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Hermes EOS Highlights Governance Concerns at Alibaba

Ahead of the Alibaba (“NYSE: BABA”) AGM on Wednesday 31 October 2018, Dr Christine Chow, Director of Hermes EOS, highlights the issues that Hermes EOS are raising with the Board of Directors and outlines voting recommendations to clients.

Executive summary

Hermes EOS encourages Alibaba to consider:

  • Disclosing the mechanism by which the Alibaba’s Cayman Islands registered investment vehicle, the Alibaba VIE, is governed
  • Appointing a lead independent director if the CEO and chair roles will be combined when the founder retires
  • Appointing an independent chair for two board committees: the nominating and governance committee and the compensation committee
  • Improving disclosure on the remuneration of directors and senior management

Background

Hermes EOS has been engaging with Alibaba since 2015. We voiced our concerns over the Alibaba Partnership structure as we consider one share one vote to be the most desirable structure that ensures the alignment between the economic interests of an investor and control rights.

Despite the above issue, we have been encouraged to see the company making steady progress on anti-counterfeit measures and improved disclosure, including the launch of its first environmental, social and governance (ESG) report at the 2018 Investor Day. These efforts create a strong foundation for the company to focus on cementing consumer trust, engaging with stakeholders and creating value for the long-term.

Following the announcement that the CEO, Daniel Zhang, will succeed the founder Jack Ma as chair in 2019, and Ma will step down from the board in 2020, we encourage the company to consider governance transition arrangements that ensures a smooth leadership transition that is aligned with Alibaba’s corporate purpose, values and aspirations.

Governance of the variable interest entity (VIE) structure

Certain industries in China, including technology and communications, restrict direct share ownership by non-Chinese individuals. To get around this, firms create variable interest entities (VIEs) owned by individuals in China (as was the case with Alibaba, by the founders – in this instance Jack Ma and Simon Xie). This can lead to key-man risk. The changes to the legal structure of the Alibaba VIE announced in September mean that once restructured, the VIE will be owned by two layers of international holding companies, which are nominally owned by a broader group of Alibaba partners and executives, spreading the previous risk. This offers important transparency and governance opportunities.

As this group of individuals controls the appointment of directors to the VIE, we recommend that Alibaba discloses the following information to create greater transparency:

  • The mechanism by which directors of Alibaba VIE are chosen, to help investors understand its rigour
  • A policy that details the name, nomination process, duties, conditions for retirement / removal, and equity interest holding requirements of directors and partners

As the Alibaba VIE structure is the only way in which equity investors from outside China can invest in Alibaba, the governance of the Alibaba VIE is of paramount importance for global institutional investors.

Governance of the nominating and corporate governance committee

Jack Ma is the current chair of the nominating and corporate governance committee. This committee takes a leadership role in defining the corporate governance culture of the company and oversees the evaluation of the Board of Directors and management. When Daniel Zhang, CEO, succeeds as executive chair of the board, we see a valuable opportunity for the company to consider appointing a lead independent director as chair of the nominating and corporate governance committee because:

  • The Alibaba Partnership holds majority voting rights to elect board directors. An independent chair of the committee offers a purposeful balance to the Alibaba Partnership structure, providing shareholders additional assurance of best practice
  • The Council of Institutional Investors (CII), a membership organisation that represents more than 100 asset owners with over US$3.5 trillion of assets under management, recommends that in general, companies’ boards should be chaired by an independent director

We appreciate that as Alibaba is prepared to appoint the current CEO as executive chair, there will be additional information in the proxy statement to explain the rationale, as required by the US Securities and Exchange Commission (SEC). On a case-by-case basis, we support boards where one individual holds both CEO and chair roles, providing a permanent lead independent director of the entire board is appointed. Along with the right character and skills for the role, the independent director should also have clearly defined powers.

Following the impending combined appointment, appointing a lead independent director to chair the nominating and corporate governance committee would be a significant step towards improved market practice.

We expect a lead independent director to fulfil the duties with demonstrable records on having the authority and actual power, such as:

  • To approve information flow to the board, meeting agendas and meeting schedules, and to convene on a regular and ad hoc basis for independent-director-only sessions of the board. This structure enables an appropriate balance between the powers of the CEO and those of the independent directors
  • To engage with major institutional investors, including minority shareholders, without executive directors being present, on behalf of the entire board and all committees

Governance of the compensation committee

Joe Tsai is the current chair of the compensation committee. This committee is responsible for setting compensation for senior management and directors and reviewing and approving corporate goals and objectives relevant to the compensation, including annual performance objectives of members of senior management.

As in the case of the nominating and corporate governance committee, we recommend an independent director to become the chair of the compensation committee.  In addition, we suggest disclosure on:

  • The total compensation of all directors with breakdown by director fees, salary (if applied), shares held and options
  • The compensation structure and performance indicators, including targets, of senior executives

Our Vote Recommendations

To demonstrate our support of the ongoing efforts of the company to improve corporate governance, while respecting the voice of minority voting shareholders within the boundaries of its Partnership Structure, we recommend a vote FOR all directors at the upcoming 2018 Annual General Meeting (AGM).  We expect to hear from the company about governance enhancement in the coming months, especially on the three areas as detailed above.

The views and opinions contained herein are those of the author and may not necessarily represent views expressed or reflected in other Hermes communications, strategies or products

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