Fixation on Party Control Is Undermining Corporate Governance Reforms

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A new study from the Paulson Institute points out that Beijing’s efforts to expand the control of the Chinese Communist Party over state-owned enterprises is likely to have a regressive impact upon corporate governance reforms.

Beijing is forging ahead with its current round of state-owned enterprise reforms, which seek to introduce mixed ownership systems to large-scale government concerns, improving efficiency via the participation of private equity.

A total of 19 SOE’s participated in the first two rounds of reforms, including China Unicom and Eastern Airlines Logistics, with another 31 local SOE’s slated to take part in the third round, which will cover five sectors including real estate, construction, building materials, telecommunications and mining.

A new study from the Paulson Institute notes that changes to corporate governance are the very cornerstone of the SOE reform agenda, which in turn directly relates to Beijing’s current drive to implement mixed ownership reforms.

According to the study by Houze Song entitled “State-owned Enterprise Reforms: Untangling ownership, control and corporate governance,” the lack of external supervision of management has been one of the chief problems besetting Chinese SOE’s since the founding of the PRC.

“The lack of external scrutiny over top executives has led to problems ranging from imprudent decisions that are not actually in the interest of the SOE’s to management’s corrupt behaviours such as stripping state assets for personal gain,” writes Song.

“Therefore progress in these two areas – corporate governance and mixed ownership – is a key measure of whether and how much China is actually reforming its SOE’s.”

Song points out that the two are inextricably related, given that strong corporate governance is needed to secure the success of mixed ownership reform by giving protection to private investors and shoring up their confidence.

This is especially the case given that the current round of mixed-ownership reforms are unlikely to confer private investors with control of the SOE’s in which they invest, given the immense size of the sector and Beijing’s desire to retain control of the economy.

Song remains deeply pessimistic about the prospects for corporate governance reform in China, however, given Beijing’s ongoing efforts to increase the clout of party organisations within SOE’s.

According to Song these efforts to expand the influence of internal party organisations within companies are a retrograde move which run directly contrary to the broader reform goal of improving their economic performance.

“Strengthening CCP control over SOE’s is an agenda that has preoccupied Chinese policymakers for at least the past five years,” Song writes.

“It is an initiative that will, in practical terms, reverse the longstanding approach of transforming SOE’s into more commercially oriented operations…consolidating CCP control over SOE’s will actually make reforms much more difficult to implement.”

Song points out that structure of SOE’s differs most markedly from that of orthodox corporations in that they simultaneously possess both a board and a Party committee – a feature which greatly complicates the exercise of power within these organisations, and poses a major challenge to corporate governance reform.

Reforms efforts this year have involved some experimentation with the delegation of more authority to SOE boards, with trials for their participation in the evaluation of management and the setting of executive compensation levels at under 10 central SOE’s or their subsidiaries.

Beijing had also mandated that all central SOE’s and their subsidiaries “corporatize” via the creation of a board by 2020 – a form of restructuring which two-thirds of central SOE’s have not yet undergone.

Song claims that these token efforts to increase the role and influence of boards will likely be derailed by Beijing’s preoccupation with retaining control over SOE’s, as embodied by a CCP Central Committee document dating from 2010 called the “Three Significants and One Large,” which requires that all major decisions involve the Party committee, the board and management.

This policy grants broader discretion to the Party committee over a greater range of business activities, with the potential to make them the highest executive authority within  SOE’s to the detriment of the corporate board.

“Decision-makers now favour putting the Party committee atop the board as the ultimate authority in an SOE,” Song writes.

“If this effort is fully implemented and enforced, then more independent boards will never really become a reality of China’s corporate landscape.”

The greatest flaw of this policy is that is severely undermines corporate governance, given that SOE senior executives are invariably Party committee members themselves.

“Empowering the Party committee in corporate affairs is tantamount to empowering SOE senior executives themselves, which will reduce independent supervision of SOE management and further stymie the effort to improve corporate governance

“Over the long term, this will likely hinder the long-standing effort to turn SOE’s into more commercial enterprises.”

 

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