The world of investing is filled with many mathematical ratios, from those used in quantitative analysis to the more complex ones used in pricing of bonds and derivatives. But traditionally, investors in public-listed companies can still count on one particularly important ratio to be simple: that of one-share, one-vote for shareholders, and the bedrock principle of corporate governance. For companies listed on the Singapore Exchange (“SGX”), that is now about to change with the Listings Advisory Committee (“LAC”) of the SGX having in late August 2016 given the go-ahead for the market operator to permit dual-class shares (“DCS”) among listed issuers – subject to certain safeguards.
Whether DCS structures are good or bad for companies and their investors has been a long-running debate, with the pros and cons already well-documented in many publications over the recent years, a good example of which can be found in this Financial Times article published in October 2013. Therefore, this article will not repeat these arguments from both sides of the fence, but instead seeks to critique four of these ostensible arguments for DCS from alternative, practical market perspectives.
THE 1ST OSTENSIBLE ARGUMENT: ENSURING LONG-TERM FOCUS
The first ostensible argument for DCS structures is that they allow company founders (particularly those who retain controlling interests in their firms) more freedom to work toward important long-term goals without having their power challenged by short-term minded shareholders who are more interested in short-term share price gains. Implicit in this argument is that founders of DCS companies prefer longer-term, buy-and-hold shareholders who understand what the founders are trying to do for the company and will patiently give the latter time to realise their vision. On the other hand, short-term minded, trading-oriented shareholders will by their demands on the board distract the founders from their strategic focus. Their short-term trading actions can also create more “volatility” in the company’s share price, which may in turn hamper the company’s fund-raising efforts.
“Volatility” in finance is either measured by using the standard deviation or variance between returns from that same security. Commonly, the higher the volatility, the riskier the security. Theoretically, if this first ostensible argument is correct, then companies with DCS should experience less volatility in their share prices. However, the evidence from a research report published by the United States’ Investor Responsibility Research Center (the “Report” from “IRRC”) in 2012 showed that over a 10-year period from 2002 to 2012, share prices of companies within the S&P 1500 with multi-class voting shares exhibited the most volatility over each of 1-, 3-, 5- and 10-year periods, suggesting proportionately greater buying and selling from short-term traders than long-term shareholders. From a practical and trader’s perspective, this makes sense, since short-term traders are unlikely to be as bothered as long-term, buy-and-hold funds about the deep-rooted governance and control concerns of DCS companies. Furthermore, the higher share price volatility exhibited may have the self-reinforcing effect of attracting even more short-term minded traders to these shares, since traders by nature prefer situations with greater volatility to generate their trading opportunities. It is noteworthy that in the public consultation by the Hong Kong Stock Exchange (“HKEX”) on allowing DCS, many large and reputable institutional investors, including Aberdeen, BlackRock and Fidelity, had come out against DCS. In other words, the findings of this IRRC Report infers that DCS structure has the contrary, unintended effect of attracting short-term minded traders (a.k.a “punters”, and the associated price volatility) to the shares of the company, instead of the long-term minded buy-and-hold investors.
The claim by founders that they need control to enhance focus is also a spurious one since there is an easy way to retain control — just own more than 50% of the shares! If they don’t want to give up control with issuance of new shares, they can either:-
(i) finance using debt or preference shares;
(ii) issue convertible debt that converts into a capped percentage of outstanding shares upon the fulfillment of certain milestone;
(iii) carefully plan and time the issuance of new shares with significant progress in the firm’s business so that the new shares need not be issued too cheaply; and/or
(iv) bring on board only investors who wholeheartedly share the founders’ vision and strategy.
Admittedly, these challenge the founder’s all-round skills in planning, finance, operational management, risk management, marketing and negotiation skills (among others), which is what running a business is about anyway. The one-share, one-vote standard promotes effective monitoring by shareholders, more efficient allocation of capital, better fiscal discipline and responsible behaviour from management. Without such discipline or the fear of being removed, the founders are prone to misallocation or wastage of capital, which makes valuing and investing in listed companies an even more hazardous proposition.
THE 2ND OSTENSIBLE ARGUMENT: CAVEAT EMPTOR
The second ostensible argument many companies give to detractors who voice corporate governance concerns about DCS structures is simply “buyer beware”. After all, no one is forcing investors to buy these companies. Issuers often argue, and regulators also believe, that as long as the DCS structure is clearly and fully disclosed to shareholders, it is their prerogative to invest or not. There are plenty of non-DCS companies to invest in.
At first glance, this “caveat emptor” argument sounds acceptable, until one realises that this argument neglects the fact that in the world of institutional fund management, index funds (which have soared in popularity in the past decade) and many funds which have equity indices as their performance benchmarks will have no choice but to invest their clients’ money into such DCS companies. Hypothetically, if both Manchester United and Alibaba were listed on SGX, their relatively larger market capitalization will certainly make them constituent stocks of commonly used benchmark indices such as the Straits Times Index or MSCI Singapore Index — both of which are capitalization-weighted indices. Such index-tracking or index-benchmarked funds, and their clients’ money, will then be “compelled” into owning companies in which their rights — and their returns — are compromised by the DCS structures. This very large pool of money will, because of their tracking or benchmarked mandate, be unable to sell the DCS even if they are frustrated.
By taking away the minority shareholders’ right to one-share one-vote, DCS structures effectively leave regulators as the sole party with power to discipline the companies or its founders. However, as the local market’s experiences with S-chip (China companies listed on SGX) scandals in recent years have shown, disciplining a listed company’s controlling or founding shareholders is an unsatisfactory affair with scant consolation for retail investors who have been badly burnt.
THE 3RD OSTENSIBLE ARGUMENT: MOVING WITH THE TIMES
In October 2015, the HKEX gave up on allowing companies with DCS, following its proposal to allow DCS structures being rejected by Hong Kong’s regulator, the Securities and Futures Commission. Meanwhile, companies listed on the New York Stock Exchange have been able to use DCS structures since the 1980s. In the past decade, DCS became particularly popular in the US among technology company founders who want to sell shares without conceding control, e.g. Google, Facebook, Zynga and Linkedin.
Is Hong Kong behind the times or not being “commercial” in rejecting DCS? Is HKEX, which is also a listed, profit-seeking entity, less bothered than SGX by the challenge of attracting new listings? Are US regulators more tolerant? HKEX’s CEO Charles Li suggested in his blog on 24 October 2013 that DCS works in the US because that country has a deeper institutional investor base, stronger checks and balances, and a litigious culture that can keep management in check and offer recourse for minority shareholders. Asia doesn’t have the same environment. Singapore is, by nature, not a litigious society, and it is rare to have large groups of people pursuing similar legal recourse against the same party in a class-action suit or representative action. In the past, Section 216A of Singapore’s Companies Act for bringing derivative or representative actions does not even apply in the case of listed companies. Since 1 July 2015, Section 216A has been amended to extend the statutory derivative action to all Singapore-incorporated companies (and not only non-listed companies) and will allow a complainant to apply to the court for leave to bring an action or arbitration in the name and on behalf of the company. However, the costs and limitations of bringing such derivative action remain, as is deference to the business judgment rule for questionable decisions of the board. Rules on representative lawsuits in Singapore are also much tighter than the class-action complaints allowed in the US. These issues are beyond the scope of discussion of this article on DCS.
THE 4TH OSTENSIBLE ARGUMENT: BOOSTING THE NUMBER OF IPO
A debate over whether DCS should be accepted in Singapore was triggered in 2011 when Manchester United PLC was considering whether to list in Singapore or not. The popular football club eventually scrapped its Singapore IPO and chose to list in the US with a DCS structure. With the acceptance of DCS on the SGX and the rejection of the same by HKEX, it must be hoped that there will be more globally reputable companies like Manchester United and Alibaba that will choose Singapore as their choice market for a primary listing, and arrest the downtrend in IPO and backdoor listings on SGX since 2012 (see chart below).
However, whether allowing DCS will make a real, quantum-leap difference in attracting the next Alibaba to list on SGX is still a big question mark. The same familiar and deep-rooted structural challenges in attracting large-cap, high quality listings to SGX remain, i.e. that of:-
- The Singapore market’s relatively small and negligible capitalization (vis-à-vis China, Hong Kong, Korea, Taiwan and India) in the benchmark indices commonly used by fund managers, e.g. the MSCI AC Asia ex Japan Index. This means that the bulk of international institutional investors’ money, and hence liquidity, will not be allocated to Singapore-listed equities, even if Singapore is the world’s third-best financial hub — which is another matter altogether;
- The greater attraction of a listing on Nasdaq or New York Stock Exchange where a technology company can garner a higher valuation, in no small part due to the greater critical mass and richer history of such stocks there, and better understanding of such stocks among the investing community there; and
- Competition from other regional stock exchanges, which is of course only to be expected and part and parcel of life in general. It is interesting to note that the Australian Stock Exchange (“ASX”) has leapfrogged from being the world’s 13th in 2013 to being the 5th in 2015 for the amount of money raised by technology IPOs —– see table below. In the financial year ended 30 June 2015, 30 technology companies listed on ASX, up from 12 in the previous financial year. This number does not even include the number of backdoor listings, or reverse takeovers, of technology companies using the shells of former, dormant mining companies. It must be a concern for SGX that Singapore-headquartered firm CoAssets, which is one of South-east Asia’s largest crowdfunding platforms, has recently chosen to list on ASX, following the example of other Singapore technology start-up firms like FatFish, social entertainment platform Migme and digital marketer Netccentric. One common complaint aired by the founders of these start-ups is that they would have to pay about S$2 million in listing expenses to list on SGX, whereas it would cost only A$250,000 in Australia. Secondly, there is also the small matter of the need for a sponsor (and their fees) for a listing on the Catalist of SGX, if the listing aspirant does not meet the quantitative criteria (for pre-tax profits, operating track record and market capitalisation) for a Mainboard listing. Thirdly and comparatively, the ASX has much lower quantitative criteria for listing. Allowing DCS companies does not in any way address these listing eligibility and costs issues faced by start-up firms seeking to tap the local equity market. It appears that though Singapore may arguably be the best start-up hub in Asia, the ASX has grabbed a strong lead over SGX in terms of hosting the listings of technology start-ups outside US, UK, Germany and China. To attract this growing number of start-ups, it may be worthwhile for SGX to explore the possibility of a Third Board that carries even lower listing criteria and reporting requirements than the Catalist.
Another noteworthy point from the Report by the IRRC is that at least in the US, on average and over time, share prices of companies with DCS underperformed those with a traditional one-share, one-vote standard in which the owner’s economic risk is commensurate with his voting power. Given the greater propensity for misallocation or wastage of capital by management under DCS structures, this finding is hardly surprising. That said, mere share price under-performance does not in any way suggest that DCS companies listed here will in time become the next flurry of governance failures that scores of S-chips have become in the past decade. However, and certainly, no healthy thriving stock exchange with active investors’ participation can be premised upon a significantly large number of under-performing stocks.
For further studies on this debate, it may be useful to research on what “stronger checks and balances” the US exchanges have in place (as mentioned by HKEX’s CEO Charles Li in his blog) that the SGX may wish to consider for themselves if DCS is to be allowed here. Like any contentious topic, whether DCS should be allowed on SGX will depend on who you ask. One should not be surprised that the investment banks, corporate finance practitioners, capital market lawyers and stockbroking community will favour DCS here because of the fees to be made, while those who focus on corporate governance or shareholders’ protection (such as Professor Mak Yuen Teen from the National University of Singapore in his article published on 1 September 2016 titled “Dual class shares: safeguards or minefields?”) will be up in arms against it. In the final count, it should be corporate governance and investors’ interest that should hold sway, because ultimately it is the investors’ money that is at stake in any investment.