Corporate China

Blog on Chinese company law & practice by Tomasz Janyst

The old cucumbers painted green – the board system in China

The three old committeeslaosanhui (老三会) consist of a party committee dangweihui (党委会), a workers congress zhigong daibiao dahui(职工代表大会), and a trade union gonghui (工会). Under the planned-economy system all firms had these three committees established and they took an active role in managing of companies. Since the new Company Law was introduced some claim that it is a tale of the past and the three old committees were replaced by the three new ones:

The three new committees xinsanhui (新三会) seem more familiar to the Western observers, they consist of a shareholders’ meeting gudonghui (股东会), an executive board dongshihui (董事会), and a supervisory board jianshihui(监事会). It may look like a typical two-tier board, but actually Chinese company law is a mix of the one-tier board and the two-tier board. There are two supervisory organs: a supervisory board and independent directors, whose competences often overlap. But that is the slightest problem with the ‘new’ Company Law. What strikes me most is that the three groups that used to control corporation in China still retain their power. Of course, they don’t exercise it directly as they used to do, often they don’t exercise it at all, but still they have a latent power to influence major corporate decisions.

There is an old Chinese adage, to paint an old cucumber green – lao huanggua shua lv qi (老黄瓜刷绿漆). Typically, it refers to old women, who pretend to be younger than they actually are. That’s exactly what the Chinese corporate law is doing – it pretends to be more modern, more investors friendly and more similar to the Western laws, but actually it retains a lot of the previous legal and economic system solutions.

Let’s take a brief look at the art. 19 of the Company Law of PRC:

Article 19 In companies, Communist Party organizations shall, in accordance with the provisions of 
the Constitution of the Communist Party of China, be set up to carry out activities of the Party. 
Companies shall provide the necessary conditions for the Party organizations to carry out their 
activities.

The Communist Party of China has around 82.6 mln of members (2012) scattered around the country and it is more than probable that there would be few CPC members at almost every major foreign firm in China and that would form a Party branch (党团组织; 党支) within a corporation. As for June 2012, there were 366 foreign enterprises that had formed Party branches in Beijing alone. The supporters of this solution claim that a Party branch within a company could act as a bridge that brings national policies into companies helping them become familiar with the situation in the country, facilitating the healthy development of foreign enterprises and guaranteeing the legitimate rights and interests of employees. Some add that that it also serves as an useful link to the government and state banks, which would be helpful in obtaining bank loans or securing lucrative contracts. Although, the power of Party committees within private companies might be small, their indirect influence is enormous. They exercise mainly a control function over the company’s activities and over the Chinese employees and if necessary report to higher party instances.

Apart from the Party branches, companies deal also with trade unions. Actually there is only one trade union – All-China Federation of Trade Unions (ACFTU), zhonghua quanguo zonggonghui (中华全国总工会), a 200 mln members giant that is closely connected with the Party. Even Walmart, known for its anti-union stand, had to establish trade unions and has to consult all the employees-related matters (working hours, lay-off, etc.) with ACFTU.

The Party and ACFTU influence on private foreign companies in China is a fact: in some cases it is strong, in some almost negligible; it has drawbacks, but also some advantages. Maybe in a long run it is better for China to maintain a strict control over private sector. Nevertheless, the way of doing business is quite different from the Western standards and anyone setting up a business in China should be aware of that.

The State is Here to Stay

“The state is bad, privates enterprises are good” – this oversimplified, manicheistic view on the role of the state in economy is deeply rooted in the public opinion in Western countries. In China the opposite of this view was believed to be true throughout the Mao’s regime and it is still extremely popular. It’s not hard to understand why since people give credit to Chinese government for the economic success, not to mention the significant role of state throughout Chinese history and the fact that the society is rather a collective one.

Still, many people tend to believe, that China and especially Chinese companies will in time closely resemble what we know from Europe or U.S. I hardly see any evidence of this happening.

China modeled its economic transformation mainly on the Singapore experience. The main traits of this model are: significant share of state-owned enterprises in the GDP and one-party rule. I would recommend a trip to Singapore to any Milton Friedman’s fan, the Chinese policy makers go there quite often to seek advice (the former Singapore Deputy Prime Minister Goh Keng Swee and Lee Kuan Yew were among Deng Xiaoping’s most trusted economic advisers). The fact is that there’s quite a lot of efficient state-owned enterprises in Singapore, not only in traditional public sector branches like education, energy, military, but also braches associated almost exclusively with private sector like, nomen omen, private equity investment – the public private equity investment firm Temasek actually sounds like an oxymoron! The Singapore model seems to work well, so why would China try a neoliberal model that’s so different from its historical and cultural experiences? 

Actually, neoliberal solutions were quite popular in China in the early 80’s. One of the most influential Chinese leaders at that time – Chen Yun (陈云) once compared the Chinese economy to a bird that is closed in a cage of central planning. This view was shared by Zhang Weiying (张维迎), a Chinese professor influenced mostly by the Austrian school of economy, who was one the engineers of early market transition reforms, particularly dual track price system (价格双轨体制). Nevertheless, the two of them lost their influence at the very beginning of Chinese economic transformation. Later on, Premier Zhu Rongji (朱镕基) implemented many neo-liberal solutions like privatization of SME while retaining control over big enterprises (抓大放小), but it could be argued whether was that done in order to truly change China’s economic system or just to meet the WTO entry requirements.  

Although China is increasingly becoming a market-oriented economy (市场取向) it’s highly unlikely that it will become a neo-liberal one. There are many versions of capitalism and China would rather follow the models tried by the other Asian countries, namely Singapore and South Korea, than the more distant and probably unfit American model. Don’t get me wrong – there are still lots of things that need to be improved in Chinese economy: corporate governance, transparency, corruption just to list a few, but the State would still maintain control over economy and directly or indirectly influence operations of many corporations and although it may seem inefficient or even unfair in macro-level and in long-term it’s better for China.

And now since China has gained a significant position in the world’s economy its self-confidence is also rising. It’s high time to learn what China really is, not what we wish it was. If Western journalists and scholars would persist on implementing neoliberal changes in China’s economy that were already cast aside by Chinese intellectuals and policy makers then…the Atlas would only shrug.

What Xi Jinping’s ascent to power might mean to China’s legal system and economy

The 18th National Congress of the Communist Party of China (十八大) appointed Xi Jinping (习近平) as General Secretary of the Communist Party and Chairman of the CPC Central Military Commission (his predecessor, Hu Jintao, had to wait few year for that second position). In March 2013 Li Keqiang (李克强) will most probably become Premier of the State Council and the Fifth Generation of leadership, called also  Xi-Li Administration (习李体制), will take full control over China.

Will the leadership transition change China in the way the liberal The Economist wishes to? It’s rather unlikely that this magazine wishes will come true in the near future. That’s good for China and in current economic situtation good for all of us.

So far the most liberal Chinese leader was Jiang Zemin (江泽民), who together with Zhu Rongji (朱镕基) opened the Chinese market for foreign investors, started privatization program and conducted the final negotiations leading in the accession to the WTO. Basically speaking, their reforms where similar to those which were made in Poland by Leszek Balcerowicz and Jeffrey Sachs in late 80’s, which arguably were not as successfull as the reforms in Singapore, South Korea or earlier on in Japan. Poland listened to the Bad Samaritans – Chicago Boys, China tried their to do that too, but quickly changed the course.

I’ve mentioned Jiang Zemin, because people gathered around him, the so called Shanghai clique (上海帮), are still a powerful group in Chinese politics, but with the new leadership their power is fading. Xi Jinping is a part of princelings (太子党) and Li Keqiang originates from the Communist Youth League (中国共产主义青年团), both of which are opposed to the Shanghai clique. That’s why the fifth generation of Chinese leaders is called a “conservative government”. Because of that it’s rather unlikely that the Chinese legal system and economy will become more liberal in the next years. In the following posts I will try to prove why that actually might be good for China and the rest of the world.

Chinese investors at the Gate

The number of Chinese FDI in Europe is growing year by year. China for the first years of its Reform and Opening Period (改革开放) focused on the FDI that were flowing into the country and on the development of domestic market. This of course is still the main concern of Chinese government. However, in recent years China’s outward FDI is growing at immense speed. From 2004 to 2010, the global value of China’s FDI grew by around 1400% (around 400% within European Union). During the most severe phases of financial crisis the world global FDI was decreasing (-61% from 2008 to 2010), but the China’s FDI on contrary -rising (+260% from 2008 to 2010). China’s outward FDI is now the highest among the developing countries and ranks the fifth worldwide.

Geographically, 72% of the Chinese FDI goes to Asia, only 5% to Europe. It is consistent with Chinese foreign policy, which tends to perceive world as few circles, all having Beijing in the middle. Asia is in the first circle of interest. Europe, US, Africa in the latter (British Virgin Islands and the Cayman Islands are also significant recipients of Chinese FDI stock, second only to HK. This fact however have no political and economic significance, it’s a tax matter only).  In Europe in 2011 Chinese companies invested only €7.4 billion ($10 billion). Chinese outward FDI in this region from 2000 to 2011 is smaller than what Switzerland invests in the EU in a single year. The value of Chinese FDI in Europe might be small, but the potential for future growth is enormous.

The Chinese outward FDI growth was described in detail in the following reports, that I can happily recommend:

1) Euro-China Investment Report 2011-2012 The European landscape of Chinese enterprises: An analysis of corporate and entrepreneurial firms and the role of the ethnic communities

2) Cash in HandChinese Foreign Direct Investment in the U.S. and. Germany

3) China Invests in Europe: Patterns Impacts and Policy Implications

No Country for Protected Consumer’s Rights

When I was in Beijing I noticed that lots of expats prefer to drive bigger car like Hammer, Dodge Charger or Jeep. The reason for this is simple, on Chinese roads the big cars apparently have priority. No one is paying attention to traffic signals, so the bigger your car the safer you are. The same rule applies to business.

I wrote before about the weak position of minority shareholders in Chinese companies. Another group which is normally weaker are the consumers. To balance the rights and duties of consumers various consumer protection laws were introduced in China, e.g. Law of the People’s Republic of China on Protection of the Rights and Interests of the Consumers (中华人民共和国消费者权益保护法). Nevertheless, there’s still a long and winding road to go for China to provide a right protection for the weaker groups.

One of the most notable examples how the consumer protection in China works is Hengsheng Computer v. Wang Hong et al (1999). Mr. Wang found that his laptop made by Hengsheng Computer keep shutting off. Within the warranty period he took the laptop back to the store where he bought it. He was denied any service. After few failed attempts, he posted an angry comment on the internet and filed a complaint against Hengsheng Computer. For several months he was still denied any service. Two newspapers, Microcomputer World Weekly and Life Time, reported on his story. After that, Hengsheng Computer filed a lawsuit against Mr. Wang Hong and the newspapers claiming libel damage. The court ruled that they were liable and ordered Mr. Wang Hong to pay damages of 0.5 million RMB, which was later lowered by Court of Appeal to 90,000 RMB (around 5 times his annual income). Of course, the warranty repair of the laptop was still denied, which I guess was a little problem for Mr. Wang compared to the huge amount of libel damages he had to pay.

Manager – one of the most dangerous jobs in China?

Last weeks were particularly bad for Chinese managers:

24th July – General manager of steel company in Jilin beaten up to death during the workers protest against company’s policy High salary for management, low for common workers  (高管高薪、底层低薪).

5th August –  Rioting miners in Zambia killed a Chinese manager by pushing a mine trolley at him. His colleague was injured and moved to a hospital.

22nd August – Vice-manager in Nancheng property management company stabbed to death with a fruit knife.

27th August – Three managers of a Hunan Shaoyang water company were burned to death by gasoline-filled bottle thrown by one of the company’s employee, who stormed into the meeting room. One deputy manager survived by jumping on the air conditioner outside.

For many of the Chinese companies the employee suicides are quite a big problem (it’s not only China’s problem, just to mention one example, many France Télécom employees also committed suicide). Now, the tide is changing and some employees decide to take revenge on a company or just suddenly burst with anger. There have been more and more stories of employees attacking their bosses, sometimes with tragic consequences. These stories may be “a man bites dog” news, but I think their frequent occurrence proves otherwise.

Management is certainly not a strong side of many Chinese companies and the work conditions are not always satisfactory. I just wonder how bad it have to be to make people try to kill themselves or their principals.

Strikes, riots, laid-off workers, raising inequality, bad management – that’s the issues that China should be most concerned about right now. The four stories mentioned above show that there’s still lot to do.

Embezzlement & Corruption Scandals: part I

As the Chinese market is getting bigger and bigger, so are the temptations for those who are looking for easy money, even those who do not refrain from using illegal means. Since the market and its regulations are not completely mature, big scandals still occur quite often. No market is free from bribery, embezzlement, fraud and extortion, but China is still far behind of international standards (it ranks 75th on Transparency International Corruption Index 2011; United States ranks 24th, UK 16th, Poland 41st).

It is the first in a series of post describing China’s biggest company scandals. I will start with a quite recent, but interesting case which is sometimes called “China’s Enron” – the Yinguangxia case (银广夏事件). Actually, China as many times in the history was first! The Yinguangxia accounting scandal occurred before the Enron scandal, which therefore could be called an “American Yinguangxia”.

Yinguangxia, located in Yinchuan, capital of Ningxia Autonomous Region, became a joint-stock listed company in 1993 with its business focusing on producing computer discs and China’s eco-agricultural industrialisation. In 2000 its shares leaped by 440% causing more shares acquisition, but also some suspicions. Two journalists from the leading Chinese financial magazine, Caijing, Mr Ling and Mr Wang published at the beginning of August 2001 an article entitled “Trap of Yinguangxia” (银广夏陷阱) revealing the illegal activities of Yinguangxia management. The article described Yinguangxia misrepresentation of export activities and a profit overstatement. It was later revealed by China Securities Regulatory Commission (中国证券监督管理委员会) that the company fabricated quite a big sum of 745 mln yuan of profit (around US$93, a tiny amount compared to $600 mln of Enron’s profit overstatement)  by way of counterfeiting purchasing and selling contracts, duty-free documents, added value tax invoices, exportation declaration statements, financial notes and business revenue fabrication, the company also lied to the market about various production facilities that actually never existed. Its auditor, Zhongtianqin CPA Firm (中天勤会计), a Shenzhen-based accounting firm, that was was the biggest auditor nationwide in 2000 in terms of the total assets of its clients (annual revenue of over RMB 60 mln), was partly responsible for the misrepresentations.

In the result of the CSRC’s proceeding four of the company’s senior officials, including the former CEO and CFO of Yinguangxia, were sent to jail for forging documents and fraudulent misrepresentation of information. The operating licence of the company’s external auditors, Zhongtianqin CPA Firm, was revoked and the professional certificates of its two certified public accountants were repealed.

The scandal started a debate about the securities law, corporate governance and stock regulation. It damaged seriously the Chinese stock market reputation. It should be noted that Chinese people now tend not to buy stocks as a form of investment, but rather purchase houses or art. They certainly have reasons not to invest in the Chinese stock market, which was even condemned by well-known Chinese economist Wu Jinglian (吴敬琏), previous head of the State Council’s Development Research Council, for being like a casino without rules (“中国股市很像一个赌场而且很不规范”).

Vase Directors (花瓶董事)

Prof. Lu Jiahao (陆家豪) from Department of Foreign Languages of Zhengzhou University worked at the ZhengBaiWen Company (郑百文). He was an independent director (独立董事) , a mandatory member of a company’s board. The company he was working in engaged in serious financial malpractice and prof. Lu among twelve other board members was found guilty. In his defense he said that  he “knew nothing about the operation of the company” and that he “didn’t have the ability to understand the accounting sheets”, he worked for free, in fact the position of an independent director was for him a “name”, a prestigious title only. Nevertheless, he was fined 100.000 yuan for participation in financial malpractice.

His case stirred up debate about the role of independent directors. Let’s look at its legal framework.

Chinese law was strongly influenced by the German legal system and therefore China has a two-tier board system, which means that there’s executive board – the board of directors (董事会) and the supervisory board (监事会). However, now Chinese legal system is under a growing influence of common law, namely American law. In early 2000s the independent directors were introduced into Chinese corporate law, which now is a unique combination of one-tier and two-tier board systems. The reason for that is simple: two-tier system was not sufficiently efficient in the corporate governance so the government decided to try the one-tier system without withdrawing fully from the two-tier system. There’s an old Chinese saying: ‘cross the river by feeling for the stones’ (摸着石头过河), which was applied not only in the economic transformation but also in the legal reforms. The authorities don’t know which system is better suited for the Chinese realities, so they try both.

The Company Law only states briefly in article 123 that: ‘A listed company shall have independent directors. And the concrete measures shall be formulated by the State Council’ (上市公司设立独立董事,具体办法由国务院规定). More precise is the Guiding Opinion on Establishment of Independent Director Systems by Listed Companies (关于在上市公司建立独立董事制度的指导意见).  From this act we know that an independent director should have no relationship with the listed company or its principal shareholders that could hinder his making independent and objective judgements. To be more precise, he cannot own more than 1% of the company’s shares (which requirement prof. Lu didn’t meet), have no family relations with the company’s executives, provide legal or financial advice to the company etc. Independent directors either work for free as prof. Lu or for profit (average pay – RMB 5000-200.000 annually; data for 2002).

The prof. Lu case illustrate the main problems with this institution. Independent directors in China are mostly teachers or researches, often having very modest business experience (prof. Lu didn’t understand the accounting sheets) and therefore they maybe are not the best supervisors, since they not always understand what they are supervising. Being neutral and objective could be their only value. Nevertheless, I doubt their objectiveness, since I can hardly believe that any unconnected, objective person could possibly be part of a company in China. Moreover, the independence of independent directors is questionable – in another case, “the Leshan Power” (乐山电力事件), the independent directors hired a separate auditing company, but this company was not granted a permission to enter the power plant facilities and do their job. The rights of independent directors are very limited. They often basically do nothing apart from signing some papers. That’s why they’re called a flower vase directors (花瓶董事*) or not-catching-the-point-directors (“不懂事”的董事). In Chinese realities, where social connections (关系) play a major role, truly independent directors probably don’t exist, and therefore this institution is rather useless.

*花瓶 – a flower vase, this term is often used to describe beautiful women who are not intelligent

The End Of History For Corporate Law?

[…] the basic law of the corporate form has already achieved a high degree of uniformity, and continued convergence is likely. A principal reason for convergence is a widespread normative consensus that corporate managers should act exclusively in the economic interests of shareholders, including noncontrolling shareholders.

H. Hansmann, R. Kraakman, The End of History for Corporate Law, (Yale Law School, Harvard Law School, 2000)

The consensus that corporate managers should act only in the economic interest of the company’s shareholders is not widespread, in fact, there might be no consensus at all. The same could be said of corporate law reaching high degree of uniformity. We are far away from the harmonisation of company law, moreover, it is no so obvious whether or not is this goal really worth reaching.

The Hansmann’s and Kraakman’s claim of the end of history for corporate law was challenged by various Western scholars (Prof. Leonard I. Rotman among others), who argued that this thesis is not valid even on the American ground, not to mention the whole world. Several U.S. court decisions (Shlensky v. Wrigley case and even Dodge vs Ford and Revlon Inc. v. MacAndrews & Forbes Holdings Inc.) support not the shareholder model, but the broader stakeholder model (covering employees, creditors, suppliers). Moreover, the Enron scandal and some more recent financial collapses revealed some harmful consequences of adhering to the shareholder primacy model of corporate governance.

And the rest of the world? Take China as an example of a mix of three corporate governance models that according to Hansmann and Kraakman are theoretically and practically bound to doom: the labour-oriented model, the state-oriented model and the stake-holder oriented model. The last being recognized broadly in the Western countries so I’ll leave it without any comment.

  1. Labour-oriented model  – the key term for this model is the “co-determination” – a practice whereby the employees have a role in management of a company originates in Germany, but now it’s quite popular in China. Of course, in practice management system there is highly hierarchical, but the Chinese corporate law protects the interest of the employees quite well. Article 17 states that a company should protect the lawful rights of its staff and workers, signing labour contracts with them and providing social security insurance and labour protection. Article 18 describes the rights to organize trade union and carrying out union activities. Investors looking for cheap labour and “easy” investment could sometimes be surprised as Wal-Mart was. This company known for its anit-union stance had to establish trade unions at its retail stores. Outside of China Wal-Mart has only one shop that has a trade union, inside of China more than 20. However, in the labour law field the reality is far behind the legal standards and the trade union are actually another state organization – there’s only one trade union, All-China Federation of Trade Unions ( 中华全国总工会). Nevertheless, the labour standards will grow as China becomes richer and it is quite noticeable that China pays more attention to the workers than many free-market countries, which is also reflected in its Company law.
  2. State-oriented model – despite many claims that the state influence on Chinese companies is very little and the companies are acting solely in their business interest (vide: Rhodium Group Report) it is obvious that state interference in Asian countries’ companies is high, and even if the state in not influencing the companies very strongly it always has the latent possibility to do so. Let’s take Article 19 of Chinese Company Law as an example – the article states that a organization of the Chinese Communist Party must be formed in every bigger company to carry out party activities. It’s a blunt example of political control over business. Second example – have you heard of Corporate Social Responsibility? The basic idea is that a company should apply its assets not only for the profit of its shareholders but also for social purposes. In Western countries it’s generally well perceived to do so and it helps building the people’s friendly brand, but in China it actually could be a kind of legal obligation according to Article 5 which states that “when engaging in business activities, a company must […] accept supervision by the government and the public, and bear social responsibilities” (公司从事经营活动,必须 […] 接受政府和社会公众的监督,承担社会责任). In fact, some companies state that they were pushed to contribute to local communities. Of course, there are many high polluters who don’t care about the environment at all, but the fact is that companies in China seem to be more connected with the local communities that their Western counterparts, what should be taken in account when doing business in China. Last but not least, Chinese companies rely heavily on credit, and credits are granted by state-controlled banks. Therefore, companies which engage in areas of business favored by the state are more likely to get funding.

The Chinese company law and practice are far cry away from Western, especially U.S. and UK, experience. It poses challenge for people holding more “traditional” Western liberal views on corporations. Because of the growing importance of China in the global economy it is now crucial to analyse it deeply.

The end of history for corporate law thesis – as all the other “end of history thesis” – is deeply-rooted in Western view of history as a linear progression. This view assumes that there exist one final stage of development for humanity, democracy and corporate law, that we would probably reach just before the Day of Judgment. I think that this view doesn’t describe well the reality. It is also false that any legal construction could ever reach a perfect form, because they’re always connected to the economic and social reality in which they exist, and that reality is different in every country and it changes constantly, experiencing progress and sometimes regress. Corporate law could converge, but probably soon after it would happen it would diverge again, since new problems would arise and they would need new solutions.

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