Gregg Li

Page 1 of 4 Tuesday, October 29, 2013

A Clear and Present Danger for Jack Ma and Hong Kong

Both Hong Kong and Jack Ma face a clear and present danger. Hong Kong has an opportunity to push the frontier on innovation through a sensible debate on partnership structure and Dual Class shares, while Jack Ma runs the risks of losing his business to US authorities should his new business ever become successful as a listed US vehicle. A blanket rejection for debate at this juncture, simply because either arrangement for partnership control or Dual Class has been deemed by a few to be unfair for subordinated shareholders, misses a golden opportunity for Hong Kong and Jack Ma. In this short article I have tried to argue that Hong Kong should give Jack Ma and us in Hong Kong a chance to explore. Who’s Jack Ma? The Jack Ma that I know is a sensible person, an entrepreneur, a realist, and above all, a quick learner. Hong Kong on the other hand, has been a fertile ground for entrepreneurs but has become increasingly divisive, non-compromising, and worse, indecisive. Not too many successful businesspersons can acknowledge their mistakes in front of an audience of professors. Jack could. At a gathering of academics a few years back, where he told the audience that sending some of his people for an MBA would be akin to sending them into a freezer and getting a ‘frozen chicken’ in return, he admitted his oversight on a past event. With the same breadth he told us and how painful it was he had to let go a few of his trusted employees when internal fraud was being perpetrated in his company, and he was to blame because he didn’t see it soon enough and wasn’t smart enough to define and communicate the values which underpin his business. Jack is a learning machine.

Jack at another occasion even hinted at the hypocrisy in the decisions of some institutional investors and their short-term mentality and how they have hid behind the veil of “good” corporate governance that encouraged long-term investment in innovation. Most funds really don’t have the long-term perspective as the founders, he retorted. If this assertion is true, how can Hong Kong learn from such experiences? Reality is a far cry from the world of the ivory towers. Dual Class Shares Let’s take Dual Class Shares and put aside the request for a Partnership Control Arrangement by Alibaba for now. So, is Jack correct in requesting for Dual Class

Gregg Li

Page 2 of 4 Tuesday, October 29, 2013

Shares for his newly listed company? Potentially, are there other ways that may give founders more long-term control than Dual Class? And, instead of giving Jack more control that we can’t take away, why can’t we allow the transfer of superior shares to future innovators in his company, as a means to encourage renewal and growth while at the same time, breaking the strangle hold from a founder? Facebook, Groupon, Google, Yelp, Zynga, and Manchester United used a Dual Class structure to be listed in the US, according to Forbes, Economist, and the Financial Times. The US markets gave exception to the one-share-one-vote since the 1940’s and Dual Share became more prominent in the 1980’s. By the year 2000, more than 300 listed firms in the US have chosen Dual Shares according to the Economist. Clearly, do the American Exchanges know something we don’t? And why is it that UK was so against the idea but the Singaporeans are now so eager to investigate? Hong Kong, on the other hand, is still struggling with another supposedly good practice in corporate governance and has yet to accept quarterly reporting as a requirement for listed companies, while China and US have endorsed it as a good practice in corporate governance. Quarterly reporting, some has argued, favored short-term thinking. In Hong Kong the debate continues and we are still far from reaching a decision since the subject was on consultation by HKEx in 2002. Hong Kong has become indecisive. The clear and present danger for Hong Kong, I believe, is a buy-in that there’s only one way for governance, and whoever shouts the loudest and has the staunchest position should carry the day. And the loudest noise seems to be coming from the institutional investors. Jack also faces a clear and present danger. He may end up losing control over a company that he thought he held majority or superior shares. Doing a Chinese listing in the US these days presents many challenges, not the least would be having to deal with the US Foreign Corrupt Practices Act that will dictate how many luncheons Jack and his directors can have or what type of food they can order with a Chinese banker who is be defined as a civil servant by the Act. His IPO will probably be scrutinized by US lawyers looking for opportunities to file a Class Action suit against Jack’s company even before it has gone IPO; and all his speeches made in the past could be construed as an evidence of prior knowledge. His Alipay, an online payment solution, may be deemed by the Dodd-Frank Act which oversees all financial institutions as a systemically important institution, and potentially Jack could be dragged in front of the US Congress to explain his governance practices to angry China bashers when US interests have been threatened. Unfortunately by then, it is no longer a matter of delisting. And let’s not forget SOX and new legislations that would mandate how many “other” unproven directors that he must hired in order to fulfill some diversity ratio.

Gregg Li

Page 3 of 4 Tuesday, October 29, 2013

Dual Class has been used in many countries and historically families have used it to keep control for themselves and sold restricted-voting shares to the public, according to the TSX and other writers. As the company grows, controlling shareholders may opt to move to more equitable voting structures in a bid to build a larger investor base. Some Dual Class shares have performed well -- Warren Buffet’s Berkshire Hathaway; others, not quite. A few CG experts pointed out cases like Conrad Black or Murdoch where abuses by the dominant and entrenched shareholders have been detrimental. Nonetheless, there are many single share companies that have been disastrous. Corporate Governance after all, is an art, and those who can master it, defines the quality of the art. According to my good friend Bob Tricker whom many called the Father of Modern Corporate Governance, “those arguing for dual (or multi) class shares cite the very successful US listed companies that have unequal voting rights. But not everyone in the US is comfortable with varied voting rights either. Some institutional investors have been lobbying for the US exchanges to ban the practice, like Hong Kong. Their argument is that dual class shares are used by dominant owners to avoid the discipline of the market by removing the threat of hostile bids - and of course preventing the institutional investors making a fortune from M&A activity”. Realistically, not all shareholders, and in particular individual small investors, are concerned with the voting rights attached to a share. Those for this position argued that they may be more interested in the potential of sharing the company’s wealth or trading on future prospects by buying cheaper, subordinated shares. Can we work with this practice? Hong Kong potentially can set up administrative protections and provide other channels to limit the longevity of entrenched shareholders on the board. In fact, have we considered that the Dual Class setup may just provide a sufficient counter-balance to the short-term mentality that comes with the practice of quarterly reporting? Like Bob Tricker, I personally have no problem with different classes of share wielding different powers provided that the external investors are totally clear what they are buying into and no one is forced to buy shares. But Hong Kong is not the only choice for an IPO for Jack Ma. And one-share-one-vote is not so holy that it cannot be dismantled or improved upon. Hong Kong will be disadvantaged if it is not bold enough to study the implications and write off this opportunity as unholy without listening to both sides of the argument. If there are indeed no other ways, argued my associate Ivan Choi, then one-share-one-vote should be defended rigorously. All in all, the only conclusion we should draw from this at this point in time, is that much more research and debates are needed. Alibaba is fascinating as a case study but the issues go much deeper. “If Hong Kong really argued the multiple voting right

Gregg Li

Page 4 of 4 Tuesday, October 29, 2013

issue in depth, and acted on the conclusions, they could lead the world in developing corporate governance thinking and practice,” said Bob. Dr. Gregg Li, Practitioner and Professor of Corporate Governance