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Dual class share system: Putting appropriate safeguards in place

M Thenmozhi and Aghila Sasidharan   | Published: May 06, 2019 21:01:30


Many investors prefer to invest in securities that give high returns with low risk. But one should make such investments only after reviewing the merits. In recent times, there has been a lot of discussion about dual class shares. As a result, it is gaining the attention of investors. Key stock exchanges in Asia-Pacific (Hong Kong and Singapore) are moving towards dual class shares.

Dual class shares refer to different type of shares issued by a single company with different voting rights, popularly known as Differential Voting Rights (DVR). There are two classes of shares, one with enhanced voting rights and the other with limited voting rights. Such class of shares enable firms to retain controlling rights and provide limited rights to shareholders in lieu of higher returns for their investment. Dual class share structure allows the entrepreneurs to maintain control of their companies even after the successive rounds of financing. The New York Stock Exchange allows the practise of dual class system and companies such as Facebook and Google have them.

Dual class shares are being introduced in the Asian Markets to attract more IPOs. Hong Kong and China introduced the dual class system in shares, this year. Two Chinese companies-smart-phone maker Xiaomi and food delivery app Meituan Dianping-were listed in Hong Kong with weighted voting rights. But adoption of dual share class in Asian exchanges will result in over-concentration of power in the hands of a few shareholders. Hence, Asian countries like Bangladesh need to make sure that they have taken appropriate safeguards before adopting dual class share system.

In some countries like Singapore and Russia, many companies are closely held by the promoters through this system. In such companies, shareholders are often a minority to begin with.

Dual class system in India is still at its nascent stage and Indian companies can issue only DVR shares.  DVR shares are like ordinary shares with fewer voting rights. The holder of such shares can enjoy all the rights such as bonus shares and right shares which the holders of ordinary shares are entitled to. Various provisions of Companies Act,2013, such as section 47 and 48, ensure the protection of shareholders belonging to different classes.In 2008, Tata Motors took the first initiative to implement the provision of DVR (one vote for every 10 DVR share) for repayment of loans, followed by Pantaloons.

The question that strikes the investors mind is: how are DVR shares different from ordinary shares? The answer is simple. DVR offers low voting rights to investors compared to ordinary shares and normally, DVR shares trade at a discount (DVR shares are always quoted at a 30 to 40 per cent discount). In order to compensate the voting rights, companies give higher dividend to the person who holds DVR. Small investors are benefitted from DVR, because they do not want to cast their vote regularly and the price differential between ordinary shares and DVR is sometimes very high.

Minority shareholders and small investors can move to DVR to take advantage of high dividend and still participate in management decision making process to a limited extent. DVR shares are favourable for companies who do not have enough funds to distribute profits and for those who want to raise funds or repay loans through shares retaining control rights. Venture firms, family-owned firms and those who want controlling interest prefer to issue dual class shares. Such shares will attract those investors who are interested only in returns and investing in such shares can generate high returns on their investment.

M Thenmozhi is Director, NISM & Professor at IIT Madras.

Aghila Sasidharan is Research Scholar at IIT Madras. The views expressed are those of the authors and do not reflect the opinion of the organization(s) they represent.

aghilak.k4@gmail.com

 

 

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