by The Economist
FOR New York Stock Exchange (NYSE), the listing of Alibaba, a giant Chinese e-commerce website, seems like a triumph. As The Economist went to press, the firm was pricing the offering; its shares were due to begin trading on September 19th. Amid all the excitement about whether the IPO would prove the world’s biggest, another of its striking features has been largely forgotten: shareholders will have little control over how the firm is run.
Alibaba only listed in New York because Hong Kong Stock Exchange, a more natural home, insists that shareholders have a say over management in keeping with their stake. The firm’s owners, who balked at this notion, took their business to a more pliable venue. Technically, every Alibaba share has equal rights, but they are circumscribed ones. A pre-defined cabal of 30 managers of Alibaba or related companies, including the firm’s chairman, Jack Ma (pictured above), will control nominations to a majority of seats on the board. According to Alibaba’s prospectus, this group “may make decisions with which you [the shareholder] disagree, including decisions on important topics such as compensation, management succession, acquisition strategy, and our business and financial strategy”.
Alibaba says this structure is needed to preserve the firm’s culture. It is not that different from many tech firms, both Chinese and American, that have two or more categories of shares, some of which confer more say in the running of the company than others. Advocates of such skewed set-ups argue that they allow the founders of fast-growing firms to raise the necessary capital to pursue their long-term ambitions without having to deal with short-term mood swings among investors. By the same token, media companies with similar rules claim that allowing a small group of shareholders to maintain control preserves editorial integrity.
“Dual-class” structures were common in America in the 1920s but were largely stamped out in a populist campaign led by William Ripley, a Harvard professor who labelled the practice a “crowning infamy” to “disenfranchise public investors”, according to a paper by Stephen Bainbridge of the University of California Los Angeles. There were exceptions—notably the listing of Ford in 1956 on NYSE and of media firms on the American Stock Exchange, a second-tier market—but Ripley’s philosophy was largely intact until the 1980s when the rise of corporate raiders brought less democratic regimes back into fashion.
The Securities and Exchange Commission, the main market regulator, responded with a ban in 1988 but a court ruled that the agency had exceeded its authority. In a comprise, the SEC gave companies substantial discretion to choose their structure at the time of an offering, but not thereafter, on the grounds that this would allow investors to understand what they were buying and invest accordingly. Tech firms, led by Google, embraced the idea; few now list without some arrangement that guarantees the founders’ continued sway.
As a consequence, America accounts for the lion’s share of public companies that give disproportionate rights to certain shareholders, with 55% of the 524 such companies in the global database of MSCI, a financial-data firm. Canada is a distant second with 40, although many firms in Europe resort to other measures that distort ownership rights. Britain used to have many such listed firms, but largely abandoned the practice under pressure from big investors. The Financial Conduct Authority, Britain’s market regulator, recently issued a formal ban on skewed voting structures for firms listed on the London Stock Exchange’s main market.
Several jurisdictions seem to be moving in the other direction. The European Union considered imposing a one-share, one-vote rule on all members in 2007, but abandoned the idea as the financial crisis set in. Earlier this year France adopted the “Loi Florange”, designed to block unwanted foreign takeovers. It doubles the voting rights of shares held by the same owner for more than two years at all listed French firms unless by-laws are amended to say otherwise. Almost two-thirds of the CAC-40, France’s largest quoted companies, already offered multiple voting rights to loyal shareholders, says Jean-Nicolas Caprasse of Insitutional Shareholder Services, an advisory firm. France also allows a form of listed limited partnership in which it is very hard to dislodge the boss, points out Hubert Segain of Herbert Smith Freehills, a law firm. Hermes, a fashion house, is one and Lagardere, a media group, another.
Last month Hong Kong’s bourse published a “concept paper” on corporate structures that would give control to select shareholders. The public has three months to comment. While the exchange itself has said it is undecided either way, Charles Li, its head, has given every indication that he would like to see the rules relaxed. “Losing one or two listing candidates is not a big deal for Hong Kong, but losing a generation of companies from China’s new economy is,” he wrote last year.
Singapore also bans dual-class shares but, partly as a result, has struggled to attract tech start-ups. It also lost out in 2012 on the listing of Manchester United, a football team, due to the desire of the controlling family to cash in without forfeiting control. The finance ministry has proposed changing the rules to allow dual-class listings; investors and lawyers believe it is only a matter of time.
Despite the temptations of blockbuster tech listings, investors dislike the idea of diminished control. The Asian Corporate Governance Association surveyed its members, including big international asset managers, pension funds and universities, about the possible introduction of dual-class structures in Hong Kong. On average, they said it would lower their valuations of firms listed there by 13%. “It would be a disaster,” says Mark Mobius of Franklin Templeton Investments, a fund manager.
There are good grounds for such misgivings. In addition to the risks that potentially lucrative takeovers may be prevented and poorly performing managers might prove impossible to dislodge, there is also the danger that those controlling a firm will make decisions that benefit them, at the expense of other shareholders. A study published in 2012 by the Investor Responsibility Research Centre Institute, a think-tank, concluded that American companies that diverge from the principle of one-share-one-vote suffer from lower returns, higher share-price volatility and various other ills including weak accounting controls and damaging transactions with related parties. Much other research corroborates these findings.
It does not help that Alibaba does not own the websites that generate its revenues (it could not list in New York if it did, since Chinese law bars foreigners from owning local websites). Instead, the listed firm owns the rights to those revenues, under a type of contract that it believes to be valid but, its prospectus admits, is the subject of “substantial uncertainties” under Chinese law.
If there is one lesson to be learned from the mix of bargains and dross on Alibaba’s e-commerce sites, it is “buyer beware”. Its shares and those of similarly structured companies may reinforce that idea.