Archive for the ‘China’ Category

Corporate Governance in China

 

In a recent posting on this blog, I wrote about the Chinese government’s attempt to exert more control over state owned enterprises (SOEs).   That led to some questions about how SOEs were actually governed.  Since I am currently involved in an ongoing study of corporate governance in China with a Hong Kong colleague, Dr Gregg Li, a brief summary of the evolution of corporate governance ‘with a Chinese face’ may be of interest.

 

The People’s Republic of China (PRC) was established in 1949, by Mao Tse Tung, following the defeat of the Nationalist Army under Chiang Kai Shek and its retreat to Taiwan.   Mao founded the PRC and remained Chairman of the Chinese Communist Party from 1949 until his death in 1976.

 

Over that period, the state proclaimed ownership of the means of production, prohibited private property, and banned incorporated companies.  In 1958, Chairman Mao initiated the Great Leap Forward, relocating millions of farmers, peasants, and city workers. Massive economic dislocation and famine resulted. The Cultural Revolution began in 1966 and lasted a decade. Communes were reorganized and state-owned enterprises (SOEs) were created, most relying on state subsidies.

 

In the 1970s, Mao’s successor as paramount leader, Deng Xiao Ping, introduced a pragmatic form of market economy, whilst still maintaining an orientation towards a centralized communist state.  The industrial SOEs, which were large bureaucracies, continued to receive their production and distribution orders from state planners.  Employees of the SOEs received housing, medical care, and schooling for their children.  Deng stood down in 1989, and is now recognized as the initiator of the changes that led to the subsequent incredible economic growth up to the present day.

 

In 1988, the State Council of the PRC, advised by experts from the Organization for Economic Co-operation and Development (OECD), produced a set of corporate governance directives for SOE reform.  In September 1999, the Fourth Plenary Session of the 15th Chinese Communist Party’s Central Committee took a vital decision on enterprise reform, in what was termed a ‘strategic adjustment’ of the state sector, it was agreed that that ‘the state should be withdrawing from what should be withdrawn’.  Interestingly, corporate governance was recognized as being at the core of the modern enterprise system.

 

A new companies’ law was enacted in 1994, and revised in 2006. Two types of company were created:

  • a ‘limited liability company’ (LLC), with at least two and no more than 50 shareholders, somewhat similar to private companies in other jurisdictions
  • a ‘company limited by shares’, in other words a joint stock company (JSC) with some similarities to public companies in other jurisdictions.

Both types of company were defined as legal persons with shareholder liability for corporate debt limited, and with property rights as well as civil rights and duties.

 

Companies were given autonomy to run their businesses according to the market in order, as the Companies’ Act said: ‘to raise economic efficiency, improve labour productivity, and preserve and increase the value of assets.’  Companies were also called on by the new law ‘to conduct their business activities abiding by the law and by business ethics, strengthen the construction of socialist spiritual civilization and accept the supervision of the government and the public.’  Companies were allowed to invest in other companies and to create groups of companies with subsidiaries and branches.

 

China’s corporate governance rules were influenced by Western experience, including the advice from the OECD, drawing principally from practice, pioneered in countries including the USA, the UK, Germany, and South Africa.  Typically, these countries are democracies with independent judiciaries. In developing and emerging economies, including Russia, Latin American countries and India, corporate governance still tends to be emergent, with the state playing a more significant role, and corruption sometimes being endemic.

 

China stands out as a case on its own.  Government is an oligarchy, exercising considerable central control.  The PRC has developed an innovative corporate governance regime, and in the process became one of the worlds leading economies.

 

The SOEs include vast companies in the oil, telecoms, steel, finance, and other major sectors. In some cases, a minority of their shares are quoted on stock exchanges in Shanghai, Shenzen, or Hong Kong, with a few being floated in London or New York.

 

Although influenced by Western experience, the governance of SOEs is unique.  Separate boards of supervisors and boards of directors were formed, partly reflecting the German two-tier board system, but with independent directors on the board of directors, as in the USA and UK.

 

For decades governance was left to companies, under the overall supervision of the State-Owned Assets Supervision and Administration Commission (SASAC) and the China Securities Regulatory Commission (CSRC).   State involvement at a higher level tended to be distant.  Some felt that the Communist Party’s leadership had been undermined.  But central authorities have recently sought to reassert Party influence over the SOEs, as mentioned in a recent blog.

 

Although SOEs remain central to China’s economy, other types of enterprise evolved with diverse ownership structures and governance practices.  Many of these firms are family businesses but others are run as village or township entities.

 

Although Hong Kong is now part of the PRC, the governance of companies there reflects a quite different story.  Since the mid-nineteenth century, Hong Kong had been a British Protectorate under a lease from Mainland China.  That lease ended In 1997 and Britain transferred its rights over Hong Kong to the PRC, which deemed it a Special Administrative Region of China.

 

Under the British influence, Hong Kong developed its own legislature, an independent judiciary based on UK-style common law, and its own currency linked to the US$.  The Hong Kong Stock Exchange began life in 1891, and now oversees the Hong Kong Corporate Governance Code.  Institutions for company registration and regulation were created, and strong professions were formed – legal, audit, accountancy, finance, and company secretarial.

 

This infrastructure and these institutions remained after the 1997 handover; as the Joint Agreement between the PR: and the UK put it – ‘one country two systems.’ But as the business worlds of China and Hong Kong grow together, some Hong Kong institutions are coming under China’s influence.

 

To reach its present economic and political significance in the world, China has travelled a unique road.  This historical and cultural context means that corporate governance in China has developed a distinct ‘Chinese face,’ unlike anywhere else in the world.  Exploring and understanding the special features of Chinese corporate governance and the challenges they might present in the future is an ongoing project

 

Bob Tricker

May 2017

Chinese Government re-asserts control of state owned enterprises (SOEs)

State-owned enterprises (SOEs) remain central to China’s economy. They include vast companies in the oil, telecoms, steel, finance, and other major sectors. In many cases a minority of their shares have been floated on the Hong Kong, Shenzen, or Shanghai stock exchanges.

The corporate governance of these enterprises has been significantly influenced by Western experience. For decades governance has been left to company’s boards of supervisors and boards of directors, under the supervision of the State-owned Assets Supervision and Administration Commission (SASAC) and the China Securities Regulatory Commission (CSRC). State involvement at a higher level had tended to be distant[1]. Some felt that the Communist Party had been pushed aside and the party’s leadership undermined.

Not any longer. In October 2016, China’s President, Xi Jin Ping, asserted that ‘the ultimate bosses of China’s state-owned enterprises must be China’s Communist Party organs’, according to the South China Morning Post (12 October 2016). The President told a high-profile conference of top officials and SOE executives that ‘after decades of fading into the background, Communist Party’s leadership must be boosted in SOEs’. The message was clear: the party will reassert its grip on the state sector.

The two-day work conference concluded that the Communist Party must increase its role, especially in ideology, oversight of personnel, and key decisions in the country’s biggest industrial and financial enterprises.

‘Leadership by the party was the root and soul and a unique advantage of China’s state firms, and any weakening, fading, blurring or marginalization of party leadership in state firms will not be tolerated’, Xi is quoted as saying. ‘We must unswervingly uphold the party’s leadership in state-owned enterprises, and fully play the role of party organs in leadership and political affairs. We must ensure that wherever our enterprises go, party-building work will follow’.

This was the first time that the country’s leadership had addressed a meeting specifically on the Communist Party’s leadership in state businesses; the first time in fact that they had shown any interest in corporate governance. Xi said that China’s state firms had to remain loyal to the party’s course to be ‘a reliable force that the party and the nation can trust’ and ‘an important force in firm implementation of the central leadership’s decisions’.

Since the 18th party congress four years ago, the leadership has called for SOEs to be companies ‘with Chinese characteristics’, which means ultimate leadership by the party. In the published comments, the president did not specifically mention boards of directors. He said the Communist Party’s should be ‘embedded’ in corporate governance. He also said the leaders of China’s state firms should be seen as communist cadres, serving party interests in the economic realm.

Why has China’s leadership chosen to reassert their ultimate control over SOEs? A number of reasons come to mind:

  • To reinforce the President’s sweeping anti-corruption campaign. Corrupt officials in SOEs, as well as the military and the government, have already been accused, but corruption remains endemic.
  • To reverse the slide towards Western capitalist thinking and reassert Communist values.
  • To improve performance of the SOEs and spur innovation as the country faces falling economic returns after many years of double digit growth. The government also launched a 200bn yuan (US$ 30bn) venture capital fund to foster SOE reform and spur innovation.
  • To build party loyalty and improve control over a huge population, whose relatively affluent middle class now has aspirations to greater independent thought. The existing control over the media, the internet, and public discussion would be reinforced if SOE management supported party ideals. Calls for independence from young people in Hong Kong cannot have improved this challenge.

 

Bob Tricker October 2016.

[1] For more on the corporate governance system for SOEs see Tricker 3e pages 297-303.

 

The Cultural Dependence of Corporate Governance

In September 2011, the Corporate Secretaries International Association (CSIA) hosted an international corporate governance conference in Shanghai, jointly with the Shanghai Stock Exchange.  CSIA represents over 100,000 governance practitioners worldwide through its 14 company secretarial member organizations. Speakers and panellists from Africa, Australia, mainland China, Hong Kong SAR, India, the UK and the US plus delegates from the 14 CSIA member countries discussed the cultural dependence of corporate governance.  For more information on CSIA see http://www.csiaorg.com

The conference considered whether corporate governance principles and practices around the world were converging.  Would a set of world-wide, generally-accepted corporate governance principles eventually emerge?  Or was differentiation between corporate governance practices inevitable because of fundamental differences in country cultures?  

Speaking at the conference the writer of this blog suggested that:

“A decade or so ago, it was widely thought that corporate governance practices around the world would gradually converge on the United States model.   After all, the US Securities and Exchange Commission had existed since 1934, sound corporate regulation and reporting practices had evolved, and American governance practices were being promulgated globally by institutional investors.  But that was before the collapse of Enron, Arthur Andersen, the sub-prime financial catastrophe, and the ongoing global economic crisis.  A decade ago it was also believed that the world would converge with US practices because the world needed access to American capital. That is no longer the case. So the convergence or differentiation question remains unanswered. 

Forces for convergence

“Consider first some forces that are leading corporate governance practices around the world to convergence.

Corporate governance codes of good practice around the world have a striking similarity, which is not surprising given the way they influence each other.  Though different in detail, all emphasise corporate transparency, accountability, reporting, and the independence of the governing body from management, and many now include strategic risk assessment and corporate social responsibility.  The codes published by international bodies, such as the World Bank, the Commonwealth of Nations, and OECD, clearly encourage convergence.  The corporate governance policies and practices of major corporations operating around the world also influence convergence.

Securities regulations for the world’s listed companies are certainly converging.  The International Organisation of Securities Commissions (IOSCO), which now has the bulk of the world’s securities regulatory bodies in membership, encourages convergence.  For example, its members have agreed to exchange information on unusual trades, thus making the activities of global insider trading more hazardous. 

International accounting standards are also leading towards convergence.  The International Accounting Standards Committee (IASC) and the International Auditing Practices Committee (IPAC) have close links with IOSCO and are further forces working towards international harmonization and standardization of financial reporting and auditing standards.   US General Accepted Accounting Principles (GAAP), though some way from harmonization, are clearly moving in that direction.

In 2007, The US Securities and Exchange Commission announced that US companies could adopt international accounting standards in lieu of US GAAPs.   However, American accountants and regulators are accustomed to a rule-based regime and international standards are principles-based requiring judgement rather than adherence to prescriptive regulations.

Global concentration of audit for major companies in just four firms, since the demise of Arthur Andersen, encourages convergence.  Major corporations in most countries, wanting to have the name of one of the four principal firms on their audit reports, are then inevitably locked into that firm’s world-wide audit, risk analysis and other governance practices.

Globalisation of companies is also, obviously, a force for convergence. Firms that are truly global in strategic outlook, with world-wide production, service provision, added-value chain, markets and customers, which call on international sources of finance, whose investors are located around the world, are moving towards common governance practices. 

Raising capital on overseas stock exchanges, also encourages convergence as listing companies are required to conform to the listing rules of that market. Although the governance requirements of stock exchanges around the world differ in detail, they are moving towards internationally accepted norms through IOSCO.

International institutional investors, such as CalPers, have explicitly demanded various corporate governance practices if they are to invest in a specific country or company. Institutional investors with an international portfolio have been an important force for convergence.  Of course, as developing and transitional countries grow, generate and plough back their own funds, the call for inward investment will decline, along with the influence of the overseas institutions.

Private equity funding is changing the investment scene.  Owners of significant private companies may decide not to list in the first place. Major investors in public companies may find an incentive to privatise. Overall the existence of private equity funds challenges boards of listed companies by sharpening the market for corporate control. 

Cross-border mergers of stock markets could also have an impact on country-centric investment dealing and could influence corporate governance expectations; as could the development of electronic trading in stocks by promoting international securities trading.

Research publications, international conferences and professional journals can also be significant contributors to the convergence of corporate governance thinking and practice.            

Forces for differentiation

“However, despite all these forces pushing towards convergence, consider others which, if not direct factors for divergence, at least cause differentiation between countries, jurisdictions and financial markets.

Legal differences in company law, contract law and bankruptcy law between jurisdictions affect corporate governance practices.  Differences between the case law traditions of the US, UK and Commonwealth countries and the codified law of Continental Europe, Japan, Latin America and China distinguish corporate governance outcomes.

Standards in legal processes, too, can differ.   Some countries have weak judicial systems. Their courts may have limited powers and be unreliable.  Not all judiciaries are independent of the legislature.  The state and political activities can be involved in jurisprudence. In some countries bringing a company law case can be difficult and, even with a favourable judgement, obtaining satisfaction may be well nigh impossible.                

Stock market differences in market capitalisation, liquidity, and markets for corporate control affect governance practices.  Obviously, financial markets vary significantly in their scale and sophistication, affecting their governance influence.

Ownership structures also vary between countries, with some countries having predominantly family-based firms, others have blocks of external investors who may act together, whilst some adopt complex networked, leveraged chains, or pyramid structures.

History, culture and ethnic groupings have produced different board structures and governance practices. Contrasts between corporate governance in Japan with her keiretsu, Continental European countries, with the two-tier board structures and worker co-determination, and the family domination of overseas Chinese, even in listed companies in countries throughout the Far East, emphasise such differences.  Views differ on ownership rights and the basis of shareholder power.

The concept of the company was Western, rooted in the notion of shareholder democracy, the stewardship of directors, and trust – the belief that directors recognise a fiduciary duty to their company.  But today’s corporate structures have outgrown that simple notion.  The corporate concept is now rooted in law, and the legitimacy of the corporate entity rests on regulation and litigation. The Western world has created the most expensive and litigious corporate regulatory regime the world has yet seen.  This is not the only approach; and certainly not necessarily the best.  The Asian reliance on relationships and trust in governing the enterprise may be closer to the original concept.   There is a need to rethink the underlying idea of the corporation, contingent with the reality of power that can (or could) be wielded.  Such a concept would need to be built on a pluralistic, rather than an ethnocentric, foundation if it is to be applicable to the corporate groups and strategic alliance networks that are now emerging as the basis of the business world of  the future. 

Around the world, the Anglo-Saxon model is far from the norm. A truly global model of corporate governance would need to recognise alternative concepts including:

  • the networks of influence in the Japanese keiretsu
  • the governance of state-owned enterprises in China, where the China Securities and Regulatory Commission (CSRC) and the State-owned Assets Supervision and Administration Commission (SASAC) can override economic objectives, acting in the interests of the people, the party, and the state, to influence strategies, determine prices, and appoint chief executives
  • the partnership between labour and capital in Germany’s co-determination rules
  • the financially-leveraged chains of corporate ownership in Italy, Hong Kong and elsewhere
  • the power of investment block-holders in some European countries
  • the traditional powers of family-owned and state-owned companies in Brazil
  • the domination of spheres of listed companies in Sweden, through successive generations of a family, preserved in power by dual-class shares
  • the paternalistic familial leadership in companies created throughout Southeast Asia by successive Diaspora from mainland China
  • the governance power of the dominant families in the South Korean chaebol, and
  • the need to overcome the paralysis of corruption from shop floor, through boardroom, to government officials in the BRIC and other nations.

The forces for convergence in corporate governance are strong. At a high level of abstraction some fundamental concepts have already emerged, including the need to separate governance from management, the importance of accountability to legitimate stakeholders, and the responsibility to recognize strategic risk. These could be more widely promulgated and adopted. But a global convergence of corporate governance systems at any greater depth would need a convergence of cultures and that seems a long way away.

Bob Tricker

5.11.2011

 

Governance in China Companies – Is Convergence a Two-Way Street?

Bob Tricker writes from the Hong Kong Special Administrative Region of China with some up-dated insights into the way the Chinese authorities govern China’s listed companies.

China’s economy continues to grow, albeit at a slower rate during the global financial crisis, and the importance of China to the economies of the rest of the world becomes ever more apparent.  But how are major companies in China governed, by comparison with the rest of the world?

As I say in my book Corporate Governance – principles, policies and practices (OUP 2009): in a country with strong central control, in which the National People’s Congress, the State Council and the Communist Party play significant roles in the governance of enterprises, share ownership is not the obvious basis for governance power.  Yet the Peoples’ Republic of China has developed an innovative corporate governance regime.

Originally, industrial state-owned enterprises (SOEs), which were in effect large bureaucracies, received production and distribution orders from state planners.  SOE employees benefited from housing, medical care, and schooling for their children, and the government provided benefits for maternity, injury, disability and old age.  Many SOEs were heavily subsidized, with the government giving them easy access to bank financing, partly to pay for the social welfare needs of the workers. The concept of company, legal entity or corporation did not figure in the Chinese language at that time.

Then, between 1984 and 1993, the government introduced a transitional model of governance for SOEs throughout China, giving them more autonomy.  In 1994, a new Corporate Law provided for the restructuring of traditional large and medium-sized SOEs as legal entities. These laws transformed some SOEs into corporations clearly defining asset boundaries and ownership.  A dual system of governance was designed with boards of directors to represent owners’ interests, plus a board of supervisors.

In 1988, the State Council of the People’s Republic of China, advised by OECD experts, produced a set of corporate governance directives for SOE reform.  In September 1999, the Fourth Plenary session of the 15th.Chinese Communist Party’s Central Committee took a vital decision on enterprise reform, in what was termed a  “strategic adjustment” of the state sector, agreeing that the state should be “withdrawing from what should be withdrawn”.  Interestingly, corporate governance was recognised as being at the core of the modern enterprise system.

Some of the reformed corporate entities were floated on the two China stock markets in Shanghai and Shenzen (a city across the border from Hong Kong), which had been set up in 1991 and 1992 respectively.  After due diligence studies on their financial standing, a few China companies were listed in Hong Kong and others on stock exchanges around the world.  Some listed “through the back door” in Hong Kong, by acquiring a non-trading listed company and backing a China business into this shell.

In 2001, the China Securities Regulatory Commission (CSRC) formulated some basic norms of corporate governance, promoting the separation of listed companies from controlling shareholders.  These guidelines called for at least one-third of the board to consist of independent directors, including at least one accounting professional, although initially suitable people were scarce.

In 2002, CSRC formulated a Code of Corporate Governance for listed companies.  This included basic principles for the protection of investors’ rights, and basic standards of behaviour for members of the board and supervisory committee.  A guidance note, issued by CSRC in 2002, required every listed company to have at least two independent directors and by June 2003 at least one third of the board should consist of independent directors.  In 2005, CSRC allowed listed companies to remunerate managers with shares and stock options.

In 2006, a fundamental review of Chinese company law created two types of limited company – the limited liability company (LLC private companies) and the joint stock company (JSC public companies), bringing the legal context much in line with the company law of other countries. For example, the responsibilities of company (board) secretaries were established.

But the state maintains a significant ownership share and control at the national or provincial level.

Contemporary corporate governance in China

The regulatory structure does not appear to be significantly different from practices in the West, when presented simply:

Picture2

But who are the ‘state regulators’ and what do they actually do?  The lines of control from various state and provincial authorities can be numerous:

Picture3

The People’s Bank of China, the tax offices, the ministry responsible for the industry in which the company operates, and other state and provincial officials all act in what they see as the interests of the state and the people.  They can determine prices, regulate supplies, take action to avoid unacceptable economic or social stress such as unemployment, bankruptcy, corruption, or financial pressures on the state economy.  They can stop undesirable competition between state enterprises.

On reflection, these are not activities that are often found in Western economies.  Or are they?  As the effects of the ongoing global economic crisis unfold, similar activities seem to be appearing.

The China Securities Regulatory Commission of the State Council (CSRC) is the Chinese Government’s corporate regulator.  CSRC publishes the corporate governance code, other corporate governance regulations, and regular reports on corporate governance reform and performance in China.  CSRC also liaises closely with the management of the stock exchanges in Shanghai and Shenzen, and with those exchanges overseas which list China stock.  The CSRC is a regulatory body, with powers analogous to the SEC in the United States, with the prime aim of investor protection.  It seeks to maintain a tight control over directors’ behaviour.

The China corporate governance code and many of the regulations mirror those in the West.  Indeed, in some cases, in reporting for example, they are stricter.  In some 15 years China has achieved what took countries in the west many times longer.

But things are not always what they seem.  Xinhua, the national news agency recently let slip that although the published remuneration of some executive directors appears to be on a level with those in the West, actually these executives pay back significant sums so that their net pay is more in line with Chinese norms.

The State-owned Assets Supervision and Administration Commission of the State Council (SASAC) holds the China Government’s shareholding in all China’s listed companies (other than those in the finance sector). In 2008, total assets were over US$1.56 trillion, with eight of the world’s top 500 companies in the Fortune list.  So SASAC is the largest institutional shareholder in the world, surpassing the Government Pension Investment Fund in Japan, the Government of Singapore Investment Corporation and the California Public Employees’ Retirement System funds.

SASAC is a Commission of the State Council and wields considerable power over the SOEs.  It ensures that the State’s interests are represented in the activities of China’s listed companies.  This means that it is involved in the appointment and removal of directors and top executives.  Recently, it has moved chief executives around between companies.  Again, not an activity that one in the West would typically associate with the state, unless, of course, one remembered that the president of the United States recently removed the head of General Motors and the British Government are currently involved in the appointment of directors to various British banks they have nationalized.

Maybe convergence is a two-way street.

Bob Tricker