The latest version of the Companies Bill tabled in Parliament seeks to weed out the practice of creating treasury stocks—a controversial tool through which a company owns a stake in itself. The Bill provides that whenever companies are merged, such shares should be extinguished.
This will pull the plug on the “trust” route that many companies have adopted in the past and others continue to.
What irks the activist investors and their advocates is that equity placed in such trusts retains its voting rights and then becomes a back-door route through which promoter groups can shore up their control over the company. This is a practice that should have no place in modern corporate governance.
A more fundamental objection is that treasury stock is like loose change in management’s hand that can be used to manipulate the market. Globally, both buy-backs and mergers create treasury shares. So a company can buy back its shares cheap and sell when prices appreciate—something a management could possibly time to its advantage. In India, however, this argument has less force since treasury stock is only created through mergers. Shares bought back, according to Indian regulations, have to be extinguished. So Indian companies can sell at treasury stock at will—if they have any—but can’t create it at short notice.
The biggest advantage of treasury stock for companies is that they can sell it in the open market to generate quick cash. This flexibility is crucial in hard times when issuing other kinds of equity is difficult. Secondly, the sale of treasury stock doesn’t require fresh issuance of shares and, hence, there is no dilution of earnings per share. These advantages, from the perspective of companies that own such stock, are far outweighed by the disadvantages from a governance perspective.
The bone of contention then really is the voting rights companies enjoy. If those rights are stripped, the whole manoeuvre of creating a convoluted legal structure through a trust will become pointless. The minority shareholders can then seek comfort in proportionate voting rights while the management gets to retain a stockpile it can sell in pieces when needed.
The current Bill will eliminate one of the furtive ways in which promoters can exert overarching influence over their companies. But it will also plug one of the more flexible ways of raising cash.
Should treasury stock put aside in trusts by companies have voting rights? Tell us at email@example.com