Sebi has introduced a new rule that will effectively kill the desire of companies to issue shares with differential voting rights. The capital market regulator has made a small amendment to the listing agreement that has a wider impact. It has said that a company shall not issue shares that have either superior voting rights or higher dividend entitlements, compared to the ordinary shares listed on the exchange. The rule is effective from July 21, 2009.
When promoters issue shares to themselves, they would prefer to issue securities with higher voting rights. It means gaining more control over a company’s affairs. But to ensure that minority shareholders do not see red, they usually agree to a lower dividend. The new rule prevents companies from issuing shares with higher voting rights. Rare will be the situation where a promoter will want shares with lower voting rights. So, promoters will most likely never want to apply for DVR shares.
But companies can still issue shares with lower voting rights to public shareholders. That would automatically bump up the promoters’ voting rights. But investors need to be compensated for lower control, so companies give them higher dividends. For example. Tata Motors issued A shares which had lower voting rights (one-tenth of the ordinary shares) but gave shareholders 5% more dividend. This will not be possible any longer.
Companies can compensate only by offering a discount to the market price. This has not worked very well in the past. Investors have not really been able to understand this aspect well, partly to do with estimating the appropriate discount. Also, price fluctuations of the ordinary shares, when the issue is open, play havoc with subscriptions. If companies can’t give higher dividends on DVR shares, investor interest will wane further.
In effect, Sebi’s move will make DVR shares unattractive to both promoters and shareholders. Sebi’s intentions must have been to prevent promoters from misusing this facility to easily get control over a company or to get higher dividends. That may be a valid concern, but could have been dealt with when DVR share issues were allowed. That was done by an amendment to the Companies Act, which comes under the Ministry of Corporate Affairs.
It seems that Sebi would not have been consulted when the rules were being drafter. This would be yet another area where overlapping jurisdictions lead to confusion on key areas. Sebi should be the sole rule-making authority when it comes to listed companies. Take the government proposal to make it compulsory for companies to have a 25% stake to be listed, Sebi should be competent enough to decide on the issue. But if this is how the government plans to force ministries to sell shares of PSUs under their control, the market regulator’s opinion will not matter.