Calling the tune

IFR Review of the Year 2014
10 min read

The curious governance structure of Alibaba, the Chinese internet retailer, has focused attention on dual-class shares and how stock exchanges around the world should view corporate efforts to keep control at the top.

Alibaba has had quite a year. In September, the Chinese internet-based business services company founded by Jack Ma in his bedroom in 1999 completed the largest IPO in history, raising US$25bn on the New York Stock Exchange. Investors ploughed into a stock that surged, paused, then rose again, hitting US$118.50 a share on November 7, up 68% in the seven weeks since its debut.

That pushed the firm’s market capitalisation beyond the US$280bn mark, far outstripping the valuation of Walmart, the world’s largest bricks-and-mortar retailer. On November 5, the firm issued its first financial results since its listing, posting a 15% year-on-year rise in net income in the quarter to end-September, with revenues up more than 50% over the same period to US$2.74bn.

The rapidity of Alibaba’s ascent to greatness and its control over its home market (where it accounts for four-fifths of all Chinese internet sales by volume) are certainly worthy of considerable attention, but there is another reason that the company is of interest to the geeky souls who examine the entrails of global capitalism: its curious and, some say, antediluvian governance structure – and how the wider world of finance has reacted to the way it has chosen to structure itself.

The Hangzhou-based company has a board, just like most sizeable corporations, listed or not. Alibaba’s formal directors include Masayoshi Son, the founder and CEO of Japanese conglomerate SoftBank, Joseph Tsai, an executive vice-chairman who helped land a vital US$1bn investment from search firm Yahoo in 2005, and Ma himself. A quartet of independent directors that includes Tung Chee-hwa, the septuagenarian former chief executive of Hong Kong, and Yahoo co-founder Jerry Yang, complete the nine-man board.­


Yet there is another force at work, hovering above the fray: an elite band of 28 “partners” – carefully chosen individuals who guide and supervise Alibaba’s official board, and thus also the company’s thinking and strategy. These partners choose who is put forward for a majority of the board positions, then vote to approve those very nominations, creating a closed loop of governance that apes the way that the US Senate approves the president’s cabinet nominees.

This “supergroup” of directors isn’t a new invention: it was formed by Ma in 2010 explicitly to speed up internal decision-making, while helping an increasingly bulky firm to operate with greater agility. The list of partners includes – again – Ma and Tsai, along with the likes of Alibaba’s chief financial officer Maggie Wu, and chief executive officer Jonathan Lu.

To be elected (read: elevated) to the 28-person upper board, you have to be listed as an Alibaba employee for at least five years, and to have made a major impact on the firm’s bottom line – hence the addition of the likes of the SoftBank CEO. You then need to be nominated by three existing partners and vetted by the partnership committee, before securing the approval of at least 19 partners in a straight up-or-down vote.

For those inside the fold, the structure makes good sense. Alibaba is in a growth phase. It wants to blaze its own trail, spending and investing as it sees fit, rather being guided by a quarterly need to generate dividends and hit earnings estimates.

Indeed, in a famous 2009 speech, Ma made clear his reservations about short-termist fund managers, placing them last in a pecking order of importance behind customers and employees, and urging “Wall Street investors” to “curse [Alibaba as a result] if they wish”.

For those outside this charmed circle, life is very different. Alibaba’s structure allows investors a limited say in how the company is run, whether they buy one share in the company or a million.

Investors don’t buy securities in a company called Alibaba; rather, they acquire stock in a Cayman Islands-registered company called Alibaba Holdings, partly in order to circumvent strict Chinese capital controls.

Common shareholders have some power. They get to vote for independent directors. And they could gang together to vote against a future board nominee. But the effort would be futile. The 28-strong partnership would simply respond by picking a new and equally internally acceptable candidate. A genuinely unhappy investor is thus left with a single form of protest: selling his or her shares.

To be sure, Alibaba stopped short of forming a dual-class stock structure prior to its blockbuster IPO, a model that has in recent years become increasingly popular among technology firms, including Groupon, Facebook, and Zynga.

Here, founders and key early investors – individuals who have often built the firm up from nothing, and who possess a high level of loyalty for, and affiliation to, their offspring – retain Class A shares, while offering Class B shares – which typically bear considerably diluted voting rights – to investors during a stock offering. That helps insiders to maintain control of a firm even after it goes public.

Dual-class share structures have long divided stock exchanges around the world. They are allowed in Continental Europe, just as they are in the US, a country that, notes Sean Geraghty, a partner at law firm Dechert, boasts “a very sophisticated technology-focused investor community that’s willing to look at new ways to do things”.

US regulators also offer a high level of protection to investors, through stringent reporting requirements and a class-action litigation system, offsetting the negatives inherent in multi-share class structures. By contrast, Britain banned most such structures in the 1960s and has never looked back; the structures are also barred in Hong Kong and Singapore.

Yet Alibaba’s mammoth float has led to a rethink within many of the world’s leading bourses. Hong Kong in particular was burned by the Chinese firm’s decision to plump for a second home on the NYSE.

Alibaba knew Hong Kong well: it floated shares there once before, in 2007, before delisting them five years later. It was keen to re-engage with the Hong Kong Stock Exchange – the bourse was its number one choice of destination for its new listing – but the two sides failed to reach an accord.

Alibaba refused to bow to Hong Kong’s one-person-one-vote regulations, which would have undermined the supervisory power of its elite group of partners. HKSE chiefs in turn were unwilling to bend the rules in order to embrace a corporation, however powerful, whose listing structure offered significantly less redress to smaller shareholders.

Change of direction?

But Hong Kong’s thinking changed after the loss of Alibaba. Foreign and local media lined up to query the city’s admirable, or stubborn (according to your preference), reluctance to bend the rules.

In late August 2014, the Hong Kong exchange issued a three-month “concept paper” to institutional and retail investors, aimed at gauging public opinion about companies with structures along the lines of Alibaba. Regulators are expected to announce before the end of 2014 whether to approve minority-control voting structures outright, to retain the ban, or to restrict it to specific industries.

David Graham, head of listings at Hong Kong Exchanges & Clearing, the holding firm that oversees the HKSE, showed his hand by emphasising the need to retain the city’s financial competitiveness.

“This is about Hong Kong as a financial centre,” he said when the paper was launched. “This is a development that may be potentially encouraging companies to list elsewhere.”

The same vexing challenge faces Singapore, which underwent a good amount of soul-searching in 2012 after the Glazer family dropped plans to list its football club Manchester United in the city-state, moving the IPO to New York instead – driven by a desire to maintain control of the asset while diluting their stake.

Other cities have adopted a different tack. London’s one-person-one-vote system is unlikely to change any time soon. Institutional investors in the City are hardly likely to support measures that lessen their say in how a listed corporate is run.

In the same vein, politicians would struggle to approve rules that undermined traditional corporate governance structures so soon after a long and distressing recession, caused largely by lax financial regulation.

Indeed, if anything, notes Dechert’s Geraghty, London is “heading in the opposite direction: tightening up provisions, and preventing big shareholders from riding roughshod over rules. Having a small number of people with supermajority voting rights [in charge] wouldn’t work in modern London, which is now geared to ensure that investors can participate fairly in the governance of a listed company”.

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Calling the tune