Corporate Governance in China: Current Developments Dr. Chen Xiao Hong Director of ERI / DRC: Director of ERI / DRC: OECD OECD Policy Dialogue on Corporate Governance in China Beijing May 2005

2 国务院发展研究中心企业研究所 Table of Contents Corporate governance: Meaning and significance I. Corporate governance: Meaning and significance Implication and content of the structure of corporate governance 1.1 Implication and content of the structure of corporate governance Why attention is paid to corporate governance globally 1.2 Why attention is paid to corporate governance globally Why attention is paid to corporate governance by China’s SOEs 1.3 Why attention is paid to corporate governance by China’s SOEs Question one for the governance of SOCs: Corporate legal form and legal relationship II. Question one for the governance of SOCs: Corporate legal form and legal relationship Question two for the governance of SOCs: The issue of system structure III. Question two for the governance of SOCs: The issue of system structure Question three for the governance of SOCs: The issue of administrative system for SOA IV. Question three for the governance of SOCs: The issue of administrative system for SOA V. Revision of China’s Company Law V. Revision of China’s Company Law

3 国务院发展研究中心企业研究所 I Corporate governance: Meaning and significance for SOEs 1.1 Implication and content of the structure of corporate governance 1. Implication: System arrangement for the relationship between stakeholders to the company and corporate framework; System arrangement for the relationship between stakeholders to the company and corporate framework; Comprehensive arrangement of relevant concept system, commercial rules and laws; Comprehensive arrangement of relevant concept system, commercial rules and laws; “Separating the operation from the ownership” in large companies makes the system of governance structure the core and the fundamental system in corporate governance “Separating the operation from the ownership” in large companies makes the system of governance structure the core and the fundamental system in corporate governance 2. Content of the system of corporate governance: System arrangement for stakeholders; System arrangement for stakeholders; Arrangement of decision-making (including supervisory) authority and corresponding rules; Arrangement of decision-making (including supervisory) authority and corresponding rules; Encouragement system for the operator and the manager. Encouragement system for the operator and the manager.

4 国务院发展研究中心企业研究所 1.2 Why attention is paid to corporate governance globally Historically, attention is paid to corporate governance by the theoretical and the industrial circles and since the 1980s attention has been paid to it once again: Many problems occurred to companies in countries such as USA, UK and Japan etc. in the 1980s; Organizational investors with enhanced power kicked off the campaign for sophistication of corporate governance; SOEs were reformed and listed during 1980~1990s and the capital market was expanded; Economic development is globalized and countries in the world compete for foreign investment; Technological revolution and innovations in financial instruments make investment in huge amount earlier, but raising higher requirement for corporate governance; A range of research accomplishments such as Campbell Report etc. were turned out.

5 国务院发展研究中心企业研究所 1.3 Why attention is increasingly paid to corporate governance in China 1. SOEs are critical to national economy The main body for the majority of service industries and the key sector for industry (covering a heavy proportion in basic industries) A key source for employment in cities and towns The main source of financial revenues The proportion of SOEs in industrial sector (in 2003, %) Amt. of enterprise Net assets IncomeProfitTaxEmployment

6 国务院发展研究中心企业研究所 1.3 Why attention is increasingly paid to corporate governance in China 2. Required by practice and policies ● Unsophisticated governance of SOEs and PLCs is a critical factor affecting the effective operation of China ’ s companies and the healthy development of large companies with competitiveness and capital market. ● It was set down in the document of CPC Central Committee ’ s Determination on Some Critical Issues Concerning the Reform and Development of SOEs from the Fourth Plenary Session of the 15th Central Committee of CPC that, normative reform of large- and medium-sized SOEs to adopt corporate system shall be performed. Corporate system is an effective organizational form of modern enterprise system and the structure of corporate governance by legal person is the core of corporate system. ● Company Law and Securities Law etc. are gradually perfected. ● The system of independent director and improving actions such as encouragement with stock options etc. are being implemented in China.

7 国务院发展研究中心企业研究所 Table of Contents II. Question one for the governance of SOCs: Legal form and legal relationship 2.1 Basic forms of and questions for SOEs 2.2 Design of SASAC and issues to be researched III.Question two for the governance of SOCs: The issue of system structure IV. Question three for the governance of SOCs: The issue of administrative system for SOA V.Revision of China’s Company Law I.Corporate governance: Meaning and significance to SOEs

8 国务院发展研究中心企业研究所 2.1 Legal forms of SOCs and problems 1.There are 4 legal forms Enterprises registered according to the Enterprise Law; Enterprises registered according to the Enterprise Law; Solely state-owned companies; Solely state-owned companies; Diversified companies; Diversified companies; State holding (including relatively holding) PLCs State holding (including relatively holding) PLCs

9 国务院发展研究中心企业研究所 2.1 Legal forms of SOCs and problems 2. Problems of significance: There is no BOD for enterprises registered per the Enterprise Law: --or the general manager assumes duties of BOD, and the company may go out of control, --or state-owned assets authority assumes duties of BOD, and over intervention is likely. There is BOD for SOCs registered per the Company Law: --all directors are insiders, --problems of unclear rights and obligations, insufficient supervision and insufficient authorization for state-owned assets authority coexist.

10 国务院发展研究中心企业研究所 2.1 Legal forms of SOCs and problems 2. Problems of significance: There is BOD for state holding companies with diversified shares: --overcontrol of company by dominant shareholders --improvement of governance is needed, but the system is unsound There is BOD for state holding listed companies: --violation of public shareholders’ benefits exists --how to reasonably regulate “dominant shareholder”?

11 国务院发展研究中心企业研究所 2.2 Two special legal issues for companies 1. Unsound legal system for special companies The monopoly of for-profit and not for-profit and the sector of commonweal enterprises The monopoly of for-profit and not for-profit and the sector of commonweal enterprises National defense enterprises etc National defense enterprises etc No Special Company Law, and the relationship between Company Law and industrial laws is not well dealt with No Special Company Law, and the relationship between Company Law and industrial laws is not well dealt with

12 国务院发展研究中心企业研究所 2.2 Two special legal issues for companies 2. Project companies to which attention shall be paid ● Companies engaged in the sector of infrastructure ● Companies engaged in public services such as water supply and environmental protection etc. (a new question after the diversification of stock right) ● The relationship with the creditor, “excessive loan” and the bank related issues ● The relationship with policies is unclear, unjustified regulation and overregulation coexist

13 国务院发展研究中心企业研究所 2.3 Problem-solving ideas and approaches ● In most cases, SOEs registered per the Enterprise Law shall be transformed into companies registered per Company Law; ● Sophisticated BOD shall be established in SOCs; ● Revising Company Law to sophisticate corporate governance; ● Sophisticating Securities Law to strengthen the reasonable supervision of company controller; ● Special company law shall be researched, or improving the relationship between the governance of special companies and the administration of public policies by legal means such as company charter etc.; ● Improving the administration of project companies by PFI and intensified competition etc.

14 国务院发展研究中心企业研究所 Table of Contents II.Question one for the governance of SOCs: Legal form and legal relationship III. Question two for the governance of SOCs: The issue of system structure 3.1 Sophisticating internal governance system 3.2 Solving the long existed issue of structure IV.Question three for the governance of SOCs: The issue of administrative system for SOA V.Revision of China’s Company Law I.Corporate governance: Meaning and significance to SOEs

15 国务院发展研究中心企业研究所 3.1 Sophisticating internal governance system 1. Sophisticated duties under the basis framework: Clarifying duties of various organs Clarifying duties of various organs Shareholders/shareholder meeting Shareholders/shareholder meeting Directors/BOD/committees Directors/BOD/committees CEO CEO Internal monitoring system Internal monitoring system Clarifying duties of various organs Clarifying duties of various organs

16 国务院发展研究中心企业研究所 3.1 Sophisticating internal governance system 2. Sophisticated system: Organizational structure and composition Organizational structure and composition Operation of BOD and outcome Operation of BOD and outcome Strategy and monitoring Strategy and monitoring Human resources Human resources Internal control and risk control Internal control and risk control Information disclosure and transparency Information disclosure and transparency Company obligations Company obligations

17 国务院发展研究中心企业研究所 3.1 Sophisticating internal governance system 3. The relationship between the governance of parent company and that of subsidiaries Special attention shall be paid to this issue Special attention shall be paid to this issue Out of control and manipulation shall be avoided Out of control and manipulation shall be avoided

18 国务院发展研究中心企业研究所 3.1 Sophisticating internal governance system 4. Two problems of significance Unclear organizational duties (between state-owned assets authority and companies, and between BOD and the management) Unclear organizational duties (between state-owned assets authority and companies, and between BOD and the management) Coverage system of the governance is incomplete Coverage system of the governance is incomplete Governance and management are blurred in terms of system, unfavorable for an effective management by the manager Governance and management are blurred in terms of system, unfavorable for an effective management by the manager 5. Problem-solving ideas and approaches Building the concept of governance Building the concept of governance Establishing sophisticated governance system Establishing sophisticated governance system

19 国务院发展研究中心企业研究所 1. The long existed issue of structure is a critical reason for unsmooth relationship in governance of SOEs Solely state- owned co. Inferior assets PLC 2. Problem-solving approaches The state assumes responsibilities Separating the inheriting companies from the listed companies Establishing trust companies (by experience from Japan) Inheriting Co. 3.2 Solving the long existed issue of structure

20 国务院发展研究中心企业研究所 Table of Contents II. Question one for the governance of SOCs: Legal form and legal relationship III. Question two for the governance of SOCs: The issue of system structure IV. Question three for the governance of SOCs: The issue of administrative system for SOA 4.1 Features of the existing SOA system 4.2 Understanding and suggestions V. Revision of China ’ s Company Law I. Corporate governance: Meaning and significance to SOEs

21 国务院发展研究中心企业研究所 4.1 Features of the existing SOA system The basic framework of existing system for SOA administration was formed in 2003: Fulfillment of financers’ duties in levels is clarified Fulfillment of financers’ duties in levels is clarified Ownership functions are unified Ownership functions are unified Main efforts are given to the promotion of system construction, “personnel” and assessment Main efforts are given to the promotion of system construction, “personnel” and assessment

22 国务院发展研究中心企业研究所 4.2 Understanding and suggestions 1. Understanding and evaluation Basic directions for SASAC: Basic directions for SASAC: Clarifying shareholder’s duties and orientation Clarifying shareholder’s duties and orientation Strengthening the construction of governance system Strengthening the construction of governance system Some actions are transitional: “first tightened and then released” Some actions are transitional: “first tightened and then released” 2. Some suggestions Strengthening governance construction Strengthening governance construction Transparent rules and open information Transparent rules and open information Independent evaluation by a third party Independent evaluation by a third party Clarified responsibilities and more sufficient authorization Clarified responsibilities and more sufficient authorization

23 国务院发展研究中心企业研究所 Table of Contents II.Question one for the governance of SOCs: Legal form and legal relationship III.Question two for the governance of SOCs: The issue of system structure IV.Question three for the governance of SOCs: The issue of administrative system for SOA V.Revision of China’s Company Law 5.1 Basic facts about Company Law 5.2 Revision of Company Law: favorable for governance reform and self-administration I.Corporate governance: Meaning and significance to SOEs

24 国务院发展研究中心企业研究所 5.1 Basic facts about Company Law Company Law is a basic law critical to corporate governance in China Going effective in 1994 Going effective in 1994 Two revisions in 1999 Two revisions in 1999 Significant revision by National Congress in 2004 Significant revision by National Congress in 2004

25 国务院发展研究中心企业研究所 5.2 Revision of Company Law will help improve corporate governance Strengthening corporate self-administration, for instance --establishment and investment etc., reducing compulsory stipulations --self-formulated rules such as company charter etc. play more important roles Improving corporate governance, for instance --clarified director’s responsibilities --responsibilities of the dominant shareholder --intensified supervision Strengthening the protection of shareholder’s benefits

26 国务院发展研究中心企业研究所 Thank You!