Cove Street Capital requires a modern browser to look and function properly. Internet Explorer stopped receiving updates in January 2020. Using it may cause display issues on our website, and put your own online security at risk. We highly recommend switching to a secure modern web browser such as Chrome, Edge, Firefox, or Safari.

Yahoo and Jack Ma

Only somewhat facetiously, I wonder out loud why Jack Ma was not arrested at the U.S. border last week when he spoke at The Wall Street Journal’s “All Things Digital” Conference. On a massive and very public scale, he is conveying a sense of the conceptual lawlessness of mainland Chinese business practices and the diffidence of the Chinese government to outside investors. It’s the Sino-Forest of governance and he is getting an unbelievable free pass from the financial press.

An interesting exchange with the editor of Chinese business weekly Caixin and Ma is reprinted below.

JUNE 14, 2011 (Bloomberg) — Alibaba Group Holding Ltd. Chairman Jack Ma said Yahoo! Inc. and Softbank Corp. failed to fulfill their duties as board directors, highlighting the rift between the Chinese online-commerce company and its biggest investors.

“Prior to the current negotiations, they exploited the imperfections of the company structure and engaged in stalling tactics,” Ma said at a briefing today in Hangzhou, China, referring to Yahoo and Softbank’s role on Alibaba’s board over the Alipay online payment unit. “As shareholders, they were right but as directors, they were both wrong.”

The comments come amid negotiations with the two investors, which are seeking compensation for the divestment of Alipay, a deal Ma said was needed to expedite the application of an online payment license in China. Shares of Yahoo and Softbank have underperformed their respective benchmark indexes since last month’s disclosure that the unit was sold without the consent of the companies.

“Alibaba should have done more to get Yahoo and Softbank on board before acting on Alipay,” said Jim Tang, a technology analyst at Shenyin Wanguo Securities in Shanghai. “Alibaba needs to not only think of its own interests, but also needs to take care of the interests of the shareholders.”

Softbank President Masayoshi Son, Japan’s richest man, repeatedly cut short discussions about the reorganization of Alipay, said Ma, whose comments were confirmed by Alibaba in an e-mail.

Belated Notice

Takeaki Nukii, a spokesman at Tokyo-based Softbank, Japan’s third-largest mobile-phone operator, declined to comment. Lisa Tam, a Hong Kong-based spokeswoman at Yahoo, said she couldn’t immediately comment.

Yahoo, owner of the biggest U.S. Web portal, last month said it wasn’t informed until March 31 about an August 2010 transfer of Alipay equity to a company outside of Alibaba. Ma previously said Alibaba’s board had discussed for three years the need to reorganize Alipay to comply with China’s restrictions on foreign investment in online payment operators.

Ma said the dispute with Yahoo is limited to commercial interests and “easy” to resolve, while differences with Softbank involve a “fundamental divergence in opinions” involving the development of Alibaba workers, Chinese magazine Caixin Online reported, citing an interview with Ma.

Yahoo, whose shares have slumped 17 percent since disclosing Alipay’s spinoff, is making “significant” progress in talks with Alibaba and Softbank over compensation, Chief Executive Officer Carol Bartz said on May 25.

“The reason you are there on the board is because you are protecting the interest of the investors,” said Duncan Clark, chairman of BDA China, a Beijing-based technology consultancy.

He said he didn’t “understand” Ma’s comments today.

How Jack Ma’s Mistake Damaged China’s Market

By secretly transferring Alipay, the Alibaba founder violated contract rights that China should reinforce.

Business contract principles and property rights together form a basic cornerstone of the market economy. But contract violations can crack the cornerstone and undermine an entire market structure.

Few people ever thought China’s Jack Ma, the highly successful Internet entrepreneur who frequents international events speaking fluent English, would ever secretly transfer the online payment service Alipay, a core asset of Chinese-foreign joint venture Alibaba Group, to a private firm he controls.

But Ma and his management team, an Alibaba minority shareholder, did indeed transfer Alipay starting in June 2009 and closed the deal in August 2010. A low price was paid, and the process went unreported until recently.

In the face of this outcome, Alibaba’s foreign stakeholders Yahoo and Softbank have two options: They can sit down at the negotiation table with Ma and work out a compensation package, or they can pursue a legal course by suing Ma and his management for maliciously infringing on shareholder interests, and hopefully bring Alipay back to the Alibaba fold.

Yahoo and Softbank together control 70 percent of Alibaba. Currently, Yahoo wants to bargain for compensation while Softbank has refused to talk with Ma, leaving room for maneuvering.

No one knows what will happen next, but public opinion has already rendered judgment. We agree with the majority who say Ma is wrong. He made a mistake by violating contract principles that support the market economy, and his error is having dire consequences.

Ma founded Alibaba and took most of the credit for Alipay’s commercial success. He has every reason to be fully committed to and concerned about the company’s future outlook. And he is well qualified to benefit from Alibaba’s growth.

However, by acting without the consent of Alibaba’s leading shareholders, Ma was presumptuous to transfer the company’s core asset to a concern under his name, for a price too low to be fair. He seriously violated a contract between Alibaba’s shareholders, and the contract between shareholders and management.

Yahoo and Softbank lost a valuable asset. Yahoo’s share price slumped as a result, and now the company faces a class-action lawsuit filed by U.S. shareholders. Unless there was some other kind of agreement that hasn’t been revealed, also seriously damaged were the interests of other members of the managerial staff with stakes in Alibaba.

The ostensible beneficiaries of the transfer were Ma and another Alibaba founding member, Xie Shihuang. Ma owns 80 percent and Xie 20 percent of the private firm that took over Alipay.

Even if Yahoo, Softbank and Ma work out a compensation agreement that’s approved by Alibaba’s board of directors, a basic fact cannot be denied: Management led by Ma took unilateral action and violated a basic principle of commercial society by failing to abide by a contract.

A contract requires credibility and integrity. A violation leads to imbalance and weakens an enterprise. So Ma is paying a heavy price: The international business reputation that he has been building for years has been tarnished, and prospects for Alibaba’s long-term growth have been diminished.

The damage does do not stop there. In economic terms, the move points to a great “negative externality.” If contracts are not respected, an entire society could face an increase in commercial risk that unnecessarily drives up business costs.

Honoring contracts is often a weakness for Chinese companies. It’s not uncommon for insiders to re-appropriate assets. But this old black eye becomes even more pronounced when it involves someone like Ma, an internationally respected figure who’s seen as a representative of Chinese entrepreneurship and, as the Alibaba chief, a success story China can be proud of.

The Alipay transfer at a discount likewise delivered a direct blow to overseas investor confidence in Chinese companies, sapping their trust. That may explain why many who once loved Ma and pinned their hopes on him now feel so much regret.

Of course, Ma’s mistake is not simply a matter of personal integrity. He is an entrepreneur with good credit, as his track record proves. And one reason why he went against contract principles on the Alipay issue is connected to the hesitancy of regulators at the People’s Bank of China.

The central bank for years delayed a regulatory decision on licensing third-party payments businesses such as Alipay. The vague process reflected a less-than-open-minded attitude toward foreign investors in third-party payment operations.

The central bank started soliciting opinions on proposed rules for third-party payment systems back in 2005. In the regulations finally enacted in June 2010, the central bank said foreign-funded third-party operators would have to follow special rules to access the Chinese market and would need State Council approval.

Yet at this point, China can and should open its third-party payment services to foreign investors. It’s unnecessarily complicated to make Chinese and foreign companies follow different sets of rules. So it is regretful that the Alipay transfer by Ma was not only an unwise move but motivated by unwise policy.

Contract fulfillment hinges on a complete institutional arrangement. The planned economy unfortunately disrupted China’s long-standing commercial traditions. Even today, we are still traveling a long, arduous road to build a market economy. In the next stretch, we should create a system in which independent mediators, arbitrators or a judicial force can be summoned to settle contract disputes. Such a legal system is needed to support the market economy. Currently, if Softbank or Yahoo sue Ma in China, the impartiality of Chinese judicial officials would be tested.

The Jack Ma success story is perhaps more famous in today’s China than the original Arabian Nights story of Alibaba. We hope that eventually Ma’s tale has a happy ending. We also hope to see more wealth stories for Chinese companies.

But this is no fairy tale scene. There is a real need to uphold the spirit of contractual agreements with honor and integrity, and thus reinforce a solid market economy in China. Reaching this goal has much to do with the future of China’s vibrant commercial system.

Share on facebook
Share on twitter
Share on linkedin
Share on email

Important Notice

You are now leaving Cove Street Capital’s website and entering Cove Street’s Mutual Fund website.