Do Dual-Class Structures Help Stock Markets Attract Listings?

Financial globalization has allowed issuers more freedom to shop among jurisdictions and thus intensified stock market competition. Against this backdrop, the Hong Kong, Singapore, China, and UK stock markets have accepted the dual-class share structure (DCSS). While empirical legal studies have examined the impact of changes in voting mechanisms, i.e. from one-share-one-vote (OSOV) to DCSS or vice versa, on the value of corporations in particular jurisdictions, few have explored the impact of the DCSS on competition among jurisdictions. Has introducing the DCSS helped stock markets attract issuers to reshape market competition? If so, to what extent? If not, why not?

In a new article, I examine whether the DCSS has helped the Chinese and Hong Kong stock markets attract Chinese issuers in comparison with U.S. markets. The U.S., China, and Hong Kong are good settings for such a study because they have global financial centers with five of the top 10 stock exchanges, which compete for Chinese issuers. Moreover, both China and Hong Kong have recently removed the prohibition on DCSS to respond to competitive pressure from the U.S., and thus the policy changes have provided a context for detecting the impact of the DCSS on market competition.

Based on hand-collected data, my article first canvasses the market competition as a driver of the Chinese and Hong Kong reforms introducing the DCSS. It then finds and explains the infrequent use of the DCSS in China and Hong Kong in the post-reform era.

Before the Chinese and Hong Kong reforms, from 2000 to 2019, 244 Chinese issuers floated on either the NYSE or NASDAQ through the issuance and trading of depository receipts; of these, 98 adopted a DCSS (40.2 percent). As of December 31, 2019, 18 of these DCSS issuers were delisted (18.6 percent), compared with 79 delisted OSOV companies (56.0 percent). As for the OSOV companies and DCSS companies that remained quoted, the total market capitalization of the former was $117.6 billion, while the total market capitalization of the latter was $898.9 billion, which equaled 10.6 percent of the combined market capitalization of all 3,584 companies listed on the Chinese stock market, or 18.4 percent of the combined market capitalization of all the HKEX-listed companies. Thus, the lower delisting rate and much larger market capitalization may reflect the financial dominance of DCSS issuers among Chinese company listings on U.S. exchanges, which is a driver of the Chinese and Hong Kong moves to introduce the DCSS for competitiveness purposes.

Given that over 40 percent of U.S.-listed Chinese companies used a DCSS, the market would expect China’s and Hong Kong’s introduction of the DCSS to prompt many Chinese companies to go public in China or Hong Kong with the issuance of dual-class shares. However, the market practice has shown that not to be the case. At the end of 2021, 371 Chinese companies were quoted on the Shanghai Stock Exchange (SSE) STAR Board with only four being DCSS issuers. Also, the use of the DCSS in the Shenzhen Stock Exchange (SZSE) ChiNext Board and Hong Kong Stock Exchange (HKEX) Main Board was sparse. The lack of DCSS usage in China and Hong Kong is more striking when compared with the continued prevalence of Chinese issuers’ U.S. DCSS listings in the same period, as 47 of the 82 U.S.-listed Chinese companies used a DCSS.

The U.S. practice has revealed the competitive advantage of admitting the DCSS in accommodating Chinese issuers, whereas the infrequent dual-class listings in China and Hong Kong in the post-reform era indicate that the benefits of the DCSS in enhancing stock market attractiveness are a myth. My article proposes and verifies two hypotheses, i.e. low demand and limited allowance, to explain the myth.

First, given that the DCSS was newly introduced in the Chinese and Hong Kong stock markets, it is not surprising for investors to fear the potential risks of buying shares of dual-class companies. In turn, the market fear may reduce the value of a dual-class listing. Therefore, if substitutes are available, DCSS may not be in high demand. Instead, rational issuers are likely to give more weight to higher share prices and employ the proportionality doctrine to signify good corporate governance to the stock market pricing mechanism. Under the Chinese and Hong Kong regulatory frameworks, substitute control-enhancing instruments typically include the pyramid shareholding structure (PSS) and shareholder voting agreement (SVA). Upon examining the 962 Chinese OSOV companies listed on the SSE STAR Board, SZSE ChiNext Board and HKEX Main Board, I reached the following empirical findings.

First, the voting power concentration of the relevant Chinese issuers was high. As of December 31, 2021, 367 and 279 Chinese OSOV issuers were listed on the SSE STAR Board and SZSE ChiNext Board, respectively. Of these 646 Chinese OSOV issuers, 543 companies (84.1 percent) had a controlling shareholder. Second, use of a PSS or an SVA was prevalent. Among the 543 companies, the founders became controlling shareholders by adopting a PSS in 237 companies, concluding an SVA in other 69 companies, and using both in other 33 companies. Besides, the founders of the remaining 204 companies achieved control by means of concentrated equity ownership. The empirical study of the Chinese OSOV issuers listed in Hong Kong reached similar conclusions. This reveals a need to maintain founder control among a vast majority of Chinese issuers. However, owing to the availability of other control-enhancing mechanisms or ownership concentration as substitutes, a dual-class listing may be attractive but not essential. That is to say, the DCSS is not in as high demand in China and Hong Kong as might be anticipated.

As to the limited allowance hypothesis and evidence, within the framework of the DCSS, protecting investors and attracting issuers may represent competing interests. This means that adding weight to investor protection may reduce the market attractiveness to issuers. Investor protection can be achieved through regulation to reduce the incidence of opportunist behaviors, which may nevertheless make the involved stock market unattractive to issuers. Therefore, the low viability of the DCSS in China and Hong Kong may be attributed to restrictive regulation. To verify this hypothesis, I investigate the extent to which regulation can explain the differences among the U.S., China and Hong Kong. For the purpose of empirical analyses, I examine only two measurable differences: the dual-class listing financial criteria and the maximum weighted voting ratio.

I find that, as at December 31, 2021, 82 Chinese companies went public in the U.S., and 47 used the DCSS. Of the 47 DCSS issuers, 12 did not meet the financial criteria for a DCSS listing on the SSE STAR Board, and 13 issuers attached more than 10 votes to each superior voting share, which was not permitted in China. Eight failed to meet both requirements. Hence, the Chinese regulation may have blocked 33 of the 47 U.S.-listed DCSS issuers (70.2 percent) from carrying out a dual-class listing domestically. The empirical analyses of the SZSE ChiNext Board and HKEX Main Board reached similar findings. Thus, the limited allowance may have substantially affected DCSS usage in China and Hong Kong.

My article suggests that for jurisdictions considering the DCSS, policymakers should note both the availability of substitute control-enhancing instruments under their regulatory frameworks and the balance they aim to strike between investor protection and market openness.

This post comes to us from Fa Chen, lecturer in law at King’s College London. It is based on his article, “Does the dual-class share structure help stock markets attract issuers? Empirical lessons from global financial centres,” available here.

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