Investment Service Center Shareholding and Exercise Philosophy

Introduction to the series on exercising stock rights (concept part)

01

What is the Investor Service Center?

China Securities Small and Medium Investors Service Center (hereinafter referred to as Investor Service Center) is a public welfare institution in the securities and financial sector established by the China Securities Regulatory Commission to specialize in investor protection and services. It was registered and established in December 2014 and is directly managed by the China Securities Regulatory Commission. As a public welfare institution for investor protection, since its establishment, the Investor Service Center has always adhered to the concept of "dedicating professional guidance to the people", guided by investor needs, expanded channels for investors to know their rights, enriched the ways for investors to exercise their rights, improved investors' compensation, relief and rights protection methods, and effectively safeguarded the legitimate rights and interests of investors.

02

What is stock option exercise?

Exercising rights by holding shares means exercising shareholder rights by holding stocks. Specifically, it means that the Investor Protection Center holds one lot of each listed company's stock and subsequent stocks, depositary receipts and other securities increased due to transfers, and exercises rights as an investor alone or jointly with other investors in accordance with the law. In addition, according to Article 90 of the Securities Law, the Investor Protection Center, as an investor protection agency established in accordance with laws, administrative regulations or the provisions of the securities regulatory authority of the State Council, can act as a collector and, by itself or by entrusting securities companies or securities service institutions,publicly request shareholders of companies listed to entrust it to attend shareholders' meetings on their behalf and exercise shareholder rights such as proposal rights and voting rights on their behalf. As ofJuly 31, 2021, the Investor Protection Center holds shares of 4,413 A-share listed companies (including 317 companies on the Science and Technology Innovation Board).

03

What are the key points to pay attention to when exercising shareholding rights?

For shareholders,the most important purpose of investing assets in a company is to obtain income from the company. In order to ensure the realization of this purpose, Article 4 of the Company Law clearly stipulates that shareholders enjoy the rights of asset income, participation in major decisions and selection of managers in accordance with the law. Among these shareholder rights, the pursuit of asset income is the ultimate goal, and participation in major decisions and selection of managers are the means to realize the right to asset income. In order to implement the above -mentioned general shareholder rights, the Company Law also stipulates more than ten specific rights in detail, such as the right to request profit distribution, the right to distribute residual property, the right to vote, the right to make suggestions, the right to propose ,the right to convene and preside over shareholders' meetings, etc. There are two main ways for shareholders of listed companies to obtain asset income, namely, obtain dividend distribution and equity appreciation income, which requires listed companies to do two things well: on the one hand, they must continue to create value, and on the other hand, they must ensure that corporate governance can escort value creation activities. Therefore, the shareholding exercise work of the Investor Protection Center focuses on both the value creation activities of listed companies and their corporate governance. When problems are found in the above two aspects of the company, the Investor Protection Center will exercise shareholder rights such as voting rights, questioning rights, suggestion rights,and propose rights by participating in shareholders' meetings, sending shareholder letters, participating in media briefings and performance briefings, and making online inquiries.

1. How to focus on value creation of listed companies

01

Focus on asset acquisitions

First, pay attention to whether there are defects in the target assets; second, pay attention to the extent to which the profitability of the target company is affected by industry policies; third, pay attention to the technological leadership of the target company with high technology content; fourth, pay attention to the factors affecting the substantial growth in the target company's performance before the acquisition and whether it is sustainable; fifth, pay attention to whether the target company's profit forecast is in line with the industry development cycle and product life cycle , and whether the performance in the forecast period has abnormally high growth; sixth, pay attention to whether the parameter selection when evaluating the target company is reasonable; seventh,pay attention to whether the performance commitment is reasonable, whether it protects the interests of the listed company, and whether the performance guarantee is sufficient; eighth, pay attention to whether the listed company has the ability to provide continuous support for its operations if the target company is successfully acquired.

02

Focus on asset sales

First, pay attention to whether there is "darkness before dawn" selling. Second, pay attention to whether the valuation of the target company is reasonable and whether there is a fire sale. Third, pay attention to whether the disposal of pending matters of the target company is reasonable. Fourth, pay attention to whether the counterparty has the ability to pay. Fifth, pay attention to whether the directors are fully and diligently performing their duties in the case of buying high and selling low.

03

Pay attention to non-fulfillment of performance commitments and changes in commitments

First, pay attention to whether the measures taken by the company to supervise the fulfillment of commitments are timely and sufficient; second, pay attention to the necessity of changing commitments and the rationality of the change plan.

II. How to focus on the governance of listed companies

01

Pay attention to whether the listed company system is compliant and sound

Pay attention to whether the articles of association of listed companies are compliant and whether the internal control system is complete.

02

Pay attention to whether the system is actually implemented

( 1) Pay attention to the actual implementation of the dividend system. (2) Pay attention to the performance of directors, supervisors and senior managers. First, pay attention to whether directors, supervisors and senior managers actively participate in shareholders' meetings and meetings of the board of directors and supervisors; second, pay attention to whether directors, supervisors and senior managers fully and diligently perform their duties in matters such as asset acquisition and sale, change or failure to fulfill commitments, goodwill impairment, loss of control of subsidiaries, etc.; third, investigate the directors' responsibilities for corporate governance failures through shareholder lawsuits and shareholder derivative lawsuits. If a company has major mistakes in corporate governance, business management, risk supervision, etc., the Investor Protection Center may recommend that the board of supervisors file a civil compensation lawsuit against the directors or senior managers who are responsible for the mistakes. (3) Pay attention to matters such as non-operating capital occupation, illegal guarantees, and collection of accounts receivable. Sort out and restore the occurrence of capital occupation, illegal guarantees and other matters, urge listed companies to activate internal control mechanisms, take all necessary measures to actively recover debts, investigate responsibilities, and safeguard the interests of small and medium shareholders.

3. Why pay attention to the above matters

01

Why focus on asset acquisitions

The Investor Protection Center welcomes acquisitions of assets that are worth the money, and opposes acquisitions with abnormally high prices, that is, acquisitions with prices far exceeding the value of the target company to be acquired. If the acquisition consideration is paid in cash, the listed company pays more cash for the abnormally high price, which directly damages the interests of the original shareholders; if the acquisition consideration is paid by issuing shares, the additional shares issued for the abnormally high price dilute the interests of the original shareholders of the listed company. Under abnormally high prices, the seller of assets uses some invalid assets to seize the cash or equity of the listed company. When the acquisition is under non-common control, the difference between the acquisition consideration and the fair value of the net assets of the target company is determined as goodwill. When the target company continues to create expected profits for the listed company, the goodwill formed by the acquisition is worth the money; when the target company fails to achieve the expected profits, the goodwill corresponding to the abnormally high valuation should be impaired. On the one hand, the impairment of goodwill directly reduces the net assets of the listed company; on the other hand, it directly reduces the net profit of the listed company in the current period. The market often amplifies the negative effects of declining performance, causing the stock price of the listed company to fall, directly reducing the market value of investors' holdings. When acquiring under the same control, the difference between the purchase price and the book value of the target company's net assets is directly offset against capital reserves, reducing the listed company's owners' equity. When the target company fails to achieve expected returns, the owners' equity reduced due to the offset of capital reserves due to the abnormally high valuation cannot be compensated by continuous profitability, and the "rotten assets" will continue to erode the listed company's owners' equity. This type of related-party transaction is suspected of embezzling the listed company's assets and transferring benefits. When the acquisition behavior constitutes a reorganization and listing, if the assets of the original listed company are not disposed of, the impact is the same as the acquisition under different control; if all the original assets are disposed of, the impact is the same as under the same control.

02

Why focus on asset sales

If a listed company sells its assets at a low price, it will dilute the interests of the company's shareholders.

03

Why pay attention to the non-fulfillment and change of performance commitments after asset acquisition

As an important transaction arrangement in mergers and acquisitions and restructuring, the performance compensation plan is an endorsement of the profit forecast, valuation and pricing of the target assets to be acquired. Generally speaking, if the commitment is fulfilled, it means that the transaction pricing at the time of acquisition is relatively reasonable. If the commitment is not fulfilled, it means that the transaction pricing at the time of acquisition is too high and the target company is not worth that much money. If the listed company can successfully recover the promised compensation, it can fully or partially make up for the losses caused by the acquisition. If the promised compensation cannot be recovered, the losses caused by the acquisition cannot be made up, and the rights and interests of the listed company and all shareholders are damaged. Therefore, the Investor Protection Center has always opposed all non-performance and changes in commitments other than force majeure.

04

Why pay attention to the design and actual implementation of the dividend system

Cash dividends of listed companies are an important form of realizing investor returns and one of the important ways to realize investors' right to income. Therefore, the Investor Protection Center should pay attention to whether the dividend system design of listed companies is compliant and whether the system is implemented in place.

05

Why pay attention to illegal guarantees and capital occupation

If the controlling shareholder or actual controller of a listed company illegally occupies the funds of the listed company or provides illegal guarantees and then deducts the funds, it will seriously damage the rights and interests of the listed company and bring significant losses to the listed company. First, it will seriously affect the normal operation of the listed company. Affected by the funds occupied by the controlling shareholder and actual controller or the funds frozen and deducted by the judicial due to illegal guarantees, the listed company will have tight cash flow, difficulty in capital turnover, broken capital chain, and unable to carry out normal operations; second, it will seriously drag down the operating performance of the listed company. Although it is impossible to prove that there is a direct causal relationship between the performance plunge of the listed company and the funds occupation, since the funds occupation occurred, the performance of many listed companies has turned from profit to loss; third, it will cause the listed company to be subject to risk warnings, bankruptcy reorganization or delisting.

06

Why do we care about directors, supervisors and senior managers performing their duties diligently?

The directors, supervisors and senior managers of a company are elected by the shareholders' meeting or appointed by the board of directors to manage the company on behalf of the shareholders. They are granted extensive decision-making, management, supervision and business execution rights within the scope of the law and the company's articles of association, and actually control the company's operations to a large extent. However, unlike shareholders, they are not the owners of the company. In order tomaximize their own interests, they may not be consistent with the interests of shareholders and the company, or even infringe on the interests of shareholders and the company. In order to protect the rights and interests of the company and shareholders themselves from being damaged, all Shareholders, including the Investor Protection Center, should actively pay attention to the performance of directors, supervisors and senior managers to see whether their starting point for decision-making is correct and whether the decision-making process is diligent and responsible.

The above exercise ideas are the summary and refinement made by the Investor Protection Center based on the current exercise practice, which effectively guides the exercise work at this stage. At the same time, the Investor Protection Center is also demonstrating and exploring how to practice shareholder activism, and gradually trying to participate in the formulation of the company's long-term plan and the value creation and value management process in an appropriate manner without interfering in the company's daily operations.

Source: China Securities Small and Medium Investors Service Center