Five years later, looking back at the thrilling board meeting

Five years later, looking back at the thrilling board meeting
  1. Encountering “barbarians”

Vanke is a respectable real estate company and one of the first five companies listed on the Shenzhen Stock Exchange. Vanke’s growth has undergone several successful metamorphoses, first from a trading company that did everything to a company that focused on real estate business; then, by benchmarking itself against real estate companies in Hong Kong and the United States at different periods of development, it became the undisputed leader in China’s real estate industry. Vanke’s product quality, scale and efficiency are second to none in China. Vanke’s cash flow reserve is also very good.

During Vanke’s growth, CRRC gave very important support. Of course, CRRC’s initial goal was to use Vanke’s development to enrich its real estate territory. However, for a variety of reasons, CRRC did not achieve its pre-conceived goal as expected, and only existed as the largest shareholder of Vanke for a long time.

The number of shares held by the largest shareholder is not large, accounting for only about 15%. Vanke’s managerial team holds about 8% of the shares. But with this 23% stake, Vanke’s management firmly controls its own destiny and has developed the company into an industry leader with sales of 200 billion yuan through its internal partnership program.

Vanke’s development is attributed to the entrepreneurial spirit, and more importantly, to the general environment of the booming Chinese real estate market. Under such circumstances, CRRC has no reason to interfere with the internal management details of Vanke, but only exists silently as an external shareholder and supervisor. It is not often that entrepreneurs are allowed to let go of their responsibilities in the Chinese stock market, and because of this, Vanke has gained a reputation of “excellent governance structure” over the years.

Is Vanke’s corporate governance really that good? I personally have reservations about it. Until today, in the Chinese securities market, a relatively decentralized shareholding, sound three committees and good performance are considered by many as the criteria of excellent governance structure. Frankly speaking, I think this is a simplification of a complex issue. In my opinion, Vanke is a typical insider control, except that this insider has maintained a strong growth motivation and entrepreneurial spirit for a longer period of time.

Many fast-growing companies in China are controlled by insiders. Some time ago, I attended a training organized by the exchange, and one of the companies that presented how good corporate governance is was insider controlled. The company had two major shareholders and a board of nine members. The two major shareholders were evenly matched, each sending two non-executive directors, the company’s management sending two executive directors, and three independent directors. The company’s governance structure appears to be perfect.

But in reality, the structure is a ploy. Having researched the company in depth more than a decade ago, I knew that everything was carefully designed to give personal control to the dominant person in the business. The reason for having two major shareholders and asking them to be equal in their shareholdings was to give them a check and balance on each other, and insiders have the most say in this check and balance. In addition, each major shareholder has only two votes on the board of directors, and all the seats of the two shareholders combined are not more than half.

We must pay attention to the fact that all systems are, in the end, designed by people and serve people. In many cases, the system is just a statement, a kind of rhetoric in favor of the person concerned. We must not be blinded by this attribute of the system, but must be able to see through the surface rhetoric to the essence of the problem.

I do not reject insider control in its entirety, but I think it should be viewed and judged in two ways. The Chinese culture tends to lead to heterogeneity and confusion of ideas, so in many cases we need authority and the power of authority to reduce unnecessary arguments and gain efficiency. Insider control then helps to give the organization authority. When an entrepreneur or manager wants to do the right thing while being disciplined, there is no doubt that insider control is a good institutional arrangement.

However, we must not equate the efficiency of insider control with good corporate governance. Good corporate governance is not only useful when the business is running smoothly, but more importantly, when the business is in crisis, the corporate governance mechanism can play a role in protecting the interests of the corporate entity; when the entrepreneurial spirit of the entrepreneur or manager is declining, it can still work and can help the iteration and continuous improvement of the entrepreneurial spirit. Obviously, in the company mentioned above, the governance mechanism does not have this function yet. Therefore, it is not good enough to be labeled as “good”.

From the series of performance of Vanke after the acquisition, we can also see that the efficiency of insider control and good corporate governance are not the same thing, and there is a clear difference between them.

Baoneng, which acquired Vanke, is an emerging private enterprise, with Yao Zhenhua at the helm. Both Baoneng and Yao Zhenhua were previously unknown. It was only when Wang Shi publicly declared “You are not welcome at Vanke, you are not qualified” that I noticed Yao Zhenhua and the company, and went to Baoneng’s Taikoo Shing in Shenzhen several times for research.

Taikoo Shing, located in Shekou, is a property developed by Baoneng, and in a sense its masterpiece. I also interviewed some people familiar with Yao Zhenhua from the sidelines. He graduated from the prestigious South China University of Technology and is said to have done a double degree while in college. In the 80s, a double-degree student in university was no less than a master’s student today. In short, he is not the so-called “vegetable seller” in Vanke’s mouth.

In my opinion, the acquisition of Vanke by Baoneng will bring risks to Vanke, but such risks are not from Yao Zhenhua’s “origin” of running vegetable market business in his early years, but from the security and stability of the acquisition funds. A large part of Baoneng’s acquisition funds comes from the universal insurance business, and the payment side of this part of the funds is not easy to cover its income side in the long run.

For example, the income from long-term holdings mainly depends on dividends, and the rate of dividends often does not cover the repayment requirements of insurance funds. In this case, the holder of the insurance capital can only rely on selling assets, earning the difference in the secondary market, or rely on other means to solve the problem of short-term financing and long-term investment (also called “short term financing and long term investment”), which will end up in a ponzi game. This is the reason why I am not optimistic about Baoneng’s acquisition of Vanke from the very beginning.

However, it is one thing for Baoneng to obtain the funds and the long-term security of the acquisition funds, and another thing for it to use the funds to make acquisitions in the stock market. Frankly speaking, I have always thought that Baoneng has been very sensible and professional in the whole process, and the acquisition targets it chose are all companies with leading advantages, high quality resources and potential for transformation. For example, Vanke, Shennan Glass and Gree are all leading companies that meet the above conditions. We can doubt whether Baoneng has the ability to improve the management after the acquisition, but the vision is impeccable in terms of the selection of the targets.

Taking advantage of the very special policy “window” of the insurance industry at that time, Baoneng went ahead and made the acquisition in the secondary market by purely market means. This, which did not violate any laws and regulations, should not cause contempt and should not simply be labeled as a “barbarian”. Moreover, Baoneng is not a cross-border company with empty gloves. If you have a chance to research the Taikoo Shing project, you will know that Baoneng’s real estate and property management business is not the best in the industry, but its management level is still moderate.

In short, mergers and acquisitions are a normal part of the capital market, and I don’t think it’s appropriate for the acquiree, the media and the public to label the acquirer a “barbarian” for no good reason when any M&A transaction occurs. What is also inappropriate is the initial statement of Vanke’s founder. Although it was a personal act, it was not like a company with a mature governance mechanism.

I thought that even if there was a need to express an attitude, the only one who could speak on behalf of Vanke was the board of directors, not Wang Shi making emotional statements as the founder and legal representative. In this regard, I agree with the view of Professor Watson, the then independent director of Vanke. Professor Watson is an economist whom I respect very much, and he became famous very early and has seen the world. After the conflict between China Resources and Vanke, because he loves his feathers, Professor Watson published long articles continuously, so that we have more sources of information. Professor Watson’s articles, which are still available on the Internet, are recommended to take some time to read them carefully.

Professor Watson wrote: “Our board of directors has not held any formal meeting to discuss the Baoneng bid after it was raised, which I think is unwarranted. Both management and CRH, as the majority shareholder, should have proposed a board meeting. As we have seen in mature markets, the only authoritative spokesperson for a bid, especially when the bidder has become the majority shareholder, is the board of directors. The board of directors has not been meeting to study it. In turn, the management is expressing its opinion in its personal capacity. I am openly critical of some of management’s practices.” Professor Watson’s words may support my earlier point that “the effectiveness of insider control” and “good corporate governance” are two different things.

  1. The great drama of voting

Finally, the time has come to June 18, 2016, which is the deadline for Vanke to resume trading. Vanke suspended its trading on the grounds of “major asset reorganization”, so when it resumed trading, it had to give an answer to shareholders: whether the reorganization plan with Shenzhen Metro passed the consideration of the company’s board of directors. If it passes, the capital market should perform well, at least not worse than then; if it does not, the share price will probably plummet.

On June 18, 2016, Vanke’s board of directors looked like this: there were 11 board members, including 3 equity directors from CRRC, 4 directors from Vanke, and 4 independent directors. According to the announcement and Professor Watson’s long article, there were 7 directors present at the meeting. Mr. Qiao Shipo, Vice Chairman of CRRC, was unable to attend the meeting in person due to his official duties, and authorized Director Chen Ying to attend the meeting and exercise his voting rights on his behalf; Professor Watson attended the meeting by telephone and also exercised his voting rights on behalf of Professor Haiwen. The chairman of Blackstone China and independent director Zhang Liping, on the other hand, attended the meeting by phone while going through customs because his plane had just landed.

Why do you say this board meeting is a big drama? This is because, according to Vanke’s articles of incorporation, the criteria for a major asset reorganization plan to be approved by the board of directors requires the approval of more than two-thirds of the board members. Vanke’s board of directors has 11 members, and it takes 8 votes to pass two-thirds. As for China Resources, there are 3 equity directors and 1 independent director nominated by China Resources (i.e. Mr. Zhang Liping). Under normal circumstances, CRRC has at least 4 votes in hand, and this number is capable of blocking. In other words, if CRRC does not want the motion to pass, it can at least ensure that the other parties cannot reach two-thirds of the votes.

Some may ask, “Aren’t independent directors supposed to represent the interests of small and medium shareholders? In my opinion, this is just a good intention. At present, independent directors in China are nominated by major shareholders, and I wonder how much people think it makes logical sense to have an independent director nominated by a major shareholder to represent millions of small and medium-sized retail investors whom he does not know.

In this sense, Professor Watson is really valuable. He was recommended by the leaders of Shenzhen Securities Regulatory Bureau, did not receive a penny of compensation from Vanke, and became famous in the 80s. All these conditions combined, he could and dared to publish a long article afterwards to explain the situation and express his views unabashedly.

Frankly, while I don’t entirely agree with Professor Watson, I truly believe that he should have received the Directors’ Award. Had he not published that long series of articles afterwards, we would have had no way of knowing through the company’s announcement alone that such a crucial meeting, which decided the fate of countless small and medium-sized shareholders, could have been so circumstantial.

The following text is directly from Professor Watson’s article.

That day Zhang Liping came back from overseas, the plane was late, and the board of directors postponed for more than half an hour to wait for him. After the plane landed, Zhang Liping took his cell phone and participated in the meeting while leaving the customs. When he came to vote on the proposal, I don’t know if he was nervous because he was going through customs inspection or for other reasons, his words sounded a little incoherent to me. I remember the original words he came up with: the first statement is my new job at Blackstone, currently there are transactions for the two major shareholders, especially there is currently a larger amount and Vanke in progress, so I have sought the advice of my lawyer, I have a conflict of interest, so I abstain.

Vanke’s executives are so smart professional, know that avoid conflict of interest and abstain from voting this can be a world of difference, can decide the fate of the restructuring plan, said ambiguous how! Zhang Liping’s words have just fallen, Zhu Xu, the secretary of the board of directors immediately followed up: then you are such words, belong to the interests associated, you belong to recuse yourself from voting, is that so? Zhang Liping replied: there is no mistake. Zhu Xu again confirmed: recusal from voting? Is that right? Zhang Liping replied: Yes. Zhu Xu followed up: then I want to remind you is about independent directors, you make recusal from voting, you must give us written reasons for recusal, sign, and then we will be announced in the announcement. Zhang Liping finally replied: I just said the reason, because of the conflict of interest, so I must recuse myself from voting. I will provide a written opinion, you give me a time, I will provide. This is the background of Zhang Liping’s request for recusal from voting on the motion to the board of directors’ confirmation letter in the later announcement.

Do not underestimate the amount of information in this paragraph. In fact, it was the result of Zhang Liping’s “recusal” that gave Vanke’s management complete control over its own fate and took the company down a different path. Let’s look at the subtleties here. If Zhang Liping had abstained from voting, Vanke’s will could not be passed because it could not reach two-thirds of the board; but at the same time, Zhang Liping did not offend his nominee “China Resources Group”. But at the same time, Zhang Liping did not offend his nominee “China Resources Group”, and Zhang Liping recused himself from voting because of his interest, then the voting base of the board of directors changed from 11 to 10 people, and at this time, Vanke’s 7 votes were just over two-thirds. This is a completely different result and a key link to determine the direction of Vanke after resumption of trading.

If not for Professor Watson’s clear descriptions, we would have no way to imagine the details, the wonderful conversations, that we would never see in the official announcement. When I first read Professor Watson’s text, I was very shocked and then confused. I have served a number of public companies, some even listed in mainland China, Hong Kong, China and the United States. In almost all board meetings, before the meeting, the secretary of the board and the relevant staff in the board office would make elaborate preparations for the meeting, including verifying which directors are interested associates and need to recuse themselves. Witness lawyers will also supervise and guide such matters from a legal perspective, and all signature documents have to be prepared before the meeting.

Vanke is a company listed in both Shenzhen and Hong Kong, and has two sets of teams as required: the A-share has a board secretary and the H-share has a corresponding “company secretary”, and has two sets of legal advisor teams in Mainland China and Hong Kong, for which it has to pay a considerable intermediary service fee every year, but there is a “live dialogue” as described above. The “live dialogue” is really shocking.

You can see the content of the company’s official announcement. “Zhang Liping, an independent director, affirms in writing to the Board of Directors of the Company that, in respect of the 12 motions to be considered at this meeting, as the U.S. Blackstone Group, for which he works, is negotiating the sale of a large commercial property project in China with the Company, bringing about potential connection and conflict of interest, there is a connection as described in Article 152, paragraph 2 of the Articles of Association of the Company, and no vote shall be cast on such We hereby recuse ourselves from voting on the 12 motions at this meeting.” Obviously, we have no way to think that there is such a dialogue behind this paragraph alone.

So, should Zhang Liping recuse himself from the voting? If Vanke and Blackstone did have this commercial property transaction, he must recuse himself according to the rules. However, China Resources issued a statement the next day after Vanke’s announcement, questioning the board’s voting result, arguing that Zhang Liping’s recusal was not justified and should be counted in the number of directors who did not approve the proposal, arguing that the restructuring proposal could not be considered as legally approved. Should China Resources Group issue this statement?

To answer these questions, I went through Vanke’s entire announcement and annual report in 2016 and found that BlackRock did have a company called Yinli, which was later transferred to Vanke. Moreover, in the company’s annual report for 2016, it is clearly stated that on June 15, Vanke submitted to the board of directors for consideration and approval by way of a correspondence vote on a motion to acquire part of the equity interests of Indus Group Holdings Limited and MWREF Limited.

This happened three days before the crucial meeting mentioned earlier. So, I was concerned: at this correspondence voting board meeting, had Zhang Liping recused himself from the vote and what was the result of the vote at that time? If Zhang Liping recused himself from voting in accordance with laws and regulations, then CRH should have judged the voting results of the 18th meeting beforehand, instead of having to later crusade vociferously. However, after searching through the announcements of Vanke on the Shenzhen Stock Exchange and several major websites, I could not find any announcement of the board meeting held on June 15 by way of communication.

According to reason, as long as a board meeting is held, whether in the form of on-site meeting or by correspondence, the results of the consideration of motions and voting results should be announced within two trading days. However, it is very difficult to understand that such a board meeting, which was somewhat like a pre-post meeting, was not disclosed in any form.

In addition, I found in my research that many of Vanke’s board resolutions that rely on communication voting are not disclosed, and they do so all year round. Information disclosure, which is the foundation of corporate governance. Vanke is seen by many as a model of corporate governance, and this acquisition by Baoneng shows us something different from a different perspective.

After the dust settled, Vanke submitted to the board of directors by correspondence vote on August 14, 2016 to consider and approve the motion on signing the business cooperation agreement with China Merchants Bank and matters related to the transaction with Indus. on September 23, 2016, it disclosed the information that it invested about RMB 3.889 billion to acquire a majority stake in Indus Group and completed the delivery.

On July 1, 2016, a very interesting event also took place. According to the Company Law, shareholders who individually or collectively have 10% of the voting rights can propose to convene an extraordinary shareholders’ meeting. Baoneng already held about 24% of Vanke’s equity at that time, so it proposed to hold an extraordinary shareholders’ meeting, and the subject of the motion was the removal of all members of Vanke’s board of directors. In response, Vanke held the twelfth meeting of its seventeenth board of directors and considered and passed a motion to disagree with the request of Kui Shenghua and Qianhai Life Insurance Co. to convene the second extraordinary general meeting of 2016. This is also very interesting.

We won’t go into details here about the grand finale of Baoneng’s takeover of Vanke, and we can say that Vanke got what it wanted. However, while management kept the company, it lost two precious years. I don’t want to comment on who is right and who is wrong in this acquisition, not having the qualification or the level. This talk, the reason for telling this story, is to illustrate a point: corporate governance in China has a long way to go.

Vanke is a company with excellent performance, a respectable company, in the face of such a big event as the acquisition, the operation of the board of directors, corporate governance are still so, not to mention the governance structure of many companies. As I said earlier, a good corporate governance structure is not the same as a simple decentralization of equity, not the same as the establishment of the so-called “three meetings”, and not simply to ensure the efficiency of insider control, but a mechanism to balance the interests of all sides, a system of concepts and systems that help multiple parties to win and live together.

(This article is for readers’ reference only and does not constitute investment, accounting, legal or tax advice provided or relied upon.

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