Alibaba Group’s 2014 initial public offering (IPO) grabbed the attention of investors around the world — and not just because it became the biggest IPO in history.
Also making headlines was the company’s unique management structure — one that gave founder Jack Ma an “absolute dictatorship,” says Wei Jiang, the Arthur F. Burns Professor of Free and Competitive Enterprise and a Chazen Senior Scholar at Columbia Business School.
In a Chazen case, Professor Jiang, along with Guochao Yang, with China’s Central-South University of Finance, Economics, and Law, and Song Shi, with the Shanghai Futures Exchange, recently examined the Alibaba Partnership arrangement and its impact on outside shareholders. They found problems in two areas: outside investors don’t get a say in how the company is run. And, if the company does well, these investors have limited ability to reap rewards in terms of cash flows and stock appreciation.
Jiang sat down with Chazen Global Insights to demystify this unusual deal.
How is the Alibaba IPO different from more traditional deal structures?
“The Alibaba deal falls into the general category of what we call a ‘dual-class’ structure. It differs from the one-share, one-vote structure in that it gives one group of investors outsized voting control.
“In a traditional dual-share system, the ‘superior share’ holders, usually the insiders including the managers, typically get 10 votes for every share they own, versus one vote per share for outside investors. Still, if a majority of outside shareholders oppose the direction a company is taking, they can nominate new members to the board.”
So what’s the problem?
“For one thing, the offering documents revealed that a separate entity, known as Alibaba Partnership and headed by Alibaba founder Jack Ma, has the right to nominate the majority of the company’s board of directors, despite the fact that the partners would maintain a minority stake in the newly public company.
“It’s an absolute dictatorship that blocks the possibility of a contested election. Outside shareholders can’t get adequate representation on the board regardless of how equity ownership evolves down the road.
“Also, in a typical dual-class share structure, as a company grows and issues new stock to fund that growth, control by inside shareholders is eventually diluted. This makes sense because when a company is in its infancy, shareholders are often times happy to let founding executives have more control and be able to make decisions faster. As a company grows beyond infancy and reaches maturity, though, outside investors get more say in how the company is managed as the management process becomes more standardized and best practice starts to matter more. It’s a natural process.
“With Alibaba there is no dilution process. All of the power is permanently consolidated in the partnership.”
How else does the Alibaba Partnership benefit?
“In a dual-class system, all shareholders still receive equal distribution of income and participate equally in the company’s growth through stock appreciation. With Alibaba, because the partners are entitled to decisions regarding assets reallocation and cash flow attribution, so they effectively receive a larger share of the company’s income. The board is also free to make deals that benefit the partnership at the expense of Alibaba Group’s outside investors.
Because of this structure, Alibaba wasn’t allowed to list on the Hong Kong and Shanghai exchanges. Why did the New York Stock Exchange (NYSE) allow it?
“The most obvious reason is that China disallows dual-class shares, and this was classified as a dual-class system because of the consolidated voting power.
“A more subtle reason is that China lacks the types of external governance through outside shareholder monitoring and market discipline that are common in the United States, such as stricter regulatory oversight and the ability for shareholders to launch activism or file class action lawsuits. It wouldn’t have been a successful listing in China because Chinese investors would not have the confidence that there were enough checks and balances to protect their interests.
“But there is a huge appetite among US investors for these types of offerings. Some very sexy companies — including Alphabet, Inc. (Google’s parent) and Facebook — have come out with these structures in recent years, and investors all wanted a piece of them. Alibaba came in through a window when investors didn’t worry too much about the share structure. They just wanted a piece of the growth.”
Yahoo and SoftBank are both now looking to sell at least part of their stakes in Alibaba. How will these sales impact other outside other shareholders?
“SoftBank has clearly not been happy. When you invest 23 percent into a company you would think that you would have some representation on the most important decisions, and now they feel they have become a passive and vulnerable investor.
“Yahoo got in because they thought there would be some business synergy, but that didn’t work out. In the end, Yahoo’s role has become more of a hedge fund, and they’ve been a pretty good hedge fund! Most of the stock is being sold through repurchase agreements with Alibaba, so other outside investors won’t feel a big hit from these sales.
“What does impact outside investors is that Alibaba is not maximizing its value to all shareholders, because the Alibaba Partnership and Jack Ma are not aligned with the shareholders. If they played the game fairly, the stock price would be higher, but they aren’t motivated by more financial gain. It seems to be more important to them that they just run the company any way they want. If they ever need to come back to the financial markets, though, that will hurt them in the long run.”