INSIGHTS | Can superboards save China tech from one-man rule?

First Alibaba, now Pinduoduo: Top leaders of China’s superstar tech firms may seem to be bowing out, but have kept significant control over their companies by forming powerful “Partnerships,” superboards which have the potential to control the board of directors. When Alibaba’s Jack Ma and Pinduoduo’s Colin Huang retired from their CEO positions, the two founders simply stepped into new roles at Alibaba Partnership and Pinduoduo Partnership.

In publicly listed US companies, a board consisting of independent directors oversees the firm’s direction, making important decisions such as hiring C-level executives. The boards are elected by shareholders to represent their interests; a democracy of sorts. For some Chinese tech companies, this model has been overridden by a self-selected oligarchy.

Alibaba and Pinduoduo’s Partnerships are, in effect, a second board of directors, a group of experienced leaders plucked from within the company that guides the company’s development—a superboard. They wield concrete powers that can supersede the board of directors at the expense of shareholder control. Some of these powers include choosing board members and future CEOs.

Bottom Line: The e-commerce companies’ superboards were formed to address concerns about one-man rule. Critics argue that the elite nature and range of powers granted to these superboards do little to address oversight concerns; they give power to those they were supposed to take it from. Yet these superboards have done little to dissuade investor interest.

The birth of superboards

Alibaba consolidates top talent: Alibaba’s Partnership launched in 2010 with the goal of allowing “senior managers to collaborate and override bureaucracy and hierarchy.” The company said it was formed to preserve Alibaba’s vision and mission: building the future infrastructure of commerce and making business everywhere easier.

• The Partnership is currently made up of 36 members.
• For the first three years of their tenure, the Partners must maintain at least 60% of the shares they had when they joined the Partnership to ensure that their interests align with those of shareholders, according to its 2014 registration statement. Afterward, they must retain at least 40%.
• Ma and Tsai are both lifetime Partners, and also sit on the board of directors. Partnership rules dictate that they can be removed by a majority Partners vote.
• Tsai said in an interview with Reuters in 2014 that changing the Partnership was “never going to happen” in order to list in Hong Kong, which at the time did not allow a weighted voting structure.
• The Partnership has the right to nominate a simple majority of the company’s board of directors regardless of voting shares, and can unilaterally appoint directors at its own discretion.
• As of July 2020, the Partnership has not exercised this right to a majority, having nominated five out of the current 10 board members.

Further consolidation: Within Alibaba’s superboard lies a super superboard, the Partnership’s administrative body, where the power ultimately lies.

• The six-member Partnership Committee is made up of an even more elite group of insiders, plucked from the Partnership itself.
• It is responsible for administering the superboard and, ultimately, makes the decisions.
• Membership is strictly limited to Alibaba’s top names: Co-founders Ma, Joe Tsai, and Lucy Peng, as well as Alibaba Chairman and CEO Daniel Zhang all sit on the Committee, according to its 2020 annual report.
• Only the existing Committee Partners can nominate a new Partner to the super superboard, a restriction which further concentrates control of the company.
• Over the past year, Ma has decreased his stake in Alibaba from 6.2% to 4.8%, and Tsai reduced his holdings from 2.2% to 1.6%. However, their places on the Partnership Committee supplant any fluctuation in ownership stake, unlike traditional dual-class share structures.

At Pinduoduo, CEO out, Partnership in: In a surprise move, Pinduoduo’s 40-year-old CEO Colin Huang stepped down from his executive position on July 1. Huang said that he plans to spend more time with the board of directors to work on the company’s mid- to long-term strategy and further develop its corporate structure, goals that sound eerily similar to a CEO’s.

• One of his main post-CEO goals is to continue “building and refining” the Partnership, which hasn’t yet reached a quorum of members so it cannot wield any of its powers.
• Aside from big-picture strategies, as part of Pinduoduo’s superboard, Partners will have the power to nominate the CEO and other executive directors.

Admission of power: Pinduoduo issued a frank warning to its shareholders about the superboard’s potential to override shareholders—once it’s active—in a prospectus filed with the SEC: “To the extent that the interests of the Pinduoduo Partnership differ from the interests of our shareholders on certain matters, our shareholders may be disadvantaged.”

• Huang acknowledged in his letter that the Partnership he envisions has obligations to shareholders. The entity should conduct fundamental research and corporate social responsibility activities, the letter said, “without impacting the short- to mid-term interests of existing Pinduoduo shareholders.”
• Huang reduced his personal holdings in the company to 29.4% from 43.3%, in addition to donating 371 million ordinary shares to the Pinduoduo Partnership. He still owns 80.7% of voting shares.
• Pinduoduo doesn’t have a super superboard like Alibaba at the moment. The Partnership’s structure and allocation of power are still evolving. For now, the superboard is in control.

Solution or smokescreen?

The Luckin parable: Though Chinese corporate governance has evolved over the years, the leaders at top tech firms tend to be a rotating cast of the same characters who hold onto power until extenuating circumstances, like a scandal or illness, force change. In Luckin Coffee’s case, the same people followed founder Lu Zhengyao from China Auto Rental to the coffee startup’s spectacular demise.

• In January 2020, Luckin founders Jenny Qian Zhiya and Lu Zhengyao admitted the company had fabricated at least $310 million of its sales.
• Observers blamed the company’s top management for the lack of effective internal supervision.  
• Concentration of corporate power in the hands of a handful of controlling leaders left Luckin ill-prepared to manage a crisis involving the executives themselves.

Made from the same cloth: It’s not just Chinese tech firms that struggle to move on from a single dominating founder-CEO. One study found nearly 40% of tech IPOs offered dual-class shares, while just 14% of non-tech firms did.

• Mark Zuckerberg—Facebook’s founder, chairman, and CEO—holds more than 400 million shares of Facebook and controls 57.9% of the total voting shares.
• In a 2019 interview, Zuckerberg called his concentration of power “valuable” admitting that if he didn’t have so much influence he would have long ago been fired by the board.
• Facebook co-founder Chris Hughes called Zuckerberg’s power “dangerous” and the board nothing more than an “advisory committee” in an op-ed.

Autocracy vs. oligarchy: Both Partnerships and dual-class shares give control rights to the management and founders, said Liu Jing, Finance Associate Dean at the Cheung Kong Graduate School of Business in Beijing. Though similar, there is a key difference.

• “[The Partnership] is more democratic than that because there are many partners,” he said.
• Rather than a single leader, he said, Partnerships involve collaboration from dozens of experienced leaders, allowing tech firms to diffuse a founder’s power while safeguarding their continued involvement.

In theory, this means superboards are well-suited to address key man risk. In reality, Alibaba’s Partnership concentrates most power in its six-person Partnership Committee, not its 36-member Partnership.  

Alibaba faces criticism: Alibaba’s corporate governance was rated worst in class by investment research firm MSCI for its “high level of risk to public shareholders due to lack of shareholder rights and independent board supervision.”

• The superboard “completely separates shareholders’ equity stake from corporate control,” according to the Brooklyn Journal of Legal, Financial, and Corporate Law.
• The Partners’ total control over the board and relatively low equity stakes leaves them with little skin in the game.
• This paradox gives them incentives to “divert value to other entities in which they own a substantial percentage of the equity,” wrote Lucien Bebchuk of Harvard Law School.
• Tech companies such as Alibaba and Pinduoduo can use their rapid growth to entice shareholders to accept changes, and even withstand pressure for equal shareholder rights.

Philosopher kings

On the bright side: The superboards could be a way to solve broader challenges that Chinese tech firms face, such as China’s foreign investment laws and hostile takeovers, experts say. Some think that the trade-off of control for stability is one shareholders are happy to make.

• Chinese law forbids foreigners from owning strategic assets in the country. Alibaba and Pinduoduo had to register in the Cayman Islands in order to list in the US.
• Loh argues the Partnership structure will help tap global capital while keeping control of the company within China
• This is crucial for compliance since technology companies can store troves of user data or have access to sensitive technology.
• Superboards’ control over the board of directors also ensures protection against hostile takeovers by other domestic or foreign companies. Founders can keep their original mission and vision safe from corporate raiders.

Outside investors are still here: The superboards’ ability to vote a majority to the board of directors hasn’t diminished interest in Alibaba.

• The Partnership Committee’s oligarchy appears to “not matter to shareholders as can be seen in the strong trend of share prices over the years,” said Lawrence Loh, Director of the Centre for Governance, Institutions & Organisations at the National University of Singapore.  
• Loh said shareholders are likely willing to trade control for “predictable and robust corporate performances.”
• Share prices for Alibaba and Pinduoduo have increased steadily through the management shifts. Pinduoduo’s share price on the NYSE peaked at $93 the day after Huang announced he was stepping down, reflecting investor confidence.

Liu said superboards, on average, “have been value-enhancing. It helped to ensure that visionary entrepreneurs are able to see their vision materialize while diversifying financial risk and obtaining needed equity financing.”

“The consistency of values across time provides steadiness for the company, including its board of directors,” he said. “For shareholders, there is probably some sacrifice in their normal control of the company as per global practices, but on balance, they may gain in owning a sturdy entity that provides assurance of strategic direction.”