If you are familiar with the e-commerce giant Alibaba (BABA), you might wonder how you are able to purchase shares in the stock given that the government for the People’s Republic of China has substantial bans on foreign direct investment that aims to keep ownership of Chinese-originated businesses in the hands of the Chinese.
These Alibaba executives induced foreign investment by creating a complicated contract scheme to get around China’s harsh laws restricting foreign investment. If you buy stock in Alibaba, you are really making an investment into a Cayman Islands holding company that owns a company that has contracts with the Alibaba operating business that entitle it to dividends, capital appreciation, and voting rights. Your “ownership” isn’t based on being an owner, but rather, is a contract right where you contract away your money while the Alibaba operating business contracts away dividends, capital appreciation, and voting rights.
To receive capital from American investors—or investors anywhere outside China for that matter—Chinese business executives have begun to create variable interest entities (VIEs) that are designed to mimic the effects of foreign stock ownership.