Jack Ma is quietly giving up control over the legal
entities that control Alibaba Group in a move aimed at reassuring
shareholders of their rights in China’s most valuable company. It is
also a reminder of weaknesses in corporate governance at the country’s
biggest companies.
Ma, who said he plans to retire from Alibaba in 2019, is surrendering
control over the variable-interest entities, or VIEs, that hold the
company’s business licences. Those licenses will be distributed among
the company’s top executives, spreading authority more broadly and
decreasing the risks that one or two people would have undue influence
over the business.
“We are in the process of enhancing the structure we use to hold our
VIEs so that we can better ensure the stability and proper governance,”
the company said in a July securities filing, adding that it plans to
complete most of the changes in 2019.
But the Ma episode is a stark example of how China’s rules leave
shareholders vulnerable in an escalating trade war. Businesses such as
Alibaba and rival JD.com that operate in sensitive industries like the
internet use VIE structures to evade restrictions on foreign ownership
when they go public overseas. Ant Financial, Alibaba’s fast-growing
finance affiliate that Ma controls, is likely to use VIEs as it goes
public in Hong Kong, unless it gets a waiver or benefits from new
policies from Beijing.
The entire framework rests on shaky legal ground. Beijing has never
officially endorsed VIEs; they were pioneered by Sina and its investment
bankers with its initial public offering in 2000. Shareholders may have
difficulty enforcing rights in China should there be breaches of faith.
“VIE contracts are only enforceable as long as Beijing desires them
to be so,” said Brock Silvers, MD of Kaiyuan Capital. ‘Alibaba’s new
structure doesn’t alter the risk of a controlling entity’s misbehavior
toward offshore investors.”
One example of VIE risk came in 2011 when Yahoo, which owned more
than 40% of Alibaba at the time, disclosed the Chinese company had
transferred its online payments business to a separate company
controlled by Ma without board permission. Yahoo shares tumbled. The
dispute was settled later the same year.
“VIEs are rife with abuse,” says Carson Block, a short-seller who has
criticised several Chinese companies. “You have effective impunity.”
The vulnerability of VIEs has drawn additional attention now because
of the increasingly contentious trade war between the world’s two
largest economies. Shareholders in Chinese companies that trade in the
US — from Alibaba and JD to New Oriental Education & Technology
Group and live-streaming service YY — don’t own stock directly in those
businesses, but rather in a shell company, often in the Cayman Islands.
“Compared with direct ownership, the VIE structure has some inherent
limitations,” said Jeff Zhang, a partner at law firm Orrick. “It was a
compromise balancing between legal restrictions and economic interest.”
Shares in many such companies have slid this year along with the
rising trade tensions. Alibaba’s stock is off 23% since its June high,
slicing its market value by more than $120bn. Ma’s decision to give up
the VIE licences shows no signs of reversing that.
Bloomberg
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