The Alibaba’s IPO is expected to be one of the largest initial public offerings in history, is as far as we hear in PARIS generating excitement and strong demand. According to a US correspondent of Proxinvest, participating investors, however, should recognize that Alibaba’s structure fails to provide adequate protections to public investors.
According to an article of Professor Lucian Bebchuk specialist of corporate governance at Harvard law School, several factors combine to create such risks. For one, insiders have a permanent lock on control of the company but hold only a small minority of the equity capital. Then, there are many ways to divert value to affiliated entities, but there are weak mechanisms to prevent this. Consequently, public investors should worry that, over time, a significant amount of the value created by Alibaba would not be shared with them.
The Alibaba Partnership made of managers in the Alibaba Group or related companies will have the exclusive right to nominate candidates for a majority of the board seats. Furthermore, if the Partnership fails to obtain shareholder approval for its candidates, it will be entitled “in its sole discretion and without the need for any additional shareholder approval” to appoint directors unilaterally, thus ensuring that it’s chosen directors always have a majority of board seats.
After the I.P.O., Alibaba’s executive chairman, Jack Ma, is expected to hold 7.8 percent of the shares and all the directors and executive officers will hold together 13.1 percent.
With an absolute lock on control and a limited fraction of the equity capital, the Alibaba insiders will have substantial incentives to divert value from Alibaba to other entities in which they own a substantial percentage of the equity.
Alibaba’s prospectus discloses that , in 2010, Alibaba divested its control and ownership of Alipay, which does all of the financial processing for Alibaba, and Alipay is now fully controlled and substantially owned by Alibaba’s executive chairman.
Public investors can also worry about the terms of the future transactions between Alibaba and Alipay. Because Alibaba relies on Alipay “to conduct substantially all of the payment processing” in its marketplace, these terms are important for Alibaba’s future success.
Mr. Ma owns a larger fraction of Alipay’s equity capital than of Alibaba’s, so he would economically benefit from terms that would disfavor Alibaba. Indeed, given the circumstances, the I.P.O. prospectus acknowledges that Mr. Ma may act to resolve Alibaba-Alipay conflicts not in Alibaba’s favor.
Given the significant related party transactions that have already taken place, and the prospect of such transactions in the future, Alibaba tried to placate investors by putting in a “new related party transaction policy.” But this new policy hardly provides investors with solid protection. Unlike charter and bylaw provisions, corporate policies are generally not binding. Furthermore, Alibaba’s policy explicitly allows the board, where the nominees of Alibaba partnership will always have a majority, to approve any exceptions to the policy that the board chooses.
Of course, the Alibaba partners might elect not to take advantage of the opportunities for diversion provided to them by Alibaba’s structure. And, even if the partners do use such opportunities, the future business success of Alibaba might be large enough to make up for the costs of diversions and leave public investors with good returns on their investment.
Before jumping in, however, investors rushing to participate in the Alibaba I.P.O. must recognize the substantial governance risks that they would be taking. Alibaba’s structure does not provide adequate protections to public investors.
September 17 2014
