Hong Kong – Weighted Voting Right Governance Structure: Reconsider Listing Of Family Business In Hong Kong.

20 January, 2016

 

 

In contrast with one-share one-vote concept, WVR refers to structure of governance granting superior voting right or other privilege to certain shareholders which is not proportional to the shareholdings whereby a share structure containing two classes with different voting power is an usual and common form occurred in the United States (“US”).  Some other mode of WVR refers to enfranchise the controlling shareholder with extra and additional power to change the directors of the board or other management personnel.[1]

 

As seen from above definition, dual class structure of share is one of the most usual modes for WVR, which means that two classes of common stock with unequal voting rights on all or particular matters subject to shareholder approval in a company.  For instance, one class of share carries one vote per share while the other class of shares carries ten votes per share.[2]

 

In major global financial centres, there is no consistent tendency on WVR.  US allows companies with WVR to be listed whereas the stock exchange in Singapore does not.[3]  As one of the major international financial centres, HK has abandoned WVR for over 25 years and Alibaba Group case of US$25 billion initial public offering (“IPO”) draw the whole city’s attention to WVR again.  In fact, rather than dual-class share structure, Mr Jack MA (“Mr MA”)[4] sought listing in US for its plan to empower senior executives without owning the majority shares,[5] Mr MA expressed in Wall Street Post his regret for earlier listing decision, though.

 

Background

 

There are already many studies and researches on the concept of WVR, results are inconclusive though.  It is undoubtedly reconsideration of WVR last year is somewhat a commercial reason subsequent to the change of listing venue by Alibaba Group from HK to US.[6]  

 

The most updated research on WVR should be the Concept Paper and the Consultation Conclusion undertaken by HKEx in August 2014 and June 2015 respectively.  HKEx received many feedbacks and one of those was from the submission of the Law Society of HK (“Law Society”), which took the view that WVR should be allowed in some circumstance and especially there is new application for listing.  Law Society was also of the view that such dual class share by weighted voting right can be align with the Listing Rules, Takeover Code and the investor interests can be protected at the same time. 

 

Following the Concept Paper, besides various responses made by the practitioners and other participants of the market, Securities and Future Commission (“SFC”) has in March 2015 made remarks that several issues have to be addressed and dealt with before proceeding with further amendments to existing Listing Rules or other regulations.[7]  HKEx by its Consultation Conclusion inclined to a general restriction on WVR with certain exceptions subject to further consultation on issues such as inter alia, ring-fencing, safeguard, detailed disclosure and eligibility criteria tests.[8]

 

However, shortly after HKEx has published the Consultation Conclusions, the board of SFC on 25 June 2015 stated that it does not support for the draft proposal of listing with WVR, grounds of which shall be further discussed below.[9]  It is uncertain at this moment whether further consultation shall proceed.

 

Another latest research on WVR was done by CFA Institute in 2014, which illustrated the matter by discussing several e-commerce companies, such as Alibaba Group.[10]  It reviewed the issue from corporate governance perspective and the view point of regulators from different jurisdictions.  It showed that even with the same concept of WVR, the arguments may be different according to different jurisdictions, company background and even if the business is family-owned or not.  It concluded investment should adopt buyer beware approach and after all, everything is about disclosure, which means if the issuer has disclosed all information the investors need to know, dual-class share structure or not is no longer a matter for the listed companies and regulators, but the investors per se.

 

Despite of the above, it is interesting for the case of HKEx, a listed company in HK, whereby the government, with only less than 6% of HKEx’s shares, took up the position to engage six non-executive directors whereby there are only twelve non-executive directors in the board.[11]

 

Principles and Laws

 

In accordance with Rule 2.03(4) of the Listing Rules, fair and equal treatment of shareholders must be regarded when reviewing the suitability of an issuer for listing in HK whereas the one share one vote concept by Rule 8.11 of Listing Rules aims to uphold this fundamental principle of fair and equal treatment.[12]  However, it was argued by LAU that whether identical treatment by one share one vote means that all the shareholders, including majority and minority shareholders, and the company are treated in a fair and equal manner, given different shareholders have different needs, interests and circumstances.[13] 

 

Although particular articles of association which might permit the company to issue shares which bear one vote per each share or otherwise such as more than one vote per each share, every member of a company in HK on a vote by poll at general meeting shall have one vote per share held, no matter he is present in person for the meeting or by appointing a proxy instead.[14]  In addition, pursuant to Rule 8.11(1) of the Listing Rules, a company cannot list in HK with shares which have power without bearing a reasonable relationship to the equity interest of the fully paid shares other than in “exceptional circumstances” agreed with the SEHK.[15]  In this sense, family business wishing to list their shares on the SEHK cannot retain their full power on the board of directors by adopting WVR, but are only able to adopt the mechanism of one vote per each share governance regime.  Such restriction remains effective even subsequent to listing.  As of the date of this essay, there is no company listed on the SEHK under this exception.[16]

 

One share one vote principle in fact aligns with the proportionality advocated by OECD[17] and the high regulatory standards which lead to investor protection.  This is regarded as the most conducive to sound corporate governance.[18]  This can mitigate the risk for entrenchment of directors and only this can ensure the management of the company has incentive to act in the best interest of the company and ultimately benefit the investor and the society as a whole.[19]

 

Empirical Studies and their Implications

 

According to the latest studies presented by HKEx in August 2014, there are over 100 companies incorporated in Mainland Chinese primarily listed in US instead of HK, out of which 29% have a WVR, and contributing to about 70% of the capital of all companies incorporated in China and listed in US.[20]  It is therefore argued that HK may attract much more Mainland Chinese companies to list in HK if SEHK allows WVR.[21]  The presentation[22] went on to state that companies with such governance structures amount to over 10 per cent of the entire capital of all companies being listed in US including Mastercard, Facebook, Google and Visa.[23]  Nonetheless, HK should never be over reliant on single candidates for IPO, such as Mainland Chinese companies, but to diversify the sources.[24]

 

On the other hand, prior to restriction of different voting rights by SEHK in April 1987, the major index of stock market in HK had a nearly 4 per cent drop as a consequence of announcement of Jardine Matheson Holdings Limited and Hutchison Whampao Limited’s respective intention of bonus share issue having different entitlement with existing ordinary shares on late March 1987 and on 8 April 1987 the SEHK announced that such issue was not permitted, such index of HK rebounded and reached the month’s high and surge with nearly 5 per cent following such announcement.[25]

 

The above historical figures has illustrated that there is not a necessary and direct causation between WVR and economic implication for the listed companies and the consequence to the society at large.  It was argued that to have the companies listed there have some bigger structure issues but not merely the lack of WVR.  By simply allowing the structure of WVR would not open the floodgates of candidates for listing in HK.[26]

 

Although there are many studies and comparison done for the WVR used wide range of jurisdiction around the world, the findings are divergent and mixed[27] and there is yet a concrete and conclusive consensus amongst the empirical studies the influence of WVR on the performance of a company, whether positive or negative, save that diminish of the share price of those companies listed is usually identified and ascribed to the presence of WVR resulting to inferior voting rights.[28]  This research finds that the WVR is more than a law and regulation issue, but it always consist of commercial reasons.[29]

 

Critical Analysis for WVR

 

The prime motive for family business owner to have WVR is to maintain control over the company after listing and influence future development of companies whereby they may lack sufficient fund to carry out their vision.[30]  In addition, WVR allows family business owner to expand company without diluting its ownership and remains control in management to focus on the growth of company in the long run without attention to the immediate financial return as well.[31]

 

Opponents usually consider that WVR is problematic from the perspective of corporate governance.  It was submitted that if superior voting power is held by a group of associated person, the managements would only consider their own good and may not pursue projects in the best interest of the company.[32] 

 

It was submitted that adoption of share structure consisting of more than one class connotes the founder’s desire of controlling a majority of votes but not taking up a majority of risk.  From the point of view of risk management, the majority shareholders bear the risk of capital but they cannot exert their opinions on the corporate exercise.[33] 

 

In addition, management become less accountable for their behavior in WVR, as with inferior voting rights, majority shareholders are lacking of removal power for management with unsatisfactory performance which increases entrenchment risk.[34]

 

However, management has its own vision and what appear not good for company may be the true and best interest of the company and the outcome usually takes years and decades to show and it is hence difficult to verify and prove whether management’s act is in the best interest of the company given there are short term and long term interest of a particular company.

 

Being the founder of a business, family member of a business must of the view not to have the business taken over by outside bidders and WVR does provide a mechanism for the family business to protect their interest which would otherwise lose their power on this.[35]  Shareholders would likely lose takeover offers which they find lucrative if the management and/or the founder members, although being the minority shareholders, consider the takeover not favourable to their interest and take anti-takeover stance thereafter as they are dominant for the company’s decision, WVR provides a tool for the management to defend against undesired takeover action and such attempts can easily be voted down by the strong management.[36] 

 

However, it was argued that should a company have two types of shares to be listed at same time, takeover bidder can just purchase the shares with extra voting rights and hence control the company, which is more convenient for the bidder than single class share.[37]  Furthermore, whether it is good or not to the company depends on whether the takeover transaction is good to the company per se.  If the takeover is beneficial to the company’s development and very attractive to the family business owner, the deal can be successful even the company has WVR.

 

On the other hand, WVR would deteriorate agency problem which may incur higher cost of capital on future fund raising[38] and even higher chance for accounting scandals and fraud[39].  WVR lacks a justification for the owner to let the majority shareholder suffers from any corporate and commercial decision which leaves no place for them to provide opinion. 

 

Under one vote one share mechanism, if the founders want to retain their control, they can merely obtain fund from bank loan, venture capital or disposal of less shares to the public during listing.  Choosing to remain as a private company[40] is also another way for HK companies even for very huge size companies, such as Chinachem Group and Centaline Agency Limited.

 

Another problem for WVR is next generation problem, as no matter how capable and brilliant they are, the owner and founder would, inevitably, retire, quit investment or invest on other business or projects.  Next generation vested the shares with voting rights might or might not be interested in the business or treat the legacy as good as the predecessors, failure to dealing with which would leave WVR losing its original significance.[41]  Sunset provision under WVR shall be discussed below.

 

Although proponents of WVR always argue that corporate governance shortcoming of WVR can be overcome by buyer beware, which means under a disclosure principles, any potential investor can choose to invest or not, it was argued that fund managers, institutions or individual investor interested in index securities cannot choose and thus being forced to hold some companies under WVR which their interest may be compromised.[42] 

 

WVR governance structure shall definitely increase the diversity of companies choosing to list in HK.  SFC was, however, of the view that such listed companies with WVR would likely become index component of index[43] and this will induce fund manager to apply “governance discount” on those shares and choose to withdraw securities listed in HK from their portfolio due to their client’s hesitation to invest in index or portfolio with components of WVR companies and this advantage of WVR shall become its disadvantage at the same time, which would ultimately harm the reputation of HK securities markets.[44]  In order to avoid this, if WVR is ever allowed in HK, listed companies with such governance structure should be excluded from the index components, otherwise the investor have no choice for their investment and a fair and transparent regime of securities market cannot be attained. 

 

Despite of above arguments, it is purely a contractual relationship between the issuer of securities and investors and since the rights are well notified to investor prior of any purchase decision and different preference of shareholders, it is hence reasonable and justifiable for the companies to be allowed to issue various securities with different combinations of control, that is WVR.[45]

 

It is also claimed that some investors do not care about the voting rights and instead they just concern about the capital gains and dividend payment.  WVR allows the company founder with brilliant mind and belief to innovate continuously and generating value after listing without concerning other shareholders opinion which may hinder the development of company.[46] 

 

Family business owner should, however, bear in mind that every company and business has its cycle.  Although WVR provides a good atmosphere and environment for the company founder to utilise fund raised to develop its company, it is not necessary true throughout the life span of company.  Family owner should consider about succession and different cycle needs in order to prevent devaluation of company assets due to poor management but without any way out by shareholder actions.  Sunset provision may be a way out and shall be discussed below.

 

Last, but not the least, although there are many advantages for WVR, it seems that such governance structure is not able to ensure the voting power of shares bearing a reasonable relationship to the equity power of those shares, which is one of the core and fundamental principles HKEx and SFC has long been endeavour to uphold in the securities market.

 

Reconsideration for Family Business Owners

 

It was claimed that to accomplish some vision by the founder member, greater voting rights are required.  It was also argued that some shareholders might prefer the management to take up all major decision and prefer such management, for example Mr Steve Jobs of Apple, to have commitment and incentive to stay in the company.  And there is no unfair to shareholders of listed companies given all information has been fully disclosed from the outset.[47]  However, having solved the problem for achieving management vision does create another issue.  Sunset provision to deal with problem for succession might be required.

 

However, even any stock exchange may condone or grant exemption based on exceptional circumstance, the success of any companies listed depends on the public and market because as Management Today further illustrated, institutional investors are less accommodating.  A representation from investment funds stated that “it is generally known that we do not favour weighted shares and Association of British Insurers takes an even firmer stand which they have formed a view that restricted voting shares are undesirable”.[48]

 

In addition, the downside which family business owner needs to appreciate for WVR is that investors generally value down the shares with voting rights which is less superior in order to show that there is risk private individual interest, envisage of not perform as good as otherwise would be and probable situation of entrenchment issue for management.[49]

 

It was suggested that the family business to have “founder’s shares”, enabling the founder to convert its shares with extra voting right back to the ordinary shares after certain period of time and/or given specific goal has been achieved, which resemble the function of sunset provision.  As this apparently solves the arbitrary power problem and the other ordinary shareholder and the company can enjoy the benefits of WVR, family business owner can take this as an alternative way to preserve their management at the commencement stage while ensure performance is not to overlook.[50] 

 

According to studies conducted for the European Central Bank, companies abandoned WVR as they grow bigger and more successful whereas another study held in US found that companies with WVR lost money in comparison with their unitary share cousins and such companies brought in far less investment.[51]  However, it should be noted that there accurate comparison can never be made due to there is no company can adopt WVR or unitary share structure at the same time and hence performance at different time may not be comparable.

 

Take a look at Singapore, being one of the nearest stock exchanges to HK, law has recently been passed to allow unlisted public companies to adopt WVR with different voting rights so as to increase flexibility in capital management.  It is believed that such move is paving a way to allow listed companies to issue multiple classes of shares in order to attract more listing applications.[52]  If it is the reality, HK would likely lose its competitiveness being an international finance centre.

 

On the other hand, many would naturally think and take it for granted that Mainland Chinese companies must first choose HK as their listing venue until the Alibaba Group case.[53]  To the contrary, it was argued that the technological companies usually choose to list in US for gaining a global profile with larger market, instead of the WVR concerns.[54]  Family business owner should take this opportunity to halt and reconsider if WVR is suitable for their new listing application and the mode for management, no matter to avoid takeover or ensure succession. 

 

Pragmatic Regulatory Safeguards

 

Based on existing Listing Rule, there are already certain safeguards for the controlling shareholder from damaging the interest of the company and other shareholders.  For example, restrictions on connected transactions shall prevent the controlling shareholder from taking advantage from the others by buying goods from outside with below market price and sell the goods to the company with above market price, in which case the ones with extra voting power must also be carefully monitored.[55]

 

According to the Consultation Conclusion issued by HKEx, there are some issues set out further to response to the Concept Paper published earlier.  It is obvious that WVR should not be allowed in all circumstances, instead, it should be subject to certain criteria and under certain circumstances.[56]  For example, WVR should (1) only be allowed for new companies seeking to list on SEHK, (2) pass threshold of market capitalization, say billions of dollars, (3) ring-fencing to companies with certain pre-determined characteristics and nature[57] such as some innovative companies[58] and small growth companies, and (4) fulfilling enhanced suitability criteria set out in HKEx’s Guidance Letter.[59] 

 

In addition, it was argued that several safeguards should be in place for investor protection against any abuse of the WVR, such as addition of sunset provision and provide shareholders with right for class action litigation, like US.[60]  However, it is argued that such safeguards are lacking of standard and even if any test to be applied are subjective per se and hence lacking of fairness.

 

Other safeguards include (1) restriction on transfer from a beneficiary of WVR to un-affiliated parties, (2) continue to stake hold certain number of equity of a company by such beneficiary, (3) increasing the status of independent directors and other non-executive directors, and (4) review the current Listing Rules, relevant laws and regulations.[61]  It is, however, deemed that such safeguards might not be sufficient to protect the interest of the shareholder other than the beneficiary of WVR and the company.  It was also submitted that in case the companies perform badly, there must be mechanism to remove the power of the voting rights.[62]

 

Referring to Toronto Stock Exchange in Canada, coat-tail provision has been, incorporated, by which shareholders of subordinated voting shares are allowed to participate for equal voting in takeover event, to ensure fair and equitable treatment, which is considered as a good corporate governance practice.[63]

 

It is important to reiterate and stress that information and disclosure to potential investor are important prior to their purchase decision, which goes back to the buyer beware logic.  In this sense, family business owner should appreciate for the success on the proficiency of investors, soundness of disclosure regime and opportunity of shareholders to obtain effective redress.[64] 

 

Even if the companies with WVR are allowed for listing on SEHK in the future, the above safeguards are yet final and subject to further discussion of regulator and practitioners by then.  Also, no matter how comprehensive are the above safeguards, the introduction of WVR will undeniably be at the expense of good corporate governance.[65]

 

Conclusion

 

The views on WVR are still divergent, in different jurisdictions and amongst market regulator and other practitioners.  However, family business owner should note that even WVR was once allowed for listing prior to 1987, the four out of the five companies with WVR listed in HK before the prohibition have been privatised and delisted.[66]  Investors and the public might not be interested to invest in companies with WVR, at least not until the foreseeable future.

 

On the other hand, the SEHK should consider how to attract family business or other types of business to list in HK, not only by WVR, but other factors like expediting listing process without affecting the quality. 

 

Moreover, although family business owner may worry that their control would be lost when other shareholders come into the board room, all family business in HK are currently running under one-share one-vote system and are doing very great and successful.

 

The ultimate premise is the fundamental principle of fairness and transparency, which are the value which cannot be prejudiced and otherwise investors would not choose to invest in HK even the WVR is allowed.  Independent judiciary, rule of law, regime with competent, fair and transparent regulation have all been making contributions to the success of HK as an attractive venue for investors and issuers.

 

To cite a phrase to conclude this research, “Power tends to corrupt, and absolute power corrupts absolutely”.[67]

 

Bibliography

 

ADAMS, Renee and FERREIRA, Daniel (2008) One Share-One Vote: The Empirical Evidence, Review of Finance, 12:51-91

ALDER, Ashley (2015 March) Opening remarks at SFC’s media luncheon, Securities and Futures Commission

ASHTON, Douglas (1994) Revisiting Dual-class Stock, St. John’s Law Review Volume 68 Issue 4

BURKART, Mike and LEE Samuel (2008) One Share – One Vote: the Theory, Review of Finance 2008, 12: 1-49

Charltons Solicitors (2014 September) HK Stock Exchange Publishes Concept Paper on Weighted Voting Rights, HK Law

CHEMMANUR, Thomas J. and JIAO, Yawen (2012) Dual Class IPOs: A Theoretical Analysis, Journal of Banking & Finance, 36: 305-319

CHEUNG, Raymond and WONG Angel (2015) Specific Listing Issues, IPO Handbook for HK 2015

CHIU, Jeckle (2014 September) Should We Adopt Weighted Voting Right Structures for Listing and Listed Companies in HK? Mayer Brown JSM

Companies Ordinance (Chapter 622 of the Laws of HK)

ESPINASSE, Philippe (2015 June) HK Doesn’t Need Weighted Voting Right, GlobalCapital, http://www.globalcapital.com/article/s5n17gdzjb1n/hong-kong-doesnt-need-weighted-voting-rights accessed on 5 December 2015

FERRARINI, Guido (2006) One Share – One Vote: A European Rule? European Company and Financial Law Review 2006, 147-177

Financial Services Development Council (2014 June) Positioning HK as an International IPO Centre of Choice, FSDC Paper No. 09

GRAHAM, David (2014 August) Weighted Voting Rights – Concept Paper, HK Exchanges and Clearing Limited

HKEx News Release (2014 August) Exchange Publishes Concept Paper on Weighted Voting Rights, http://www.hkex.com.hk/eng/newsconcul/hkexnews/

2014/140829news.htm accessed on 30 November 2015

Hogan Lovells (2015 August) HK – Listed Companies – Consultation Conclusions – Weighted Voting Rights, Conventus Law

HK Exchanges and Clearing Limited (2014 August) Concept Paper on Weighted Voting Rights

HK Exchanges and Clearing Limited (2015 June) Consultation Conclusions – To Concept Paper on Weighted Voting Rights

LAU, Lawrence J. (2014 December) On Weighted Voting Rights, Working Paper No. 26

Law Society of HK, The (2014 November) Concept Paper Weighted Voting Rights

LOH, John (2015 June) HKEx on the Losing End in Dual-class Debate, GlobalCapital, http://www.globalcapital.com/article/s46ygsbyd0zb/hkex-on-the-losing-end-in-dual-class-debate, accessed on 5 December 2015

Management Today (1996 March) Golden Rules for Keeping It in the Family; Can Share Voting Be Structured to Protect against Takeover? Haymarket Publishing Limited

MICHAEL, Bryane (2015 June) Alibaba Listing Slight Shouldn’t Blind HK to the Cold Hard Facts of Dual-class Shareholding, South China Morning Post on 9 June 2015

NEUVILLE, David (2015 July) A Heavy Weight: Controversy over Weighted Voting Rights for HK Listed Companies, Simmons & Simmons Elexica

NG, Tiffany (2015 January) Understanding “Weighted Voting Right Structures”, Information Services Division, Legislative Council Secretariat, Legislative Council of HK

ORSAGH, Matt (2014 April) Dual-Class Shares: From Google to Alibaba, Is It Troubling Trend for Investors? CFA Institute, Market Integrity Insights

OSBORNE, Simon (2014 August) HKEx Treads Carefully on Voting Rights, the Tradenews.com, http://www.thetradenews.com/news/Regions/Asia/

HKEx_treads_carefully_on_voting_rights.aspx accessed on 29 August 2014

PAJUSTE, Anete, (2005 March) Determinants and Consequences of the Unification of Dual-class Shares, European Central Bank Working Paper 465

ROSE, Caspar (2008) A Critical Analysis of the “One Share – One Vote” Controversy, International Journal of Disclosure and Governance, Volume 5, 2, 126-139

Rules Governing the Listing of Securities on The Stock Exchange of HK Limited

Securities and Futures Commission (2015 June) SFC Statement on the SEHK’s Draft Proposal on Weighted Voting Rights, https://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR69 accessed on 5 December 2015

SERCU, Piet and VINAIMONT, Tom, Double Bids for Dual-class Shares, Leuven Economic Working paper AFI 0613

XU, Ting, Excess Control Rights Benefit Debtholders? Evidence from Dual-class Firms, SSRN Paper

YIU, Enoch (2015 March) SFC outlines conditions for dual-share listings, South China Morning Post on 19 March 2015