Abstract
The value of vote hypothesis states that the value of differential voting rights reflects the value of private benefits of control enjoyed by controlling shareholders with superior voting rights at the expense of minority shareholders with lower voting rights. Although the extant evidence is generally consistent with this hypothesis, it is inconclusive, and based mainly on studies in developed economies. We first synthesize the evidence on this issue in the emerging economies. Next, we provide new insight on this subject with description and analysis of a proposed regulatory change for removal of the 10 % voting cap in the banking sector in India in 2005. We hypothesize that removal of the voting cap would increase the probability of a takeover and induce positive value gain for banks that the proposal relates to. Consistent with our prediction, we observe significant abnormal returns of 7.8 % for private Indian banks over the 2-day interval surrounding the announcement. Cross-sectional analyses further reveal that the valuation gain is inversely proportional to the bank’s foreign and insider ownership. This study makes important contributions to the growing literature on the valuation impact and efficiency gains of liberalization of foreign ownership restrictions in emerging markets.
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Notes
- 1.
However, as we note later in the paper, voting caps and ceilings exits in several European countries.
- 2.
Khanna and Yafeh (2007) argue that in underdeveloped countries, concentrated control by business groups may be more efficient for poorly-managed economic institutions. Some control by management may also prevent expropriation by other control groups, and control can also motivate monitoring. Adams and Ferreira (2008) present a detailed review of this literature.
- 3.
India imposes a 10 % cap (26 % cap since January 2013) on the voting rights of foreign investors in private banks which, according to many market observers, is acting as a major barrier to foreign banks taking large ownership positions in Indian banks despite a 74 % ownership limit. As a result, there is increasing pressure on the Government and the RBI to relax the voting cap and allow proportional voting rights. However, supporters of the voting cap maintain that as a sector of “strategic importance”, the banking sector is the channel not just for monetary policy but also for many preferential policy directives. For example, they highlight the thrust on “financial inclusion” and “micro finance” in the Indian context. It is a natural anxiety for many of these market participants that foreign banks will not have the necessary commitment to developmental priorities of the host country (Dr. Rupa Rege Nitsure, Chief Economist, Bank of Baroda, December 2006).
- 4.
Ghosh et al. (2008) note that predominantly FIIs owned stocks in Indian banks, which implies that foreign investors were more interested in short-term gains with no long-term commitment.
- 5.
Section 12(2) of the 1949 Banking Regulation Act states that, “No person holding shares in a banking company shall, in respect of any shares held by him, exercise voting rights on poll in excess of ten per cent of the total voting rights of all the shareholders of the banking company.” The only exceptions were the Government of India which was the majority owner in nationalized banks, and the RBI.
- 6.
Questioned on the reasons for placing a restriction of 10 % on voting rights as presently applicable under the Act, the Ministry, in a written reply inter alia informed: “The reasons for placing restrictions on voting rights arose primarily from the concern that permitting proportionate voting rights to the promoters may result in abuse by them such as problems of credit concentration and credit diversion that had beset the banking sector in the past, prior to nationalization.”
- 7.
Ghosh et al. (2012) discuss this period in detail. Throughout this period, the foreign investment community pressured the Indian Government for further liberalization of the capital market. For example, On March 20, 2004, K.N. Memani, the Chairman of the American Chamber of Commerce in India, expressed disappointment that US-based investors are not enthusiastic about investing in Indian private sector banks despite the Government hiking the foreign direct investment cap to 74 % because the voting cap prevented foreign investor from having any effective control on the decision-taking process.
- 8.
A long list of studies have explored these issues. We do not review these studies individually in the interest of brevity. Interested readers are urged to look at Claessens and Van Horen (2012) for more details on these studies.
- 9.
Interested readers are referred to Ghosh et al. (2013) for a detailed discussion of the institutional and political developments that forced the central Indian government to send the bill for debate at the parliament as well as empirical analysis of the determinants of the observed positive stock reaction around the announcement of the introduction of the bill to amend the Banking Regulation Act.
- 10.
A promoter is a person or entity who exercises substantial control over the company or a person who undertakes all necessary steps in the floatation of the company. The relationship between a promoter and a company which he has floated must be deemed to be a fiduciary relationship from the day the work of floating the company started. Control shall include the right to appoint the majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholding agreements or voting agreements or in any other manner.
- 11.
In 2003, only three private banks had holdings by foreign promoters (or, direct investors). One of these ownership positions was divested by 2005.
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Ghosh, C., Petrova, M. (2014). Security Voting Structure and Firm Value: Synthesis and New Insights from Emerging Markets. In: Boubaker, S., Nguyen, D. (eds) Corporate Governance in Emerging Markets. CSR, Sustainability, Ethics & Governance. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-642-44955-0_1
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