Can't cut the cord

GOME: In Hong Kong, shareholders are learning about governance with Chinese characteristics. Electricals retailer GOME wants to neutralize its jailed mainland founder Huang Guangyu, whose meddling is threatening the company's growth. But the proposed solution - diluting his stake through an equity placing - raises some issues of its own.

Huang was incarcerated for financial crimes earlier this year, but retains a 35 per cent stake in GOME. Nor is he a passive investor. He wants to oust GOME’s chairman and four directors at a shareholder meeting on September 28, and install his own candidates - including his sister. His grip on GOME’s share price persists: It fell 12 per cent on the day his plans were revealed.

There is another alarming wrinkle. Huang controls about 350 of the 1,100 or so stores through an unlisted vehicle, which pays a small management fee to the listed part. He is threatening to end that contract - but his stores would keep their name, and he would have the right to block listed GOME from opening new branches near his own, so long as his stake in it remains above 30 per cent. GOME has responded to these unorthodox problems in kind. First, it invited private equity firm Bain Capital to invest in June 2009 on rather too favourable terms. Bain claims a 10 per cent stake, but holds this in the form of convertible bonds that have not yet been exercised. Its actual shareholding is almost nil. Despite that, it gets to appoint three directors to the board, and a penalty fee of $350 million if they are kicked out before Bain converts, as it says it will before Septemebr 28.

Now the company wants shareholders to renew a mandate that would allow GOME to issue shares to new investors, diluting Huang below 30 per cent. But that too jars with good governance. However daunting Huang's influence, the board would do better to find new investors first, and then ask for permission. Were the new shares to be issued in full to Bain, the buyout firm’s stake could increase to more than 25 per cent.

GOME’s board may argue it needs to bend the norms. Prospective investors might be turned off by a lengthy approval process - or demand sweeter terms because of it. But that just leaves GOME's shareholders facing an unenviable choice: give up some rights, or brave more meddling by the company's founder.

Investors in other Chinese companies founded back when entrepreneurs wrote their own rules should take note.