In this blog post, Vrinda Saraf, a student at Mumbai University and pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, describes the role of corporate governance in the buy back of shares.
What is Corporate Governance?
Catherwood has defined corporate governance as, “Corporate governance means that company manages its business in a manner that is accountable and responsible to the shareholders. In a wider interpretation, corporate governance includes company’s accountability to shareholders and other stakeholders such as employees, suppliers, customers and local community.”
Corporate governance goes beyond the administration of the company. It alludes to a just, effective and clear functioning of the corporate system of the company.
It refers to a set of systems, processes and practices which assure that the company is managed, keeping in mind the best interests of all the stakeholders.
What is the Buy-back of Shares?
Buy-back of shares means the company purchasing its own shares. It is a widely followed method of capital restructuring all over the globe.
It is a financial strategy which restructures the capital of the company with the aim of increasing the earnings per share, preventing hostile takeovers, increasing the returns to the stakeholders and re-arranging the capital structure.
“The laws related to buy-back of shares in India are covered by the-
- Companies Act, 2013
- Companies (Share Capital and Debentures) Rules, 2014
- Securities and Exchange Board of India (Buy-back of Securities) Regulations, 1998 and Securities and Exchange Board of India (Buy-back of Securities) (Amendment) Regulations, 2013”
Sections 68, 69 and 70 in the Companies Act, 2013 deal with buy-back of shares. Section 67 of The Companies Act, 2013 does not allow a company to buy back its shares, there are, however, exceptions to this rule. With changing circumstances, business ideologies and practices, it was felt that companies should be allowed to do so. Section 68 of the Companies Act, 2013, allows a company to buy back its shares if certain conditions are satisfied.
CORPORATE GOVERNANCE AND BUY BACK OF SHARES:
As stated above, Section 68 permits the buy-back of shares if certain conditions are fulfilled. They include-
- The Articles of Association of the company should warrant the buy-back of shares by the company.
The Article of Association is a document prepared by the promoters and it contains rules and regulations for the management and day to day functioning of the company. It basically contains rules regarding the internal management of the company. Now, according to the Companies Act, 2013, a buy-back is prohibited unless it is sanctioned for in the articles. This speaks a lot on how corporate governance plays the first step in buy-back of shares, as it depends on the promoters and stakeholders of the business to decide if they would want to keep an option of buy back open in the future by inserting the clause in the articles.
- A special resolution of the shareholders is required for a buy-back of shares.
The notice of the meeting where the resolution would be passed should be followed by an explanatory statement in compliance with S. 68(3) of the Act. However, a special resolution is not required if the amount is less than ten percent of the paid-up equity capital and free reserves of the company. A resolution passed by the directors at a board meeting is sufficient for a buy-back.
Again, just as the earlier condition, this condition too involves the directors and other stakeholders of the company and corporate governance again comes in the picture, regulating the buy-back of shares. Another way of looking at it would be that since the articles of association of a company also lay down the matters relating to board meetings, meetings of shareholders and the procedure to be followed, the involvement of corporate governance once again becomes inevitable.
- The funds for buy-back of shares are limited to the company’s free reserves or its securities premium account or the money from the issue of any shares or another specified security.
Again, as mentioned in the articles, are provisions relating to reserves and share capital of a company. The articles again warrant the arrival of corporate governance in the buy-back procedure.
Other conditions required which are necessary for buy back of shares are-
- The company must maintain and update a register containing all the particulars of the shares which it has bought back.
- When a company engages in buy-back of shares, it is prohibited from making a further issue of the same type of shares for the next six months. However, the company can issue bonus shares and can “discharge its subsisting obligations” for example, issuance of sweat equity shares, conversion of preference shares or debentures into equity shares.
- A declaration of solvency must be filed with the ROC and SEBI before the resolution for buy-back is given effect to.
- The process of buying back must be completed within one year from the date of the resolution passed.(shareholders or directors, as the case, may be)
- The buy-back may be-
- from the existing shareholders on a proportionate basis or;
- from the open market;
- by buying the shares issued to the employees in relation to a scheme of stock option or sweat equity.
- The company should physically destroy the shares it has purchased back within seven days from the date on which the process of buy-back becomes complete.
- After the process of buy-back is completed, the company must file a return (according to the prescribed format) with the ROC and SEBI within thirty days of the completion of the process.
- The penalty for failure to comply with any of the regulations above or any law made by SEBI in connection to this matter, is punishable. The company has to pay a fine starting from Rupees one lakh to Rupees three lakh. Also, every officer in charge of the default is punishable with imprisonment up to three years or with same fine (one lakh to three lakhs) or with both.
- Section 70 of the Companies Act, 2013 further states that the buy-back should take place directly by the company, and not through another vessel like a subsidiary company or an investment company.
It goes without saying that the companies which are listed on the any recognized stock exchange will have more compliance requirements according to the laws and regulations made by SEBI in this respect in addition to the Companies Act 2013 and other rules.
As seen from the above conditions, corporate governance plays an indisputable role in the buy-back of shares whether directly or indirectly.
CASE STUDY: RELIANCE INDUSTRIES
In 2000, Reliance Industries came out with a buy-back plan. They had cash flows in excess of Rupees three thousand crores, and this helped them for the buy-back. The Reliance stock was performing well despite the fluctuating stock market. The timing of the buy-back is rather interesting as the stock exchange was on a declining spree and Reliance was heading for an overseas listing.
According to the guidelines laid down by SEBI, if a company was going for a buy-back of shares, it couldn’t raise new equity for the coming two years. This was important as Reliance was going for an overseas listing. It meant that the overseas listing would convert the GDR’s to ADR’s. Analysts believed that the buy-back plan would help Reliance in getting a better overseas listing price and would also lift its stock price on the local stock exchanges. The guidelines also stated that Reliance would have to mandatorily cancel the shares that it has bought back.
The buy-back price was set at Rupees 303 and the market price of the shares at that time were Rupees 303. This announcement leads to a swelling in the share price, however, the company was unable to make any buy-backs as the market price was more than the buy-back price and the shareholders were unwilling to sell the shares.
The non-willingness of the shareholders to sell the shares denotes that the investors in the company believed in the company to deliver better results in the future and they were positive about its growth.
CASE STUDY: SUN PHARMA
This year, Sun pharma announced a buy-back of 7.5 million shares at price of Rupees 900 per share, and the promoters indicated that they would be interested in participating in the buy-back.
However, analysts feel that this method has been adopted “as a tax-efficient tool”, due to the size of the issue which is valued at 100 million USD and the promoters participation in the process and not due to “attractive valuations”. The analyst further states that he would have been worried if the company would have announced a bigger buy-back, over and above the dividend which would be based on the valuations. It is felt that, this route has been chosen “as an alternative route for cash distribution”.
The promoters participation in addition to the process (tender offer) and the premium of 20% given to the shareholders, the analysts do not agree that they find the company’s valuation to be enticing as suggested by the buy-back offer.
Also, it is possible that after this buy-back the dividends declared by the company my further dip, which would be detrimental to the interests of the shareholders.
CONCLUSION:
As it is known, the onus of overseeing the strategies and performance of the company rests on the shoulders of the board of directors, they must take decisions which would benefit all the stakeholders of the business, without compromising on the interests of any. They must frame their policies and enforce them so as to maximize the benefit of all stakeholders. In the same manner, while buying-back of shares, it should be kept in mind that the shareholders are not at a loss, all regulations are complied with and the highest degrees of ethics are practiced. It is good corporate governance that takes certain companies that extra mile compared to others and indisputably, it should be followed in all practices.
