ISE03/14-15

• Voting is the key right enjoyed by shareholders and it is a tool for them to express views on important matters of the invested companies. In Hong Kong, listed companies must ensure that the voting power of their shares bears a reasonable relationship to the equity power of those shares. In other words, the right of a shareholder to vote should be proportional to the size of his or her shareholdings, and this is reflected by the "one-share, one-vote" standard.
• Contrary to the "one-share, one-vote" structure are the governance structures which give certain persons voting power or other related rights that are disproportionate to their shareholdings. Such governance structures are referred to as "weighted voting right structures" by the Hong Kong Exchanges and Clearing Limited in its consultation paper published in August 2014 to solicit public views on whether such structures should be permissible under Hong Kong's Listing Rules.^{1Legend symbol denoting Since 1987, the Stock Exchange of Hong Kong Limited has prohibited companies to list in Hong Kong with weighted voting right structures. Prior to 1987, there were five listed companies with such structures. Four of them have already been privatized and delisted. Currently, only one remains listed on the Stock Exchange of Hong Kong Limited.}

What are "weighted voting rights structures" all about?

• Share structures with weighted voting rights can exist in different forms. The dual-class share structure is the most common form, which refers to the capital structure of a company having two classes of common stock with unequal voting rights on all or particular matters subject to shareholder approval. A typical form of the dual-class share structure is that shares of one class carry one vote per share ("Class A shares") while shares of the other class carry multiple votes per share ("Class B shares").^{2Legend symbol denoting Other existent forms include capital structures where Class B shares carry one single vote per share while Class A shares have no voting rights or only have voting rights in limited circumstances.}
• Class A shares with inferior voting rights are usually issued to the public for trading whereas Class B shares are held by founders of a company and/or insiders such as founder's family, directors and management. The key of the dual-class share structure is that it enables founders or insiders holding Class B shares to retain control over the company after public listing, for instance, electing a majority of directors to the company's board.
• To illustrate, if a company in dual-class structure has 4 million Class A shares with one vote each, and 400 000 Class B shares with 10 votes each, then Class B shareholders will be able to control 50% of votes while owning just about 9% of common stock.^{3Legend symbol denoting For Class A common stock, there are 4 million shares involving 4 million votes; for Class B common stock, there are 400 000 shares involving 4 million votes. So the total common equity of the company comprises 4.4 million shares with 8 million votes, of which 9.1% ownership and 50% votes are held by Class B shareholders.} This concentrated voting power held in the hands of the latter group enables them to exert influence on critical matters.

Arguments supporting share structures with weighted voting rights

• The dual-class share structure is often claimed by proponents that it allows the founders and management to maintain control over the strategic direction of the company. Such a structure helps them focus on the long-term growth of the company instead of immediate financial return. It is also seen to be a tool to defend against unwanted takeover attempts, as the controlling parties can vote down takeover proposals by exercising their voting power.
• Furthermore, there are claims that some shareholders, particularly small individual investors, may be less concerned with the voting rights attached to the shares. Rather, they are more keen on capital gains and dividend payment. Hence, investors will be willing to buy shares of companies with high-growth potential even when those shares can only offer them with inferior voting rights. The dual-class structure has been preferred by some giant listed technology companies in the United States. Investors favour these companies with the belief that the brilliant company founders are capable of innovating continuously and generating value for shareholders after listing.

Oppositions against share structures with weighted voting rights

• From the corporate governance perspective, weighted voting right structures are considered to be problematic, because such governance structures, with superior voting power held by a group of associated persons, increase the risk that the management may pursue projects that are not in the best interests of the company but for their own good. This deteriorated agency problem may imply higher cost of capital on future fund raising.
• There are also concerns that such governance structures may make the management less accountable for their behavior. With inferior voting rights, the majority shareholders will lack the power to remove the management for unsatisfactory performance. More importantly, shareholders may lose the opportunity to consider lucrative takeover offers from outsiders if the founders/management take an anti-takeover stance. The dual-class share structure therefore receives considerable criticism and oppositions, especially from institutional investors who are more concerned with shareholder rights.

Should companies with "weighted voting right structures" be welcomed?

• There seems no consistent tendency towards greater acceptability of share structures with weighted voting rights in other major financial centres. For instance, Singapore has recently passed a law to allow unlisted public companies to issue shares with different voting rights to increase the flexibility in capital management. The move is believed to be paving the way for the relaxation of its listing rules to allow multiple-share classes to attract more listing. The United Kingdom, in contrast, has tightened its listing principles last year to prevent super voting shares or any share structures of primary listed companies that lead to voting power being kept within a small group of shareholders.
• According to the Stock Exchange of Hong Kong Limited, there is inconclusive evidence as to whether weighted voting right structures have posed a negative impact on the performance of the companies. Nevertheless, equitable treatment of shareholders is central to good corporate governance practice. In Canada, the Toronto Stock Exchange has put in place the "coat-tail provisions" to ensure equitable treatment. Under such provisions, in the event of a takeover bid, holders of subordinated voting shares would be allowed to participate equally with the holders of superior voting shares.
• According to the Organisation for Economic Co-operation and Development Principles on Corporate Governance, investors should be able to obtain information about the rights attached to all classes of shares before they purchase, and any changes in voting rights should be subject to approval by those classes of shares which are negatively affected, in order to achieve equitable treatment. Hence, to a certain extent, whether weighted voting right structures are acceptable as alternative structures should hinge on the proficiency of investors, soundness of the disclosure regime and opportunity of shareholders to obtain effective redress.

Prepared by Tiffany NG
Research Office
Information Services Division
Legislative Council Secretariat
9 January 2015