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Control freak-out

16 April 2014 By Una Galani, Peter Thal Larsen

Hong Kong needs to make a stand for shareholder democracy. Alibaba’s decision to shift its giant stock market listing to the United States has sparked a debate about control of public companies in the former British colony. Hong Kong’s stock exchange, whose rules wouldn’t have permitted a plan to let Alibaba insiders nominate a majority of board directors, is preparing a public consultation on shareholder rights. But dumping the principle of “one share, one vote” would be a mistake.

For a city that likes to bill itself as China’s gateway to global capital markets, missing out on the initial public offering of the largest e-commerce company in the People’s Republic is a symbolic blow. The snub raises fears that other fast-growing Chinese companies will choose to raise capital elsewhere, leaving the Hong Kong exchange as a stagnant backwater dominated by local tycoons and stodgy Chinese state-owned companies. Weibo, another hot Chinese tech company, is also planning a New York IPO.

In the United States, insiders can control public companies even when they no longer own the majority of the shares. Google and Facebook – to name just two of the companies Alibaba views as its peers – have blazed a trail by creating multiple classes of shares with different voting rights.

Proponents of change argue that, in order to remain competitive, Hong Kong must take a similar approach. This thinking is wrong-headed, for three reasons.

First, companies aren’t actually abandoning Hong Kong in large numbers. Although some Chinese groups have chosen to list on U.S. exchanges, the exodus doesn’t warrant an identity crisis. Hong Kong was the world’s second biggest market for IPOs by proceeds in 2013, according to Thomson One, ahead of the United Kingdom and Singapore. Large companies like pork producer WH Group are preparing to raise capital there this year. That’s a big achievement for a financial centre that doesn’t have a large home-grown base of institutional investors.

Second, companies that reject Hong Kong may do so for reasons other than corporate governance. Only half the mainland businesses that listed in the United States over the past three years have adopted multiple share classes. Another factor driving them away is the requirement that companies have to be profitable for at least three years – or meet certain other financial criteria – before they are allowed to list in Hong Kong. That rule has kept away small weak companies, but also some fast-growing start-ups.

In the past, Chinese companies chose the United States because of a perception that investors and analysts there better understand technology. However, the rise of Chinese internet groups like Hong Kong-listed Tencent is evidence of growing interest in the industry from Asian investors. Poor research coverage in the United States has prompted some U.S.-listed Chinese companies to go private with a view to returning to Asia.

The third reason for Hong Kong to defend the status quo is that its corporate governance is already weak. Local tycoons exercise power through cascades of partially-listed subsidiaries, each often controlled by a parent company. Li Ka-shing’s empire is a prime example [Graphic: Li Ka-shing still has what investors want]. Meanwhile, many Chinese state firms are opaque and make decisions with little consideration for external shareholders.

Loosening Hong Kong’s rules would allow controlling shareholders to exert an even tighter grip. That was the threat in the 1980s, when local trading house Jardine Matheson proposed creating a class of non-voting shares. Two conglomerates controlled by Li tried to follow suit, prompting the regulator to step in and ban the practice. In the United States, the prevalence of class action lawsuits helps to keep companies and their founders in check. But Hong Kong’s legal system is a lot less friendly to litigious shareholders.

A successful capital market needs to be attractive to both issuers and investors. If Hong Kong were to relax its rules, it might attract some new listings or entice large companies back from the United States. However, it would dilute shareholder protection – which could push up the cost of capital for the broader market.

Many public company investors are currently willing to give up voting rights for exposure to fast-growing technology companies, but their enthusiasm has not yet been tested in a downturn. Though the loss of Alibaba is a setback, loosening Hong Kong’s rules would bring greater risks for uncertain rewards. All the more reason to make a firm stand for shareholder democracy.


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