A Tale of Two DVRs
Differential Voting Rights (DVR) shares, as the name suggests, have different (generally inferior) voting rights than “regular” or “ordinary” shares for a given company. There are many subtle variations in the way these securities are structured and different countries regulate them differently.
The main purpose of issuing “DVRs” is to raise capital or improve liquidity of a company’s stock while mitigating dilution in control of the controlling shareholder. For an investor in DVRs with inferior voting rights, there has to be some reason to buy them such as better liquidity or higher dividend yields. If the incentives are not strong enough, DVRs will trade in the market at a discount to the regular shares. Of course, we are assuming that the companies in question are trustworthy and follow good corporate governance practices. If not, inferior voting rights shares will in any case trade at a discount because holders would expect to be treated unfairly.
Let’s look at two companies with good corporate governance track records.
Berkshire Hathaway Inc., a United States-based company, issued “Class B” common stock in 1996 which has, proportionally, 1/6th the voting rights of the “Class A” common stock. The other main difference is that, at the option of the holder, Class A can be converted into Class B but not the other way around. Out of the total equity capital of Berkshire, 55% is Class A and 45% is Class B. The Class B currently trades at par with the Class A as it should, in my opinion, for as long as minority shareholders are being treated fairly.
Tata Motors Ltd. issued “DVR A Ordinary” common stock in 2008 which has 1/10th the voting rights of the common stock. DVR A shares also get 5% more in dividends than the common. Out of the total equity capital, 85% is common stock and 15% is DVR A Ordinary common stock. The DVR A currently trades at a 50% discount to the common stock. The most convincing, though not good enough, explanation I have seen for such a large discount is the periodic sale of the DVR A shares by the promoter group since 2009. The Tata group was forced to buy more than their allocation of these shares in 2008-09 because the market had crashed in 2008 and the DVR issue was undersubscribed. Another reason usually put forth to explain the discount is that India doesn’t have many DVR securities and that investors are not yet comfortable with this kind of security.
I think the large discount has more to do with DVR regulations in India and the general regulation-enforced inflexibility of the capital structure of Indian companies. Tata Motors management could have tried to reduce the DVR A discount for the benefit of shareholders by effecting a reverse-split of the common stock, splitting the DVR A and allowing one-way conversion from common to DVR A. This would drive everybody but the most stable and large shareholders to the DVR A, thus improving liquidity and acceptance while having the added benefit for the Tata group of increased control over the company. However, Indian law currently does not permit conversion between common stock and DVRs.
I suppose capital structure flexibility will improve as the financial market in India matures. Until then, even DVRs of the best run companies may continue to trade at huge discounts here.
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