Differential Voting Rights - Advantages, Example of DVR Shares

Differential Voting Rights (DVR) shares are a special class of equity shares that offer different voting powers compared to ordinary shares. In the Indian stock market, most DVR shares provide fewer voting rights but compensate investors with higher dividend payouts. For example, a company might issue DVR shares where ten shares carry only one vote, whereas one ordinary share carries one full vote. This structure allows companies to raise capital without founders losing control of the business. For retail investors, DVR shares are often attractive because they usually trade at a discount on the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE), offering a cheaper way to own a piece of a high-quality company.

What are Differential Voting Rights (DVR)?

Under the Companies Act 2013, specifically Section 43(a)(ii), a company limited by shares can issue equity capital with differential rights as to dividend, voting, or otherwise. Most people are used to the one share, one vote rule. DVR shares change this rule to meet specific needs of both the company and certain types of investors.

In India, current regulations primarily allow for inferior voting rights. This means you get a smaller say in company meetings than an ordinary shareholder. To make these shares appealing, companies usually offer two main incentives:

1. Higher Dividend Rate: You might receive 5% to 10% more in dividends than ordinary shareholders.
2. Discounted Price: These shares typically trade at a significant discount to the ordinary share price on the stock exchange.

Why do Companies Issue DVR Shares?

Companies choose the DVR route for several strategic reasons that benefit the long-term stability of the business.

• Retaining Promoter Control: Founders often need to raise huge amounts of money to expand. If they issue too many ordinary shares, they might lose their majority stake. DVRs allow them to bring in money while keeping the voting power in their own hands.
• Preventing Hostile Takeovers: Because DVR shares have limited voting power, an outsider cannot easily take over the company by just buying these shares from the open market.
• Attracting Passive Investors: Many retail investors do not care about voting in annual meetings. They only care about capital growth and dividends. DVR shares are designed specifically for this group.
• Funding Large Projects: When a company needs to fund a massive acquisition or a new factory, DVRs provide a way to get equity funding without a governance chaos that might come with too many new voting members.

Differences Between DVR and Ordinary Shares

It is important to understand how these two classes of shares compare before adding them to your portfolio.

Feature	Ordinary Shares	DVR Shares
Voting Rights	1 Vote per Share (1:1)	Fractional (e.g., 1 Vote per 10 Shares)
Dividends	Standard Dividend	Usually 5% to 10% Higher
Market Price	Higher (Market Value)	Lower (Traded at a Discount)
Liquidity	Usually High	Often Lower
Best For	Investors seeking control/voice	Passive investors seeking income

Read more: Difference between DVR and Ordinary Shares

Rules for Issuing DVR Shares in India

Not every company can just start issuing DVR shares. The Securities and Exchange Board of India (SEBI) and the Companies Act have strict requirements to protect investors.

1. Articles of Association (AOA): The company's rulebook must explicitly allow the issuance of DVR shares.
2. Shareholder Approval: An ordinary resolution must be passed by the existing shareholders in a general meeting.
3. Profit Track Record: The company must have a consistent record of distributable profits for the last three years.
4. No Defaults: The company should not have defaulted in filing annual returns or financial statements for the last three years. It must also be clear of any defaults in paying dividends or repaying loans.
5. Limit on Total Shares: Total shares with differential rights cannot exceed a specific percentage of the total post-issue paid-up equity capital. Recently, this limit was updated to 74% of the total voting power for certain cases.

Famous Example: Tata Motors DVR

The most well-known example in the Indian market is Tata Motors. In 2008, Tata Motors became the first company in India to issue DVR shares (often called A ordinary shares) to fund its acquisition of Jaguar Land Rover.

In this case:

• Voting Rights: 10 DVR shares carried only 1 vote (a 1:10 ratio).
• Dividend: DVR holders were promised a 5% higher dividend than ordinary shareholders.
• Price: The shares were issued at a discount to the ordinary shares.

For many years, Tata Motors DVR was a favorite among value investors because it allowed them to own the same business at a much lower price while earning more dividends. Recently, the company announced a plan to simplify its capital structure by converting these DVR shares back into ordinary shares, which highlights that companies can choose to unify their share classes later on.

Advantages of DVR Shares for Retail Investors

If you are a small investor, DVR shares offer several clear benefits:

• Lower Entry Cost: Since they trade at a discount, you can buy more shares with the same amount of money. If ordinary shares cost Rs. 1,000 and DVRs cost Rs. 600, your capital goes much further.
• Better Dividend Yield: Because you paid less for the share and you get a higher dividend amount, your yield (return on investment from dividends) is much higher than that of an ordinary shareholder.
• Participation in Growth: Apart from the voting rights, you get all other benefits. You are eligible for bonus shares, rights issues, and share splits just like any other owner.

Risks and Limitations

While the discount sounds great, there are trade-offs to consider:

• Lower Liquidity: Fewer people trade DVR shares compared to ordinary shares. This means if you want to sell a very large number of shares quickly, you might have to accept a slightly lower price.
• Price Gap Persistence: The discount between DVR and ordinary shares can stay for a long time. There is no guarantee that the gap will close quickly.
• Limited Voice: If you are an investor who likes to participate in company governance or question the management at meetings, these shares will limit your ability to do so.

Conclusion

Differential Voting Rights shares are a unique tool in the Indian equity market. They offer a middle ground for investors who are happy to trade their voting power for better financial returns. By buying these shares at a discount on the NSE or BSE, you can increase your dividend income and own a stake in established companies at a lower cost. However, always check the liquidity and the specific dividend policy of the DVR before investing.