Wednesday, Aug 23, 2017, 6:42 AM CST – China


SOE Reform

Back in Action

After stagnating for 10 years, China’s SOE reform has fired up once again. Is this the beginning of something special?

A worker with CNR Corporation Limited, one of China’s leading State-owned rolling stock companies, works on a high-speed train in Changchun, capital of Jilin Province, January 23, 2013 Photo by Xinhua

Automobiles line up to refuel at a gas station run by Sinopec, October 8, 2011 Photo by IC

A Sinopec refinery situated in Xinjiang Photo by Xinhua

A number of high-ranking corrupt officials, or “tigers,” have been caught since the new Chinese Communist Party leadership waged high-profile crackdown on corruption a year ago. Among them, more than 30 are former senior officials from State-owned enterprises (SOEs). The annual survey on criminal cases involving Chinese entrepreneurs by under the Supreme People’s Procuratorate found that, as in previous years, bribe-taking, graft and embezzlement of public funds remained the most common crimes committed by SOE executives.

This has not helped SOEs improve their already unpopular image. In the first 11 months of 2013, the profits of SOEs with more than US$3.3 million annual revenue from their main business grew by 8.4 percent on the same period of 2012, well below the 16.3 percent and 15.7 percent for Chinese private companies and foreign-funded companies in the same category respectively.

Meanwhile, the total net profits of the top 500 Chinese private companies in 2012 were just 65 percent that of the four State-owned banks. There are far more SOEs than private companies on the Fortune 500 global list. While this looks good for SOEs on paper, the accolades have attracted more criticism than applause from the Chinese public.

As the Party mouthpiece the People’s Daily noted in an article in April 2013, “SOEs can do nothing right” in the eyes of the public, who are effectively their shareholders. They are accused of poor efficiency if they lose money, monopoly if they make money, lacking competitiveness if they lag behind private companies, squeezing private investment if they become industrial leaders, using public money to bolster their own reputation if they engage in philanthropy, and lacking social responsibility if they donate too little to charity.

Long-anticipated SOE reform was finally resumed in the last month of 2013. On December 18, Shanghai, which accounted for one-ninth of total SOE assets at the provincial level, became the first to announce its campaign. The next day, the State Assets Supervision and Administration Commission (SASAC) unveiled the national roadmap. A number of local governments announced they would follow suit.

No Debate, Action!

Indeed the commitment to secure the “dominance” of public ownership has made the part on SOE reform one of the most confusing and disappointing sections of the economic reform package set by the CPC at the high-profile Third Plenum of its 18th Central Committee, which concluded in November 2013. Somewhat unexpectedly, action was taken just one month after the meeting, and started with the most sensitive topic: ownership.

The measures that have been specified so far follow exactly what was dictated in the decision. “Mixed ownership,” the introduction of private investment into SOEs, has immediately been put at the top of the agenda in this round of reform. Huang Shuhe, vice minister of the SASAC, made it clear at a press conference on December 19 that the State’s shares in SOEs would be reduced.

The massive privatization of SOEs in the 1990s and early 2000s engendered widespread criticism of the policy of “State retreat and private advancement,” which to a large extent led to the stagnation of the SOE reform in the following years. The trend had reversed since 2008, when the huge stimulus to deal with the global financial crisis further consolidated SOEs, a move generally considered to have undermined the private sector and market competition. Concerns over “State advancement and private retreat” refused to die down. The “mixed ownership” written into the Third Plenum document triggered yet another debate on who would retreat and who would advance this time.

Policymakers don’t like getting caught in these tangles. At a meeting in December 2013, Zhang Yi, the newly appointed SASAC minister, called for stopping such debates to move to “advancement of both.” This idea seems to be shared by economists and the market. At a forum in November, Professor Li Yi’ning at Peking University, who was one of the first advocates for private investment in SOEs in the 1980s and who tutored China’s incumbent premier Li Keqiang in his PhD studies, said that the purpose of reform was now “win-win” for both SOEs and private companies.

In December, five private equity companies together took 20 percent of shares in the Shanghai-based property giant Greenland, bringing its State-owned shares down to 47 percent. Giant SOEs are expected to go on the market. To prepare for that, the securities regulators have recently resumed listings which had been suspended for more than one year. SASAC issued a document in early January 2014 stressing transparency and no restrictions on buyer qualifications in transactions at State asset exchanges.

The concept of mixed ownership in SOEs is nothing new. Even most central SOEs are indeed joint-stock companies after years of reform towards diversified shareholding structures. However, SOEs generally hold stakes in one another. Overseas investors, for example, buy and sell 25 percent shares of the Hong Kong-listed Industrial and Commercial Bank of China (ICBC). The purpose of the reform this time is to reduce the dominance of State ownership in SOEs. Besides private institutional investors, SOE staff will also be encouraged to hold their company’s shares and more non-tradable State shares, with preferential dividends offered to individual investors.

The benefit, explained Huang, the SASAC official, is to improve their corporate governance by reducing the common practice of direct government intervention in SOE operation, another chronic problem for SOEs. Zhang Yuliang, chairman of the SOE Greenland, said in his speech at a forum in Shanghai recently that market-oriented interests of private investors can balance those of government appointed managers who care more about pleasing their superiors than market performance.

The SASAC, which is supposed to represent shareholders, will also change its method of supervision to reduce direct intervention in corporate operation. State-owned investment companies will be established to stand between SASAC and the SOEs in its charge. SASAC will only keep an eye on the asset value changes on the books of these companies, which for their part will make industrial or portfolio investment in a range of sectors, explained Li Jin, chief researcher with the China Enterprise Research Institute, to NewsChina.

Two Hands

Another major problem of corporate governance cannot be solved just by reducing government intervention. The success of any modern big company practicing the separation of ownership from control largely depends on how to motivate and discipline managers. This is because senior employees do not fully converge with owners on interests, but do have the advantage of holding more detailed information on the company than owners – they may pursue their own short-term interests at the cost of owners’ long-term interests. Economists urging ownership reform have always argued that this problem may be particularly severe in SOEs where no-one can really represent all owners in monitoring senior managers. This is even more challenging when those executives are government officials with political interests.

On one hand, Chinese SOE executives are paid much less than their counterparts in the private sector. In 2009, the Obama administration imposed a US$500,000 pay cap on financial companies that received the taxpayer-funded bailout. The Financial Times found that American and European bank bosses earned US$9.7 million on average, even at the peak of the financial crisis in 2010. A survey released recently by Beijing Normal University showed that the average income of listed companies in the financial sector which is dominated by SOEs was US$380,000 in 2013. Currently, the record highest salary for any SOE official is reportedly less than US$2 million. Like other government officials, they are required to retire at the age of 60 or 65.

On the other hand, Chinese SOE executives have excessive, unfettered power within their organizations. They are much less constrained in using money than government officials are in using budget funds. Worse still, the chairperson of the board and the CEO of an SOE are often the same person, making it impossible for the board to do its duty in supervising managers, and even the most frivolous travel and entertainment expenses can easily be written off. Since 2010, the Ministry of Finance began to release the budgets of central SOEs. However, the information does not include details about how they use their money.

As a result, Chinese SOE executives have less incentive to take market risks for corporate interests, but more freedom in spending, or even embezzling, shareholders’ money. Over the years several government agencies, led by the Ministry of Finance, have had to issue one document after another prohibiting SOE officials from spending  company funds on things like luxurious offices, fitness club cards, or “family expenses.”

In Shanghai, it is stated clearly in the reform plan that local SOEs, at least in competitive sectors, will have a different chairperson and CEO. More managerial positions will be available in the job market, and incentives like corporate options will be given to managers.

How Real?

The planned reform on ownership and executives appears to have touched the core of SOE privilege, and has thus gained much applause. However, both have been tried before and, based on previous results, there are justified concerns over how much serious positive change the renewed efforts will bring.

According to the SASAC data, more than half of central SOEs and their subsidiaries have already received private investment. The capital market is regarded as the main way for SOEs to have more private investment. However, China’s stock market is neither fair nor well-regulated. Some analysts have pointed out that this shows that fewer State-owned shares in a company does not necessarily lead to less State control in an environment of weak property rights protection and a strong government. If those problems are not solved, the old issue of SOEs accepting private investors’ money but not their opinions could raise its head again.

For State-owned investment companies to be established, their operation should also be independent from the government. Many analysts liken this model to that of Temasek, the investment company fully owned by the Singapore government. However, Li Jin warned “not to be too optimistic” about their autonomy in China.

Since at least 2000, the central and some local governments, including Shanghai and Guangdong, have tried several times not to give administrative titles to SOE executives, but all have failed. In Shanghai’s trial, no deputy managerial positions will have administrative titles. This is a concrete step forward, but it is always the top boss who has the final say in SOEs. It seems that general managers and chairpersons will continue to be senior civil servants and at the same time represent the different rights and interests of operation and ownership.

Over the past few years, SASAC has imposed complicated, tough economic indicators to assess SOE executives. However, in many cases an SOE’s performance partly relies on changes in government policy such as subsidies, market access, price controls, not market competition, and it may have other political responsibilities, like food or oil supply security, disaster relief, and refraining from cutting jobs in order to maintain social stability during economic downturn. It is hardly possible to distinguish whether losses or profits should be attributed to market or policy changes, or what Justin Yifu Lin, former World Bank chief economist, called “policy burdens” in his long-time research on China’s SOEs.

Besides, SASAC at the ministerial level has little power to decide the political career of SOE leaders who are also government ministers. It is even harder for shareholders to do so. Even though the assessment system is fully feasible, it may not be the most important factor for an official’s career. After China Ocean Shipping (Group) Co. (COSCO) incurred huge losses and faced de-listing on China’s stock market, Wei Jiafu, former chairman of COSCO, responded to shareholders that there was “no problem” as long as the central government understood its plight.

New Label

Even if these measures work well, the effect will be most evident on SOEs in competitive sectors where the State holds the minority share or is prepared to do so, as it did in the late 1990s in sectors like consumer products manufacturing, retail, steel and wine. The SASAC has announced that the deployment of State assets will once again be “rearranged.”

According to SASAC’s plan, the State will continue to fully own or be the holding party in any enterprise relating to national security, strategic industry and the hi-tech sector. This is not only the same as what was arranged in 1999, but is today’s reality. The progress lies in that the specific business, even in the same company, also matters. The Third Plenum resolution makes it clear that competitive business, even in sectors dominated by the State, should be open to private operators.

At the end of December 2013, 11 private companies providing e-commerce, electronic consumer products, retail, and Internet domain registration services, received telecom service licenses. Analysts believe similar relaxation will follow in other sectors. For example, it is widely expected that oil exploration will remain in the hands of the State, but the refining and selling of oil, as well as oil pipeline operation, will be comparatively open. In addition, the State Council has decided to purchase some public services from the market.

This means the privileges of market access, easy bank loans and price controls will be redistributed among SOEs and between SOEs and private companies. Every SOE will be classified according to the new standard, which is yet to be published, according to the SASAC. Those classified as being in competitive fields will not only face the prospect of greatly reduced (if any) privilege, but also less room to argue that its losses are attributable to policy. Li Jin has repeatedly noted that interest distribution is the core of the SOE reform.

How their business will be classified will not only reshape the SOEs themselves, but the structure of market competition – this, in turn, will frame the success of reform.


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