Corporate governance in China

By Priya Chetty on January 9, 2012

In recent years, corporate governance has been receiving a lot of attention in China. The reason for this attentionis the debate if China can develop an effective corporate governance system to improve its companies’ performance and protect the minority shareholders. The Chinese stock market was created in the late 1990s. It has grown to become the eighthlargest in the world in less than 15 years. Based on the statistics from the China Securities Regulatory Commission (CSRC), there are about 70 million investor accounts opened across the country. Approximately 200-300 million Chinese people, directly or indirectly, invest in the stock market and are affected by it.

Questions on how to maintain the investors’ enthusiasm regarding the stock market and strengthen their confidence in the market has always remained a heated point of discussion in the public policy arena. It is even more relevant and urgent now that a series of recent corporate scandals have damaged the investors’ confidence.

Corporate governance reforms gained prominence only in the past three years even though China’s transition from a state-planned into a market-oriented economy started almost two decades ago. In 2001, a local business publication, “Caijing Magazine,” exposed the YingGuangXia Chinese Renminbi (RMB) which was a 745 million fraud, the biggest economic scandal in the history of mainland China. This revelation drew the attention of regulators and public investors to the importance of corporate governance and exposed the weakness of the country’s legal, regulatory, and accounting systems. Corporate governance has since then been given top most priority. This topic has been mentioned often in all of the recent keynote speeches by China’s premier, the chairman of the Central Bank, the chairman of the China Securities Regulatory Commission (CSRC), and numerous other government officials and scholars.

Within a mere two years, China has made great strides on the corporate governance front. The consent to improve corporate governance is the top most priority among all sectors, including government bodies, regulators, intermediaries, corporations, and investors. Legislators, regulators, and professional institutions have since issued a number of laws, rules, regulations, and standards with the intention of laying a strong foundation for good corporate governance. However, change may not happen overnight because the separation of ownership and management of a company is still a very new concept in China.

The progress of the corporate governance reform depends on the efforts at the individual company level to close the gap with global best practices and the ongoing country-level initiatives that have a hand in shaping China’s corporate governance infrastructure. Individual companies, through their own efforts, can achieve top-notch corporate governance independent of the local market’s governance infrastructure. External environment factors however play a huge role in raising the country’s standards by incentivizing or consenting to sound governance practices. The four major areas that comprise corporate governance infrastructure are market infrastructure, legal environment, regulatory environment, and informational infrastructure.

The government’s role in corporate ownership is in a state of transition as the Chinese market continues the transformation from a planned economy to a market economy. Due to the current trends dealing with the privatization of state-owned enterprises (SOEs), the separation of regulatory and management roles and the development of domestic capital markets, the government must suitably manage and reunite its concurrent and at times conflicting roles as majority shareholder, business manager, industry regulator, and supreme ruler. Although the ongoing market reforms should lead toward gradual improvements in the external market environment, which will have an impact on company, level corporate governance, several key characteristics highlight some fundamental weaknesses of China’s corporate governance infrastructure. Mainly, the persistent concentration of government ownership and influence in privatized SOEs, complex and opaque corporate ownership structures, enforcement of shareholder rights, financial accounting transparency and disclosure, board of director independence and effectiveness, and the lack of shareholder activism are all matters that should be taken into account in order to achieve consequential advances in corporate governance. Primarily these challenges signify the rapid but uneven development of the domestic capital markets. Retail investors, as a group, have not demonstrated a strong interest in corporate governance matters. Eventually, however, the Qualified Foreign Institutional Investor scheme will lead to more market-driven improvements in corporate governance.

Even though there have been a few positive developments on the legal and regulatory fronts that have led to some top-notch corporate governance codes, guidelines, and listing requirements, effective implementation and enforcement of these principles may prove to be elusive for many years. China’s legal and regulatory environment has moved forward in order to keep up with the country’s rapid economic growth and evolution to a market economy with the implementation of new laws and regulations and the establishment of new regulatory bodies. Yet, such progress has been partially damaged by some inconsistencies and redundancies around these new rules and institutions, partly as a result of different government and market sector groups that wish to bring about reform without full coordination and common oversight. Rules and regulations safeguarding governance of the financial and capital markets are ingrained in the PRC Company Law, Securities Law, and the Code of Corporate Governance.  It is necessary that Companies traded on public exchanges adapt a two-tiered board system. There are no clear necessities regarding the responsibility and accountability of the board members. In practice, truly independent and effective board failed to notice that executive appointments and compensation cannot be simultaneously legislated and implemented. Selective enforcement is still commonly sighted.