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Shareholder rights

2014-09-22 06:14:48

Out of control

More of the world s big stockmarkets are allowing firms like Alibaba to

sideline their shareholders

Sep 20th 2014 | New York, Paris and Shanghai

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.

Shareholder autocracy

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.