In the early afternoon of September 28 in Hong Kong, it wouldn’t be a stretch to say a gathering of shareholders made a big mark on the modern history of corporate China. In an extraordinary shareholder meeting called several weeks before, they gathered at the five-star Regal Hongkong Hotel in the city’s Causeway Bay district to vote on the fate of Gome Electrical Appliances, China’s largest home appliance retailer with more than 1,000 stores nationwide and a market capitalization of HK$37.5 billion as of late September. In voting to maintain the status quo, the shareholders brought temporary calm to the company, which had been fractured for months by a battle between the firm’s embattled founder, Huang Guangyu, and his successor as chairman of the board, Chen Xiao.
At the meeting, the resolutions proposed by Gome’s incumbent chairman Chen Xiao, were approved, while four of the five proposals initiated by Huang, who is the major shareholder, were rejected, albeit by small margins. At Huang’s urging, shareholders did agree that the board will no longer retain the power to issue stocks that could dilute his shares, but they did vote to keep Chen as chairman.
For a country that is just now learning the ropes of capitalism, it was a landmark case. Over recent months, Gome has been putting governance procedures to the test and — unusually for China – pitted the management team against the founder and major shareholders in a public spat over control of the company, says Ding Yuan, accounting professor of China Europe International Business School (CEIBS) in Shanghai.
“The vote is just the beginning, not the end,” he adds. Indeed, conflict is expected to continue for much longer — not least because Huang is expected to raise trademark disputes over the use of the name “Gome” and there will likely be disagreements about how to operate the stores in the chain that are not included in the Hong Kong-listed company’s portfolio, but are the assets of Huang’s own private company.
What is also striking for experts such as Ding is the actual results of the voting. “In a country where the traditional culture highly favors fidelity and loyalty in terms of ‘master and servants,’” most bets were on shareholders voting in favor of Huang. Voting down his proposals was “a painful choice for the small shareholders,” he says, noting how they cast aside tradition and focused on what ultimately would be best for company. On top of that, he commends both rivals. “We saw two parties end the game in such a legal and sober manner and play by rules,” says Ding. “It’s a victory for all parties, who pursued their best interests but within a framework of clear rules. The process is laudable.”
There’s another governance element that can’t be overlooked, says Raffi Amit, a management professor at Wharton and chairman of Wharton’s Global Family Alliance. “The case highlights the classic problem in the governance of family-controlled companies — how to address conflicts between family shareholders and non-family members,” not just in China, but elsewhere, he says. “Enforcement of minority shareholders rights in family firms is an important issue that this case highlights.”
And it’s particularly pertinent for Chinese companies for one reason: The country’s one-child policy has left many family businesses in China struggling to appoint next-generation successors, with a growing number having to place non-family members to top leadership roles and rely more on external stakeholders. Bearing that in mind, Ding and others say Gome offers other companies a wealth of lessons, for better or for worse.
A Tangled Tale
While the motivations driving Huang and Chen couldn’t be more different, they are equally cunning. Huang founded the firm in 1987 in Beijing, transforming a small electronics store into a national retail giant. Said to be a ruthless competitor, Huang was known to bend the rules to suit his purposes. That includes Huang wring and re-writing rules about how Gome’s boardroom was run so that board members were granted a range of special powers. As experts note, Huang chopped and changed the rules at his peril — his amendments to the Articles of Incorporation were subsequently used by Chen to increase the control he and his allies held over the company.
The seeds of the conflict were planted shortly after Gome listed on the Hong Kong stock exchange in 2004. The major revision to its Articles of Incorporation was enacted in 2006, when the board was authorized to appoint directors, issue and repurchase shares, and offer equity to members of the management team. It was around this time that Gome acquired China Paradise Electronics – the country’s third-largest appliance retailer — and its founder and chairman, Chen, replaced Huang as CEO.
Over the course of the years after its public listing, Huang had been steadily selling his shares in Gome, and his holdings fell from 75% to around 35.55% by mid-2008. Then in November of that year, there was a dramatic turn of events. Huang was arrested, and later sentenced to jail, on charges of insider trading, among other illegal business practices.
Chen wasn’t about to sit on the sidelines as the drama unfolded. He was appointed chairman two months after Huang’s arrest, and it was then that the board began making decisions without the full consent of Huang or his family. That included Gome issuing HK$1.8 billion of convertible bonds (about 11% of total shares) in June 2009 to Bain Capital, a private equity firm, diluting Huang’s shares. As part of the deal, Bain was allowed to appoint three of its own non-executive directors. (Other minority shareholders include JP Morgan, Morgan Stanley and FIL.)
A month later, Chen moved again to cement his power, this time by launching a stock option plan without Huang’s full knowledge. The plan awarded about 3% of Gome’s shares to more than 100 executives. As a result, shares were further diluted, infuriating Huang and his family.
At the annual general meeting in May this year, Huang, who held 33.98% of Gome through his company, Shining Crown Holding, and his family voted down Bain’s three directors’ nominations. But later the same day, Chen had the board appoint the three directors, claiming that Huang’s decision did not represent all shareholders. Chen added that his actions were in accordance to the Articles of Incorporation.
Although he was jailed on May 18, Huang continued to exert his influence from behind bars. On August 4, he sent letters to the company asking it to remove Chen as chairman. On the next day, Gome sued Huang, questioning his share repurchases in January and February of 2008, in violation of his fiduciary duty as a board director. On August 30, Huang was sentenced to 14 years in prison, and fined RMB 600 million (US$90 million). (His wife, Du Juan, had also been arrested, but her three-year sentence was later commuted.)
The climax came on September 28. Huang, with a stake of around 33% in the company, called the shareholders’ meeting to vote on a number of resolutions, including whether to keep Bain’s three directors and remove Chen as chairman of the board along with another board member, replacing them with Huang’s sister and one of his business allies.
In the Public Eye
As the case played out before the nation, the Chinese public was inundated with news about it over recent months, inciting a vast range of opinion never seen in the short history of capitalist China and underscoring the unusual rules of public discourse in China, where political discussion is stifled but business-related issues are vigorously and openly discussed. Much of the general public seemed firmly in Huang’s camp. In an online vote on QQ Finance Channel, nearly 2.5 million people voted in support of Huang, compared with around 220,000 in support of Chen, while a number of online messages accused the latter of being a traitor.
Among numerous executives, journalists and academics, it was widely agreed that, above all, Gome needs to have a strong management team running the company, while having a majority shareholder who is kept in the loop, but is not involved in day-to-day decision making. In his blog on August 26, for example, Gi Qi, founder, CEO and chairman of Hanting Hotel, a Shanghai-based hotel chain, wrote that he hoped Chen would win, so that a professional management team could run Gome, while Huang would reap the benefit from the team’s work as a major shareholder.
In contrast, Ma Guang Yuan, a corporate lawyer and a researcher at Peking University, wrote in a blog on August 25 that Gome would suffer if the vote went in favor of Chen. If Huang lost, the battle would go on, he asserted, and the turbulence would continue, leaving the company hard pressed to deliver a strong financial performance for investors.
Li Wei’an, dean of the business school at Tianjin-based Nan Kai University, said in a TV program about Gome, which aired a few weeks before the vote in September, that one of the big lessons to draw from Gome is that boards should be given the authority to make crucial decisions without shareholder approval, but only in exceptional circumstances. He also voiced concern about the growing trend among Chinese business people attempting to keep maximum control of their companies with minimum shares. “There is risk in this model, as we have seen from this case,” he said.
Toward Better Governance
Experts also wonder whether the vote exposes regulatory gaps. “Regulatory oversight and tighter enforcement of regulations can mitigate the kind of issues that the Gome family is facing,” states Wharton’s Amit. “What surprises me is that as owners of about a third of Gome’s outstanding shares, the family does not seem to be adequately represented on its board of directors.”
According to Amit, a clear distinction must be made between the role of management, the rights and obligations of owners, and the control mechanisms. He also notes that the conflict between the new management and the founder is adversely affecting the business as they battle away against each other, rather than focusing how on to manage and create shareholder value.
“It became clear that corporate governance had not been addressed carefully when Huang found out, from prison, that an attempt was under way to dilute the family’s equity ownership through the issuance of new shares,” says Amit. “Even though Huang has been convicted of security law violations, he has certain rights as the owner of about a third of the company’s shares. Even though he no longer has an executive management role in the company, I am puzzled by the attempt that seems to have been led by non-family shareholders to dilute the shares of the family to a point where he no longer has blocking rights on major decisions.”
As Han Xu of Peking University’s Guanghua School of Management notes, “Ensuring procedural justice is as important as making the right management decisions. The transparency of the decision-making process is crucial for trust between shareholders and managers.” A victory for Chen, he notes, will ultimately be counterproductive for the company. “Huang’s family won’t give up, and the company will still get bogged down in the internal conflicts,” he says, echoing the predictions of others.
The case’s importance shouldn’t be underestimated for other reasons, says Ding of CEIBS. “It’s the first high-profile dispute [in China] in which management is fighting against controlling shareholders,” he states, noting that traditionally, the two have been allies, and give scant regard to the rights of minority shareholders. “In this respect, Gome is a landmark case for the governance of Chinese companies,” he says. While such conflict might be common in developed markets, it’s unusual for China. “As the shareholder structures of Chinese companies become more diversified, we will see more conflicts like this,” he predicts.
At the end of the day, governance best practice is a learning process, says Liang Neng, a management professor and associate dean of CEIBS. “The best corporate governance structures for Chinese companies will only be achieved [by learning] from cases like [Gome],” he says. “All rules are shaped and developed in [during times of] crisis, when conflicts can no longer be avoided.”