Concept:
Shares with differential voting rights (DVR shares) are like ordinary equity shares but with differential voting rights. They are listed and traded in the same manner as ordinary equity shares. However, they mostly trade at a discount as they provide fewer voting rights compared to ordinary equity shares. Companies generally compensate DVR investors with a higher dividend.
Background:
In India since 2001, issue of DVR shares has been allowed. These can be used to thwart hostile takeovers, as for all practical purposes, they decouple economic interest and voting rights. Shares with DVR are mainly targeted at passive investors. In most cases, small or retail investors hardly exercise their voting rights, nor do they have an understanding of corporate affairs to an extent that they can influence corporate actions. They invest in shares only for economic returns. Therefore, they give away their voting rights in favour of those investors who run the company and have management control. Thus, this mode offers investors an avenue to acquire shares at lower prices with prospects of higher dividends in return for surrendering their voting rights.
Importance:
DVR shares offer investors an opportunity to earn better returns in lieu of surrendering their voting rights and also allow a company to dilute its equity without matching dilution in the promoters’ stake. At times companies issue DVR shares to fund new large projects. This also helps strategic investors who do not want control but are looking at a reasonably big investment in a company.
Legal requirement:
Section 86 of the Companies Act permits the issue of equity shares with DVRs, subject to conditions prescribed under the Companies (Issue of Share Capital with Differential Voting Rights) Rules, 2002.
Conditions:
Rule 3 provides that every company limited by shares may issue shares with differential rights as to dividend, voting or otherwise, if apart from specified procedural compliances, it conforms to the following:
- It has distributable profits in terms of section 205 of the Companies Act, 1956 for three financial years preceding the year in which it was decided to issue such shares.
- It has not defaulted in filing annual accounts and annual returns for three financial years immediately preceding the financial year in which it was decided to issue such shares.
- The issue of such shares cannot exceed 25% of the total issued share capital of the company.
Global perspective:
A large number of global giants have raised funds through DVR issues, prominent among them are Google, NewsCorp and Berkshire Hathaway.
Indian scenario:
While DVR is a well-accepted instrument used by blue-chip companies in international markets to raise funds, even after a decade of the government’s Notification, the concept is yet to gain wide currency in India.
Pantaloons Retail India Ltd. Bonus Issue:
In July 2008, PRIL, India’s leading retailer, was the first to issue bonus shares with a DVR option. The company made a bonus issue of 1: 10 shares with differential voting rights and 5% additional dividends as well. Although there is no fund-raising involved in a bonus issue of shares, the idea was to get the markets familiar with such instruments and create another alternative to raise funds in the future. “Differential voting rights (DVR) has become a widely used innovative instrument in global markets and by coupling a bonus issue with a DVR, we believe in enhancing alternatives for our shareholders,” Kishore Biyani, MD of PRIL had stated in a press release.
Gujarat NRE Coke Ltd. DVR:
In September 2009, the company issued B Equity Shares of the Company with Differential Voting Rights (DVR Shares) with lower voting rights (1/100th of the voting right of ordinary equity share). The same were issued as bonus shares in the ratio of 1 B equity shares for every 10 equity shares held.
The above illustrates the past one year relative performance of the ordinary equity share (512579) vis-à-vis the DVR share (GUJNREDVR) and the broader markets (BSE Sensex). We find that while both the ordinary as well as the DVR share have moved in a direction opposite to the BSE and have witnessed reduced share prices; the magnitude of the fall for DVR (29%) is less than that of the ordinary share (39%).
(Source: Google Finance)
Tata Motors DVR:
In October 2008, Tata Motors became the first Indian company to make a rights issue of shares carrying differential voting rights (DVR) (issue size: Rs.1960.42 crores). DVR shares have 1/10th of voting rights of ordinary shares and offer a 5% higher rate of dividend over the normal shares. It issued these shares at Rs.305 i.e., about 10% lower than the issue of normal rights at Rs.340.
The diagram shown alongside illustrates the past one year relative performance of the ordinary equity share (500570) vis-à-vis the DVR share (TATAMTRDVR) and the broader markets (BSE Sensex). We find that while both the ordinary as well as the DVR
share have outperformed the BSE; the magnitude of the gain for DVR (39%) is less than that of the ordinary share (48%).
(Source: Google Finance)
Conclusion:
For an investor, who believes in being a part of the company’s decision processes, DVR shares are not attractive due to limited voting rights.
However, if one is a minority investor and isn’t concerned much with voting rights per se, then investing in the DVR would certainly be an attractive proposition. DVRs mostly trade at a discount, largely due to the fewer voting rights they enjoy. However, at times, the gap between DVR and ordinary shares is large, providing good opportunity to investors. (Globally, the discount between shares with DVRs and ordinary shares is about 10%.) Not only does an investor stand to gain from capital appreciation in a scenario where the price difference between the ordinary and the DVR share reduces over a period as a result of rising awareness about the product, he will also be entitled to higher dividends. Furthermore, he can always invest back in ordinary shares by exiting DVRs once the differential narrows. Thus, the riskreward ratio of investing in DVRs looks somewhat skewed towards the latter. The only caveat is that before investing in a DVR, investors need comfort about the company’s fundamentals and prospects, and more importantly, its management.
