The recent, apparently resolved conflict between Alibaba and the Chinese government agency SAIC over counterfeit goods raises questions about whether shareholders should have confidence in the future growth of the company. With a valuation of over 30 times earnings, the market is pricing in a high degree of conviction about the company’s future growth. In this Note, our intention is simply to offer some greater transparency to the essential governance issues which must be analyzed in conjunction with considering an investment in Alibaba.
As we noted in our previous flash commentary about Alibaba¹, the company’s governance structure concentrates voting power in the hands of a small group of insiders connected to management. This structure fails to provide shareholders confidence that they can influence the outcome of director elections, that outside directors have meaningful influence in the boardroom, and that disclosures would be made in a timely and rigorous fashion. Accordingly, checks and balances at the company are weak, consistent with a 2012 study by the IRRC Institute finding that companies with unequal voting rights tend to have weaker internal controls, among other concerns.
Moreover, as we noted in our Flagship report “Gauging Governance Globally,²” countries with low scores on The World Economic Forum’s Corporate Governance score and The World Bank’s Ease of Doing Business Index, combined with poor corporate governance, tend to be associated with lower valuations. China has one of the lowest scores for national governance, according to our analysis.
SAIC’s “white paper” made a number of concerning accusations about the integrity of the goods being sold on Taobao, the company’s peer-to-peer website, and about the company’s internal controls. Some private estimates suggested that counterfeit goods may comprise up to 80% of the good sold on the site. The “white paper” indicates that the company was informed about these concerns in July, but no mention of this issue appeared in company filings. Counterfeiting could be a significant problem for Alibaba. While the Chinese government is one source of potential regulatory risk for the company, foreign governments may also move to protect their companies from piracy. Perceptions that counterfeiting is tolerated may also hamper the company’s ability to form relationships with sellers who are victims of piracy. Finally, a perception that the company’s products lack integrity may hamper the company’s ability to grow outside of China in the long term.
Further, a lawsuit filed recently in New York against Alibaba alleges that the company intentionally misled investors by not informing them of SAIC’s concerns ahead of the company’s IPO.
After a meeting with management, the “white paper” was removed from the website, the conflict apparently resolved. However, shareholders have few assurances that this decision implies the absence of a problem. No reasons were offered for the change, and no details of any agreement between the company and the government were disclosed. In an analyst call, the company denied the allegations and described its anti-piracy programs, but provided no details of comprehensive internal controls. The company does not appear to have performed a comprehensive audit of the products sold on its site.
None of this suggests that Alibaba is necessarily covering up a lack of product integrity or that it sought to mislead investors. However, the opaque governance of the company prevents shareholders from a credible assessment of the company’s true risks, which is critical for the company’s valuation at this stage.
Alibaba has vociferously denied all allegations, but the lack of accountability embedded in its governance structure complicates its ability to persuade investors of its version of events. In the short term, investors should be concerned about the integrity of the company’s products. In the long term, investors will need to be concerned about the integrity of the company’s disclosures.
John Wilson is the Head of Corporate Governance, Engagement & Research at Cornerstone Capital Inc. Prior to Cornerstone, he was the Director of Corporate Governance at TIAA-CREF and the Director of Socially Responsible Investing at the Christian Brothers Investment Services. He is also an Adjunct Assistant Professor at the Columbia University Graduate School of Business.
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