www.cicbv.ca/UserFiles/File/pdf/Do%20Voting%20Rights%20Affect%20Institutional%20Inve stment%20Decisions.pdf (last accessed on 27.07.2009) 26 Gry, Tara, Dual Class Share Structures and Best Practices in Corporate Governance, (August 18, 2005) available on www.parl.gc.ca/information/library/PRBpubs/prb0526-e.htm (last accessed on 27.07.2009) 27 Srinivas, SrikanthChanging Voting Rights, Business World, (June 13, 2008), available on http://www.businessworld.in/index.php/Columns/Changing-Voting-Rites.html (last accessed on 27.07.2009) 28 Jalil, Tania Kishore, Differential voting rights shares trading remains dull, Business Line, (July 2, 2009), available on http://www.thehindubusinessline.com/2009/07/02/stories/2009070251771200.htm (last accessed on 27.07.2009)
24

in 1980s, began to ensure the presence of its bodies such as Industrial Development Bank of India, Life Insurance Corporation and some government sponsored mutual funds on the boards of the target company to always vote with the promoters. 29 One of the instances of the interference by Government can be seen in the Swaraj Pauls failed attempt at hostile takeover of Escorts. But in the present age, the institutional investors are becoming the biggest chunks of shareholders and their voting rights will affect a lot in the companys affairs. Thus, to restrict the increasing activism of these investors, Tata Motors might have issued these shares to have more control by the management. Another reason might be protection against hostile takeover since Tata Motors is a largely held public company and thus the shareholding of the promoters is not very high. The promoter groups of different companies are trying to consolidate their position buying more shares in their names. Mr. Kishore Biyani of Pantaloon Retail India Ltd. has increased his stake from 44.66 percent to 50 percent through a preferential offer. 30 Mr. Mukesh Ambani of Reliance Industries Ltd. has increased his stake from 49.83 percent to 50.98 percent. 31 Issue by Pantaloon Retail (India) Ltd: After the issue by Tata Motors Ltd., Pantaloon Retail (India) Ltd. in February 2009 offered bonus shares with differential voting rights to the existing shareholders of the company. These bonus shares were offered in the ratio of one bonus share with differential voting rights for every ten equity shares held by the shareholders on a specified date. 32 The new shares were called Class B shares which entitled the shareholders to an additional 5 percent of the dividend over the dividend payable to Class A shares payable to shareholders in any financial year. However, ten Class B shares would carry one vote. 33

Ibid. SEE Singh, Piya, Taking Control, Business World, (September 24, 2007), available on http://www.businessworld.in/index.php/Corporate/Taking-Control.html (last accessed on 27.07.2009) 31 Ibid. 32 Pantaloon Offers bonus DVR shares, (July 25, 2008) available on http://www.indianexpress.com/news/pantaloon-offers-dvr-bonus-shares/340185/ (last accessed on 27.07.2009) 33 Ibid.
30

29

However, trading of the abovesaid Tata Motors shares in the exchanges were very low, sometimes being one share traded only in the entire session. 34 One of the reasons behind this is the lack of awareness about these instruments in the market. Mr Jagannadham Thunuguntla, Head of Equity at SMC Capitals said, Our markets here lack the maturity to understand differential voting rights at this point in time. It will take some time for investors here to appreciate an instrument like the differential voting share. In developed markets differential voting shares are common instruments. 35 The trading of differential voting shares of Pantaloon Retail has been better than Tata Motors. With the issue of these instruments, the corporate sector reacted differently relating to the working and liquidity of these shares. Experts like Mr. Narayan Ramachandran, Managing Director and Country Head, Morgan Stanley believe that in order to sell non-voting shares, the sweetener of higher dividend must be given to attract small investors since they attend seek higher dividend than voting rights. He observed that since institutional investors care about the capital gains, such shares would not necessarily be in demand by them. There might create a confusion regarding various classes of shares in the market. 36 Others like Mr. Prithvi Haldea, Managing Director, Prime Database believes that people need to familiarize with these instruments before they are traded. Moreover, since the differential voting shares carry much lesser voting rights, they should trade at 8-10 percent discount. The investment by institutional investors is expected to be restricted in these instruments since their charters prevent them from buying such shares. Eventually these shares will be in demand by retail investors. 37 Ruling by Company Law Board: In a much awaited ruling by the Company Law Board in March, 2009 in the case of Anand Jaiswal v. Jagatjit Industries Limited 38 , it ruled in favour of the promoters thus

Jalil, Tania Kishore, Differential voting rights shares trading remains dull, Business Line, (July 2, 2009), available on http://www.thehindubusinessline.com/2009/07/02/stories/2009070251771200.htm (last accessed on 27.07.2009) 35 Ibid. 36 SEE Will Differential Voting Rights work in India, Economic Times, (May 30, 2008), available on http://economictimes.indiatimes.com/Markets/Stocks/ViewsRecommendations/Will_differential_votin g_rights_work_in_India/articleshow/3084229.cms (last accessed on 27.07.2009) 37 Ibid. 38 MANU/CL/0002/2009

34

10

arming them with an effective tool to ward off hostile takeover threat even with a minority holding in the company. 39 Karamjit Jaiswal and his unlisted firm, LP Jaiswal and Sons Pvt. Ltd, together owned 23.59% (8.59% by Karamjit Jaiswal and 15% by his firm) in liquor firm Jagatjit Industries. In pursuance to an approval by the board and shareholders of Jagatjit Industries, LP Jaiswal and Sons Pvt. Ltd. subscribed to 2.5 million shares in Jagatjit Industries, increasing its stake to 19.1% from 15%. However, each of these 2.5 million shares carried 20 voting rights. Karamjit Jaiswal later acquired around 2.19 million ordinary shares, increasing his stake to 13% from 8.59%. With this, he and LP Jaiswal together owned a combined 32.1% in Jagatjit Industries Ltd. However, because of the differential voting rights of the shares acquired by LP Jaiswal and Sons, this minority holding had corresponding voting rights of 62%, giving Karamjit Jaiswal complete control over the company. In 2006, LP Jaiswal and Sons Pvt. Ltd. along with associated persons, after their holding crossed 15% made a public announcement of open offer to the extent of 20% of the voting capital of Jagatjit Industries as required under SEBI Takeover Regulations. 40 Meanwhile Anand Jaiswal and Jagatjit Jaiswal, who together own 12% in Jagatjit Industries filed a petition before the Securities and Exchange Board of India (hereinafter referred to as SEBI) challenging that the pricing of differential voting shares has been done in an inappropriate manner. 41 Moreover, they also contended that the in-principle approval from stock exchanges has not been received and the provisions of Companies Act have been violated. SEBI held in its order that it is not competent to decide the present issue. 42 The powers of SEBI have been enumerated under Section 55A of the Companies Act, 1956. At present, section 55A of the Companies Act, 1956 confers upon SEBI the right to administer certain provisions relating to the issue and transfer of securities and non-payment of dividend in the case of listed public companies and those companies that intend to get their securities listed. Since Section 86 of the Act doesnt

Kalesh, Baiju, Promoters set to benefit from clarity on DVRs, Live mint, (May 6, 2008), available on http://www.livemint.com/2008/05/05235749/Promoters-set-to-benefit-from.html (last accessed on 27.07.2009) 40 Ibid 41 Ibid. 42 SEE Order No. WTM/TCN/01 /CFD/ APRIL /08, (April 8, 2008), available on www.sebi.gov.in/cmorder/jagatjitorder.pdf (last accessed on 27.07.2009)

39

11

come under the purview of the Section 55A, SEBI left it to the Company Law Board to decide upon. Mr. Anand Jaiswal and Jagatjit Jaiswal had petitioned before the Company Law Board to declare a resolution passed at the companys Extraordinary General Meeting on June 16, 2004 as null and void through which 2.5 million preferential shares were allotted to LP Jaiswal & Sons, each share containing 20 voting rights. 43 The Company Law Board upheld the validity of the resolution passed at the meeting thus stating that issue of differential voting shares is permissible under Section 86 of the Companies Act read with the Rules prescribed by Central Government. The Board directed Karamjit Singh and associated persons to buy out, on behalf of the Company, Mr. Anand and Jagatjit Jaiswals stake in the company for around Rs. 73 crores. The company will acquire the stake as buyback of shares in cash, and consequently the equity share capital, will stand reduced to that extent. The transaction is to be completed within three months from the date of the order of Company Law Board. 44 Reforms by SEBI: SEBI has initiated some reforms pertaining to differential voting shares from time to time. In February 24, 2009, SEBI brought out Amendments to SEBI (Disclosure and Investor) Protection Guidelines, 2000 45 . It relaxed the norms laid down in the Securities Contract (Regulation) Act, 1956 for listing in the exchanges in the case of differential voting shares. The Amendment inserted clause 8.3.5.2 which provided for Application by a listed company for listing of equity shares with differential rights as to voting, dividend etc. 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;

CLB intervention may put an end to Jagajit family feud, Economic Times, (March 17, 2009), available on http://economictimes.indiatimes.com/News-by-Industry/CLB-to-put-an-end-to-Jagatjitsfeud/articleshow/4274055.cms (last accessed on 27.07.2009) 44 Ibid. 45 SEE Notification No. SEBI/CFD/DIL/DIP/ 34/2009/24/09

43

12

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. Thus, the rationale behind this amendment was to facilitate the process of listing of differential voting shares thereby relaxing some strict norms required for listing otherwise. Subsequent to the ruling by Company Law Board in the case of Jagatjit Industries Limited, SEBI came up with some changes vis--vis shares with superior voting rights in a SEBI Board Meeting on Primary Market reforms on June 18, 2009. 46 It proposed that no listed company can issue shares with superior voting rights. This was brought in to prevent the possible misuse by the persons in control to the detriment of public shareholders. Because if precedence set by Jagatjit industries Ltd. is followed, the promoters can increase their voting power through issue of these shares by a preferential allotment. Moreover, the present pricing guidelines are applicable to shares having uniform voting rights only. It was a significant change so far the interests of the public shareholders are concerned. Finally, SEBI came up with a circular dated July 21, 2009, making amendments to prohibit issue of shares with superior voting rights. 47 It amended the Equity Listing Agreement, inserting Clause 28A by which the company agrees that it will not issue shares in any manner which may confer on any person, superior rights as to voting or dividend vis--vis the rights on equity shares that are already listed. Though SEBI had amended the Equity Listing Agreement, the respective stock exchanges have to amend accordingly. The prohibition of shares with superior rights brought by SEBI is confusing and contradictory in some aspects. Basically, the shares having superior rights as to voting or dividend or otherwise have been prohibited with no change in issue of shares with inferior voting or dividend rights. So the differential voting shares issued by Tata Motors Ltd. and Pantaloon Retail (India) Limited as discussed earlier can be prohibited on the ground that though the shares give fewer voting rights but it grants a
Vide PR No.192/2009, available on http://www.sebi.gov.in/press/2009/1922009.html (last accessed on 27.07.09) 47 Vide Notification No. SEBI/CFD/DIL/LA/2/2009/21/7, available on http://www.sebi.gov.in/circulars/2009/cirla2.pdf (last accessed on 27.03.2009)
46

13

superior right as to dividend. Moreover, the issuance of normal shares as to voting can also be banned since they are superior to the inferior voting shares. SEBI needs to address these issues immediately otherwise it will only create confusion and delay over the issuance of these shares by the companies.

Conclusion: The issue of shares with differential voting rights has not been used a great deal by the Indian companies. Moreover, it has not attracted the investors so much, one of the prime reasons being lack of awareness about these instruments. Though these shares are a great means to raise capital without much dilution of control, more often than not, these instruments are used by the promoters of the company to have an absolute control over the management of the company by issuing these shares. They tend to misuse their position, thus resulting in loss to ordinary shareholders. The Companies Bill, 2008 also proposes to do away with shares with differential voting rights. Clause 37 of The Companies Bill, 2008 lays down that that the share capital of a company limited by shares shall consist of two kinds i.e. Equity share capital and Preference share capital. In relation to equity share capital, the clause says that it is that part of the issued share capital of the company which has no limits for participation, either with respect to dividend or with respect to capital, in distribution of profits or otherwise. This provision virtually prohibits the issue of the differential rights as to dividend, voting or otherwise recognised by section 86 of the Act. The authors believe the issuance of shares with differential voting rights should not be done away with completely. If the differential voting shares may be divided into two kinds, namely, shares with superior voting rights and with inferior voting rights, it is found that the primary concern of the institutional as well as the retail investors has been having greater control of the company by the management with proportionately lesser economic ownership by issuing superior voting shares through preferential allotment, which may be detrimental to the interests of the investors; and this was the reason for which SEBI issued the circular dated July 21, 2009, which prohibited the issuance of shares with superior voting rights. However, shares with inferior voting rights may be economically beneficial to the retail investors who will be willing to buy shares yielding higher dividend issued at a discounted price. The liquidity and marketability of these shares are likely to increase manifold amongst small investors, 14

who are generally concerned about appreciation of prices and payment of dividend. Moreover, the inferior voting shares are much less susceptible to misuse as against the shares with superior voting rights since they would be issued to investors at large, who would subscribe to such shares only if they have confidence in the companys performance. Thus, instead of prohibiting issuance of differential voting shares completely as proposed in The Companies Bill, 2008, provisions may be inserted permitting issue of shares with inferior voting rights by a company.

15