Institutionalizing Political Influence in Business: Party-Building and Insider Control in Chinese State-Owned Enterprises

The United States government and judiciary have long been trying to understand the state-backed or state-influenced actions behind Chinese enterprises that threaten US businesses and economy. Amidst the trade war between the US and China, the White House maintains that China has been using corporate governance tools, such as establishing party committees inside businesses, for achieving its industrial policy and national strategy. Specifically, ‘corporate governance has become a tool to advance China’s strategic goals, rather than simply, as is the custom of international rules, to advance the profit-maximizing goals of the enterprise.’

In my article published in the Vermont Law Review, I took advantage of a recent ‘party-building’ (dangjian) reform in Chinese state-owned enterprises (SOEs) to dissect the power struggle between the Chinese Communist Party (CCP) and SOEs and shed light on the opaque terrain of political influence in business in China. By presenting the party-building charter-amendment data from 2015 to 2018, my article documents the voting responses of external shareholders and finds evidence of insider control in SOEs and SOE managerial resistance against political influence.

Since 2015, the Chinese government has undertaken a new round of SOE reform that aims to address the insider-control problem and revitalize the public sector. A key measure to enhance monitoring and state control is the so-called ‘party-building’ (dangjian) reform, which aims to strengthen the control of the Chinese Communist Party (CCP) over business and the economy. President Xi pointed out that party leadership and party-building is the ‘root’ and ‘soul’ of Chinese SOEs.  Specifically, the CCP and the state require all SOEs to amend their corporate charters to formally include corporate party organizations in the governance system, allowing the CCP to influence material business and even personnel decisions. Internal corporate party organizations have long existed in SOEs and even in large privately owned enterprises in China, but they were almost invisible in the formal corporate governance system. Little was known about their real operations and influence on companies’ business decisions. The unprecedented charter amendment exercise presents an opportunity to closely examine the role of party organizations in each SOE. By examining the responses of outside shareholders and SOE managers during the charter-amendment process, my article aims to unravel the power dynamics of political control over businesses in China.

Enhancing party control over SOEs, on the one hand, curbs managerial opportunistic behavior and decreases agency costs; on the other hand, it shifts the goal of business decisions away from profit maximization to political or policy considerations and hampers shareholder wealth accrual. Party-building reform might benefit SOEs because enhanced party monitoring decreases the agency costs arising from the problem of insider control. However, outside shareholders and SOE managers might not welcome the amendment. The existing literature has examined the characteristics of early adopting firms and the extent to which party-building provisions are adopted. However, no prior study has examined the voting process or how shareholders and managers responded to the amendment proposal. My article fills this gap by documenting the voting behavior of different shareholders and managerial resistance to the amendment.

My article collects data in relation to the charter amendments of all 3,537 A-share listed companies in China between January 1, 2015 and December 31, 2018. During this four-year period, one-third of Chinese listed companies formally included party organizations in their corporate charters—and 84% of the adopting firms were SOEs. My article finds resistance to these adoptions both from outside shareholders and SOE managers. The approval rate of minority and foreign shareholders on party-building amendments is much lower than the overall rate, at 77.16% and 52.95%, respectively, suggesting that minority and foreign shareholders are voicing their concerns regarding the party’s interference in business. In particular, international proxy-advisory firms have suggested that institutional shareholders vote against proposals that lack transparency and accountability.

My article also finds that resistance from SOE managers manifests in the insider-control problem that the SOE reform aimed to address. A total of 14.16% of adopting firms amended their party-building provisions more than once. Recognizing that listed companies do not propose charter amendments lightly, multiple amendments are signs of resistance from SOE insiders against party intrusion and control. A careful look into the content of the amendments shows that the centers of these battles are provisions relating to personnel-decision rights, which are considered more intrusive to firm management. Even after multiple amendments, resisting SOEs still adopted much fewer party-building provisions than others.

Further regression analysis finds that resisting SOEs tend to be high-power, nationally important central SOEs whose managers have the political resources to resist party control. However, these resisting SOEs are less profitable and internationally competitive than non-resisting SOEs, suggesting signs of tunneling or insider control. Contrary to the conventional belief that writing is no more than putting something already practiced into words, my article argues that writing-in is actually a political renegotiation process between the CCP and SOE managers who have de facto control over business decision-making. However, a charter amendment does not warrant power shifting; it is just the first step. It remains to be seen whether institutionalizing party influence in business makes real changes in business decision-making.

Lauren Yu-Hsin Lin is an associate professor of law at City University of Hong Kong.