The Hong Kong stock market has long relied substantially on mainland Chinese companies to list there. In recent years, the mainland firms represented 70 per cent of the turnover; whereas about 60 per cent of the IPOs are from China. This consequently makes attracting more quality firms from other countries to list in Hong Kong a high priority, if the city is to become a real international market. In September 2013, Chinese e-commerce giant, Alibaba, abandoned its efforts to list in Hong Kong, due to the regulators’ refusal to relax the listing rules. If otherwise successful, this would have been one of the biggest IPOs in recent years, with a potential transaction of HK$100 billion (£8 billion) transaction.[1] Thus, the loss of Alibaba IPO has sparked concerns on whether Hong Kong should reform its listing rules.
Same Share, Different Votes?
The controversy of Alibaba’s plan was centred on its bid for a waiver of Hong Kong listing rules to allow its partnership structure. This would allow the 28 partners, mainly founders and senior executives, to keep control over a majority of the board, even though they collectively own only about 10 per cent of the company. Traditionally, companies are allowed to issue different categories of shares (e.g. ordinary shares & premium shares). Each has its own defined rights and investors can choose what to buy accordingly. Thus, it usually poses no problem to issues of transparency and fairness.
However, the dual-class stock structure Alibaba wanted to adopt runs contrary to the normal scenario. This dual-class structure allows the subdivision of ordinary shares into Class A and Class B shares, in which the different classes have distinct voting rights and dividend payments. Usually, only the share class with limited voting rights is publicly traded; while the other non-traded stock is offered to company founders, senior executives and family. This enables shareholders of non-traded stock to retain control of the firm with a relatively small amount of total equity in the company.
In fact, these types of dual-class share structures are not that exceptional. In the US, there are several hundred companies with dual or even multiple class listed shares, most notably Ford and Google. [2] These non-conventional structures are more often found in media and technology companies. The rationale behind is that these innovation-intensive markets are more volatile. Thus these structures are necessary to allow them to focus on long term goals, avoiding the inconsistency of policies by shareholders who are more concerned about short-term rewards.
However, even if this justification could be accepted, the dual-class structure is subject to numerous objections and criticism. Firstly, such arrangements undermine the fundamental ‘one-share, one-vote’ principle, causing substantial unfairness to investors. They create an inferior class of shareholders, regardless of their capital contributions to the company. The overriding management power is handed over to a selected few, who are then enabled to shift the financial risk onto others.
More importantly, they subject the companies to greater problems with their corporate governance. They allow management to make bad decisions with limited consequences. This is why dual-class companies are more prone to executives’ abuse of their control to their own advantage. Academic research reveals that shareholders with super-voting rights are reluctant to raise cash by selling additional shares, since that would dilute these shareholders’ influence. Dual-class companies also tend to be burdened with more debt than single-class companies.[3]
Dual Shareholding Structure in Hong Kong
Dual-class stock structures are not entirely new to Hong Kong. Back in the 1980s, a number of listed companies were authorized to create a dual shareholding structure by issuing both Class A and Class B shares. These listed companies were predominantly family businesses which aimed to retain control of the board, and to ultimately avoid falling victims of hostile takeovers. Nevertheless, this measure of expediency created significant unfairness for investors. Contrary to the US, there is no right to class actions in Hong Kong, so it is comparatively more difficult for individual investors to bring litigation against the wrongdoers. Therefore, in 1987, the Hong Kong Securities and Futures Commission (SFC) and the Hong Kong Stock Exchange (HKEx) decided that listed companies should no longer be able to have dual or multiple class stock structures. They then made a joint declaration to prohibit listed companies’ further issuance of Class B shares. Class B shares have subsequently become rare in Hong Kong.
Reform in Hong Kong? For Better or Worse?
The HKEx chief executive Charles Li suggested they should be granting a waiver as a measure of expediency, since Alibaba’s is a special case. However, as it then was, expediency should not override transparency and legitimacy in a fair and open stock market. This case once again highlights the conflict of interest for HKEx’s dual role as IPO regulator and a publicly traded company that benefits from listing fees and trading volumes. Back in 2003, the expert panel of the Hong Kong government has proposed the merging of HKEx’s listing authority into the SFC. Yet, only a small part of the recommendation was adopted in the end.
In light of the concerns in recent years over Hong Kong’s competitiveness as an international financial centre, the government’s top financial advisory body, Financial Services Development Council, has begun a review of Hong Kong’s listing regime in late November 2013.[4] It is argued that resolving the regulator’s conflict of interest, and maintaining the transparency and fairness of the stock market, among others, should be the key elements of the proposal of any potential reforms.
Footnotes
[1] Alibaba abandons Hong Kong for York, sources say, South China Morning Post (25 September 2013)
[2] http://en.wikipedia.org/wiki/History_of_Google
[3] P Gompers, J Ishii and A Metrick, ‘Extreme Governance: An Analysis of Dual-Class Companies in the United States’ Rodney L. White Center for Financial Research Working Paper No. 12-04
[4] HK Financial Services Development Council, ‘Strengthening Hong Kong as a Leading Global International Financial Centre’ FSDC Research Paper No. 01 (2013)
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