Wu Jinglian State Council Development Research Centre China Europe International Business School 26 February 2004 The Role of Special Board Committees —— China’s Experience

2 The establishment of special committees made up of independent directors has an important role to play in improving the quality of the board’s work. In recent years, China has implemented a series of reforms to enhance the work of these committees and has achieved clear successes. There are also still many issues that have yet to be fully resolved.

3 1.1 The function of corporate governance Corporate governance consists of an entire system of constraints, incentives and balances the objective of which is to maximize company values. It is used to regulate relationships between the interests of the company’s stakeholders including shareholders, creditors, management, staff, suppliers, retailers and consumers. The function of corporate governance is to manage conflicts of interest: between stockholders and management; between major shareholders and small shareholders; and to consider the interests of other stakeholders 1. Board committees are an important framework for corporate governance

4 1.2 The two-tier structure of the German model of corporate governance Shareholder Committee Supervisory Board Management Board Trusteeship Authorized Agent Staff Election 1. Board committees are an important framework for corporate governance

5 1.3 The single-tier structure of US and British models of corporate governance Shareholders Non-executive directors (US: External Directors) Executive Directors (US ： Internal Directors) Shareholder Meeting Board of Directors Utilizing the stock market to strengthen supervision and incentives in relation to the the board of directors (resolutions by vote) (functions are carried out collectively at meetings) Other High-level Executives Executive Organization (a tiered structure headed by a senior officer) 1. Board committees are an important framework for corporate governance

6 1.4 Comparing the advantages and disadvantages of the two structures The advantage of the two-tier structure is that the board of supervisors has greater independence in relation to the executive. Its disadvantage is that it is far away from the real business of the company and lacks information to carry out its functions The advantage of the single-tier structure is that it has more information in relation to the business of the company. The disadvantage is that is easily manipulated internally so that it simply becomes a “rubber stamp” 1. Board committees are an important framework for corporate governance

7 1.5 This does not signal the “end of history” In the latter part of the 20 th century, corporate governance moved towards single-tier structures (“OECD Principles of Corporate Governance” ） However, this does not mean the “end of history” for two-tier structures Internal improvements made to boards of directors with single-tier structures: the “Corporate Governance Movement”, started in the 1990s 1. Board committees are an important framework for corporate governance

8 1.6 Positive measures for remedying “internal control” in single-tier structures Increase the ratio of external directors on boards Emphasize the independence of directors （ “independent directors” ） Hong Kong: establish “independent non-executive directors” （ “independent directors” ） Establish committees for auditing, remuneration, nomination etc under the board of directors, managed by independent directors Enhance the work of these committees 1. Board committees are an important framework for corporate governance

9 Since the beginning of 2001 the China Securities Regulatory Commission has organized large-scale activities to publicize and promote the study of corporate governance In August 2001 it promulgated the Guidelines For Establishing A System Of Independent Directors For Listed Companies, requiring listed companies to establish a system of independent directors In January 2002 it promulgated the Standards Of Corporate Governance For Listed Companies, proposing that boards of directors can establish special committees, including committees for auditing, nomination, remuneration and assessment, with a majority of independent directors acting as conveners 2.1 Steps taken by the China Securities Regulatory Commission 2. China’s efforts and successes

The introduction of Hong Kong’s system of independent directors Shareholders General Meeting Internal directors Utilizing the stock market to strengthen supervision and incentives in relation to the board of directors Other executive officers External Directors Independent Directors 2. China’s efforts and successes

Practical progress The majority of listed companies have established the system of an independent board of directors The majority of listed companies have established audit and remuneration committees, some companies have established nomination committees Audit committees have started to play quite a large role in carrying out audits of quarterly and yearly reports and related transactions 2. China’s efforts and successes

China Unicom’s example This is a Hong Kong red chip company in which the state is controlling shareholder The company’s board has 10 directors, 4 are independent non-executive directors The audit and remuneration assessment committees consist of independent directors The committees are conscientious and responsible, and have won the understanding and support of the internal directors Improvements in Unicom’s corporate governance turned a small company made up of several departments into a competitive organization which in 2003 won an Euromoney award for best corporate governance in the greater China region, coming joint fourth with Sinopec 2. China’s efforts and successes

Standard & Poor’s evaluation of China’s corporate governance Reform of China’s corporate governance has seen initial success Problems that still exist: the structure of stock rights has not been sufficiently rationalized there is too much interference from large shareholders no transparency of information boards lack independence and their effectiveness is also inconsistent investors lack the initiative they should have as parties with rights and interests 2. China’s efforts and successes

14 Developing the role of special committees 3.1 Establishing and perfecting the system of independent directors There is still debate whether independent directors have a role The experience of other countries indicates that they do The main issue as far as Chinese companies are concerned is not abolition. It is how to address poor quality and the lack of independent directors To activate the role of independent directors, coordination of elements such as equity structures, controlling shareholders, the executive code of conduct and the enhancement of supervision is necessary

All listed companies should establish committees currently, not all listed company have established audit, salary, assessment and nomination committees some committees exist in name only all listed companies must set up audit committees (or carry out the relevant function through the supervisory board) and remuneration, assessment and nomination committees the composition and work of the committees must be disclosed in the annual report and inspected by the board of supervisors 3. Developing the role of special committees

Enhancing the role of audit committees (board of supervisors) Make clear the functions, powers and responsibilities of the audit committee (supervisory board) Increase the number of committee members familiar with financial affairs Instruct the audit committee (supervisory board) to take responsibility for the overall planning of external and internal audits (financial control) 3. Developing the role of special committees

Synthesize the experience of special committees and independent director committees, and improve working procedures Use the assessment of related transactions as an example, explaining the necessity of improving working procedures 3. Developing the role of special committees