Now that Alibaba has gradually faded from media attention, maybe our market can finally have a more rational and open discussion about weighted voting rights and our future competitiveness. Some in the market have lamented Hong Kong’s “loss” of Alibaba’s IPO, but most are busy congratulating the city for “standing its ground” and not abandoning its core values.
The key question is then: what are the core values of Hong Kong? Can we maintain Hong Kong’s long-term competitive advantage while insisting on those values?
The debate over Alibaba’s listing plan should be a catalyst to kickstart an important debate over these two questions, but they are seldom brought up. Most of the discussions revolve around these rhetorical questions:
- Should Hong Kong compromise its “one share, one vote” principle to secure the listings of powerful companies from China?
- Should Hong Kong sacrifice “one share, one vote” for large commercial gains?
- Should Hong Kong blindly follow the US in its corporate governance structures and destroy the spirit of “one share, one vote”?
What is common about these questions is that they make it difficult for people to disagree. The answers are easy. If these are the only issues to consider, I agree that consulting the market would be a waste of time. But these questions don’t come close to touching on the core issues in this debate.
What are the core values of the Hong Kong market?
In my opinion, Hong Kong’s core values are the rule of law and due process. These are sacrosanct foundations of our market that must be protected at all cost. These core values dictate that we must not change our rules haphazardly for a single company and any significant change would need to go through due process. But on the other hand, due process does not dictate refusal to debate the future of our market. Our market still has room to improve and our efforts should not stop simply because one company has left for another market. It’s time for us to let our emotions subside and have a rational debate.
Is “one share, one vote” part of Hong Kong’s core values?
Many commentators argue that “one share, one vote” is an untouchable part of Hong Kong’s core values when it comes to corporate governance and financial market regulation. So is “one share, one vote” a core value? Is it so important in Hong Kong that it has been universally applied without exception?
It turns out that “one share, one vote” is actually not absolute at all in Hong Kong. For example, HKEx itself is not subject to this principle, as the Hong Kong government gets to appoint six out of the 12 non-executive directors and name the chairman, regardless of how many HKEx shares it owns (currently at 5.8 per cent).* That can be justified on grounds of public interest, as HKEx has a statutory responsibility to operate the central securities marketplace and its shareholders’ interests are subordinate to the public interest.
Another example where “one share, one vote” has been consistently denied is to controlling shareholders, family groups or big SOEs in the context of connected party transactions. Hong Kong's Listing Rules prohibit controlling shareholders from voting on connected transactions no matter how important those transactions are to the controlling shareholders or the company. There are compelling public policy grounds for these rules: to protect minority investors against possible self-dealing or conflict of interest by the controlling shareholders. “One share, one vote” is, again, put aside for good reason: investor protection.
At least as far as these exceptions go, “one share, one vote” is not universally applied in Hong Kong.
Does investor protection equal “one share, one vote”?
In this debate, many people connect “one share, one vote” with investor protection. But are they really the same thing? “One share, one vote” is a rule that ensures those who have more of a firm’s share capital have more influence over the company; that is: money is king.
But investor protection is a much bigger concept; it is an overarching series of rules and regulations aimed at ensuring investors, particularly public investors, are as protected as possible from wrongdoing by those in power. In other words, investor protection is the end, and “one share, one vote” is only one of the many means. If the latter fails to fulfill the end, it can be overruled, just like in the case of connected party transactions.
So when we discuss weighted share structures, shall we focus solely on “one share, one vote” or shall we look beyond it? For many years, this has been an open question, and remains controversial among academics and regulators. The defenders of “one share, one vote” like its intuitive simplicity and fairness of the principle, which is almost in tune with “one person, one vote”. Those who advocate allowing dual class shares argue that contractual freedom and freedom of choice creates a more effective and robust market and that full disclosure and more aggressive post-listing regulatory compliance provide more effective investor protection than insisting on the “who has more money rules” doctrine. Whose view is more valid and who should decide? If investor protection is the goal, then the question becomes, what should the regulator focus on?
In a company with a controlling shareholder, the regulatory focus is always on protecting minority public investors against possible wrongdoing. The “one share, one vote” principle actually works in the opposite way here. In a company widely held by public investors without large concentrated holdings, the regulatory focus is primarily on ensuring disclosure compliance by management rather than “refereeing” among shareholders. “One share, one vote” is not as relevant here because disclosure is the key.
More complex questions arise in the context of technology and new economy companies which tend to have three distinctively different groups of shareholders: founding shareholders/management, large and influential early investors and public investors at the IPO. While the interests of all three groups of investors are aligned most of the time, there can be times when they aren’t; especially when long-term and short-term interests diverge.
In this situation, which investors need to be more protected, and against whom? Should the founding shareholders be protected against the short-term tendencies of its large early investors or later activist institutional investors? Or should the pre-IPO private investor sitting on large gains be protected for their right to seek an early exit?
What are the primary interests of the IPO public shareholders, particularly individual investors, who most likely bought the IPO because of the success of its founders? Due to their minority status, the public shareholders at the IPO will have limited influence on the governance decisions of the company. Are their interests better served by the founders having more or less control over the company’s future destiny? Are their interests better served if the large early investors maintain more control of the company than the founders? When the founders and large pre-IPO investors have a major conflict in strategy or direction, which side’s interests are more aligned with public investors?
If we believe that founders are disproportionally important to technology companies, as in the case of Apple and Google, are public shareholders’ interests better served by giving them more control to achieve their vision? In that context, how much control is too much and how much is just about right? What happens if the founders’ interests are no longer as aligned with public shareholders when they reduce their holding below a certain level? Can the control then be taken back? How? When and by whom? These are more difficult questions to answer, hence they deserve more serious discussion.
Hong Kong’s Competitive Edge
From one perspective, it’s much easier not to bother with these challenging issues and choose clear and simplistic rules that don’t require regulators to undertake the undue burden of balancing interests. The US has chosen the full disclosure route; thus allowing dual class shares and leaving all the thorny issues to be resolved by the market through investor choices and valuation.
The choice made by the US (over 20 years ago) to allow dual class shares created a real dilemma for Hong Kong. After all, the US capital market is still considered to be the largest, deepest and most sophisticated in the world today. It is difficult to conclude that the US regulators chose to allow the dual class share regimes because they do not care about investor protection. The success to date by firms like Google and Facebook makes it difficult for us to conclude that US investors have lost out as a result of such structures.
Which route should Hong Kong choose? Most of us would probably feel uncomfortable to simply follow the US practice because our market is so different, especially in terms of private enforcement through class actions. Another easier choice is the opposite of the US practice: complete refusal to consider any different share structures for any company, technology or otherwise. “One share, one vote”; nice and simple.
If we only care about reputation, this approach will certainly help maintain Hong Kong’s nominal regulatory purity. If investor protection is the primary driver, however, it would be interesting to find out exactly whom the policy would end up helping and protecting and whom it could potentially hurt. Let’s look at how this approach might impact different stakeholders in our markets:
- For potential China listing candidates from the technology and new economy space, their absolute top choice of listing venue has always been Hong Kong. Many would be, however, forced to go to the US should weighted shares be a key consideration offsetting other advantages Hong Kong has to offer. If this becomes a trend, Hong Kong could lose a huge franchise for good.
- For investors strongly opposed to weighted share structures, whether international or local investors, they will not participate in such offerings no matter where the company is listed. Whether Hong Kong allows weighted shares is of limited relevance to them, despite their criticism of such structures;
- For large international institutions that can accept weighted share structures, they will go wherever the listing is and invest there if they see value in the company. Whether Hong Kong allows such structures is again of limited relevance to them.
- For Hong Kong local institutions and investors interested in participating, they will still have to face an unpleasant choice between standing on the sidelines watching others enjoying the party or overcoming the inconvenience of participating in a remote offering. Worse, if they choose this latter option, they would have to do it without the protection of our own home regulators.
At least from these perspectives, inaction appears to have helped nobody in Hong Kong, but it does hurt Hong Kong’s competitiveness in attracting new economy companies. We should ask then: between blindly following and completely rejecting the US model, is there a middle road onto which we could walk where we could consider allowing some weighted share rights to founding shareholders of technology companies while at the same time ensuring that we adequately protect the core interests of the public investors?
Hong Kong has earned a lot of praise and respect for taking a principled stand. We are all proud and rightly so, but we should not misplace our pride and accept the praise and congratulations we received as an endorsement not to engage in a deeper and tougher debate on how to strengthen our market. Due process means giving the process due time, space and respect; it does not give an excuse for inaction.
I once wrote of my dreams in this blog, and the many characters in my dream who came together to debate different positions on Hong Kong’s market. I am still hopeful this discussion can happen in real life. We all love Hong Kong and want it to be as successful as it can be.
Whether or not Hong Kong makes changes to its listing regime is secondary; what matters is that we identify the fundamental principles at stake and debate them properly in an effort to search for answers to those genuinely challenging questions. We may very well end up agreeing to maintain the status quo even after all the debates; by then we would all know that we have reached a consensus with all views considered. This process alone would greatly benefit Hong Kong as we would have demonstrated to the world the rationality, the inclusiveness and the wisdom of the people in Hong Kong.
* According to the Securities and Futures Ordinance, the Hong Kong Special Administrative Region Government is entitled to appoint up to six members to the HKEx Board to represent the public interest.
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