Summary
This article explains the concepts of ordinary equity shares and Differential Voting Rights or DVR shares. It also discusses the major similarities and differences between these two classes of shares. The article will also delve into some of the provisions in the Companies Act 2013 regulating the issue of DVR shares and provide examples. Lastly, the article explains the risk-return tradeoff inherent in the issue of DVR shares.
As an investor, you might come up with various different kinds of shares while trading in the market. DVR shares have different voting rights for the shareholder as compared to ordinary shares. In this article, we shall dive deep into the intricacies of both share types and help you understand their characteristics.
What are ordinary shares?
Ordinary shares are tokens that represent ownership of a company. The latter issues ordinary shares with the aim of raising equity capital. Holders of ordinary shares are the owners of the company. Consequently, equity shareholders have a say in the running of the company.
Owners or equity shareholders determine company policy by exercising their voting rights at the company’s Annual General Meeting (or AGM). Normally, one ordinary equity share possesses one voting right. As owners of the company, equity shareholders also participate in the financial results of the company and are paid dividends as a reward for their capital contribution. The company’s Board of Directors generally decides upon the quantum of dividend to be paid to shareholders.
What are DVR shares?
As the name suggests, Differential Voting Rights or DVR shares are issued by companies that provide the investor with greater or lesser voting rights compared to ordinary shareholders. In addition, DVR shares may hold sweeteners like a comparatively higher dividend payout to compensate for their lower or lack of voting rights.
DVR shares are mostly preferred by retail investors who do not influence company policies by voting. As the number of shares held by these smaller investors is not significant, their votes do not materially affect the direction of the company. Consequently, DVR shareholders receive a higher dividend payout as a reward for giving up their voting rights.
Issuing DVR shares is also beneficial for a company’s promoters as they can raise capital from financial markets to finance company growth without ceding control of the future direction of the company’s policies.
Some companies in India have issued DVR shares. Tata Motors was the first Indian entity to issue DVR shares in 2008. Following this, DVR shares were also released by Jain Irrigation, Future Enterprises, and Gujarat NRE Coke.
What are the regulations governing the issuance of DVR shares in India?
Unlike in the US, in India, companies aren’t permitted to issue shares with multiple voting rights. Voting rights in DVR shares must necessarily be lower than that of ordinary shares. Besides, there are several stipulations for issuing shares with DVRs in India according to the Company’s Act 2013 including:
- The company must have reported profits for at least three years preceding the issuance of shares with DVRs.
- The company must file accounts for these years without any discrepancies.
- The value of the issued shares with DVRs mustn’t exceed 25% of the company’s share capital.
Similarities and differences between DVR shares and ordinary shares
DVR shares and ordinary shares are similar in certain features but different in others. The two share categories have similar rights in the issuance of bonus shares and share issue rights. However, the two share categories also have significant differences:
- DVR shares have lower voting power when compared to ordinary equity shares.
- As they have lower voting power, DVR shares enjoy higher dividends when compared to ordinary equity shares. A premium is paid to DVR shareholders that is over and above the dividend receivable by ordinary equity shareholders, as compensation for the lack of or lower voting rights.
- DVR shares are often sold at discounts compared to ordinary equity shares, due to their lack of voting power.
Advantages of holding DVR shares
DVR shares provide benefits to both issuers and investors. Some of these advantages include:
- Involvement in the company’s decision-making process: DVR shareholders needn’t play an active role in the strategic direction and management of the company. This can save small and passive investors a lot of time and money. On the other hand, issuers of DVR shares can raise capital efficiently without the promoters ceding control of the company.
- Lower price compared to ordinary shares: Due to the lack of voting power, DVR shares sell at discounts compared to ordinary shares. This feature makes this share category more affordable and attractive to investors.
- Higher return on equity (ROE): As DVR shareholders receive a dividend premium compared to ordinary shareholders and pay a relatively lower price for their shares, their ROE is higher consequently.
In conclusion
On balance, investors interested in gaining exposure to DVR shares must ensure that their return on equity is sufficiently high to compensate for not having a say in the company’s decision-making process. On the other hand, the issuers of DVR shares must ensure that the dividend premium payable on the shares, as well as the discount offered on these shares are adequate in order to attract potential investors.