The Gigantic Corporate Tug of War

Author: Katelyn Shiring, Goucher College

9/29/14

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American Internet giants such as Facebook, Google, or eBay do not hold the record for the highest-earning IPO in US history, as one might think. Instead, it belongs to the Chinese e-commerce giant, Alibaba, which had its official IPO on the New York Stock Exchange on September 19, 2014. Alibaba was started by Jack Ma in 1997 in his Hangzhou apartment and encompasses three sites that host independent merchants and businesses. It has hundreds of millions of users, making it the largest and most profitable e-commerce site in the world. Last year, its revenue surpassed those of Amazon and eBay combined, reaching a total of $248 billion. On the day of its IPO, Alibaba’s trading price started at $68 per share and its high reached $99.70 per share.

This record-breaking IPO looks like the culmination of China’s efforts to become an international economic powerhouse and finally break into the foreign sphere of investment. Alibaba’s emergence as the world’s largest e-commerce site draws parallels to the growth of China’s middle class: both are surprising and hold significant power and influence in the world economy. However, this victory is overshadowed by the Chinese government’s continuing tight restrictions on foreign investment in e-commerce. If China wants to continue to grow as an economic power and become more relevant in stock trading, it will need to loosen its restrictions.

When investors purchase Alibaba group shares, they are not actually purchasing   “Alibaba Group China”, as the NYSE ticker name would suggest –instead, investors are buying into Alibaba Group Cayman Islands. Why the tropical location over the Communist giant? It’s not because of Jack Ma’s preference for Caribbean islands; in fact, it is illegal for Chinese e-commerce companies to directly sell shares to foreign investors. Alibaba, like many other Chinese companies, use a Variable Interest Entity (VIE) to circumvent these restrictions. A VIE refers to an entity in which the investor holds only a controlling interest that is not based on the majority of voting rights. The VIE structure itself was created solely to circumvent Chinese restrictions on foreign investment in technology and Internet industries. In practice, using a VIE is similar to the popular practice – common among native Chinese and foreigners living in China alike – of using a Virtual Private Network (VPN) to access blocked sites such as Facebook, Twitter, and YouTube in China. This detail has been overlooked during the celebration of the IPO, and the extravagant festivities that followed the record-breaking sale stood in stark contrast to this minute but important legal detail.

The VIE structure actually is potentially illegal under Chinese law. Yet “potential” is the key word in this statement, however, because China has not officially declared the VIE structure to be illegal. Instead, they consider the legality of VIEs on a case-by-case basis. Wal-Mart and mobile carrier China Unicom’s uses of VIEs were declared illegal, while other companies such as RenRen, a social network, and Baidu, a search engine, got away with using VIEs without incident. This is typical of China, which has a history of letting illegal activities persist until the paper trail leads back to them. But publically declaring the VIE structure to be illegal would be too detrimental to the Chinese economy because it would scare away foreign investment, which is currently a critical part of China’s booming economy. It is up to the shareholders to consider the risk if Alibaba faces the same fate as Wal-Mart and China Unicom.

Shareholders and economists are optimistic that because Alibaba is such a huge accomplishment for China in terms of pride and revenue, the government will turn a blind eye to the “sometimes illegal” VIE structure. This is just another example of China’s internal struggle between wanting to be a present force in the world economy, and sticking to its – at times – closed-off values. If China were to loosen up their restrictions, it would facilitate both more investment in Chinese companies and the entrance of more Chinese companies into foreign markets, similar to what Alibaba is trying to do.

China’s National Development and Reform Commission has promised to free up the market by simplifying administrative controls and restricting central government micro-management on economic issues, as well as shortening approval times on investments, but whether or not the NDRC’s statements are valid and timely is another question. Overall, the fact that China is well aware of their own arbitrary restrictions and have implemented plans to address these investment issues speaks volumes on their eagerness to cooperate with foreign markets. In order for China to truly capitalize on economic opportunities like Alibaba, they will need to ultimately loosen their restrictions on foreign investment and embrace a free market economy.

Katelyn is an undergraduate student at Goucher College

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