The Application Of Dual Class Structure In China

Unlike the "One Share, One Vote" principle, when a single company issuing two or more types of shares, a dual class stock structure was created. Usually, a dual class common stock structure consists of Class A and Class B, with one share class is offered to the general public while the other is offered to company founders, executives and family. The class offered to the general public has limited voting rights, while the class available to founders and executives has more voting power and often provides a majority control of the company.It has been largely believed that Dual class shares can create a "win-win" scenario for management, allowing company founders or controlling interests to hold on to power even though they no longer own a majority. They are able to raise capital without a proportional dilution of voting power.Some believe that companies benefit from the dual- class structure, for two reasons, first, concentrated control stems mainly from the fact that controlling shareowners often have a significant portion of their own wealth at risk; second, the reputational risk born by controlling shareowners with disproportionate shareholding.However, it has been recognized that five main elements of firm and market behavior. These main elements include: agency problems; firm valuation; earnings management; investment decisions and recapitalization. Based on economical theories and empirical evidences, arguments against dual class structures are(1) against-proportionality principles. The one share one vote principle ensures that shareholders with the same interest(residual interests) are given an equal say on matters affecting the value of their shares. However, adopting dual class structure allows superior-voting shareholders have a greater say in management issues which might impact company’s future cash flows;(2) a dual-class share structure that allows controlling shareholders to retain control while holding a relatively small equity stake in a company makes it more likely that the controlling shareholders will extract personal benefits from the company(i.e. excessive salaries or perks), because they can enjoy the full benefits they take out of the company, but suffer less downside through the reduction in the value of their equity stake in the company resulting from their extraction of private benefits. It is also considered that a smaller equity interest could incentivize controlling shareholders to transfer quality assets out of a listed company to other companies in which they have a greater stake, and vice versa( "tunneling" or "value shifting");(3) where a company adopts dual class structure, the non-controlling shareholders may be prevented from removing directors who extract private benefits, fail to manage the business so as to maximize its value and performance or act contrary to the wishes of the minority shareholders. The whole phenomenon has been referred to literature as "management entrenchment risk".To the contrary, arguments in favor of dual class shares structures are(1) Long terms. While entrenchment is detrimental for investors if a company performs badly due to poor management, it can also benefit a company since it insulates the directors from shareholder pressure to generate short term returns that are not in the company’s long term interests;(2) Detrimental market impact. The prohibition on dual class structures restricts investors’ ability to invest in companies using the structure, and thus renders the Exchange a less efficient marketplace for achieving the effective allocation of capital from investors to listed companies. In addition, controlling shareholders are prevented from diversifying their wealth into other entrepreneurial projects which could benefit the market as a whole;(3) Allow financing without dilution. Dual class structure allows the company to expand without diluting the founders’ ownership any further and to maintain management continuity. This is maybe the quiescence of dual class structure, since it grant financing opportunities to controlling shareholders/ managers without handing over control.It should be noted that given by the pro or con arguments listed above, there is a lack of consensus as to whether those risks in fact have a negative impact on a company’s performance. However, it has been observed that laws and regulations can limit the negative impact of dual class structures.Based on jurisdiction comparison, a range of approaches to dual class structures are adopted which fall into three main groups:(1) some jurisdictions allow dual class structures under both their corporate law and listing rules(e.g. the US, Canada and Sweden);(2) other jurisdictions allow companies to have dual class structures under their company law, but prohibit such companies from listing.(e.g. Hong Kong, the UK, Australia and Singapore);(3) Some prohibit both listed and unlisted companies from using dual class shares(e.g. Germany, Spain). Besides, some restrictions in use on jurisdiction which allow dual class structures find a series of restriction usually imposed on dual class companies voluntarily, for example,(1)restriction on transferssuperior voting shares must convert into one share one vote shares if beneficial ownership(residual claim) is transferred to persons who are not "affiliated" with the original holders;(2) restriction on minimum equity threshold held by founders or others- If at any time the founders of the company hold less than 5% of the superior voting shares, all superior voting shares in issue must convert into one share one vote shares;(3) restriction on change of control event- conversion of all superior voting shares into one share one vote shares if there is a change in control of the company.It has been observed that Dual Class structures have recently become more popular for mainland Chinese companies listing on US exchanges where dual class structures are allowed, and it should not be neglected the fact US listed mainland Chinese companies with dual class structures have a combined market capitalization which is 70% of the total market capitalization of all US listed mainland Chinese companies. China is now entering a period in which there are many new successful companies controlled and run by first-generation founder-owner-managers. It may be in their interests and potential shareholders’ interests for them to remain in control so that they have the commitment and incentive to continue to develop and grow their companies after their IPOs. Mainland exchanges will lose out the advantages these companies brought to the whole capital market if IPO of these companies are "forced out " due to the reason of not allowing listing company adopt dual class stock structure.Given by the fact PRC corporate law leave room for dual class shares structures, our question in the thesis is mainly about what additional restrictions should be raised by the mainland Exchange if dual class structures are allowed, special suggestions are made in the thesis including(1) a requirement for warnings in all corporate communications;(2) a cap on the number of votes that can be carried by one share;(3) enhancing the powers of independent non-executive directors;(4) stipulated circumstances that may require a company to unwind its dual class structures;(5) significant pre-sale waiting period.