Alibaba’s New York IPO: A wake-up call for Asia
By: Dr Emir HRNJIC
September 8, 2014
Over the past two decades, we’ve become used to hyperbole about the latest “big thing” to come roaring out of the thundering engine that is the Chinese economy. In the case of e-commerce giant Alibaba, however, we have an example that is living up to the hype.
When Alibaba floats on the New York Stock Exchange, it is expected to be one of the biggest IPOs in history – a watershed moment for Chinese firms, especially Chinese tech firms, on the global stage.
Most analysts expect the IPO to eclipse Facebook’s $16bn floatation in 2012 and possibly even the 2008 Visa IPO, the largest ever in the US.
But the decision to float in the US also marks something of a wake-up call for exchanges here in Asia, who risk losing out on some high value listings unless they prove more accommodating to firms pushing for dual class offerings.
Once Alibaba stocks start trading – now expected sometime in September – speculation is high that the firm will raise $20bn or more. That would value Alibaba at around $150bn, an amazing feat for a business founded in 1999 by English teacher Jack Ma.
Ma had originally wanted to list Alibaba in Hong Kong and spent more than a year trying to do so.
The territory seems a natural fit because of language as well as cultural and geographical proximity. In addition, the overwhelming bulk of Alibaba’s revenues - 86.9 per cent in 2013 - originate within greater China and investors there, many of whom have used Alibaba’s services, understand its business.
Nevertheless, Hong Kong regulators rejected Alibaba’s application due to its unique (and complex) governance structure, designed to keep control within a small group of partners.
In process, regulators overlooked the provision which allows dual-class share structure under “exceptional circumstances” (Rule listing 8.11); perhaps to avoid setting a potentially awkward precedent.
Either way, after a year of talks, the inflexibility of Hong Kong regulators prompted Alibaba to turn its attention instead to the US market.
The move marked a significant loss for Hong Kong, which missed out on a prestige opportunity to add a dynamic and high-profile tech firm to its listings and diversify its China listings away from the current concentration on the finance and property sector
But Alibaba’s decision to list in the US also has important implications for Asian regional markets as a whole, including here in Singapore which has seen a dearth of major IPOs in recent months.
Singapore also expressly bans dual-class shares because of concerns over “entrenchment of control”. The only exception to this rule is media group Singapore Press Holding; its “management” shares have 200 votes each as compared to “ordinary” shares with one vote each.
The pervasive criticism of dual class structures in Asia is that they are unfair, giving one group of shareholders disproportionate influence over corporate governance.
Specifically, dual class share structures give this one (usually very small) class of shareholders higher voting rights than another class, although both are entitled to the same dividends. For instance, a firm’s founder may hold 5 per cent of cash flow rights, while holding 50 per cent of voting rights.
Alibaba, for its part, wants to retain a corporate partnership structure that gives the firm’s founding partners effective control of the board. The reasoning, it says, is to preserve the firm’s culture shaped by the founders.
It’s a similar model to that found in other major internet floatations such as LinkedIn, Facebook and Google.
In fact, dual-class share structures have been allowed on all United States exchanges since 1985, and have been used by more than six hundred firms, including Nike, Visa, and Manchester United.
Costs and benefits
But critics of dual-class share structures argue that they are not equally fair to all shareholders and could even be detrimental to the interests of those with lower voting rights.
Shareholders with higher voting power, usually top executives, may decide to consume extravagant perks and take excessive risks, with the consequences disproportionately borne by other shareholders who have almost no say in the matter.
Studies have found that companies that have insider voting rights, such as in a dual-class share structure, also tend to have lower market value. This suggests that a company’s founder may decide to accept a lower valuation of the company in order to maintain control.
One recent study also found that CEOs of companies with dual-class share structures receive higher compensation and make worse acquisitions.
But such structures clearly have benefits too.
Proponents argue that they allow controlling shareholders to pursue their long-term vision, protecting the firm from pressure from public investors who prefer short-term outcomes.
Dual class listings can also incentivise and ease the transition for company founders to take their companies public, without the fear of losing control.
Moreover, compared to other ways of retaining founder control - such as pyramid ownership or cross-shareholdings like those frequently used in countries such as South Korea and Japan – the dual-class share structure is simpler and more transparent.
Another stream of research shows that shareholder value is improved by dual-class share recapitalisations, which is when companies with a single-class share structure adopt a dual-class share structure.
Compared to single-class firms of similar sizes within the same industry, such firms have grown on average 20 per cent more than other firms and earn 23.11 per cent higher stock returns over a four-year period.
Two factors have been shown as critical in determining whether firms and their shareholders benefit from having a dual-class share structure: the transparency of the company, and the level of its managers’ talent.
On the former, recent empirical studies have shown that transparent dual-class share structure firms perform better. For example, a decrease in opacity of 10 per cent for a founder-controlled firm with a dual-class share structure led to a 5.2 per cent increase in firm value, compared to non-dual-class, non-founder controlled firm of a similar size and in the same industry.
This is consistent with the notion that insiders in transparent firms focus on shareholder value enhancement, while those in opaque firms are more likely to seek to entrench themselves.
The recent theoretical model suggests that dual-class firms with talented managers perform better, while those with less talented incumbents may use the dual-class structure to exploit minority shareholders and destroy the value.
Implications for SGX
The question then is if the US has managed to successfully implement dual-class share listings - and in doing so lured major IPOs like Alibaba away from Asia - is it time to for markets here in the region, such as Singapore’s SGX, to follow suit?
One caveat is that circumstances in the US are different from those in Asia. The exchanges there are more mature and there are more influential and activist investors.
In addition, the US has a strong litigious culture, where minority shareholders can sue a company if the controlling shareholders abuse their power or breach their fiduciary duty. Such a culture is far less entrenched here in Asia.
Having said that, in the light of Alibaba, it may be time for the SGX and others to look at whether dual-class share structures are now workable here, to attract successful companies whose founders are reluctant to cede control.
In Asia, with its plethora of family firms, it is conceivable that many need capital but are concerned with potentially losing control of their companies.
At the same time, investors' concerns over potential corporate abuse could be alleviated through a simultaneous improvement of regulatory enforcement, transparency and corporate governance.
Even though controlling shareholders have the power to elect directors to the board, the directors still have a duty to safeguard the interests of all shareholders. Hence, a possible governance safeguard would be to mandate a greater number of independent directors and give them control of the nominating committee, thereby ensuring strong oversight and monitoring of top management.
Another measure might be to impose extra disclosure requirements on dual-class IPOs – such as higher disclosure standards for related party transactions and executive compensation – to minimise the chance of corrupt activity.
As oversight and corporate governance are enhanced, investors' concerns over dual-class listings will be alleviated. After all, the objectives of improving regulatory enforcement, transparency and corporate governance are already a priority for our regulators.
Above all Alibaba’s decision to list in the US has shown that markets here in Asia need, at the least, to reconsider their approach or risk losing out on major IPOs.
Alibaba: The rise of an e-commerce ecosystem
Alibaba was founded in 1999 by Jack Ma out of his apartment in the Chinese city of Hangzhou.
Today Ma, who revels in his self-created rock star personality, is chairman of one of the planet’s biggest e-commerce firms, with a growing portfolio of services bringing in an annual turnover dwarfing that of Amazon and eBay combined.
Ma has summed up his vision for Alibaba saying he does not want to build the company into an empire, but rather into an “ecosystem”.
“Every empire will be toppled someday, but an ecosystem is sustainable,” he told reporters last year.
For Alibaba to build its own ecosystem – funding a spate of acquisitions and development of new services - it needs cash.
Hence the decision in 2013 to go for an IPO.