Private control with Public money: How far can we go?

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In India, listed entities are prohibited from issuing equity shares with superior rights as to voting or dividend. The markets regulator came out with the consultation paper in March, after an Advisory Committee submitted a report recommending the use of DVRs as a mode of capital raising in listed companies. Vidhi’s response paper is based on review of recent academic literature and an assessment of the peculiarities of India’s capital markets. The paper has cited research that shows that over time, the potential advantages of dual class stock structures (as DVRs are known internationally) tend to recede, and the potential costs tend to rise. This holds true for even those DVR structures which are accompanied by appropriate protective mechanisms.

According to Vidhi’s response paper, DVR structures can be particularly problematic in markets with concentrated ownership patterns, as is the case in India. More specifically, such structures might encourage founders to take risks more aggressively (with lesser accountability) as the economic consequences of their decisions will be disproportionately borne by the public shareholders.

Capital structures which enable promoter/founder-led companies to raise capital while preserving control, either through retaining shares with superior voting rights or issuing shares with lower or fractional voting rights to public investors are at variance with the well-recognised corporate governance principle of ‘one share one vote’ (especially in publically listed companies).

 The debate around the desirability and efficacy of such capital structures, which has been a contentious and long-standing one in corporate law scholarship, rekindled after Google’s initial public offering (IPO) in 2004, after which other major companies such as Facebook, Zynga and Alibaba also made mega listings by implementing different versions of DCS. Globally, the permissibility and implementation of DCS structure varies greatly: while some countries such as Denmark, Netherlands, Switzerland, and more recently, Hong Kong, permit such structures (the applicability of limitations on the use of such structures varies across jurisdictions), other countries such as the United Kingdom, Germany, Spain, Australia and China, prohibit the use of DCS structures.

 In the event that SEBI decides to permit the issuance of DVRs for listed entities in India, we propose that they be permitted in limited sectors where the founders’ vision and involvement is critical in the lead up to the company’s IPO and immediately thereafter, subject to a mandatory sunset provision of one year after which their superior voting rights should fall away.

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