Tag Archives: corporate governance

How Private Chinese Companies Can Signal Party Fealty

CHINA HAS A unique model of corporate governance. It is one in which the ruling party has formal standing not only in state-owned enterprises (SOEs), as is to be expected, but also in privately owned companies.

Formalising and strengthening that standing has been an official policy since 2015. Research by Lauren Yu-Hsin Lin and Curtis Milhaupt from the law schools of the City University of Hong Kong and Stanford University, respectively, that recently crossed this Bystander’s desk shows that the policy has been less rigorously adopted by SOEs than might have been expected.

However, the authors also find that one in 16 stock-market-listed private companies had also taken it up, mainly, they conclude, as a way of signalling their fealty as compliance is not mandatory in the private sector. 

The research covers the period from 2015, when the party-building policy was launched, to 2018. It does not cover the ‘rectification’ campaign against privately owned technology companies to ensure their alignment with national goals, which will likely have spurred more compliance with the policy.

Among SOEs, adoption ranged from token changes to substantive accession of corporate control to the Party, for example, by combining the roles of company chairman and secretary general of the Party unit within the company, with the appointment being made jointly by the Party and the company.

The more politically connected an SOE is, the more compliant with party-building it tends to be. The authors identify a similar effect among private companies, with adoptions of the policy most prevalent among firms with politically-connected directors or chief executive officers.

The study covers all 3,446 A-share listed nonfinancial Chinese companies, which were grouped into three categories:

  • those with more symbolic provisions, such as simply referencing the Party constitution in the firm’s corporate charter; 
  • provisions that allow the Party to appoint, manage or supervise corporate personnel; and 
  • provisions concerning the party’s decision-making powers within the firms.

Nine out of ten private companies that voluntarily amended their charters only adopted symbolic or less material provisions. This implies a broad reluctance to allow party intervention in day-to-day corporate management.

Even among those that did accede in allowing more Party intervention, there was a notably low adoption rate for provisions such as management’s prior consultation with the party committee, the dual appointment of the chairman as also the party secretary, and the appointment of a full-time deputy party secretary.

As with SOEs, these three provisions proved to be the least popular among private companies, the researchers suggest, because they allow the Party to monitor and intervene in daily management. 

That, in turn, suggests that the party’s demand for political conformity on the part of the business sector is constrained not only by agency problems but also by market discipline and corporate law to a greater extent than is commonly assumed. 

Nonetheless, as the authors observe, all Chinese firms, regardless of state or private ownership, must remain in the Party’s good graces to grow and prosper. 

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Carmakers Get A Taste Of China’s Changing Business Climate

Another foreign industry pining its hopes of future growth on the Chinese market has fallen under the beady eye of the National Development and Reform Commission (NDRC), the country’s top economic planner. This Bystander reads reports that the NDRC has put the China Automobile Dealers Association (CADA) to work researching the price of foreign cars sold in China, both those imported and those locally produced. This is not attention carmakers will relish.

The nominal issue at hand is whether foreign carmakers are setting a minimum retail price for their vehicles, which could break the 2008 anti-monopoly law. Last month, state media accused foreign luxury carmaker carmakers of reaping what they said were exorbitant profits in China and should face an antitrust investigation. It now seems that they knew of what they wrote.

The NDRC has already been successful in getting foreign milk-powder producers to pay fines and lower their prices. It recently fined five of them, including Mead Johnson Nutrition, Danone and Fonterra, and one local firm a total of $110 million for anti-competitive behaviour in effectively setting prices for retailers. Earlier this week, five Shanghai-based jewelry firms were fined $1.7 million for price fixing. Foreign drug makers are also feeling the pressure for making payments to doctors to use their drugs. Some three score of foreign and local pharma firms are under investigation for possible price manipulation.

That a mix of foreign and local companies are being punished is significant, even if foreign firms are bearing the brunt. Authorities have never been above targeting foreign companies for an abuse when they want to send a message to local firms that it is equally unacceptable from them. Tackling corruption within the Party and the government has become a core policy for the new leadership, but it also needs to break a similar culture in business that companies, if sufficiently well connected, can be above the law, too.

If China is to have the better corporate governance that it will need as it develops and rebalances its economy, the grey areas in which many firms now operate will shrink. Carmakers are only the latest to be given an indication of that.

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The Persistence Of Party Power Over China’s Private Enterprises

Xinhua has lifted the skirts of the Party’s influence over private enterprises. Some 3.8 million grassroots Party organizations, which will include those in private enterprises, but also everything from private schools to non-governmental organizations, now exist, up from 2.1 million in 1978, it says. The exact number of Party cells in companies is difficult to determine, though we have seen statistics that said there were Party organizations in 250,000 companies (including foreign owned companies such as Wal-Mart) with 3 million members at the end of 2006, plus 800,000 self-employed Party members. The numbers have surely risen since, as overall Party membership has risen from 70 million to 80 million, with 23% of the total, or some 18 million people now, managerial level staff in public and private enterprises. The implication of the Xinhua piece is that the Party’s goal is to have a presence in every private enterprise with at least 80 employees.

The Party has never made any secret of its belief that it provides the political guidance for the whole economy. In a country where the Party mimics the organs of government and state and once controlled all businesses of any size, to do the same for the private-sector economy should come as no surprise. Free-market capitalism has no meaning in China, if by free is meant free from the Party’s leading role.

Yet beyond the statistical titillation of the apparent success of a policy to  grow formal representation in private enterprises that was kick started in 2002 lies the questions of whether this provides an explanation of how private companies’ business goals are kept aligned with Party policy and how it changes the structure of the country’s elites. Have the old elites secured control of the new economy: or is their power only temporarily persisting in it, to wane as market institutions eclipse the administrative power of the cadres; or are the old elites just being replaced those made newly wealthy by business?

We suspect the answer lies along the lines of the second option and that temporarily is being strung out over decades by the adeptness of local Party committees in keeping their fingers in the decision-making pie of private enterprises thanks to a institutional environment that is already based on formal and informal personal connections. For companies, sponsoring a Party cell, is as much about winning a “red hat” as it is about making a “black hat” available for local officials whose careers have been judged by their success in achieving local economic development. A vested interest shared limits the resistance to reform. Political capital is still as important as financial capital to an enterprise in China. Close ties between a company and local officials make access to scarce resources such as capital easier for a company via the Party’s network of connections, and minimizes the risk of the thing any business most dislikes, uncertainty, particularly policy uncertainty.

It is anyway a delicate line to walk for a Party whose commitment to national economic growth is taken as a basis of its political legitimacy to rule. The growing liberalization, internationalization and industrialization of the economy demands to an increasing degree professional managerial expertise in enterprises. Cadre core skills such as price controls, plan fulfillment and quota setting are not the functional expertise required of a manager in a modern company.

State-owned companies, by definition, already have a high degree of political involvement, including those with publicly-listed subsidiaries, which may prompt some interesting corporate governance and disclose-to-shareholder questions. Perhaps such companies should have to list in the their annual reports their top-ranking Party members as they are required to list their directors and top earners?

What strikes this Bystander is how the liberalization of China’s economy has been accompanied by a relatively stable power structure and the survival of the political elite, which has also acquired an extensive stake in the economy. Unlike in Russia, part, not full privatization of state-owned enterprises, particularly in the pillar industries, has been an important to prevent the creation of large areas of privately owned property in the economy beyond officialdom’s sway.  The Party has, so far at least, found a way of absorbing the rise of private power that which elsewhere in industrializing economies has led to the rise of new centers of political power. Indeed for central government, the bigger challenge is the power of semi-independent local party bosses on whom have to be imposed periodic crackdowns from the center in the form of anti-corruption campaigns.


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Would You Catch Corrupt Practices In Your Firm?

We suspect that IBM’s $10 million settlement with the U.S. securities regulator over accusations that it gave cash and gifts to Chinese and South Korean government officials in violation of the U.S. Foreign Corrupt Practices Act represents business as usual more than the rare bad apple. For the several years that what the U.S. Securities and Exchange Commission called IBM’s “conduits for bribes” continued, the company had anti-bribery policies in place, yet failed to detect the alleged transgressions. The question for Western multinationals operating in China to ask themselves now is whether they would have done better.

IBM neither admits nor denies wrongdoing, as is the practice in such cases. In its complaint filing the SEC, which handles Foreign Corrupt Practices Act cases; the U.S. Department of Justice would only be involved in a criminal case, said:

From at least 2004 to early 2009, employees of IBM (China) Investment Company Limited and IBM Global Services (China) Co., Ltd. (collectively, “IBM-China”), both wholly-owned IBM subsidiaries, engaged in a widespread practice of providing overseas trips, entertainment, and improper gifts to Chinese government officials. The misconduct in China involved several key IBM-Chipa employees and more than 100 IBM China employees overall.

The SEC accused IBM employees of creating slush funds that were used to pay for overseas excursions by Chinese government officials masquerading as offsite training courses. IBM employees are also alleged to have given gifts, such as cameras and laptops to the officials.  This how the SEC said it all worked:

As part of its business, IBM-China entered into contractual agreements with its government-owned or controlled customers in China for hardware, software, and other services. These contracts contained provisions requiring IBM-China to provide training to the employees of these customers given the high-tech nature of IBM’s products and services. In some cases, IBM held this training offsite and required the customers to travel. In advance of any training trips, IBM-China employees were required to submit a Delegation Trip Request (“DTR”) detailing the business purpose of the trip, all planned sightseeing or entertainment activities, and anticipated expenses. The DTRs required approval by IBM-China managers. IBM-China’s policies required customers to pay for side-trips and stopovers unrelated to the training.

Between 2004 and 2009, IBM’s internal controls failed to detect at least 114 instances in which (1) IBM-China employees and its local travel agency worked together to create fake invoices to match approved DTRs; (2) trips were not connected to any DTRs; (3) trips involved unapproved sightseeing itineraries for Chinese government employees; (4) trips had little or no business content; (5) trips involved one or more deviations from the approved DTR; amI (6) trips where per diem payments and gifts were provided to Chinese government officials. Moreover, IBM-China personnel also used its official travel agency in China to funnel money that was approved for legitimate business trips to fund unapproved trips. IBM-China personnel utilized the company’s procurement process to designate its preferred travel agents as “authorized training providers.” IBM-China personnel then submitted fraudulent purchase requests for “training services” from these “authorized training providers” and caused IBM- China to pay these vendors. The money paid to these vendors was used to pay for unapproved trips by Chinese government employees.

The takeaway for multinationals doing business in China is that 114 instances over at least five years slipped through IBM’s internal policies and controls designed to prevent or detect such violations of the U.S.’s Foreign Corrupt Practices Act. Remember, it is not just the bribes that the act goes after, it is also the accounting tricks that companies employ to cover them up. For whatever reason, in this case those controls proved deficient in preventing employees of IBM’s subsidiaries and, in the South Korean case, joint ventures from using local business partners and travel agencies as “conduits for bribes or other improper payments to government officials over long periods of time.” Are you confident yours would?

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