Wednesday, September 24, 2014

“Dual-class” Share Structures

The recent NYSE listing of Alibaba has once again brought to the fore the issue of dual-class share structures, as discussed in this column in the Economist. Alibaba’s founder and a group of insider shareholders have control rights that are disproportionate to their economic rights. The wave of dual-class structures in tech-IPOs was triggered by Google’s IPO in 2004, which was followed by another large listing of Facebook in 2012 and now Alibaba (in what has been dubbed the largest IPO ever). The Economist indicates that dual-class structures are quite common in US public companies, with “55% of the 524 such companies in the global database of MSCI” giving disproportionate rights to shareholders.

The advantage of dual-class structures is that it allows companies to raise capital and at the same time preserve the control held by founders and insiders. At the same time, it also carries certain concerns. From a corporate governance perspective, the deviation from the customary “one-share-one-vote” rule places control in too few hands thereby rendering limited protection of the interests of the remaining shareholders. The ability of persons with limited economic interests to exercise greater control over the company may exacerbate agency costs that operate in the corporate governance sphere. Moreover, and related to governance as well, dual-class structures operate as takeover defences and allow incumbents to enjoy protection from hostile takeovers that may act as a curb on inefficient management. Using dual-class structures, the incumbents may enjoy favourable protection against such corporate raids.

Despite these concerns, why are jurisdictions permitting the use of dual-class structures that are increasingly becoming more common? It seems the answer is to attract listings on their stock exchanges. As the Economist notes, it is not surprising that Alibaba decided to list on the NYSE rather than the Hong Kong Exchange given that the latter does not recognise dual-class structures. Hong Kong itself seems to now be succumbing to the pressure to attract listings and is reviewing its own position through a concept paper that is a precursor to a public discussion on the issue. Similarly, while Singapore does not currently permit dual-class structures, it is considering legislative amendments to its company law to introduce the concept. After substantially dilly-dallying on the issue, the Companies Act, 2013 in India now recognizes the concept of shares with differential rights (sections 43(a)(ii)), although SEBI has imposed further curbs in the ability of public listed companies to issue shares with superior rights.

All of these beg the question whether the urge to attract listings and provide more flexibility to issuers and investors may result in eclipsing the concerns pertaining to structures both from the perspectives of corporate governance and takeovers, so as to result in the phenomenon of a “race to the bottom”.

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