India is witnessing a growing trend of shareholder activism, where investors are increasingly being viewed as positive participative forces. Past instances have shown that in the right circumstances, shareholder activism can contribute to unlocking value for all shareholders. Further, shareholder activism is not necessarily limited to isolated individual instances of demand for change. Rather, in a developing market, it assumes the role of being a catalyst in fostering an atmosphere of good corporate governance and structural stability.
Private companies, with sizeable investments from institutional investors, in the natural course of their growth cycle, may seek listing in the future. This, in addition to other macroeconomic factors, should result in a larger number of listed companies in India witnessing more dispersed shareholding (i.e., lesser concentration of promoter shareholding and larger share of public shareholding, both institutional and retail) in the future. The legal and financial infrastructure is also facing a push towards this direction. For instance, the government's proposal to increase public float in listed companies to 35% (thirty-five per cent), on the belief that, inter alia, a larger participation by the public in a traditionally promoter driven market such as India, would promote stronger corporate governance and transparency. While shareholder activism as a concept continues to evolve in the Indian context, there are two key recent developments worth noting that may have a role to play in shaping this phenomenon further.
Superior Voting Rights
In 2009, SEBI had barred listed entities from issuing shares with superior rights on the apprehension of possible misuse of superior voting rights and the detrimental impact on other shareholders. By a press release dated June 27, 2019, followed by amendments to the SEBI Listing Regulations and ICDR Regulations on July 29, 2019, SEBI decided to permit tech companies (intending to be listed) to have shares with superior voting rights ("SR Shares"), and set forth the framework to govern such SR Shares (the "DVR Framework").
As per the DVR Framework, to-be-listed companies in the 'tech sector' are permitted to issue SR Shares to promoters who occupy an executive position with the issuer. The understandable intent appears to provide impetus to promoter dependent businesses, to be able to scale and go public. This flexibility aims at aiding promoters in retaining control while permitting dilution in shareholding to raise capital. Despite the well-meaning intent, the very concept of superior rights necessarily creates the existence of a disadvantaged class, in this case, the other shareholders. This concept itself, aggravated by the prevailing promoter dominated Indian corporate culture, could potentially: (a) deter and dissuade other shareholders who have until recently, and largely still today, been passive shareholders, from participating in the affairs of companies with SR Shares; and (b) counteract the thrust towards a more active investment environment driven by stronger corporate governance, transparency and active shareholder participation.
The regulators appear to have considered this and in order to address such concerns, included certain safeguards in the DVR Framework, in the form of, amongst others, sunset provisions for lapse of such superior rights. However, two prongs under the event based sunset provisions, in their current form, are likely to further complicate matters for the other shareholders due to lack of clarity.
To explain the issue further, per the event based sunset provisions, SR Shares must mandatorily be converted into ordinary shares, inter alia, on either: (i) merger or acquisition of the issuer of such SR Shares, if pursuant to such merger or acquisition, the holders of the SR Shares are no longer in control of the issuer; or (ii) the SR Shares being sold by their holder. It is unclear how these event-based sunset provisions will apply in companies having more than one promoter holding SR Shares. For example, if there is a merger or acquisition pursuant to which one of the promoters holding SR Shares cedes control of the issuer but the other promoter, along with the acquirer, continues to remain in control of the issuer – will the SR Shares held by such other promoter (who continues to retain control of the issuer) be converted into ordinary shares, or only the SR Shares held by the transferring promoter be converted?
This assumes significance in the context of exit opportunities and valuations for promoters and other shareholders. In a situation where there is more than one promoter holding SR Shares, and if such two (or more) promoters are unable to work together for any reason, the ability of any promoter to exit would be significantly curtailed as his superior rights cannot be transferred, and if the other promoter(s) continue to retain their superior rights, acquirers may not be willing to provide optimum value for such acquisition. The knock-on effect would be felt by other shareholders, where either the acquisition bid itself fails and an exit opportunity is lost, or the exit price is sub-optimal due to the inability of the exiting promoter to obtain what would otherwise be a fair price. Further, in such a scenario if the promoter opts to wait until the time-based lapsing of the SR Shares, operational challenges during the intervening period could lead to lost opportunities and ultimately, destruction in value for all shareholders. Furthermore, if one were to rewind and move up the timeline a bit further, this framework highlights certain complex issues to be considered regarding the acquisition of 'control' and the related requirement of making an open offer in the first place, in a scenario where an acquirer enters a company where there are existing promoters with SR Shares.
Structural overhangs (such as the above) on meaningful exit opportunities would dilute and erode the positive effects of activism by shareholders. Hence, it is important that appropriate clarifications are introduced by SEBI on the foregoing.
Regulation of Proxy Advisors
The second update in relation to shareholder activism is the SEBI working group's report on issues concerning proxy advisors dated May, 2019 (the "Report"). Proxy advisory firms play a very important role in shareholders' engagement with the management by bridging the gap between management proposals and strategies, very frequently enmeshed in accounting and financial jargons, and the company's shareholders.
These firms are relatively new in the Indian context. Given the thrust towards a broad based diversified corporate culture, proxy advisory firms will increasingly play the required role of facilitating a meaningful interaction between the shareholders and the management, and will play a key role in shareholder activism going forward. In this spirit, the SEBI working group has rightly adopted the stance that overregulation, particularly in the form of any restriction on scope of advice or role of proxy advisors, would thwart their positive impact on corporate governance.
In this regard, the one concept that is worth emphasis, and assumes center stage in any form of governance discussions is conflict of interest. Further, given the limited number of institutions in the field and their dual capacity role – one that of an advisor to the shareholders and the other as a consultant to corporates, conflicts are bound to arise. While such dual role is recognized to have the positive effect of a holistic redressal of issues, the working group's recommendations on enhanced procedures with respect to managing conflict of interest (to ensure objectivity and independence), and the manner in which they have to be disclosed by proxy advisory firms, should be in the mandatory compliance bucket rather than in the general 'comply or explain' bucket.
While shareholder activism as a concept evolves and gains traction in the Indian context, it would be interesting to see how changes in law, which are result of rational and justifiable intent actually pan out in practice. The accommodative approach adopted by the SEBI working group with respect to regulation of proxy advisory firms should be viewed as pragmatic and mature to let certain matters be guided by market forces and sentiments, particularly in a developing economy. On the other hand, measures like the DVR Framework, which are promoter oriented, are likely to dampen the spirit of shareholder activism. As such, the DVR Framework will be a good test to see whether the intent of long term value creation by promoters, which is the intent behind this new initiative, is welcomed as a value enhancing opportunity, or the practical implications of it result in investors becoming wary of investing in such structures for the fear of locking in value and compromising on exit opportunities in an already restrictive and promoter influenced market (thereby curtailing the shareholder activism trend).
 Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015
 Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018
 Defined to mean companies, which are "intensive in the use of technology, information technology, intellectual property, data analytics, bio-technology or nano-technology to provide products, services or business platforms with substantial value addition."
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