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adjustment’ of the state sector, it was agreed that that ‘the state should be withdrawing from what should be withdrawn’.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.