When Alibaba Group Holding Ltd went public in September 2014, it became the largest ever initial public offering (IPO), raising $25 billion on the New York Stock Exchange (NYSE). For founder Jack Ma, NYSE was not the first choice for the IPO; he would have preferred to list his company in Hong Kong on the Hong Kong Exchanges (HKEX). The probable reason why he chose NYSE was that the exchange allowed him and his co-founder Joseph Tsai to maintain control of the company despite not owning a significant percentage of the shares. The HKEX did not allow such structures. According to their rules at the time, every shareholder should have voting rights proportional to the number of shares that they held in the company.
Alibaba was not the first major company to choose to list in the US because of the restrictions on what are called dual class shares or shares with differential voting rights (DVR). Earlier, in 2012, Manchester United Plc. chose to list on NYSE, after applying for listing on the Singapore Exchange (SGX) and not getting the listing approved because of restrictions placed on dual class shares.
Alibaba and Manchester United set off a debate among regulators and policy makers in Asia, eventually resulting in changes that now allow DVRs, so that companies can be listed in both Hong Kong and Singapore. But why did regulators frown upon DVRs in the first place?
One share, one vote
One share, one vote is a principle that we generally hold as fundamental to preserving the rights of minority shareholders in a company. If you are the founder of a company and you want to raise capital to fund your growth, you can do so either by taking on more debt, or by selling shares. But if you borrow too much, you run the risk of not being able to repay. Companies in the early stages of their growth cannot accept such risk and prefer to sell a part of their ownership to shareholders. However, with every new share, you have a little less control of your company. In a way, DVRs allow you to eat your cake and have it too. You raise capital by selling shares, but these shares have lower voting rights, so you get to keep control.
The catch is that by allowing DVRs, regulators are diluting the only way in which minority shareholders can get their voice heard, and this can be very bad in the long run. There are many examples of founders at odds with their shareholders, but the most famous is that of Facebook. Mark Zuckerberg, Facebook’s CEO, chairman and founder, controls 51% of his company’s voting rights, though he owns only 14% of its shares. Minority investors are locked in a fight with Zuckerberg on several issues, including changes to the voting structure and establishment of a risk oversight committee. However, they don’t have the power to get any of their proposals passed.
The Indian context
What does all this mean for India? Should we follow the lead of Hong Kong and Singapore? In fact, we already have provision for DVRs, though very few companies have used these structures so far. A major difference between India and Asia in general is that we do not have a second line of defence for minority shareholders.
The threat of a class action suit is a powerful deterrent against abuse but these are not available or common in most Asian markets. Another important difference is the power wielded by institutional investors. Direct retail participation is generally lower in the US compared to Asia. Consequently, the influence of minority shareholders in Asia is less, and investors rely upon the ability of regulators to protect their interests.
Need for corporate governance
Corporate governance has been a hot topic in India recently. High profile cases involving long admired companies have taken up many column inches of newspapers and hours of television debate. The Companies Act of 2013 introduced many mechanisms for protecting minority shareholders, including resolutions that require a majority of the minority to pass. Sebi has been at the forefront of these efforts; the latest being the Uday Kotak Committee on Corporate Governance that recommended several ways to prevent abuse of power by promoters. In this context, allowing DVR structures that may potentially disenfranchise minority shareholders is a departure from the norm.
Markets require trust to function smoothly. Regulators and policy makers play a major role in building this trust, but companies that raise capital and professionals who advise them are equally responsible. DVRs hinder the ability of the board of directors to exercise their rights as fiduciaries. There is a fundamental disconnect between efforts to empower independent directors and demand for DVRs, and we should think carefully before making changes that reduce the rights of minority shareholders.
Vidhu Shekhar, CFA, is the country head of CFA Institute in India