Download Corporate Governance, Corporate Context

China Hearings, Portcullis House, May 23rd 2007
Global Economic
Policy Institute
Corporate Governance, Corporate Context
Is there a real private sector in China ?
An appeal against investor naivety !
Theme - understanding risks ‘at the level of the firm’
GENERAL TOPICS …
Global Economic
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Summary of unusual features of the Chinese economy…
The importance of the private sector in China
Behaviour of the economy – something looks wrong
Why ‘state & private’ is not so ‘black & white’
Strategic plans vs. ‘the law of unintended consequences’
Conclusions for economists and foreign investors
Disclaimer: all conclusions and data are indicative & subject to verification.
Understanding better Chinese economic risks and
pitfalls
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Policy Institute
Some unusual features of the Chinese economy
It’s not just the growth and size of the economy that is unusual……..
The China growth story & ‘problem by-pass’ strategy
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Export-led growth. (Exports 35% GDP in 2004 – 40% 2005, 40%+ 2006)
Government revenue up as % GDP
growth sectors more easily taxable
1994 govt revenue 11% of GDP – 2006 24% GDP
Budget deficit 2006 1.4%GDP
China's GDP grew 10.7 percent to $2.7 tr. in 2006
Target was 8%
Target for 2007 – 8% again (IMF forecast 10.0%)
Growth mainly from private & coop sectors, BUT 100m workers remain in
state enterprises; some profitable but most unprofitable - huge debts
PRC government has a ‘problem by-pass’ strategy – to see new ‘private’
sector engulf the problem SOEs, gradually deal with SOE-related debt
‘If growth rate exceeds 11 percent, inflation would jump heavily and lead to overheating’
(Fan Gang - Chinese Government - Monetary Policy Panel)
There is no ‘model’ – economic factors are unique
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The state is still ever-present
State sector still more than a third of GDP
Four huge state banks – central policy but commercial lending decisions at provincial level
Very large non-performing loans (NPLs) – to state sector (bigger than savings ?)
The Party at all levels still involved in corporate governance & investment choices
Unprecedented size of investment as a % of GDP
Investment funded by debt at low interest – thin markets for equity capital
Low returns on investment, even lower in state sector
Low consumer spending - huge savings but very low interest rates
Unreliable accounts and financial data – huge NPLs with private sector too ?
Small proportion of enterprise equity traded
Understandable political knife-edge…
Largest peacetime migration ever - 200m+ went East !
Unprecedented rise in FX reserves – very conservative treasury function
Monetary policy heavily influenced by fears of unemployment and even more civil unrest
‘Prediction has no future’
Conventional wisdom ?
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Growth comes from the new private sector…
…plus inefficient-but-vast & well-resourced megastate-firms in protected sectors.
‘Opening up policy’ – foreign investors are welcome to
join in
‘The private sector is the engine of growth’
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Policy Institute
% of added value by firm ownership
1998
1999
2000
2001
2002
2003
Chg.
Private
sector
50.4
51.5
52.8
55.5
57.4
59.2
8.8
Public
sector
49.6
48.5
47.2
44.5
42.6
40.8
-8.8
State controlled
36.9
37.1
37.3
35.7
34.6
33.7
-3.2
Collective
12.7
11.3
10
8.8
8
7.1
-5.6
100
100
100
100
100
100
Total % GDP
% value added – GDP. Source; NBS & OECD ests.
Rates of return are low – but the private sector does better Global Economic
Policy Institute
Look again at China’s unusual economic landscape
Something is not quite right…
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Runaway investment ? (Investment as a % of GDP)
> ‘Infrastructure building is 45% of GDP’ - CEIBS Shanghai
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The advent of ‘free financing’ in China
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Aggregate lending raises further concerns
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From ‘Fixing China’s Banks, Not Russia’s’ by Michael S. Bernstam and Alvin Rabushka
‘The major problem in China's fast growing economy is the quality of investment’ – IMF (WEO 2005).
Historic NPL rates suggest unsustainability
Global Economic
Policy Institute
Chinese bank sector lending 1998-2003
3
2
Non-performing
1
Performing loans
0
1998 1999 2000 2001 2002 2003
Bank of China's NPLs were found to be 2.6 times as high using international criteria as
they were using the traditional Chinese definitions (N Lardy 2001).
China risks: End of the low inflation era ?
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What happened to last year’s fears ?
‘PBC sterilisation of money supply, reserve ratio hikes, and temporary
‘commands’ to banks & SOEs – at the end of the administrative measures
road ?’
‘It is more difficult to achieve a soft landing as the investment excess is
much greater than 2002/3’ (Morgan Stanley 03.05)
‘WTO membership opens up banking sector in 2007 – reform timetable is
tight (foreign banks will take deposits and ‘good loans ?’)’
‘1 yr deposit rate only 2.25% AND Grey market loans 8%-20% =
unsustainable monetary expansion & inflation ?’
Do serious economic risks remain ?
Efforts to contain growth have not been fully successful
‘I don't see the necessity to raise interest rates again’ (Guo
Shuqing, Director, China's State Administration of Foreign
Exchange - Bloomberg March 05) (Dr Guo also ruled out a largescale appreciation in the renminbi)
Inflation will ease to 4 percent or less in 2005 –
[from a seven-year high of 5.3 percent in July and
August 2004] (Premier Wen Jiabao March 05)
The People’s Bank of China (2004) criticized ‘the blind
expansion of seriously low quality, duplicate projects’
in steel, aluminium, and cement’.
‘Credit curbs that were imposed last year on
overheated industries like steel, cement and
property, cannot be loosened. Land use will be
more strictly regulated to stop illegal construction’
(Premier Wen Jiabao March 05)
Global Economic
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The Chinese Government
expressed ‘concern
about the impact that a
large change in the
renminbi might have on
employment’. – IMF ‘04
‘The apparent effects [cooling
investment] have been
achieved.’ Ma Kai, Minister at the
State Development and Planning
Commission (March 05)
‘Changes to bank reserve
requirement have had successful
short term effects’ Central Bank
Governor Dai Xianglong May 2005
The central parity rate of yuan against U.S. dollar has appreciated by only 5.54 percent since July
2005, when the yuan-dollar peg was ‘scrapped’. Bank of China
Why ? – Much lending is still political.
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2/3 of SOCB loans still to prop up state-owned enterprises.
‘The best way to get capital in China is to be too big to fail’.
Local governments have ‘blueprints’ & borrow at short
notice for new projects, & for JVs & FIEs
New ‘quasi-banks’ (Q-Bs) are defying administrative belttightening in SOCBs
SOE/local government borrowing unaffected by higher
interest rates at Q-Bs (10%-20%) - secured on undervalued
assets ?
Negative real interest rates = private capital flight to new QBs ($25-$30bn fled to QBs in 2004*)
* John Dessauer, Investor’s World, Jan 05
** Economist Oct04
Hence the question…
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Is there are real private sector in China ?
How private is private ?
The economy is not behaving like a private-sector-led system
Understanding private sector development in China
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Some key questions
How much of the private sector-led growth is from
new private sector companies, and how much from
‘privatised companies’ ?
How are the new private sector companies formed ?
Are they really private entrepreneurs ?
How does the privatisation process work ?
Are privatised firms really private ?
The progress of the private sector in China, post-1979
Global Economic
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Rural agriculture and individual business (1978-1984)
Local privatization of SMEs (1995- ) officials often buyers
‘Contract responsibility’ reform in state-owned and collective
enterprises, 1984-95, led to….
…‘Legalisation’ of urban individual businesses
Collective + individual ownership TVEs 1978-2006.
2002 onwards – new urban start-ups (& 2007 private asset law)
‘The United Front Work Department of the Central Committee of the Communist Party of China has recognized
business people and professionals as a new pillar of socialism with Chinese characteristics’. China Daily July 06
Ownership, status, & quasi-privatization changes
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Corporatisation, marketisation & partial MBOs, more than privatization
Repatriation of exported funds to HK/Taipei, replaced by…….
…..administrative insider (MBO) private ownership schemes (scams ?) >>
Much confusion over terms & definitions
Complex, pragmatic sequence of SOE rule changes in capital markets
Small %s of SOE equity listed & traded – extrapolation to market cap unwise
Overall financial picture of group finances (esp. debt) obscured ?
Which entity in the crossholding structure is listed ?
ROI requirement system – few disincentives to prop up on-paper profits
‘20% rule’ in privatisation very loosely interpreted by officials
JVs between state firms and same-firm, manager-owned Cos. enables
tunnelling of assets
‘Privatisation.. is constrained by excessive debts and worker redundancy’
KAI GUO & YANG YAO (Beijing Univ.) Economics of Transition, April 2005 .
>> PRIVATIZATION: Returning ‘foreign’ capital is being replaced
by direct management ownership – investors beware !
Year
Trends
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Composition of private shares
Private shares in all firms
Private shares in privatizing firms
Management
Employees
Outsiders
1996
4.1
61.6
0.5
24.2
75.3
1997
5.3
57.2
13.3
26.2
60.6
1998
7.1
61.1
13.2
30.5
56.3
1999
12.1
65.2
14.5
27.9
57.6
2000
20.9
76.4
21.4
32.5
46.1
2001
26.1
80.4
25.7
34.1
40.2
Guo, Kai & Yao, Yang. Causes of privatization in China .The Economics of Transition Feb 05
Chinese state-owned & quasi-state enterprises
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More than 1400 ‘listed’ SOEs
= 2/3 assets, ½ urban workers, ¾ investment & credit
Insiders: most directors are executive + state reps, party appointees
60%+ of shares non-traded, complex holding structures increase opacity
Most receive overt or covert subsidies
One third officially makes losses
Pragmatic approach to SOE reform and ownership changes…
BUT… ‘the law of unintended consequences’ applies
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1979-1991 Autonomy reforms (SOE Contract
Responsibility System post 1987, & SOE law 1988) +
separation of various property & managerial rights,
recognition of ‘management techniques’, role clarity
Shanghai Stock Exchange: March 2000 – new CG rules for
listed firms
CRS ‘failed’ (WB survey). Need to replace oscillating
control vs. autonomy, local/national etc
Codes and Standards of Corporate Governance of
Chinese Listed Companies 2001 + independent directors
system, for insider problem
Continuing inefficiency + problem of information
asymmetry + competing control claims = need for
formal system for state bodies to share ownership &
control…
2001 New SPC legal framework to allow investors to sue
listed companies for losses caused by false financial
disclosures.
1992/3 Use of company law, SOE corporatisation, &
standardised corporate governance rules. Many state
SMEs became ‘private’ (20% of other SOEs could be
‘private’, but this was loosely defined).
Ownership/control confusion persists at some levels.
1st mtg of the 10th National People’s Congress, the Stateowned Assets Supervision and Administration
Commission of the State Council (SASAC) – supervises
large SOEs & mediates between state institutions –
cumbersome, monitoring, supports senior SOE managers
Further waves of measures to address SOE debts –
AMCs initiative emerged.
1999 4th. mtg/15th National Congress – ‘Modern
Enterprise system’ recognises corporate governance
as core further reform needed
June 2003 1/3 independent directors a requirement. Some
scope for personal liability of directors.
Rise of Authorized Investment Institutes (ie Holding
company, National Assets Management Co, Group Co.)
But, by 2005 - Supreme People’s Court - 1,000 suits against 14 listed firms for losses arising from
false financial disclosures, none settled by Court in favour of investors (RIIA Naomi Li)
The private-but-not-private approach brings problems
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Pre-IPO manipulation is common
Some very major capital market scandals
China Eagle $752m, ICBC $893m, CCB $18m, Xinjiang Delong $249m,
China Securities $687m etc etc etc
‘Accounting problems’: Yi’an Keji, Yinguangxia, Lantian Gufen, MaiKeTe
‘Propping & Tunnelling’
Some consequences of fudged state/private ownership
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State-linked corporate insiders managing ‘returns’
Especially if ‘private’ owners are local government
Related party transactions (RPTs) - shifting of resources between
controlling owners and listed firms with complex crossholdings…
‘Propping’ to meet securities regulators’ ROI earnings targets for…..
…share issuance
…maintaining listing status
Creates scope for ‘tunnelling’ via inter-state-company trades…
To enhance rent-extraction transactions
To extract wealth from the firms
See Propping and Tunneling through Related Party Transactions MING JIAN & T.J. WONG January 2006 - Chinese University
of Hong Kong and SUG at Nanyang Technological University. Their academic language studiously avoids the word ‘theft’.
‘Propping’… how does it work ? – an example
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Head Office
Complex
Crossholdings
Debt
Subsidiaries
Profit
Profit
Listing (eg 20% of target subsidiary)
Costs
‘Tunnelling’… how does it work ? – an example
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JV
State enterprise managers
State enterprise
Land
Repatriated cash
from HK etc
Cash
Workers’ time
Building materials
Profit agreement
Machinery
Joint venture
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CONCLUSIONS & RECOMMENDATIONS
For foreign investors and the Chinese Government
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The impact on foreign investment decisions
‘Not so fast………….’
Investment choices in China are more complex
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Partners, suppliers, customers can be subject to political
decision-making
Understand ownership structures, especially quasi-state
and complex cross-holdings
Choose provinces and localities carefully
consider especially competition with provincially-owned firms
Short term profit can dominate decision-making
not share value or net assets
RPTs, tunneling, and propping may be prime motivators
Rent-seeking may dominate
‘Executives may have many hats’
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Public policy
In line with Hu Jin Tao’s ‘market socialism fairness’ policy
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What changes in economic & social policy might
be afoot ?
Political pragmatism in capital market development &
ownership changes will stop..
..Will be replaced by a strategy of fairness & wide
share ownership (to prevent a Chinese ‘megagarchy’)
Hu Jin Tao’s old guard will thus become ‘modernisers’
New Chinese reforms might be less technocratic
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Role of the Party – withdrawn from governance
But in its place – an actual strategy towards ownership
(international help needed)
New collective ownership legalities
SME equity protected – individual economic rights
Equity markets instead of land grabs
Re-integration of the ‘9 ownership rights’
Principles-based financial regulation
Disincentives for complex crossholdings & opacity
An end to tunnelling and propping
The beginnings of laws against monopolistic & unfair practices
No more price hike riots ?