Mixed Ownership Reform and Corporate Governance in China’s State-owned Enterprises

The criticisms made of state-owned enterprises (SOEs) are well known. SOEs are said to be generally inefficient as they rely on state patronage and do not compete fairly. Such inefficiency can also be an outcome of the need to serve political goals at the expense of business and financial discipline. SOEs also afford opportunities for patronage and nepotism that lead to boards and management that are not fit for purpose, and can facilitate corruption. Moreover, even with the best of intentions, it is not clear that bureaucrats have the necessary exposure and experience to make optimal decisions for SOEs. Our paper focuses on the latest attempt by the People’s Republic of China (PRC) to strengthen governance within her SOEs.

China has not been immune to some of the inherent weaknesses of SOEs. More importantly, China is aware of such weaknesses and ownership reform of such enterprises has been at the centre of its economic reform programme since the early 1990s. This has, however, generated mixed results, one example being the rampant corruption in the 1990s to the early 2010s.

Given the collectivization of property that was established after 1949 when the Chinese Communist Party (CCP) gained power, a significant milestone in the reform process involved corporatization whereby state assets were allocated to corporate vehicles owned by the state. This was facilitated by the PRC’s first Company Law, which was promulgated in 1993. The intent was to create modern enterprises with governance structures comprised of shareholders (who could be private individuals), the board of directors, the supervisory board, and the manager. This was a significant departure from the previous Marxist economic ideology that the state owned and controlled the means of production.

This period of corporatization and limited privatisation from 1992 to 2003 may be traced to the CCP’s decision in 1992 to establish a ‘socialist market economy with Chinese characteristics’ under which the public sector would dominate but which allowed other types of ownership to coexist. In the period that followed from 2003 to 2013, the State-owned Assets Supervision and Administration Commission of the State Council (SASAC) was established to manage SOEs, indicating that the Chinese state would behave as a shareholder.

From 2013, SOE reform entered its present phase, one in which more emphasis is given to the critical role of the private sector in the Chinese economy. This represents a convergence of state ideology with market reality as the private sector in China has grown exponentially over the last two decades. Accordingly, the Chinese government no longer insists on majority control over SOEs except for those in strategic industries. Consistent with this, the role of SASAC has shifted from asset management to capital management to allow SOEs more autonomy to facilitate commercial decision making, and preferably be listed with diversified shareholding and sound corporate governance.

Our paper, ‘Mixed Ownership Reform and Corporate Governance in China’s State-Owned Enterprises’, focuses on this latter aim of facilitating mixed ownership through a fusion of state-owned capital, collective capital and non-public capital so as to increase the value of state-owned capital and its competitiveness. The rationale for this reform lies in the premise that by enabling capital with different kinds of ownership, including private and foreign investors, to co-exist, they will be able to draw on the different owners’ inherent strengths.

To understand how mixed ownership reform (MOR) has been implemented, an empirical study of changes in ownership and board composition in over 30 SOEs which have recently completed MOR was conducted. A typical way in which MOR is implemented involves an SOE holding company divesting part of its ownership in an important subsidiary, typically between 30% to 45%, to the private sector and in some cases other state actors. In selecting private-sector investors, the SOE looks more at factors such as management experience, technology, or development of new products or markets, rather than financial investment.

Part of the reform involves an attempt to strengthen corporate governance within the new mixed enterprises through a system of checks and balances, board independence, efficiency in decision making, directorial accountability, and also CCP control. We observe that the impact of MOR on SOE corporate governance has been increasingly embodied in the ‘retreat of the state’, the ‘advance of the (Chinese Communist) Party’, and a gradually emerging separation of power between the CCP and the board in SOEs. This means that while the CCP is being institutionalised in the formal corporate governance mechanisms of SOEs, the state/government is also expected to retreat from SOE governance with boards expected to exercise independent judgment in the management of SOEs.

While this may appear contradictory, this is a rational development in the context of China’s recent economic history. As mentioned above, corruption has been a serious issue within the CCP and the exertion of stronger party control through an anti-corruption drive was implemented several years ago. At the same time, the CCP has found the Singapore “Temasek” model attractive and wants to enable greater enterprise autonomy so that decisions can be made on a more commercial basis facilitated by the involvement of private enterprise with representation on SOE boards.

The latest reform can also be seen as the Chinese state’s acceptance of the notion that ownership matters and sharing—rather than strong state control—brings about efficiency and better governance. The MOR, which can be seen as a form of partial privatisation, attempts to offer a practical solution to the issue of under-monitoring in Chinese SOEs. Through MOR, non-state capital is introduced into SOEs to effect ownership change and diversified board composition. Private investors with board representation have the incentive to monitor management thereby complementing the CCP’s anti-corruption effort. This is also tied in with other institutional changes which further strengthen control-sharing, including shifting SASAC’s regulatory philosophy. In addition, MOR functions as industrial policy for the state to make use of private resources such as technology and market networks owned by strategic investors.

A word of caution though is that while the desire for SOE reform appears strong, it remains to be seen how such reform tendencies can be sustained and institutionalized as opposed to being the personal initiative of the current, strong, leader in China. In countries with a competitive democratic system, the need to establish legitimacy at each election cycle can act as a constraint on the ruling party of the day. It is not clear that the Chinese Party state, which is itself above the law, faces sufficient institutional constraints to ensure a deep rooted and sustained commitment to good governance as a whole of which management of its SOEs is a subset.

Jiangyu Wang is Associate Professor at the Faculty of Law, National University of Singapore. 

Tan Cheng-Han is Dean & Chair Professor of Commercial Law at the School of Law, City University of Hong Kong.