Perils of dual class shares

Sebi should not rush to import foreign norms to India

The Securities and Exchange Board of India (Sebi) has constituted a committee to examine the norms governing the issue of shares with differential voting rights — dual-class shares, as they are also known — by listed companies in India. Worldwide, such shares are used, particularly by companies in the technology sector, so that ordinary investors can participate in the growth shown by these companies in valuation while allowing the original promoters or founders to retain control even with small beneficial interest. From the Indian perspective, the hope is that companies operating in the Indian market will be encouraged to list in Indian stock markets, thereby reinvigorating the currently anaemic initial public offering scene. While foreigners will then be able to invest, managerial control will be retained by Indians. Certainly, there is a good reason to suppose that encouraging such firms to list closer to home will be a good thing. It is also a valuable principle that more ways to structure the raising of capital are better for markets in general. 

Yet the Indian circumstances are such that Sebi should be very cautious in changing the norms governing dual-class shares. A few companies have taken advantage of existing possibilities in terms of differential voting rights in India, and the shares so issued now trade at a far greater discount than when they were issued — and the market for them is relatively thin. This reflects the simple fact that trust in Indian promoters is not particularly high. It will be impossible to restrict the issuance of dual-class shares to just the tech “unicorns” that are being stated as a possible reason for liberalisation of differential voting norms. Nor can such shares be limited only to those companies with “good” records on corporate governance. When rules change, they change for all listed companies. 

And so, the question that must be asked is, what the impact of such shares would be on corporate governance more broadly. As recent studies on corporate governance have shown, Indian promoters are adept at managing the rules in order to retain control of their companies to the detriment of minority shareholders and other investors and creditors. This is in spite of the fact that, on paper, India has some of the most stringent regulations in terms of protecting minority shareholders in the world — reflected in the high ranking given to these rules in the World Bank’s Ease of Doing Business report. A change in this would adversely impact the flow of capital into the Indian equity markets. Other aspects of the Indian case should also be considered: For example, in jurisdictions such as the US, it is easier to force promoters to follow their fiduciary duties through the court system than in India. And then what of the future? What happens when companies that issue differential voting shares have to plan for a succession? Even if the founders are to be trusted, can the second generation be as reliable? Dual-class shares create a mechanism for permanent family control that would be particularly pernicious. What happens after the founder? His family retains control, even with no business acumen. And they can never be ousted. For all these reasons, Sebi should not rush to any judgment about importing foreign differential voting norms into India.