Preferred stocks seen as move to expand overseas

After much anticipation, the long-awaited unveiling in China of measures to allow companies to raise funds by selling preferred stock was announced on Friday by the China Securities Regulatory Commission.

This long-overdue initiative was perhaps hastened by the decision of Alibaba Group Holding Ltd to float on the New York Stock Exchange in preference to Hong Kong, partly because of the opportunity to issue preferred shares in the United States.

But what are the pros and cons of this move and will it lead to a sustainable boost to China's sluggish mainland stock exchanges?

More fundamentally, will this increase the international competitiveness of China's mainland corporations?

Essentially, preferred stocks provide investors with greater priority over the issuer's corporate earnings and dividend payments in particular. Holders of preferred stocks also take priority during any asset distribution process if the issuer goes into liquidation.

On the issuer side, and this is perhaps the key reason behind the recent announcement by the commission, preferred shareholders are not granted voting rights and therefore have relatively limited input into corporate decision-making at any level of the issuing organization.

If China's growing corporate presence on the international business stage is to continue, then the unhealthy and potentially destabilizing influence and input of often short-term, financially motivated shareholders has to be curtailed.

International expansion and establishment of a strong corporate and maybe strong product brands always take time, consistent levels of commitment and a clear strategic direction. Such an expansion will be severely hampered by the financial demands of ever-hungry shareholders.

Being held hostage to the short-termism of its shareholders is not the only potential pitfall that lies ahead for Chinese companies as they increasingly expand internationally. The threat of hostile takeover is also large and will become larger once international market penetration takes place.

Full control over decision-making and a dilution in shareholder voting rights, as a result of the issuance of preferred shares, is therefore very much a necessary freedom that more and more Chinese companies should seize.

It was no surprise to witness a slight surge last Friday in China's Shanghai stock market in anticipation of this announcement. It ended 2.7 percent above the previous day's close.

In spite of this gain, it is unlikely that some sort of bull run will occur soon. Instead, the gradual return of investor confidence is more likely.

Any massive boost to the Shanghai stock market is unlikely given that investors have to pass the 5 million yuan threshold to actually invest in preferred stocks. Shanghai's A-share market is composed mainly of small and medium-sized investors. Their relatively small size may prove prohibitive in attracting sufficient interest in any preferred shares offering.

Rather than being a negative factor, this could actually turn out to be very much a positive element. It may push many of China's ambitious yet internationally inexperienced small and medium-sized enterprises into forming much-needed joint ventures and/or full-blown mergers with suitable partners of a similar size and ambition. Such amalgamation may then prove sufficiently attractive to any preferred shareholding interest.

Both Japan and South Korea serve as prime examples of the rapid international expansion of smaller companies when they work together to form a critical size and market power.

The commission's recent preferred shareholding announcement should, therefore, not just be seen as a measure aimed at a short-term boost to China's stock markets, nor an initiative designed to shore up the larger Chinese banks' capital bases.

The author Mike Bastin is a visiting professor at the University of International Business and Economics in Beijing and a senior lecturer of marketing at Southampton Solent University's School of Business.