When
Alibaba shares trade on the New York Stock Exchange later this week, in
an IPO expected to be the biggest in American history, investors will
finally be able to own a part of a company that controls 80 percent of
China’s large, and growing, e-commerce market.
But there’s only one problem: The investors won’t actually
“own” Alibaba shares at all. At least not in the traditional sense.
That’s because Alibaba, like 95 of the 200 Chinese companies
listed on the New York Stock Exchange and Nasdaq, employ “variable
interest entities” (VIEs), an organizational structure that allows
Chinese companies in sensitive fields to attract foreign investment --
all while ensuring total Chinese ownership.
In a conventional IPO, investors purchase ownership rights
to a corporate share regardless of nationality. But under Chinese law,
companies operating in
particular industries -- like Internet technology
-- must be wholly Chinese-owned. So in order to make the IPO work,
foreign investors will instead buy shares in a separate, Cayman
Islands-listed company that is contractually tied to Alibaba. The VIE --
in this case Alibaba’s Chinese company -- has a license to conduct
business in China and provides fees and royalties to the offshore
company.
VIEs provide investors with a clever workaround: They allow
foreigners to obtain a piece of China’s IT firms while obeying the
Communist Party’s regulations.
Everyone wins, right? Not quite. While VIEs have existed
for 14 years, serving well-known Chinese companies like Baidu and
JD.com, the Chinese government has never endorsed nor condemned
the structures, which means there are no laws that underpin the
contracts used by the VIE. Meanwhile, some -- including the U.S.
Securities and Exchange Commission -- have pointed out that there’s no
guarantee the China-based VIEs will act in the best interests of the
offshore company foreigners have invested in.
In the run-up to Alibaba’s IPO, will the unconventional VIE
structure deter would-be investors? According to Wei Jiang, the head of
the Jerome A. Chazen Institute of International Business at Columbia
University, the company has always presented itself to would-be
investors with candor.
“I don’t think individual investors would feel like they’re
being misled -- and most don’t really care how much direct control they
have over the asset,” she said.
If the VIEs were enough to make investors skittish in the
days leading up to the event, they haven’t shown it: Strong investor
demand may prompt the IPO’s underwriters to close order books early and raise the offering price above the top price of $66.
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