Noriko Kagawa
This
paper examines corporate governance in the Chinese State-Owned Enterprises
(SOEs). Corporate governance deals with how effectively owners of companies
supervise management t to protect shareholders' interests and assure
returns of investment. Establishing an effective corporate governance
structure is a common task for operating modern corporations in which ownership
and management are separated. The importance of corporate
governance in the Chinese SOEs was recognized when the enterprise reform
entered a new stage, that is, the introduction of the modern enterprise
system. By the initiation of the system, the SOEs were expected
to transform into modern corporations and to improve their efficiency.
However the modern enterprise system has not contributed to improving the
SOEs poor performances partly due to the lack of an effective monitoring
system. The absence of functional monitoring in the SOEs derives
from confusion of roles and functions of each unit in internal organizations
and the lack of external control mechanisms.
In order to know how other
countries deal with the owner and manager relationships and organize a
corporate governance structure, I study two corporate governance models:
the Anglo-American and the Japanese models. The comparative study
shows that each corporate governance model was devised according
to the given economic conditions, historical back grounds, and economic
purposes, and that a corporate governance model is subject to change with
economic development and a change in a market environment. Therefore,
there exists no corporate governance model that functions effectively in
every condition, and China is required to establish her original corporate
governance model, solving characteristic problems with enterprise operations
in China. In establishing an effective corporate governance
structure, the primary task of China is to create the institutional
frameworks, such as the functional legal and financial system, for operating
market economy and to separate administration and commercial activities
in operations of the SOEs. This leads to the establishment of
functional internal and external monitoring mechanisms, which are indispensable
for effective corporate governance.
The reform of the state
owned enterprises (SOEs) is indispensable for the achievement of China's
economic reform. Without the SOEs reform, other economic problems
that China currently has, such as government budget deficit and inflation
would not be solved. The primary problem with the SOEs is their
poor economic performance and a small increase in productivity compared
with non-state enterprises. Over the causes of the SOEs' inefficiency,
scholars have developed active debates and proposed appropriate reform
programs for improving their poor performances. As diverse
arguments that I shall examine later show, it is difficult to specify a
decisive cause of the SOEs poor performance. It would be more appropriate
to state that the SOEs' inefficiency is generated by various intertwined
elements rather than by one specific factor.
In this
paper, I focus on a problem with internal organizations, especially
corporate governance of the SOEs among various sources of their inefficiency.
Corporate governance deals with how effectively company owners can supervise
management in order to protect shareholders' interests. Organizing
an effective corporate governance structure is a common task for operating
modern companies under every economic system. Importance of establishing
an effective cooperate governance structure in the SOEs was recognized
when China entered a new stage of the enterprise reform, which is corporatization
of the SOEs. In 1995, China initiated the "modern enterprise system,"
which aimed to transform the SOEs into modern corporations. However,
the SOEs' efficiency has not improved by the introduction of the system,
partly because of lack of effective monitoring system of management.
The state, as an owner of the SOEs, has failed to supervise management
in the SOEs sufficiently because of high costs of checking under the imperfect
market system. Under such circumstance, managers of the SOEs are
able to operate their enterprises according to their own interests without
being checked by owners. The management without owners' supervision
inevitably gives rise to inefficiency. Therefore, it is significant
for the SOEs to construct effective corporate governance structure for
monitoring management and improving their efficiency.
This paper examines the current problem with a corporate governance structure
in the SOEs and consider whether China can learn from corporate governance
models of other countries. First, I introduce two competing
arguments about the causes of the SOEs' poor performance to present a background
of the SOEs reform. Second, I describe a general concept of corporate
governance, and review the past experiment of "modern corporate system,"
pointing out the current problems with corporate governance in the SOEs.
Third, I study the Anglo-American and Japanese corporate governance models
and compare characteristics of each model. Finally, I consider whether
China can learn from the above two corporate governance models in constructing
its own corporate governance model.
I. Debates on the State-Owned Enterprise Reform
Poor economic performance of the
SOEs has given rise to various problems that impede progress of the economic
reform in China. The first problem caused by the poor performances
of the SOEs is government budget deficit. The government has subsidized
the SOEs to help their poor economic performances, and the large amount
of the subsidy has become a major cause of serious government budget deficit.
The second problem is inflation which has occurred frequently because of
the SOEs’ strong demand for credit. Due to the lack of credit in
banks, the Chinese central bank has to increase money supply to compensate
for the shortage of deposit in banks. The increase in money supply
naturally results in inflation. The third problem is delay of financial
institutions reform. Banks that lend loans to the loss-making the
SOEs suffer from accumulation of bad loans, and the accumulation of bad
loans prevents banks from operating sound management and delays the reform
of the financial system . Thus, the SOEs' poor performances have
become an obstacle to sound economic operations by the state, and have
given rise to instability in China's macro economy. Therefore, the
SOE reform is indispensable to stabilize macro economy and to obtain
the successful economic reform.
Although various reform programs
have been carried out since 1979, such as decentralization of decision-making
on management and enhancement of workers incentives to work, economic
performance of the SOEs has not improved as much as that of collective
or individual owned enterprises. As Table
1-1 shows, the share of SOEs in total industrial output has been
declining, while that of non SOEs have been increasing.
The ratio of increase in total factor productivity is also larger
in the non-state sector than in the state sector(See Table1-2).
Responding to this fact, various discussions about the causes of the SOEs'
inefficiency arose, and these arguments can be roughly divided into two
schools of thought: ownership focused and market focused ones.
The school of thought that
focuses on ownership blames an unclear definition of ownership and the
separation between ownership and management for the SOEs' inefficiency.1
According to them, the state, as an owner of the SOEs, has failed
to supervise management in the SOEs effectively because of high cost of
checking, and the insufficient monitoring has allowed managers to pursue
their private interests at the expense of profits of enterprises.
As policy measures to solve the efficiency problem, this school of thought
advocate the introduction of the shareholding system that permits the SOEs
to sell their stocks to employees or to individual investors. They
assert that the introduction of the system contributes to increasing the
SOEs' efficiency, expecting that selling shares gives workers in the SOEs
consciousness as owners of their enterprises and make them care more about
profit making.
On the other hand, the second
school of thought claims that creating a functional market is more important
than reforming ownership structures in order to improve the SOEs'
poor performances. Justin Lin et. al. attribute causes of
the SOEs' poor performances to the lack of a competitive market environment
rather than with an ambiguous definition of ownership. Against an
assertion that blames separation of ownership and management for the SOEs'
inefficiency, Lin et.al. point out that the separation and conflict between
owners and managers has existed ever since the appearance of modern corporations
and that the ownership structure is not the focal point in the SOEs'
efficiency problem. They assert that price distortion, soft-budget
constraint, and high cost for monitoring management impair the SOEs' performances,
and that such conditions are generated by an immature market system. According
to them, the introduction of the shareholding system would not improve
the SOEs' efficiency without existence of a fair market.2
Jun Ma also emphasizes that establishment of the functional market
system is a precondition for the effective shareholding system.
Ma states that the most important external conditions for SOEs reform are
matured financial and managerial labors markets, hard-budget constraints,
and restricted government interventions in enterprises operations.3
Since the purpose of this
paper is not to identify the specific cause of the SOEs' inefficiency,
I do not judge which argument properly deals with the current efficiency
problems with the SOEs. Instead, I introduce another argument
that combines the core arguments of the above two school of thought.
Magdi Iskander maintains that interplay of internal and external incentives
is crucial for improving the poor performances of the SOEs. Internal
and external incentives in his discussion refer to internal organizational
and governance system of the SOEs, and functional market mechanisms and
the reliable legal system, respectively.4
These internal and external incentives contain ownership and market reforms
that each of the school of thought raises as a crucial factor for improvement
of the SOEs' performances. The interplay of internal and external
incentives is necessary to organize an effective corporate governance structure
as well since the institutional framework in a country, such as financial
institutions and market mechanisms, determine the nature of its corporate
governance structure. I will discuss the relationship between the
institutional framework and the organization of corporate governance
structure in later chapters.
According to Iskander, establishment
of an internal incentive structure of the SOEs requires: achievement of
"corporatization;" clear definition of role for the SOEs' owners and managers;
differing the SOEs' commercial objectives from social ones; appointment
of non governmental representatives to members of the board of directors
and of commercially oriented chief executive officers; and a competitive
structure of managers' salaries. 5
Iskander maintains that merely the existence of internal incentives is
insufficient and that external incentives, which affects control
of a company and management accountability to external shareholders, are
also indispensable for the achievement of efficiency. The external
incentives in Iskander's argument are: a competitive product and capital
market; well-developed labor market; clarification of companies' legal
obligations; and bankruptcy.6
Existence of these conditions are significant in order to organize
an effective corporate governance structure. However, the Chinese
SOEs have not fulfilled the required conditions for an effective corporate
governance structure despite the introduction of "modern enterprise
system," which aims to establish the modern corporate governance structure
in the SOEs. Now I turn to examining the past experiment of the "modern
corporate system" and the current problems with corporate governance in
the SOEs.
Table 1-1: Industrial Output of State-Owned
and Non-State Owned Enterprises(percentage
share)
(100 million yuan)
| 1992 | 1993 | 1994 | 1995 | 1996 | |
| State-owned Enterprises | 17824 (51.5) | 22725(47.0) | 26201(37.3) | 31200(34.0) | 28361(29.7) |
| Collective owned Enterprises | 12135(35.1) | 16464(53.0) | 26472(62.7) | 33623(66.0) | 39232(70.3) |
| Township
Enterprises |
3534
|
5374
|
8102
|
11932
|
11730
|
| Village
Enterprises |
3632
|
5163
|
9658
|
11847
|
15900
|
| Cooperative
Enterprises |
870
|
1322
|
2611
|
2134
|
3387
|
| Individual owned enterprises in urban and rural areas |
2006(5.8)
|
3861(8.0)
|
7082(10.1)
|
11821(12.9)
|
15420(13.8)
|
| Enterprises of Other Types of Ownership |
2688(7.0)
|
5174(11.0)
|
9018(14.0)
|
5231(16.0)
|
16582(16.0)
|
| Gross Industrial Output Value | 34599 | 48402 | 70176 | 91894 | 99595 |
Table
1-2 : Estimated Rates of Annual Productivity Growth in Chinese Industry
(percentage)
| 1980-84 | 1984-88 | 1988-92 | |
| Total factor productivity | |||
| State sector | 1.8 | 3.0 | 2.5 |
| Urban and township | 3.4 | 5.9 | 4.9* |
| Township-Village | 7.3* | 6.6* | 6.9* |
| Labor productivity | |||
| State sector | 3.8 | 6.2 | 4.7 |
| Urban and township | 8.6 | 7.0 | 13.8 |
II. The Past Experiments of the Modern
Enterprise System
Corporate governance
In the early times
of capitalism, companies were owned and managed by their owners because
their size and capacity of production were small. As the size of
companies became large with progress of industrialization, owners of companies
found it difficult to handle strong demands for capital and increasing
risks of running businesses by themselves. In order to respond to
this situation, shares of a company were divided to more than one investor
so that business risks could be dispersed. As a result of emergence
of companies owned by a number of investors, it became impossible that
a company was run by a single owner, and separation of ownership from management
progressed.7
Under such condition,
owners are required to establish a governance structure which controls
managers and assures achievement of efficiency, maintaining transaction
costs at a level as low as possible. The challenge posed to
owners has been "how the owners-the principal-can achieve efficiency, profitability
and accountability while also permitting the managers-the agents-the necessary
degree of autonomy to operate the corporation in a competitive market environment."8
Corporate governance is about solving the principal-agent problem,
which arises due to the separation of ownership and management, and for
ensuring returns on shareholders' investment.
Organization of a corporation
The primary actors of the modern corporation are shareholders, the board
of directors, and managers. Shareholders have all the rights related to
property rights. These rights include decision-making right, appointing
managers, and investment beneficiaries. The shareholders express
their interests through the shareholders congress which has the supreme
control of a company. The board of directors is the top decision-making
organ in a company and supervises management on behalf shareholders.
Its main responsibilities in management decisions include strategic planning,
such as merger and acquisition, and appointment and dismissal of executives.
Under the instruction of the board, managers conduct the daily management
of the company. These three entities can be found in companies in
developed countries, although variant forms of organization exist in some
countries.9
Modern enterprise system and its problems
In November 1993, the 14th
Central Communist Party of China issued the Decision on Issues
Concerning the Establishment of a Socialist Market Economic Structure,
which emphasized the importance of introducing the modern corporate system
to the SOEs. In the following year, the national level 100-firm corporatization
experiment was announced by the State Council. The 100 large and
medium industrialized SOEs to participate in the program were selected
by mid-1995.10 The central government
is to aid the pilot firms in corporatization through reform of property
rights and corporate governance systems.
The modern enterprise system
which was formally implemented in 1995 aimed at corporatization of the
SOEs under the Corporation Law of China, which became effective in 1994.
The major reform objectives in the system include: transforming the SOEs
into corporations by a clear definition of ownership, and establishment
of efficient corporate governance structure. The corporatized SOEs are
required to set up the board of directors that represents owners' interests,
to produce separate corporate entities that supervise the management of
each enterprise, and to create the supervisory board. Members of
the board should include outside specialists of business management, separating
the government administrative functions from the commercial functions in
the SOEs. 11
The expectation which underlay
the initiation of the system was that managers and workers in the SOEs
would avoid short-term behaviors and encroachment of state assets once
ownership was clearly defined and owners interests were represented by
the board of directors. However, a number of experts conclude that the
modern enterprise system has not contributed to improving the SOEs' efficiency,
and that there are still organizational problems in the SOEs from the standpoint
of corporate governance.
Heting maintains that the
corporatized SOEs still have problems with relationships between the shareholders
congress and the government, the board of directors and managers,
and the Party organizations and governance structure. First, according
to Heting, the shareholders congress is required to obtain permission for
their decisions from its upper authorities. Second, managers are appointed
not by the board but by the authorities, and the post of the general manager
is held by the director of the board. Such conduct substantially
confuses the roles of the two different posts. Third, the chairman
of the board is appointed by the top of the Party organization instead
of by the board members. 12
Ma also finds problems with
the modern enterprise system in the overlap between the general managers
and the director of the board, and in the administrative appointment of
SOE managers. Furthermore, Ma points out that the three old committees-
party committee, trade union, and the congress of workers representatives-co-exist
with the three new ones- the shareholders congress, the board of directors,
and the supervisory board. According to Ma, the lack of clear definition
of the responsibilities of these entities and the relationships among them
causes internal conflicts and inefficiency in decision-making. 13
Xue and Wang show that the
implementation of the modern enterprise system has not changed the inside
structure of the SOEs by examining the composition of the board of directors
and the supervisory committee in the corporatized SOEs. According
to the results of Xue and Wang's study, members of the board and the supervisory
committee are dominated by the government officials, and the state shareholders
are over-represented in proportion to individual shareholders in both the
board and the supervisory committee.
14
Summarizing the above argument,
the current problem with corporate governance in the SOEs are administrative
intervention in personnel appointment and dismissal, the resulting mixing
up of roles of each entity in corporate organizations, and the informal
role of the Party's organizations in operations of the SOEs. In addition
to these internal organizational problems, the SOEs do not have required
external conditions for establishing an effective corporate governance
structure, such as a developed stock market, banking system, and legal
framework. It is not only the Chinese SOEs but also every modern
corporation that has problems with organizing an effective corporate governance
structure. Next chapter examines how corporate governance structures
of the Anglo-American and the Japanese models are organized
and how they function to deal with the principal-agent problem and other
problems associated with separation between ownership and management.
III. A Comparative Study: Corporate
Governance in the Anglo-American and the Japanese
Models
The organization and characteristics
of corporate governance are different from country to country, depending
on their historical backgrounds and external environments, such as market
mechanisms and legal frameworks, surrounding companies. Despite the
different characters, each corporate governance model was devised to achieve
an efficient corporate organization and to deal with the principal(owners)-agent(managers)
problem under the given economic system. This chapter examines structures
and characteristics of two corporate governance models: the Anglo-American
and the Japanese model, and characteristics of the two models.
The Anglo-American model of corporate governance 15
The major participants
in the Anglo-American corporate governance model are the shareholders,
the board of directors, and the officers. The shareholders who subscribe
for or purchase one or more companies shares own the company. The
rights of the shareholders include : receiving dividend payments per share;
to appoint and dismiss the board of directors; approval and disapproval
of essential changes regarding the company; communicating with other shareholders;
and exercising the shareholder rights against the company.
The board of directors, which is elected by the shareholders, engages in
supervising officers' management activities. It is composed of a
mixture of inside directors, quasi-inside directors, and outside directors.
Inside directors maintain a position in the company as an officer
or employee. Quasi-inside directors hold non-director relationship
with the company in the form of the company's outside council or investment
banker. Outside directors have no relationship with the company other
than holding its shares. The major rights and duties of the board
of directors are: to monitor the company' s performance; to elect and dismiss
the officers; to announce dividend payments; to raise capital through distribution
of new securities or contraction of new debts; to change the direction
of the company' s businesses; to check and approve the company's financial
statement. The officers are the highest level of employees
of the company and are responsible for handling the company's daily management
and for policy making. The officer positions are generally occupied
by Chief Executive Officer, president, chairman of the board, vice president,
secretary, and treasurer.
The Japanese corporate governance model
Major participants in the
Japanese corporate governance model are shareholders, the board of directors,
and the main bank. The shareholders have the residual control of
a company and exercise this right through the General Shareholders Assembly
(GSA), which is held at least once a year. The shareholders rights
include: obtaining information; voting and opposing resolutions in the
board; participation in profits and assets in a winding-up; claiming the
new issued shares; and withdrawal.
The board in the Japanese
company is composed mainly of insiders: a president, senior executive
directors, and executive directors. The president, who is appointed
by the present members of the board, selects new members of the board.
Whereas the board of directors in the Anglo-American company consists of
the mixture of inside and outside directors, the Japanese counterpart is
comprised mainly of high positioned employees of a company, and a de
facto substructure of top management.16
The main responsibilities of the board of directors are: representing the
shareholders interests; and decision-making on a corporations administration.
The main bank in the Japanese
corporate governance system plays the roles of both shareholders and business
partners. Most companies have a financially strong tie with one bank,
that is, a main bank that holds the largest share in the companies.
The major functions of the main bank are: to elect the board members; to
monitor management of a company; and to rescue a financially unstable
client company by replacing management or by dispatching the banks manager
to the company as an advisor. 17
Comparison of characteristics of each corporate governance model
Characteristics of the Anglo-American
and the Japanese corporate governance model are quite different from each
other. One prominent difference between the two models is ownership
structure in a company. As Table
3-1 shows, almost half of corporate shares are held by individual
investors in the Anglo-American companies, while it is a financial institution
that holds the largest share in the Japanese companies. The entire
percentage of institutional ownership exceeds seventy percent in
Japan. This institutional ownership concentration in Japanese companies
stems from reciprocal equity ownership among companies, and such cross-shareholding
aims to prevent hostile takeovers and to enforce informal business contracts. 18
The different ownership
structures between the two models generate different management control
structures. In the Anglo-American companies, shareholders exercise
their influence on company management through a market since ownership
is relatively dispersed and shareholders do not directly intervene in decision-making
on management. If shareholders are not satisfied with managers performance,
they express their dissatisfaction by selling the company's stocks and
by subsequent takeovers. On the other hand, shareholders in the Japanese
companies intervene directly in decision-making or propose remedy plans
when a company enters into distress. This active intervention is
usually exercised by the largest shareholder, namely, the main bank
of a company. Owing to such direct corporate control by institutional
shareholders, hostile takeovers rarely occur in Japan.
19
What makes a difference
in mechanisms and characteristics between the two models? Xu
and Wang assert that differences in the firms legal and regulatory environment
determine the ownership structure and corporate governance in a particular
country. For instance, the small percentage of financial institutions
shareholding in the Anglo-American model is because the law prohibits banks,
mutual funds, pension funds, and insurance companies to hold company shares
over the regulated rate. 20
The legal framework in the US and Britain functions to protect shareholders
interests as well by regulations on information disclosure, insider-trading,
and minority shareholder rights. 21
In the case of Japan, the Anti-monopoly Act sets the limit on the
rate of shareholding by banks, however, the legal regulation on financial
institutions shareholding is not as strict as in the US (See
Table 3-2 ).
Patrick discusses influences
of a historical background of each country on organization of a corporate
governance structure. Strong involvement of banks in the Japanese
corporate governance model originates from underdevelopment of a security
market as a means of raising capital. 22
In addition, Japanese companies demanded a stable financial source to maintain
a large amount of investment in the high growth-era, and banks were considered
to be a more suitable supplier of finance than the security market.
On the other hand, the early development of security market in the
US and Britain made the countries choose a security market based financial
system.
Kester emphasizes a difference
in economic purposes of the two models as the origin of different characteristics.
Kester asserts the Anglo-American corporate governance model gives priority
to the reduction of agency cost associated with separation of ownership
and control in modern corporations. This type of system demands the formal,
legal system to monitor managers and to protect owners' interests.
Unlike the Anglo-American model, according to Kester, the Japanese model
emphasizes the reduction of transaction costs associated with inter-corporate
business relationships. Kester points out that the characteristic
systems in Japanese corporate governance, such as the main bank system,
cross-shareholding, and keiretsu, are devised to share business information
and risks and to maintain long-term business relationships among companies,
reducing costs of information access and monitoring. 23
In short, characteristics
of corporate governance are determined by the legal system, market mechanisms,
historical background, and economic purposes of governance models (See Table
3-3). Both the Anglo-American and Japanese models were structured
based on specific economic goals and under peculiar market conditions.
Each corporate governance model has strong and weak points in handling
specific problems. For examle, insufficient public disclosure of
financial performance information by Japanese companies might direct managers
to pursue their private interests at the expense of shareholders benefits.
The characteristic of the Anglo-American model that evaluates shareholders
interests might become an obstacle to achieve long term profits.
Therefore, to argue which corporate governance model is superior
to the other and more effective is nonsense. In this sense,
there is no single best corporate governance model that functions effectively
in every economic condition. This is because the structure
of corporate governance is subject to change with economic development
and with the resulting change in market conditions. For instance,
the main bank system in Japanese corporate governance model functioned
most effectively in the high growth era. However, the system might
experience a fundamental change as the ongoing financial "big-bang" reform
proceeds. The role of the main bank in Japanese corporate governance
might decline, while that of market expands in the current market
oriented global environment.
Considering the above discussion,
it would not be a good plan for China to introduce either corporate governance
model, the Anglo-American or Japanese, to the SOEs as it is since China'
s current market environment and its historical background are quite different
from those of the US and Japan. China is required to organize
its own corporate governance structure according to its economic goals
and the given market conditions. In next chapter, I consider what options
for constructing a corporate governance structure are available to China
and what priority to achieve effective corporate governance is.
Table 3-1 Ownership of Common
Stock, 1990
(Percentage of outstanding shares owners)
|
|
|
|
|
| All corporations |
|
|
|
| Financial institutions |
|
|
|
| Banks |
|
|
|
| Insurance companies |
|
|
|
| Pension funds |
|
|
|
| Other |
|
|
|
| Nonfinancial corporations |
|
|
|
| Individuals |
|
|
|
| Foreign investors |
|
|
|
| Government |
|
|
|
Table3-2 Legal and Regulatory Constraints
on Corporate Control
|
|
|
|
|
| Banks | Stock ownership prohibited or requires prior approval of the Federal Reserve Bank and must be "passive." | Bank of England may discourage ownership on prudential grounds. Capital adequacy rules discourage large stakes. | Prior to 1987, banks could hold up to 10 % of a firm's stock. After 1987 can hold up to 5% |
| Life Insurance companies | Can hold up to 2% of assets in a single firm's securities. Can hold up to 20% of assets in equities. | Self-imposed limits on fund assets invested in any one company stemming from fiduciary requirement of liquidity | Can hold up to 20% of total asses n equities. |
| Other Insurers | Control of non insurance company prohibited by NY Insurance Law | Same as above | No restrictions |
| Mutual Funds | Tax penalties and regulatory restrictions if ownership exceeds 10% of a firm's stock. | Cannot take large stakes in firms. | No restrictions |
| Pension Funds | Must diversify | Self-imposed limits on fund assets invested in one company stemming from fiduciary requirements | No restrictions |
| General | SEC notification required for 5% ownership. Antitrust laws prohibit vertical restraints. Insider trading laws discouraging active shareholding. Creditor in control of firm liable to subordination of its loans | Insider trading laws discouraging large stake holders from exerting control. | Regulatory notification required for 25% ownership |
Table3-3: Importance of different
corporate control mechanisms in large non-financial firms
| Mechanisms |
|
|
| Board of independence/Power over management |
|
|
| Importance of pay/performance relations in top management compensation package |
|
|
| Monitoring by financial institution stockholders |
|
|
| Monitoring by non-financial firm stockholders |
|
|
| Monitoring by individual stockholders |
|
|
| Frequency of hostile takeovers |
|
|
IV. Lessons for the Chinese Enterprise Reform from Corporate
Governance Models of Other Countries
The above comparative study
of the two corporate governance models has shown that a country devises
a corporate governance model in accordance with the given market environment,
a historical experience, and the specific economic purposes. The
US organized a corporate governance model that emphasizes protection of
shareholders' rights and that relies on a market for monitoring management
of companies under the functional legal and market system.
On the other hand, the Japanese model focuses on reducing transaction costs
associated with business relations among companies and counts on the main
bank as a supervisor of management and as a supplier of loans.
An underdeveloped security market and a strong demand for the rapid economic
development created this bank-oriented mechanism in Japan. Thus,
it is necessary to examine characteristic problems to China in establishing
an appropriate corporate governance model for improving the SOEs' efficiency.
The characteristic problems
with China are extensive administrative interventions in the SOEs'
internal affairs, such as personnel appointment, wage setting, and investment
plans. Heting regards these excessive interventions by the
government as an inheritance of a centrally planned economy. According
to Heting, the SOEs were only one production unit in the planned
economy system in which production plans were assigned through administrative
instructions. Hence, enterprises under the centralized planning economic
system are subject to be a political entity rather than an economic one.
Heting claims that the SOEs' administrative nature which was nurtured
through the planned economy are difficult to be removed in
the short period of time. 24
Undelineated property rights
of the SOEs is another characteristic problem with China and one of the
most fundamental issues in the SOEs reform. Theoretically, it is Chinese
people that have property rights of the SOEs from the standpoint of public
ownership. Since it is impossible that Chinese people exercise their rights
in the SOEs' assets and monitor management in the SOEs in a real sense,
the SOE Property Regulations(1994) specifies that the State Council exercises
the property rights over the SOE assets on behalf of the Chinese people.
Furthermore, the Supervision Regulations (1994) stipulates that the
state assets are supervised centrally or at the local level under the administrative
guidance of the National Administrative Bureau for State-Owned Property(NABSOP). 25
Thus, the organization of the state assets management is a multithread
bureaucratic system.
Scholars maintain that the
unclear definition of the SOEs' property rights and the bureaucratic asset
management system put restrictions on the monitoring capability of the
state as a shareholder. The World Bank report argues that the state
plays a role of a supervisor of management and of a manager of the SOEs
simultaneously and that such overlapping of functions derives from the
fragmentation of property rights. 26
The question is, according to the report, "a lack of clarity as to
who really is in control of an SOEs' assets as an 'acting' owner on behalf
of the state." 27
Under the multilayered bureaucratic structure, it is difficult
for the state to convey its intentions to the level of each enterprise.
Ma points out that the undeliniated
property rights make the principal-agent problem more complicated in the
SOEs than in private companies of capitalist economy. According to
Ma, the principal-agent problem usually occurs only between the board of
directors and managers. In the case of the Chinese SOEs, the
principal-agent problem is observed not only between the board of
directors and the management but also the state(owners) and the board members(who
represent the state) . Ma claims that the existence of two
level of the principal-agent problem in the SOEs is because the board directors
representing state ownership are not owners of firm assets in a strict
sense. Due to the lack of consciousness of owners and of sufficient
incentives to monitor management, monitoring by the boards reduces effectiveness
of monitoring and accountability to owners, namely, the state.
28
In addition to the lack
of an inside monitoring structure, China does not have effective external
corporate control mechanisms as well. The importance of external
monitors is apparent from examples of a main bank in the Japanese
corporate governance model and of a functional security and merger market
in the Anglo-American model. 29
In the case of Japan, its insider dominant composition of the board of
directors seems to harm the capability of monitoring, however, the main
bank and other institutional shareholders complement the function of the
inside monitors by placing strong pressures on managers constantly.
Upon taking these characteristic
problems to the Chinese SOEs into account, I will consider what policy
options China can take to establish an effective corporate governance structure.
I will examine possible reform measures on internal organizations in the
SOEs and external control mechanisms separately.
Internal organizations
The intensive administrative
intervention in management and an unclear definition of property rights,
which are peculiar to China, cause confusion in roles and functions of
each entity in the SOEs and prevent effective monitoring. Iskander
and others suggest that depoliticization in the SOEs operations and
specification of property rights and of each entity's obligations
in corporate organizations are necessary to establish an effective corporate
governance structure. 30
According to them, depoliticization in the SOEs would be advanced by
nomination of non-governmental, commercial oriented representatives to
members of the board and top managers.
In order to solve the problem
of the confusion of roles and functions of each unit in corporate
organizations, the World Bank report asserts that it is crucial to
remove the role of a manager from the state and that the state should
concentrate on supervision. 31
As clear from the comparative study of the Anglo-American and Japanese
governance models, defining rights and obligations of each participant
in corporate governance are preconditions for effective monitoring.
At the same time, it is necessary to remove an unclear definition of the
SOEs' property rights, which is the cause of the confusion in monitoring
structures in the SOEs.
External conditions
The comparative study of
the corporate governance models suggest that not only the internal
but also the external corporate control system is necessary for organizing
an effective corporate governance structure. These external control
mechanisms include a competitive market and functional financial
institutions. In establishing the external control system, which system,
a security market based system or a banking based one, a country relies
on is an important question as examples of the Anglo-American and Japanese
models suggest. Of course it is possible that a country fosters
and utilizes both system simultaneously, and this actually is the
due course of economic development. However, it is worth examining
characteristics of exteral control systems in the Anglo-American and Japanese
models and preconditions for creation of a functional external corporate
control mechanism in China.
Scholars have discussed
which unit, a security market or financial institutions, China can
rely on as a source of finance and an external supervisor of enterprises.
Supporters of the security market oriented system maintain that direct
finance from the stock market is more profitable than to loan from unreformed
and inefficient banks. They also claim that the stock market becomes
an effective supervisor of enterprises since a stock price in the market
constantly puts pressure on enterprise managers. According to this view,
to create new institutions(the security market) is relatively easier than
to reform existing ones(banks). 32
Against the above view,
advocators of the introduction of the bank oriented system claim that banks
become more reliable monitors of management and suppliers of funds to the
SOEs than the security market at least in the period of development.
Although they acknowledge the importance of the security market as an external
monitor, they maintain that the security market cannot be an effective
external monitor of the SOEs in the near future since the security market
takes a long time to be well-developed and well-regulated. Qian argues
that the current Chinese security market is devoid of crucial elements
to make the security market functional, such as trained analysts, reliable
accounting data, regulations on trading, and unfluctuated price, because
it has not been long since the security market was introduced in China.
According to Qian, such underdeveloped security market is subject to be
a place of speculative trading and rent-seeking. For these reasons,
Qian asserts that banks are more appropriate as an external controller
of the SOEs' management and that, in this respect, China can learn from
the Japanese development experience, particularly the main bank system.
33
Xu and Wang, and Ma also
state that the Japanese main bank system deserve attention by discussing
the role of banks as shareholders. Xu and Wang assert that concentrated
ownership by institutional shareholders is more beneficial under weak law
regulation on protecting shareholders. Under such conditions, individual
shareholders are afraid of holding company shares for a long time and do
not seek for a long-term profit. 34
Ma states that large institutional shareholders are profitable in
that they have strong incentives to monitor management and can avoid a
free-rider problem that is caused by opportunistic behaviors of individual
investors.35
The last section in this
chapter has introduced some scholars' arguments that the Japanese
corporate governance model is more applicable than the Anglo-American model
to China, considering its current economic development condition, and the
Japanses corporate governance model was constructed for the rapid economic
growth. Concerning this point, Aoki states that the main bank system was
devised "under specific and unique historical and developmental conditions"and
that "the main bank system and its performance characteristic could hardly
be reproduced in different historical environments." 36
Although Japanese economy was underdeveloped right after World War II,
the difference between China and Japan is that the former never experienced
the modern market economy and financial system before the economic reform
while the latter did before the introduction of the main bank system.
Both the Anglo-American
and Japanese corporate governance models could provide beneficial instructions
with China on internal organizations and external monitoring systems. Still,
it is necessary for China to establish its own corporate governance structure,
taking its current economic condition, historical legacy, and economic
goals to achieve into consideration. In order to achieve this goal,
China are required to put much effort to create institutional frameworks,
such as the functional legal and financial system, for operating market
economy, while promoting the separation of administration and commercial
activities and the specification of theroles and functions of each entity
in the SOEs. China can create its own corporate governance
model only when effective internal governance organizations and external
monitoring mechanisms are established.
Conclusion
This paper has examined
corporate governance in the SOEs, hypothesizing that one of the causes
of the SOEs' inefficiency derives from the lack of an effective corporate
governance structure. Establishing a functional corporate governance
structure is a universal task for owners of modern corporations in which
ownership and management are separated. In order to know how other countries
organize effective corporate governance structures, I studied the two major
corporate governance models: the Anglo-American and the Japanese models.
This study showed that each corporate governance model was constructed
according to the given economic conditions, historical backgrounds, and
economic purposes, and that there is no single best corporate governance
model that functions effectively in every condition. Therefore, it is appropriate
for China to create its own corporate governance model, examining its own
economic environment, historical background, and the direction of the reform.
In order to create an effective corporate governance structure, it
is necessary for China to solve the problems that are peculiar to her,
which are administrative interventions in the SOEs management, the
confusion of rights and obligations of each participant in corporate governance,
and the lack of the institutional framework to support functions of corporate
governance. Among a number of problems China has to deal with to
organize a corporate governance structure, creating the institutional frameworks,
such as the functional legal and financial system, for operating market
economy and separating administration and commercial activities in operations
of the SOEs are primary tasks. Solving these problems lead to establishment
of functional internal organizations and external monitoring mechanisms,
which are indispensable to achieve effective corporate governance.
ENDNOTES
1 Cui points out that there are two versions of ownership focused discussion. One is "popular version" that public ownership is by definition unclear, since merely private ownership is clear in its individualized ownership nature. The other is "sophisticated version" that the ownership problem lies in the lack of the state's capacity to manage state assets and to assign proper managers rather than in unclear definition. The position of this paper is close that of the latter. Zhiyuan Cui, Whither China? The discourse and practice of property rights reform in China, manuscript, pp. 6-8. Back to the text
2 Lin, Justin Y., Cai, Fang, and Li, Zhou, "Creating an Environment for Fair Competition is the Core of Enterprise Reform, " In The Reformability of China's Sate Sector, 1997. Back to the text
3 Ma, Jun, Shareholding Experiment, Modern Enterprises System, and State-Owned Enterprise Reform, manuscript. Back to the text
4 Iskander, Magdi, "Improving State-Owned Enterprise Performance: Recent International Experience," In Policy Options for Reform of Chinese State-Owned Enterprises, Broadman, Harry, ed., 1996. Back to the text
5 Ibid., p.19. Back to the text
6 Ibid., p.20. Back to the text
7Heting, Jin, On Corporatization of Enterprises and
Corporate Governance, In Policy Options for Reform of Chinese
State-Owned Enterprises, p.109. Back to the text
8 Muir, Russel and Saba, Joseph P., Improving State
Enterprise Performance: The Role of Internal and External Incentives,
World Bank Technical Paper Number 306, 1995, p. 3. Back
to the text
9 A supervisory board is variation in a corporate governance
structure and found in German corporations. It has the same
functions as the board of directors in American and British companies.
In China, according to "The Corporate Law of China," a role of a supervisory
board is to supervise the activities of the board of directors and managers.
Heting, p.110. Back to the text
10 The World Bank, Chinas Management of Enterprise Assets: The State as Shareholder, 1997. p.4. Back to the text
11 Ma, p.13. Back to the text
12 Heting, p,112. Back to the text
13 Ma, p.15. Back to the text
14 Study of Xu and Wang shows that individual shareholders hold average 0.3% of the seats in the boards and 0.5% in the supervisory committee, while the state shareholders have average 50% of the seats in the former and 41% in the latter. Xu, Xiaonian and Wang, Yan, Ownership Structure, Corporate Governance, and Corporate Performance: The Case of Chinese Stock Companies, The World Bank, Economic Development Institute, Office of the Director, 1997. Back to the text
15 This section refers to Appendix B. pp.61-74 in Muir and Saba. Back to the text
16 Aoki, Masahiko and Patrick, Hugh, eds., The Japanese Main Bank System: Its Relevance for Developing and Transforming Economies, 1994, p.15. Back to the text
17 In case performance of the company is not improved by these measures, the main banks could resort to liquidating the company. Ibid., p. 88. Back to the text
18 The cross-shareholding among Japanese companies is based on so called keiretsu system. Keiretsu refers to business groups that are organized around a main bank, trading company, and large industrial manufacturer. The company groups have a strong business relationships within a group. Back to the text
19 Xu and Wang, p.42. Back to the text
20 The Glass-Steagal Act of 1933 prohibits banks from holding stock in other companies through affiliations with investment banks. The Bank Holding Company Act of 1956 prohibits banks from holding stocks over 5 percent of the voting stock in any non financial companies or from otherwise controlling an industrial company. The British banks are required to obtain approval from the Bank of England when they hold over ten percent of share in a company. Xu and Wang, p.45., Kester, W Carl., American and Japanese Corporate Governance: Convergence to Best Practice?, In National Diversity and Global Capitalism, Berger, Suzan and Dore, Ronald, eds., Cornell University Press., 1996. p.130. Back to the text
21 Xu and Wang, p.42. Back to the text
22 The Japanese companies were prohibited the issuance of bond until the mid-1970s. Patrick, Hugh, "The relevance of Japanese finance, " In The Japanese Main Bank System, Aoki and Patrick eds., 1994. pp. 354-355. Back to the text
23 Kester, pp. 118-123. Back to the text
24 Heting, p.112. Back to the text
25 The World Bank, Chinas Management of Enterprise Assets: The State as Shareholder, 1997, pp.20-23. Back to the text
26 Ibid., pp. 24-25. Back to the text
27 Ibid., p.25. Back to the text
28 Ma, Shareholding Experiment, Modern Enterprise System, and State-Owned Enterprise Reform, http://members.aol.com/junmanew/cover-htm, 1998. Back to the text
29 Heting, p.114. Back to the text
30 Iskander, pp. 48-49. Muir and Saba, pp. 35-38, Heting, pp. 114-116. Back to the text
31 The World Bank, pp. 24-26. Back to the text
32 Qian, Yingyi, Financial System Reform in China: Lessons from Japans Main Bank System, In Aoki, Masahiko and Patrick, Hugh, eds., The Japanese Main Bank System, pp. 573-574. Back to the text
33 Ibid., p.574. Back to the text
34 Xu and Wang, p. 45. Back to the text
35 Ma, 1998a Back to the text
36 Aoki, Monitoring Characteristics of the Main Bank System: An Analytical and Developmental View, In The Japanese Main Bank System, p.110. Back to the text
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