China corporate governance report: trends

Euromoney Guide, June 2008

You’re unlikely to find anyone inside or outside China who doesn’t think corporate governance has improved there in recent years. “Ten years ago when I was doing IPOs in China I remember saying that companies had to improve their corporate governance,” says Guy Cui, managing director at Hopu Investment, a US$2.5 billion China fund manager whose founders include the well known ex-Goldman Sachs and CICC banker Feng Fenglei. “They needed to have good boards, and those boards needed to have some sort of power, with the management truly reporting to it. And right now I’m very pleased to see that in China this is very well accepted.”

David Li, the chief executive of UBS Securities, the China-domiciled securities and investment banking business of UBS, says that “in the last five years, corporate governance has improved a lot in China, in structure and in practice.” He argues there are three reasons for this. “One, the more people gain exposure and experience, the more they understand how important corporate governance is. Two, there is a lot of international exposure, whether in a joint venture or acquisition or going to practice in an international field, and the sense of corporate governance there is important. And three, the regulatory requirements have improved.”

The huge advances that have been made in the development of the regulatory framework for corporate governance in China are covered elsewhere in this guide. In terms of accepted practices, in some cases China is actually something of a leader in Asia. “China is one of the few places in the region, along with Hong Kong and Thailand, where votes are actually counted in company meetings,” says Jamie Allen, secretary-general of the Asian Corporate Governance Association. “They do count and publish the results. In most places, including Singapore, it’s a show of hands.”

That said, corporate governance practices are clearly still a work in progress in China, and there is much more development to take place.  For example, a common observation is that Chinese companies are increasingly willing to appoint independent non-executive directors to their boards, but that they just don’t have the right available pool of talent to draw from domestically.

“What is needed in China is they don’t have that pool of independent non executive directors that you get in Hong Kong and Singapore, because the professionals are too young,” says Kha Loon Lee, Asia Pacific head of the CFA Institute Centre for Financial Market Integrity. “You meet a lot of partners of law firms, accounting firms, and they are so young. You need that pool of retired lawyers and accountants to be effective. In China, they probably exist but in a much smaller number than in Hong Kong and Singapore.”

Marshall Meyer, professor of management and sociology at Wharton Business School in the University of Pennsylvania, agrees there are challenges in getting the right independent directors. “So often the independent directors are people who come from the academic world or a party background,” he says. “They tend to be very senior retired rather than active business people, and some without senior executive experience. That’s another piece where governance practices still diverge pretty substantially [from the west] in my judgement.”

Qiao Liu, associate professor in finance at the University of Hong Kong, adds: “China introduced the practice of independent directors early on in its corporate governance reform process, but in terms of practice the major constraint is that the number of independents is quite small. You tend to source these people from university professors, and not many of them are capable of effectively monitoring companies’ management.” (Interestingly, Qiao argues that empirical evidence shows that the correlation between board independence and performance is actually not that significant in China.) “A lot of times the controlling shareholders have a major say in who will be the independent directors. The selection process itself is not effective.”

There are other challenges too. “The biggest problem they have is inter-company loans,” says Lee. “That’s a reality, and if you talk to some of these proxy voting services they’ll tell you that’s still a problem today.” This comes about partly because the typical structure of a state-owned listed company in China involves a listed subsidiary of an unlisted state-owned parent. “Each industry, such as telecommunications, will have one umbrella entity, often the ministry that regulates it, with a number of holding companies (eg China Telecom, China Mobile) that operate nationally through subsidiaries, usually in partnership with the local government (eg China Mobile Guangdong, China Mobile Zhejiang),” says Lee. “It is not uncommon for units of one government agency to hold tiny stakes in the business of another.”