Finance

Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

Imagine buying a home when the previous owner continues to live in it and call the shots, indefinitely. Imagine running a market that matched such sellers with buyers.

That’s the dilemma facing Hong Kong and other financial hubs such as Singapore and London as they consider accepting the dual-class shareholding structure used by U.S.-listed tech giants like Facebook Inc. and China's Baidu Inc. The system allows founders to remain in control with a minority of the equity and, in some cases, gives new owners no voting rights at all.

Alibaba Group Holding Ltd.  ditched Hong Kong for New York after the city's stock exchange blocked a similar arrangement  for its world-record initial public offering in 2014, dealing a blow to the former British colony's fundraising ambitions.

On purely ethical grounds, it's hard to see why Hong Kong should yield on its long-cherished "one-share, one-vote" principle. But there's no doubt the city's stock market needs to find a way of attracting China's emerging new-economy stars or persuading those already publicly traded, such as Baidu or JD.com Inc., to seek secondary listings in Hong Kong.

Out of Control
Baidu and JD.com are the biggest by market value of Chinese companies with weighted voting rights that are listed in the U.S.
Source: Bloomberg
Note: Alibaba is excluded because it employs a different structure to enable founders to keep control.

If the Chinese city drops its objection to dual-class structures, then safeguards -- and specifically embedded time limits, also known as "sunset clauses" -- will be key.

Hong Kong Exchanges & Clearing Ltd. ended a consultation Aug. 18 on allowing two types of market to house new-economy firms: one for "pre-revenue" companies that would be open to professional investors only; and the other for firms that use weighted voting rights.

The results of the exercise will be released in the next few months but, according to the exchange operator, the cost to Hong Kong of sticking with its principles has been steep. Chinese companies with weighted voting rights raised $34 billion in the U.S. in the past decade, or 11.5 percent of the total netted from initial public offerings in the territory over the same period. 

That the Hong Kong stock exchange needs to be sexier isn't in doubt. Internet behemoth Tencent Holdings Ltd. may be the Hang Seng Index's top stock, boasting a $400 billion market value, but it sits in a lonely space in Hong Kong, with few new-economy peers for company.

Heavy Handed
Of the top five Hong Kong IPOs this year, only one, Wuxi Biologics, is neither a state firm nor an old economy stock
Source: Bloomberg

At the same time, China's listed companies have a spotty corporate-governance record, so weakening the ability of shareholders to exercise oversight may exacerbate risks. BlackRock Inc., which has been vocal about its distaste for uneven control mechanisms, pointed out in a recent submission to the exchange that weighted voting rights are no guarantee of attracting tech stocks. Canada allows weighted voting rights, the New York-based money manager said, but has fewer tech and biotech listings than Australia, which doesn't. 

If the consultation finds that such shareholding structures are the only way to shake Hong Kong out of its old-economy-driven reverie, then the exchange should at least insist on sunset clauses. These set a time limit on dual-class arrangements, after which companies revert to one-share, one-vote.

Dual-class shares give founders the power to push through their vision for a company without having to worry about short-term investor pressures. But without checks and balances, management abuse and unwise decisions -- such as resisting a takeover that's clearly in the best interests of the company -- are inevitable. All privileges need limits.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Note: Alibaba didn't propose a dual-class structure but one where the company's "partners" would have the power to vote for the majority of the board in perpetuity. 

To contact the author of this story:
Nisha Gopalan in Hong Kong at ngopalan3@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net