In a recent article, Thomas Mehaffy and I, use Alibaba as a case study to analyse the legal challenges posed by the variable interest entity (‘VIE’) and disproportional control structures. In September 2014, Alibaba Group Holding Limited (‘Alibaba’) successfully launched a $25 billion initial public offering (IPO), the largest IPO ever, on the New York Stock Exchange. Alibaba’s IPO success witnessed a wave among Chinese Internet companies to raise capital in the US capital market. A significant number of these companies have employed a novel but poorly understood corporate ownership and control mechanism—the VIE structure and/or the disproportional control structure. The VIE structure was created in response to the Chinese restriction on foreign investments; however, it carries the risk of being declared illegal under Chinese law. The disproportional control structure, usually in the form of dual-class shares, helps founders or controlling shareholders maintain control post-IPO with less equity contribution. Around 30 percent of US-listed Chinese companies adopted a dual-class share structure or similar mechanism to enhance insider control. The percentage is much higher than that of US public companies, which is about 6 percent.
Specifically, this Article dissects the structure of the VIE and sheds important light on inherent legal and governance risks associated with the VIE structure, along with potential policy solutions to protect investors and reduce information asymmetry. Similar to most US high-tech companies that adopt dual-class share structures to maintain control by founders, Alibaba grants a partnership, consisting of its founders and executives, an exclusive right to nominate a majority of its directors. Furthermore, Alibaba implements various anti-takeover measures to strengthen insider control, many of which are considered detrimental to the interests of minority shareholders. Such excessive insider control presents a puzzle as to the success of this world’s largest IPO and casts doubt on the long-debating issue of whether corporate governance really matters. In this article, we argue that the idiosyncratic value brought by a charismatic founder-executive—in this case, Alibaba’s Jack Ma—together with voluntary commitments made by Ma himself in Alibaba’s prospectus, help mitigate the potential abuse inherent in disproportional insider control structure. However, the success of such a structure hinges on the reputation and commitments of specific founders, and may not function to the benefit of investors in the long run.
Yu-Hsin Lin is an Associate Professor at City University of Hong Kong School of Law and a guest contributor to the Oxford Business Law Blog.