Jack Ma, Alibaba’s VIEs and that US$120bil market cap plunge

HONG KONG: Jack Ma is quietly giving up control over the legal entities that control Alibaba Group Holding Ltd in a move aimed at reassuring shareholders of their rights in China’s most valuable company.

It’s also a reminder of weaknesses in corporate governance at the country’s biggest companies.

Ma, who said he planned to retire from Alibaba next year, is surrendering control over the variable-interest entities, or VIEs, that hold the company’s business licenses.

Those licences will be distributed among the company’s top executives, spreading authority more broadly and decreasing the risks that one or two people would have undue influence over the business.

“We are in the process of enhancing the structure we use to hold our variable interest entities so that we can better ensure the stability and proper governance,” the company said in a July securities filing, adding that it planned to complete most of the changes in 2019.

But the Ma episode is a stark example of how China’s rules leave shareholders vulnerable in an escalating trade war.

Businesses such as Alibaba and rival JD. com Inc that operate in sensitive industries like the Internet use VIE structures to evade restrictions on foreign ownership when they go public overseas.

Ant Financial, Alibaba’s fast-growing finance affiliate that Ma controls, is likely to use VIEs as it goes public in Hong Kong, unless it gets a waiver or benefits from new policies from Beijing.

The entire framework rests on shaky legal ground. Beijing has never officially endorsed VIEs; they were pioneered by Sina Corp and its investment bankers with its initial public offering in 2000. Shareholders may have diffi- culty enforcing rights in China should there be breaches of faith.

“VIE contracts are only enforceable as long as Beijing desires them to be so,” said Brock Silvers, managing director of Kaiyuan Capital. “Alibaba’s new structure doesn’t alter the risk of a controlling entity’s misbehaviour toward offshore investors.”

One example of VIE risk came in 2011 when Yahoo! Inc, which owned more than 40% of Alibaba at the time, disclosed the Chinese company had transferred its online payments business to a separate company controlled by Ma without board permission. Yahoo shares tumbled. The dispute was settled later the same year.

“VIEs are rife with abuse,” said Carson Block, a short-seller who has criticised several Chinese companies. “You have effective impunity.”

The vulnerability of VIEs has drawn addi- tional attention now because of the increasingly contentious trade war between the world’s two largest economies.

Shareholders in Chinese companies that trade in the US – from Alibaba and JD to New Oriental Education & Technology Group Inc and live-streaming service YY Inc – don’t own stock directly in those businesses, but rather in a shell company, often in the Cayman Islands.

“Compared with direct ownership, the VIE structure has some inherent limitations,” said Jeff Zhang, a partner at law firm Orrick. “It was a compromise balancing between legal restrictions and economic interest.”

Shares in many such companies have slid this year along with the rising trade tensions. Alibaba’s stock is off 23% since its June high, slicing its market value by more than US$120bil.

Ma’s decision to give up the VIE licences shows no signs of reversing that.