Shareholders must have right to hold managers to account
Ordinary investors face higher – and often hidden – risks and are all too likely to lose out under structures that strip them of their rights
A dozen years ago, when your columnist was working at the Wall Street Journal, our well-intentioned boss decided that his editorial staff needed to brush up their knowledge of accounting.
Three of us were duly sent to the Hong Kong office of one of the Big Four accountancy firms for a morning's lesson on how to decode corporate balance sheets and income statements.
The accountant lecturing us also meant well. To grab our attention, he started off by handing out photocopies of a newspaper report - from the South China Morning Post as it happened - to illustrate what he said were some common mistakes journalists made when covering corporate finance and accounting reports.
The report concerned a Hong Kong-listed company named Boto, which had attracted a loyal investor base by becoming the world's largest manufacturer of artificial Christmas trees.
Each year, Boto generated handsome profits shipping millions of low-cost plastic spruce trees to the United States, where they sold at fat margin.
It was a great business, but not innovative enough for Boto's chairman. As the report detailed, he had invested about HK$40 million of his shareholders' money in a computer animation company founded by his 24-year-old son.
The accountant explained in detail why he thought the report had misrepresented what he judged to be a perfectly respectable transaction.
The three journalists in the room disagreed. "What about the ordinary shareholders?" we asked. They had bought into a solid business making Christmas trees, only to find themselves suddenly taking a punt on an untried startup in a high-risk field. They had been misled.
The rest of the morning was spent in a spirited argument about corporate governance and minority shareholder rights. I didn't learn anything new about how to read a balance sheet, but I did get a valuable reminder that accountants, like lawyers, investment bankers and management consultants, work for the people who pay them. And it's company managers who sign their cheques, not ordinary shareholders.
It's worth remembering that amid all the current kerfuffle over Alibaba and its proposed Hong Kong listing.
Alibaba, the mainland's internet retail giant, is being pushed to go public by a line-up of private equity and sovereign wealth funds, which want a more liquid investment.
But the company's bosses don't want to loosen their control. So they approached the Hong Kong stock exchange proposing a "partnership" structure, which would give them the right to stuff the board with their own choice of directors, even though collectively they own just 10 per cent of the stock.
Not on, said the exchange: no differential shareholder rights allowed.
At that point, Alibaba's bosses threw a hissy fit and threatened to decamp to New York.
Now, amid a storm of criticism, largely from accountants, lawyers and investment bankers, exchange chairman Charles Li Xiaojia has gone wobbly. In his blog last week, he argued that "innovative companies" can deserve special consideration when it comes to governance. The existing rules he described as "one extreme", warning that if Hong Kong is not prepared to relax its stance, "we could lose the chance to embrace the future and all the benefits it would bring".
Yes, if Hong Kong sticks to its insistence on single-tier share structures, it may lose some listings to the United States, where dual-share classes and similar structures are allowed.
But the US is a different market. Regulators there believe that if you give them all the information, investors can make up their own minds about the risks. As a result, the US has much stricter disclosure standards than Hong Kong. Notably, companies have to report their results every three months rather than every six months as they do here.
The American approach works in part because investors in the US are far more professional than in Hong Kong. According to the Securities Industry Association, just 10 per cent of American adults own shares directly as retail investors. According to the Hong Kong stock exchange, here the proportion is 36 per cent.
So it's all very well for US regulators to say "buyer beware", but as the Lehman minibond furore demonstrated, that approach doesn't work in Hong Kong. When retail investors here fail to read the small print and lose out, they get angry and blame the regulators.
And under structures that strip ordinary shareholders of their rights, they are all too likely to lose out because they cannot hold company managers fully to account. These structures might be fine as far as accountants and lawyers are concerned, but for ordinary investors, they carry heightened - and often hidden - risks. They are a lousy idea.
Incidentally, within months, Boto had sold its Christmas tree business, renamed itself Imagi and refocused itself on computer animation. Its shares have since fallen 97 per cent.