The Hindu Business Line : Splitting shares over face-value

If the regulator feels the Indian equity market has reached the stage where investors can deal with so many different parameters, it could do investors a service by linking dividend declaration to the scrip's quoted value.

THE Securities and Exchange Board of India (SEBI) would be best advised to review the gamut of issues surrounding the splitting of face value of shares before accepting the Secondary Market Advisory Committee's recommendations on the issue.

According to media reports, the Committee has recommended that companies whose scrips are quoting below Rs 500 per share should not be allowed to be split the face value of their share.

This probably takes out more than two-thirds of the listed scrips in the market, which in itself may be a sound regulatory principle, where you allow departures and experimentation on a limited basis. Yet, this recommendation does not resolve the basic problems arising out of the splitting of face value of the listed scrips, which plague the market and confuse most investors.

In its original form, company law permitted corporates to issue shares in the denomination of Rs 10 and Rs 100. The fundamental premise here was that shares with a face value of Rs 100 would be subscribed to, held and traded in by high net worth individuals, corporates and institutions, while the rest of the scrips would have a larger investor base, including small investors.

Linked to the concept of the face value was an equally important principle relating to dividends. Company law in India required corporates to declare dividends on the face value of their share, even if the scrip was quoting at 100 times the face value in the market. This is unlike many developed markets such as the US where dividend declaration is linked to the quoted value.

This linkage between issued price and dividend declared is of significant importance. It allows for easy comparisons between companies by dividend earners. The Indian capital market has not yet reached that stage where dividend earners are significant in numbers or vocal, but the mature equities markets cater to two sets of investors the world over: The risk takers and the "play-safe" dividend earners.

The latter segment comprises widows and pensioners. They are the backbones of companies, the long-term investors who buy stock, lock it in their cupboards and forget about it, living only off the dividends their holdings offer, as opposed to risk takers, the short-term investors who trade in equities to maximise returns. Such investors bring volatility to trade per se, as well as to trades in that particular scrip.Since the law has to be far-sighted and equal, the Indian corporate law had provisions for safeguarding the interests of both sets of equities investors, even if the latter segment had not yet developed fully.

At the ground level, the original provisions had the effect of splitting the equities market into two: Companies which issued shares with a face value of Rs 10 per share and declared dividends on that value and companies that issued shares at Rs 100 and declared dividends linked to that face value. This meant that for bulk of the shareholders, the equities market meant dealing with two variables: The face value, which was largely Rs 10 per share, and dividends declared on that value.

Today, this is not the situation. The market is currently split into five segments, comprising companies that have issued shares at the face value of Rs 1, Rs 2, Rs 5, Rs 10 and Rs 100. Each of them is declaring dividends on the face value, which means investors have to deal with 10 variables and the various permutationsconsidering that over 7000 scrips are listed on the various bourses, which could translate into dealing with 230-odd companies spread across 30 broad industry segments. That is a lot of variables to deal with for uninitiated investors in an immature market!

To elaborate further, let us take an example. Assume there are two companies, A and B, both in the steel sector, issuing shares at Rs 1 and Rs 10 each. Both declare a 100 per cent dividend in the same year. Assume our investor holds 100 shares each in both companies. Now this investor would be wrong if he thinks he has earned the same level of returns from the two companies, for A has yielded him Rs 100 while B has earned him Rs 1000 that year.

That is a 10-fold difference for two companies declaring the same level of dividends in the same industry in the same year and subject to the same kind of external influences.

One would assume this is something that a regulator in an immature market, safeguarding the interests of not too financially literate investors, would take into consideration while formulating laws. Yet, that has not happened.

When IT companies demanded at the peak of the IT boom that they should be allowed to split their shares, the regulator was quick to accommodate the issuers without going into the fallout of this change on ill-informed investors.

Today, the other companies too would like this benefit. So, we have the regulatory mechanism considering a further fragmentation of the market based on quoted price of the share — yet another parameter — without fully evaluating the benefits to the market as a whole.

The moot question that needs to be answered before embarking on this course is what happens when the quoted value falls below the cut-off price of Rs 500? Would the issuer restore status quo, reverting to the original value? Imagine the confusion. Or, would he try to maintain the value of the scrip to avoid the ordeal of reverting back to the original price. Then imagine the potential for price rigging and insider trading!

If the regulator feels the Indian equity market has reached the stage where investors can deal with so many different parameters, why not do the investors a service by linking dividend declaration to the quoted value of the scrip. But that would not suit companies — the vocal and influential segment of the equities market — would it?

For what this really means is that if we were to assume in our example that the scrips of company A and B were quoting at face value in the market, it would translate into these companies being forced to declare a 1 per cent dividend each, instead of cent per cent dividend that they get to announce now! It is time the regulator brought consistency in the laws it introduces. For that, a balance must be struck between the interests of issuers and investors.

(The author, a freelance writer, can be contacted at jayanthiiyengar1@yahoo.com)

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