Chinese Corporate Governance

No.62
November 1999
Research Fellow Jianmin Jin

1. The many years of meager capital efficiency in Chinese companies has become a major factor in China's present economic hardships. A development strategy not based on comparative advantage, coupled with extensive political and administrative interference, has resulted in overinvestment and the encouragement of excessive risk-taking by Chinese businesses. Furthermore, though management autonomy has spread in conjunction with China's business reforms, the establishment of an appropriate system of management supervision has been slow, resulting in a void of management discipline.
2. In response to the current state of Chinese businesses, authorities are pursuing various policies aimed at money-losing businesses, such as financial support and the elimination of production capability resulting from overcapacity through administrative decree. However, administratively led industrial reorganization policies that suppress competition have been unable to produce radical improvement of Chinese businesses' chronic deficits. Only those businesses that have been reorganized as listed, publicly traded companies have shown any improvement in chronic deficits and can be considered models for business reform.
3. Formally, China's publicly traded company system is modeled after the business organization system of leading industrialized countries. In essence, however, stock-issuing restrictions, in which the majority of a company's stocks are owned by the government, and stock circulation restrictions, in which government-owned and corporate-owned shares are not circulated, mean that the state controls the "publicly traded" companies' decision-making capabilities. By controlling a dominating share of a company's stocks, the government is not only able to demand the enforcement of industrial policies and capital efficiency, but it is also possible to use administrative measures to appoint top management. In other words, a great majority of Chinese businesses have no marketability, and there is a lack of responsibility in the management ranks. This organizational structure is the reason for the lack of improvement in Chinese businesses' chronic deficits.
4. In order to fundamentally reform the chronic deficit problems of Chinese businesses, it is imperative to construct corporate governance that is founded on market principles. Specifically, it is crucial that government and administrative interference be blocked through governance mechanisms, and that the exercise of rights be concentrated in the hands of dispersed, private stockholders. Furthermore, securities companies, securities investment funds, and other investment marketing organizations should be relied on more often as candidates for external supervisory bodies. Contracted operation and maintenance of government-owned and private-owned shares by commercial contract-based trust funds is one realistic policy option for the improvement of Chinese businesses' management culture.
5. Protecting the independence of auditor's boards, improving the shareholders' litigation system, and promoting privatization through the improvement of the business system can serve as additional checks on corruption and cozy relationships within top management. Lastly, a Chinese corporate governance system founded on market principles would be complete with the establishment of a system of governance for both external and internal business management.

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