WEALTH CREATION AND DVR

Shares of different classes are very common but in India only four companies have issued shares with differential voting rights (DVR). DVR shares are similar to ordinary shares but they carry lower voting rights and receive extra dividend for the sacrifice. A DVR shareholder has the right to attend the Annual General Meeting (AGM) and the right to vote which is in a ratio lesser than that of an ordinary shareholder. Globally, DVR shares trade at a discount of 10-15 per cent to the ordinary shares but in India this discount is very high and has, for example, touched a peak of 64 per cent for Jain Irrigation.

A DVR issue can help the company address the following objectives: a) increase share capital without substantial dilution of stake for promoters, b) separation of economic interest and voting interest, c) thwarting hostile takeovers, and d) rewarding passive shareholders by offering them cheaper shares and higher dividends.

This instrument can be used by the management to their own advantage and hence a SEBI circular of 2009 prohibits companies to issue shares with higher voting rights and higher dividends. Since Tata Motors and Future Retail issued DVR shares before this guideline, these are the only two companies which offer higher dividends to DVR shareholders. In fact, Tata Motors is the first company in India which raised funds by issuing DVR shares as a right issue and offered a discount of 22 per cent to the prevailing price and 5 per cent additional dividend over the ordinary shares. All other companies issued DVR shares to the existing shareholders as bonus shares.

Spreads are a measure of the difference between the prices of two classes of shares. A higher spread indicates the discount at which DVR shares are trading on the exchange and having an opportunity for higher gains. As the underlying fundamentals of the company are the same, the share price of both the classes of shares should behave similarly; however statistical results as measured by Engle-Granger’s residual-based co-integration approach proves, both classes of shares of Tata Motors and Future Retail have a long-term association whereas Jain Irrigation and Gujarat NRE do not reflect such a bond.

Descriptive Statistics of Spreads

Large spreads suggest the deep discounts at which such DVR shares are available. Since a majority of retail investors are passive investors, the focus should be on long-term growth prospects in a company and wealth creation. As such, they should invest in DVR shares and take the advantage of higher dividend and higher discount. If the spread decreases and an investor wishes to possess voting rights, he or she can sell the DVR and purchase ordinary shares. The risk of investing in the company is shared equally by both classes of investors, and hence such deep discounts are unjustified.

Profile of Ordinary and DVR Shares

DVR shares trade at a discount for two reasons. One is the liquidity issue and second is the voting rights’ issue. Data on average traded quantity suggests that Tata Motors’ DVR has relatively high trading volumes and the average spread is not justified with liquidity. Dividend yields for DVR shares issued by Tata Motors and Future Retail are much higher than for the ordinary shares. The compounded annual growth rate (CAGR 2013-2015) strongly suggests that returns on DVR are relatively higher than ordinary shares. DVR shares can be of great interest for the banking sector which will have to raise additional capital (in excess of 2.5 lakh crore) to comply with Basel III norms. Banks can raise fresh equity from the market without diluting control.