2. Competitive Position
As mentioned above, Hong Kong is the leading international market for the listing and trading of Mainland Chinese companies. The Concept Paper notes that the ability to attract a broad spectrum of Mainland companies to list on the Exchange could be an important factor in ensuring Hong Kong’s continued relevance as China opens up its financial markets. So far, Mainland companies using WVR structures have chosen to list in the United States. The majority of these are information technology companies and include JD.com and Alibaba Group. The US exchanges, the NYSE and NASDAQ, allow the listing of companies with WVR structures, although this is in the context of a different legal and regulatory regime to Hong Kong’s, which is discussed further below. The Concept Paper also notes that Hong Kong is ranked third in the area of investor protection in the “Doing Business 2014” measure of business regulations published by the World Bank and International Finance Corporation. The United States is ranked sixth for investor protection.
In June 2014, the Financial Services Development Council’s (FSDC) published a paper entitled “Positioning Hong Kong as an International IPO Centre of Choice” which comments that Hong Kong risks over-reliance on Mainland China as the source of its IPO candidates and recommends making “every effort to diversify its ‘client base’ and actively open up to quality companies from all corners of the world”.5 The Concept Paper also points to the implementation of the Shanghai-Hong Kong Stock Connect pilot programme, which was scheduled for October 2014, as a development which could have a fundamental impact on Hong Kong’s attractiveness as a listing venue for overseas companies. The Exchange has stated that the programme is scalable in size, scope and market in the future and that cross-border capital raising may eventually be permitted under the programme, subject to SFC and CSRC regulatory approvals. The ability to list on the Exchange with a WVR structure might therefore prove attractive both to companies with WVR structures which are already listed on other exchanges, and to privately-owned overseas companies with such structures looking for their first public listing.
The FSDC’s paper also comments that the “one share one vote” principle embodied in Rule 8.11 merits more detailed study and re-consideration with the benefit of a public consultation. Pointing to the fact that Rule 8.11 may have deterred the Hong Kong listing of overseas companies with genuine commercial or legal reasons for having WVR structures (e.g. a legitimate desire to raise funds without diluting control), the Concept Paper urges the Government and regulators to review the rule and consider whether modifications or partial relaxations are appropriate.
3. Empirical Studies and Hong Kong Weighted Voting Rights Pros and Cons
3.1 Arguments against WVR Structures
The Exchange summarises the arguments against WVR structures as follows:
- ProportionalityCompany shareholders normally have one vote for every ordinary share held. This is because, by buying additional shares, they put more of their own capital at risk and are therefore entitled to a greater proportion of the company’s future cash flows. The gain of an additional vote for each share purchased ensures that shareholders have a greater say in who manages the company for the purpose of producing future capital gains and cash flows. They also gain a proportionate say on whether cash flows will be paid out as dividends. The one share one vote principle in Hong Kong thus ensures that shareholders with the same interest are given an equal say on matters affecting the value of their shares.
- Empirical EvidenceThe Exchange conducted an in-depth review of the empirical academic studies that have been carried out on the effect of a dual-class share structure or DCS, which are summarised at Appendix IV to the Concept Paper. The consensus view is that investors generally apply a discount to shares with inferior voting rights in a dual-class share structure, which the studies argue reflects the following risks:
- Controllers’ consumption of private benefits – it is argued that a dual-class share structure that allows controlling shareholders to retain control while holding a relatively small equity stake in a company makes it more likely that the controlling shareholders will extract personal benefits from the company (e.g. excessive salaries or perks). This is because they can enjoy the full benefits they take out of the company, but suffer less downside through the reduction in the value of their equity stake in the company resulting from their extraction of private benefits;
- It is also considered that a smaller equity interest could incentivise controlling shareholders to transfer quality assets out of a listed company to other companies in which they have a greater stake, and vice versa (which is known as “tunneling” or “value shifting”); and
- Entrenchment risk –day-to-day decision making is typically delegated to a company’s board of directors, while shareholders’ approval is required only for the most important matters, such as the appointment and removal of directors. Theoretically, the knowledge that they can be removed by shareholders should motivate directors to perform well and act in the best interests of the company as a whole. Where however a company has a WVR structure, the non-controlling owners may be prevented from removing directors who extract private benefits, fail to manage the business so as to maximise its value and performance or act contrary to the wishes of the minority shareholders.
3.2 Arguments in favour of Weighted Voting Rights Structures in Hong Kong
Arguments put forward in support of allowing weighted voting rights structures include the following:
- Long-termism – A WVR structure may promote long-termism as it gives incumbent directors the freedom to run a business in order to maximise growth and value for shareholders over the long term. While entrenchment is detrimental for investors if a company performs badly due to poor management, it can also benefit a company since it insulates the directors from shareholder pressure to generate short term returns that are not in the company’s long term interests;
- Detrimental market impact – the prohibition on weighted voting rights structures in Hong Kong restricts investors’ ability to invest in companies using the structure, and thus renders the Exchange a less efficient marketplace for achieving the effective allocation of capital from investors to listed companies. In addition, controlling shareholders are prevented from diversifying their wealth into other entrepreneurial projects which could benefit the market as a whole; and
- Allow financing without dilution in Hong Kong – Fast growing companies looking to list on the Exchange may already have had one or more rounds of private equity or debt financing and exhausted their ability to grow through private investment. The founders will have diluted their stake in the company as a result. A WVR structure would allow the company to expand without diluting the founders’ ownership any further and to maintain management continuity.
3.3 Impact of Weighted Voting Rights Structures in Hong Kong
While investors typically apply a discount to shares with inferior voting rights to reflect the risks of consumption of private benefits, underperformance and management entrenchment, the Concept Paper concludes that there is a lack of consensus as to whether those risks in fact have a negative impact on a company’s performance. The Concept Paper also notes that some studies provide evidence that laws and regulations can limit the negative impact of WVR structures.
4. Jurisdictional Comparison
The results of the Exchange’s review of the rules and practices in other jurisdictions are set out in Appendix 3 to the Concept Paper. A range of approaches to WVR are adopted which fall into three main groups:
- Some jurisdictions allow WVR structures under both their corporate law and listing rules (e.g. the US, Canada and Sweden);
- Other jurisdictions allow companies to have WVR structures under their company law, but prohibit such companies from listing (e.g. Hong Kong, the UK, Australia and Singapore);
- Some prohibit both listed and unlisted companies from using WVR structures (e.g. Germany, Spain and Mainland China).
In terms of competition for listing Chinese companies, after the US, the Exchange principally competes with Singapore and the UK. The Singapore Stock Exchange (SGX) does not allow primary listed companies to have WVR structures. The UK prohibits the listing of “premium listed” shares with mechanisms designed to consolidate power in the hands of a small number of individuals. WVR structures are allowed for “standard listed” shares, but institutional shareholders in the UK are generally hostile to these structures. As at the end of May 2014, 57 Mainland Chinese companies were primary listed on the SGX, but there have been no new listings of Mainland Chinese companies since 2012. Eleven Mainland Chinese companies are listed on the London Stock Exchange. However these are all listed on AIM, the London Stock Exchange’s market for smaller growth companies. None of these companies have WVR structures.
5 FSDC paper “Positioning Hong Kong as an International IPO Centre of Choice”, “Section 5 Conclusion”, page 60.