How Jack Ma's Mistake Damaged China's Market
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 fairytale 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.
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