I object to Dual-Class Share Structure* (DCSS) companies as they violate the natural justice of the One Share One Vote (OSOV) principle. I believe they give management an extra mechanism to treat minorities unfairly and ultimately the share prices of companies with these structures will trade at a discount to peers with OSOV structures. These discounts will lead to contagion resulting in a higher cost of capital and thus competitive disadvantage for other companies listed in such markets.
The Hong Kong Stock Exchange (full disclosure, of whose Listing Committee I’m currently a Member) is planning to allow DCSS companies to list and will, in the coming months, be moving ahead to flesh out specifics of how this is to be achieved.
The paper highlighted this week is therefore of especial interest. Writing in the March 2017 edition of The Journal of International Business and Law, a former judge of the Chaoyang District Court of Beijing Judge Fa Chen and Dr. Liyuan Zhao, of the Middlesex University (U.K.) take us on a tour of the experience of Chinese DCSS and OSOV companies listed in the U.S. since 2011 (before which they believe listings were not suitable for inclusion into their survey).
They provide useful context as to why Chinese companies opt for DCSS listing more than other non-American companies. They believe it has to do with easier access to capital in China in recent years for hostile takeovers and the inadequacy of legislation to help companies defend themselves.
Why are takeover rules inadequate in China? They trace the problem back to the early days of securities rule crafting in China where the Hong Kong (i.e. an old British) model was heavily cribbed. They also think legislators had little inkling that hostile takeovers in China could become, well, so hostile. They remind the recent Baoneng attack on Vanke would have been unthinkable just a few years ago.
They provide a comparison of how DCSS and OSOV companies in their sample have fared since listing and come to the conclusion that DCSS companies, in aggregate, have done better than OSOV companies; BUT there’s gaping hole in their analysis. The data is market capitalization weighted and so includes Alibaba, which dominates.
I would add, their sample period is one in which the U.S. stock market has enjoyed a persistent upward tick. Concluding from this sample DCSS companies tend to do OK is analogous to concluding building homes in Beijing with no heating is fine if you just sample May through September.
Notwithstanding the above, the paper is a useful (if Kalahari-dry!) read wherever you stand in the DCSS vs. OSOV debate. You can access it in full via this link To Be or Not to Be.
Happy Sunday.
[* I prefer the term Dual-Class Share Structure to the more frequently used shorthand in Hong Kong of Weighted Voting Rights (WVR). The distinction is as important as that of ‘gaming’ and ‘gambling’ or ‘e-sports’ and ‘computer gaming’ i.e. don’t allow partisans to hide behind semi-palatable euphemism where the reality is less attractive. DCSS may not encompass all the methods by which managements seek to punish minorities through control structures but it makes it clearer to the uninitiated the reality of these various mechanisms.]