The Dual-class Share Structure

• Publication year: 2015

The Dual-Class Share Structure

Olivia Wang

THE DUAL-CLASS SHARE STRUCTURE

Olivia Wang^*

In September, 2014, Alibaba Group Holding Ltd. (hereinafter Alibaba), China's dominant electronic commerce company, brought about one of the biggest initial public offerings (IPO) in the stock market.¹ Alibaba's IPO revealed that the company adopted a dual-class share structure.² This dual-class share structure first aroused the author's concern when the author learned that the reason why Alibaba chose to go public in the United States was that the US stock exchanges allow companies going public adopt a share structure different than the normal "one share one vote" structure. In Part I of this Essay, the author gives a brief description of how the availability of the dual-class share structure in the US stock market became an attraction. Then in Part II the Essay goes on to discuss in more detail that why Alibaba (and some internet companies and high-tech companies, see below for more detail) insists on this structure. The author found that such structure contributes to innovations and seems to enable efficient decision-making process. In Part III, however, the author will show that the dual-class share structure is a double-edged sword. The structure would impede checks on managements, which makes the shareholders in a dual-class share company less protected.

I. Dual-Class Share Structures Is the Reason Why Alibaba Chose to Go Public in the United States

Dual-class share structure allow insiders to hold common stock with multiple votes per share, while the public holds common stock with only one vote per share.³ National Association of Securities Dealers Automatic

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Quotation System (NASDAQ) and New York Stock Exchange (NYSE) both allow companies with the dual-class share structure to list on the securities exchanges.⁴ Not all stock exchanges allow this kind of deviation from the basic "one share one vote" shareholder structure. For example, Hong Kong Stock Exchange (HKEx) in its listing rules clearly states:

The share capital of a new applicant must not include shares of which the proposed voting power does not bear a reasonable relationship to the equity interest of such shares when fully paid ("B Shares"). The Exchange will not be prepared to list any new B Shares issued by a listed issuer nor to allow any new B Shares to be issued by a listed issuer (whether or not listing for such shares is to be sought on the Exchange or any other stock exchange) except: (1) in exceptional circumstances agreed with the Exchange. . .⁵

So far, HKEx has denied the use of the "exceptional circumstances" exception by any applicants,⁶ including Alibaba.⁷ Alibaba has repeatedly confirmed its determination to keep the current shareholder structure.⁸ After receiving written confirmation from the NYSE that its dual-class share structure wouldn't be an obstacle for a U.S. listing,⁹ Alibaba picked NYSE for its IPO.¹⁰

II. Dual-Class Share Structures Has Its Advantages

Besides Alibaba, several internet companies, e.g. Google¹¹ , Facebook¹² , Groupon¹³ , LinkedIn¹⁴ , etc., went public with a dual-class share structure as

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well. Dual-class share structure is popular for a reason, and this Part II describes in both general and specific ways as to how this structure benefits internet or high-tech companies.

For management in general, the benefit of dual-class share structure is obvious. With the superior voting rights in hand, although an IPO will reduce the management's proportion of stock ownership, management has no concern with their control over the company being diluted.¹⁵ Non-controlling shareholders, in turn, are protected from conducting coercive takeover and from making mistakes with regard to the daily operation or management of the company.¹⁶ The latter argument is supported by the so-called "short-termism" concerns.¹⁷ Short-termism refers to companies taking actions that are profitable in the short term but do no good to the companies in the long term.¹⁸ A typical example of short-termism is that a company, under the pressure of activist investors, seeks to increase short-term earnings by cutting research that would be beneficial in the long run.¹⁹ Such long-term costs of short-termism are mainly produced by both shareholder interventions and management's fears of such interventions.²⁰ Therefore, shield boards from activist shareholders are desirable among managements, which hope to better serve the long-term interests of companies and their shareholders.²¹ Dual-class share structure is one way to meet this goal of board insulation.

For internet or technology companies, dual-class share structure is highly valued because such structure contributes to innovations that would hardly generate short-term benefits, but would probably bring better future lives. In a letter to its shareholders, founders of Google stated: "outside pressures . . . often tempt companies to sacrifice long-term opportunities to meet quarterly

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market expectations."²² With regard to Google's insist on dual-class share structure, the letter explained that Google "designed a corporate structure that is will to protect Google's ability to innovate."²³ Indeed, Google glass and Google driverless car are good examples of innovations without short-term benefits but with a view to future life. Such freedom in developing high technology attributes to some extent to Google's shareholder structure. In contrast, Apple Inc. does not have a dual-class share structure, and it is likely that shareholder actions might bring Apple to a dilemma. A recent noteworthy case is that hedge fund manager David Einhorn urged Apple to start distributing to shareholders some of the large cash holdings it had accumulated.²⁴

As an electronic commerce giant with multiple services available, Alibaba is seeking both the expansion on its current services to other countries besides China, but also innovations that better serve the goal of development and cooperation in the future. For example, Alibaba opened an institution named "AliResearch" in April, 2007.²⁵ This institution aims at building up a business knowledge sharing platform that provides business data analysis, and successful cases of mom-and pop shops or other types of small businesses.²⁶ One significant business data AliResearch provides is called "internet Shopping Price Index (iSPI)", a product of AliResearch's cooperation with scholars and the National Bureau of Statistics of the People's Republic of China, which function is to indicate the general price level of goods or services trade in two of Alibaba's flagship online retail platforms, Taobao and Tmall.com.²⁷ In addition, AliResearch also put efforts into building up a digital library that covers data information from areas of trade, finance, map, life services, etc.²⁸ Right now the library has 58 billion books collection, amount to 100PB data information.²⁹ These data enable online merchants to obtain the the big picture of their industry, the market profile of their brands, and consumer

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behaviors relating to their online shopping.³⁰ Building up a Big Data platform is both time-consuming and costly, however, once successful, it will bring major impact to the electronic commerce industry. Public investors are likely to disfavor a long-term project like AliResearch merely because its lack of short-term benefits. It is fair to conclude that Alibaba's dual-class share structure makes the Big Data dream possible to come true.

III. DANGERS IN DUAL-CLASS STRUCTURE

Although dual-class share structure has its advantages, it seems to be disfavored by investors. In recent years Council of Institutional Investors (CII) expressed to NYSE and NASDAQ several times its request of going back to the principle of one share, one vote.³¹ In one of the letters CII specifically expressed that it was disappointed that NYSE allowed the listing of Alibaba after Alibaba was reportedly denied listing by HKEx.³² In the view of long-term investors, some of the worthy goals, such as "enhancing the accountability of the listed companies", and...