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  • Niharika Mukherjee

The DVR Conundrum from a Corporate Governance Perspective

[Following is the post authored by Niharika, student at National Law School of India University, who secured the second position at IDIA Odisha Article Writing Competition 2023.]

The Securities and Exchange Board of India (SEBI)’s 2019 Framework on Differential Voting Rights (DVR) shares represented a curious volte face in its position on these shares. Having followed a highly restrictive approach towards regulating them for a decade prior to the release of this framework, the SEBI seemingly persuaded by the potential benefits of these shares for ‘technology companies’ that, having asset-light models face exacerbated difficulties in securing debt capital, took a significant step towards liberalizing their use.

However, I argue that while the rationale behind this policy change was sound, the final framework misses the crucial factor that makes DVR shares useful in the first place. That is, their ability to offer a quid pro quo of higher dividends for lower voting power, to a wide range of retail shareholders, who are typically uninterested in corporate control in any case. SEBI’s failure to recognize this primary purpose of DVR shares, I argue, has led to undermining the potential for these shares to facilitate a viable model of corporate governance that would ease corporate leadership by dedicated and visionary founders, rather than short-term profit seeking institutional investors.

To make this argument, this article is divided into three parts. Part I reviews some of the key legal and economic arguments for the use of DVR shares, in terms of their capacity to facilitate good corporate governance. Part II argues that SEBI’s 2019 framework clearly ignores the primary benefits of DVR shares as noted in the relevant literature, and, by being overly restrictive, fails to accomplish its objective to any desirable extent. The article concludes with recommendations for modifying the framework drawn from the arguments made herein.

Part I: Merits and Demerits of DVR Shares for the Health of Corporate Governance

DVR shares are controversial. It is simple to see why -- because they undercut one of the fundamental principles of the almost unanimously accepted ‘agency theory’ of the modern corporation, that is, a tying together of corporate control with economic ownership. The general acceptance of the need to tie these two facets of the relationship between a shareholder and a company are obvious -- tying them together helps to ensure that a shareholder will, to protect her rational economic interests, exercise diligence and prudence in playing her part in taking decisions affecting the company.

While the tying together of control and ownership makes perfect sense in theory, it is evident that in present day, and particularly in the Indian market, shareholders other than wealthy institutional investors have little effective role in shaping corporate governance. The average retail investor, therefore, invests in equity shares not so much to have their capital grow over a long duration as much as to make visible gains in the short run, in the form of dividends. Therefore, it is rational, economically, for a retail shareholder to value higher dividends more than substantial voting rights, at least compared to a founder or promoter, who may not only have a substantially large economic stake in the company, but also have a long-term vision for how the company can produce consumer (and shareholder) value over time. This difference in the expected preferences of retail investors versus founders has prompted the introduction of shares with differential voting rights -- that is, voting rights not proportional to economic ownership of shares, in contrast to ordinary shares -- in jurisdictions across the world.

Given this logical, and intuitive rationale behind DVR shares, literature across law and economics proposes that they carry the following types of benefits:

  1. Applying the Coase theorem popularly used in the economic analysis of law, DVR shares promote efficiency. They do this by decreasing the transaction costs of moving goods from those who value it less to those who value it more. The goods, in this context, are voting rights and dividends, which are transferred from retail investors to founder-shareholders, and from founder-shareholders to retail investors respectively. DVR shares allow for this bilateral transfer to take place at one go, without requiring complicated exercises in consensus-generation among retail investors by founder-shareholders.

  2. DVR shares promote investment in innovation. While enhanced corporate control by institutional investors is likely to privilege short-term growth over long-term innovation in a company, concentrating control among founder-shareholders allows for the latter to be adequately prioritized. As DVR shares offer a mechanism for generating capital without letting go of control by founder-shareholders -- albeit more likely from a wide mass of retail investors as opposed to a narrow set of wealthy institutional investors -- they facilitate innovation-friendly corporate governance.

  3. DVR shares protect companies from hostile takeovers, thus freeing up more resources for value-generation. They are seen as particularly effective safeguards against hostile takeovers because, unlike other takeover defenses, they do not necessarily involve trading off a significant degree of financial health for the sake of retaining control over the company.

  4. DVR shares offer a voting structure more suited to a company than ordinary shares. While this is arguable, a prominent school of thought on corporate governance argues that the ‘one-share-one-vote’ principle is more suited to ‘pure democratic relations’ than the modern corporation, which more closely resembles a ‘nexus of contracts’ or a ‘nexus for contracts’. The latter concept privileges contract-fulfilment and economic efficiency over a political or moral idea of democracy, and DVR shares, by putting control in the hands of those most likely to privilege the long-term interests of the company- namely, founder-shareholders- are a better-suited instrument to achieve this.

Part II: SEBI's Failure to Leverage DVR-based Incentives

It is clear from the above list of benefits from DVR shares that they are useful for company founders distributing economic ownership (hence, generating capital) from a disaggregated mass of retail investors, without losing control over corporate control. This is possible, most conveniently, by selling many ‘inferior voting rights’ to many retail investors, while retaining ‘ordinary’ or ‘superior voting rights’ shares with the founder-shareholder. However, unfortunately, SEBI’s 2019 framework for regulating DVR shares completely misses this point by disallowing IVR shares -- shares that provide the buyer with voting rights disproportionately low relative to the economic stake associated with it, typically with the promise of higher dividend payout than ordinary shares -- from being sold by companies altogether. This means that companies intending to use DVR shares can only use ‘superior voting rights’, that is, those shares which offer higher voting rights to some shareholders relative to their economic stake.

While this may facially seem no different from the use of IVR shares, the crucial difference is this: IVR shares can be sold to many retail investors, meaning disaggregation of economic ownership and concentration of control among the founder-shareholder, in exchange for higher dividend payouts. On the other hand, SVR shares can only be sold to founder-shareholders, keeping the remaining capital structure unchanged - meaning that the remnant of the economic and control stake in the company is not disaggregated to the degree possible through IVR shares. Thus, SEBI’s 2019 framework allows only for DVRs to be used to privilege founder-shareholders, but not to also incentivize retail shareholders to buy shares of companies offering these shares.

Whose interests, then, does the framework serve? The answer is simple: institutional investors. It is simple to see how. SEBI’s framework reveals the board’s intention for DVR shares to be used by asset-light fund-hungry ‘technology companies’, including, most prominently, tech startups, presumably to allow their founders a method of winning the ‘battle for control’ they typically face against wealthy institutional investors.

However, without the instrument of IVRs, which could allow such founders, at the time of taking their company public, to gain capital from a wide mass of retail investors without giving up control, founders are left to use DVR shares in only one way: that is, by convincing their institutional investors to allow founders to retain control through SVR shares, while the investors bring their capital to the company. While some startups with highly influential founders have been able to carry out this task at least in earlier stages of funding -- the prominent Indian example being that of Ola -- for most others, this is a nearly impossible task.


Following the argument made above, SEBI’s 2019 framework on DVR shares clearly misses the point of these shares altogether, thus depriving Indian companies from reaping the corporate governance benefits of these shares. To rectify this, the framework must be modified to allow companies to sell not only SVR shares, but also IVR shares, with higher dividends, freely. This will make DVR shares a powerful shield for founders to use against institutional investors, without needing to make a difficult tradeoff between gaining capital and retaining control.

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