For the past three decades, China has been one of the world’s most admired economic success stories. It has long ceased to be a belligerent force in international geopolitics and has become a fully accepted and well-regarded member of the international family of nations. Yet, there is not a week that goes by when I am not confronted with outright scepticism, if not fear and hostility, over how much China can be trusted – for example, to live up to WTO obligations; to respect intellectual property; and to be a good partner. No matter what aspect of trust we are talking about, the western executives that I work with are not “buying” the story of China maturing into a well-governed economy.
All of this is about governance – and not just “corporate” governance. All over China there are issues that are reaching fever pitch: mass action in the Chinese countryside over corruption and poverty; the Politburo of the Chinese Communist Party singling out corruption last month; the unveiling of new anti-corruption measures by the China Banking Regulatory Commission in March; and the suggestion in April by the UN’s International Committee on Economic, Social and Cultural Rights that China is violating workers’ rights to organise.
Likewise, Chinese corporate governance issues have also been in the spotlight. In 2003, Huawei, a network equipment maker and one of China’s emerging global contenders, was sued by Cisco in a highly visible action for intellectual property infringement. The matter was resolved last year when Huawei agreed to significant revisions to its own code, manuals and screen interfaces.
In December 2004, Singapore-listed (but Chinese state-owned) China Aviation Oil speculated on fuel prices, bet wrong, and then sold off 15 per cent of the company to western investors – all without any public disclosure. In April, engine manufacturer China Yuchai International, a Bermuda-based Chinese holding listed on the New York Stock Exchange, saw its shares drop from a late 2003 high of $36 to $10.40 at the end of April. The problem? Well, as one Motley Fool analyst so clearly put it when referring to China Yuchai: “When is a value stock not a value stock? How about when you can’t understand who’s really in charge of the freakin’ company!”
Or, how about the warning notice issued by another NYSE-listed Chinese company, Brilliance China Automotive, which announced on March 18: “Shareholders of the company and investors should exercise caution when dealing in the shares of the company.” While they were no doubt referring to demand and competition conditions for automobiles in the Chinese domestic market, there is a broader message here as well. Clearly, pressure for change is overdue.
Governance in China is not an issue where a straightforward approach will suffice. To begin with, the eternal conflict between the political interests of the state which, despite exiting from the economy, is still a major owner of assets, and the economic interests of corporate actors, is bigger, more vivid, and more complicated in China than perhaps any other nation. China, after all, is still the People’s Republic and there remains an enormous sense of obligation in many state and party quarters to the “people.” When hard economic sense runs headlong into the popular interests of the “people,” the concept of corporate governance inevitably suffers.
On a distinctly less noble level, there is at least a generation of party and state officials whose careers, if not lifestyles, have been built around the sort of patronage to which good corporate governance is diametrically opposed. And, then, there is the party’s paranoia about sharing “leadership” in important social areas, which most definitely would include the sorts of employment and investment decisions routinely made elsewhere in the corporate sector.
Despite all of this, as the Chinese market opens up, as foreigners invest in Chinese enterprises and as Chinese enterprises invest abroad, the reality is that the genie is out of the bottle and China is under increasing pressure to tighten up the way its enterprises are governed. Increasing calls for clarity in ownership, transparency in decision-making, equity in relationships, clear ground rules in behaviour, voice and representation in leadership and responsibility in social action will all become far more a part of the Chinese managerial scene in the future than they have been in the past.
Bad omens?
The number four – si when pronounced – can have bad connotations in China. It is a homonym for the word “death,” and connotes the ultimate in bad luck. Nobody in China wants a phone number, for example, with a four in it. For the same reasons, the fourth day of the fourth month can be particularly ominous. This year, April 4 – si si – may, in fact, live up to its threat as a harbinger of “bad luck” for those Chinese managers who have not, until now, had to worry unduly about how they govern the organisations of which they are a part. On April 4, Harvard University – itself, ironically, in the middle of very public governance issues – divested its holdings in PetroChina, a subsidiary of the China National Petroleum Company (CNPC). The divestiture of roughly $4m is not enough to warrant notice in itself. But, highly visible governance pressure from an outside, non-Chinese interest group (in this case Harvard University) on a newly globalising, Chinese company is. Why is Harvard University taking this action? PetroChina’s parent, CNPC, has invested over $1bn in Sudan, and social activists have linked its support for the unpopular regime to the genocide that is taking place in Darfur. Harvard’s actions mark the beginning of the end of the aloofness of China’s businesses. Powerful social forces will compel them to work like modern corporations and answer for their actions.
Unveiling Chinese corporate governance
As Chinese companies move abroad, acquire western corporations, sell their branded products into western markets, and seek to entice western investment funds, they will be forced to re-examine who they are and how they behave. Undoubtedly, as the si si omens might predict, the governance of Chinese companies that seek a place on the global stage will cease to be wrapped in a shroud of secrecy and will increasingly be revealed to the outside world. Once this happens, can real changes in internal governance be far behind?
Far from being bad luck, any changes in the governance of Chinese enterprises, whether initiated inside or outside the country, will ultimately be to China’s benefit. For the most part, the largely inadequate governance of Chinese organisations may well be one of the most important factors determining the ultimate success or failure of their debut on the world stage: as investment opportunities, as partners, as neighbours, and even as suppliers and customers. At present, Chinese corporate governance mostly exists only as a concept. The IMD World Competitiveness Yearbook for 2005 ranks China 54th out of 60 geographic entities assessed in terms of “ethical practices,” 56th/60 in terms of “credibility of managers,” 54th/60 for “corporate boards”, 59th/60 for “auditing and accounting practices,” 45th/60 for “social responsibility,” 42/60 for “health, safety and environmental”, and dead last – 60th/60 – for “shareholder value”. This hardly points toward “trust”, “transparency”, “openness”, “responsiveness” or even “improvement”. As Chinese enterprises increasingly become a more important vehicle for advancing the interests of the Chinese people, both abroad and at home, concerns over how they are governed, and by whom, will undoubtedly increase.
Whose property?
China’s corporate governance problem is both endemic and systemic. The seeds of doubt have been sown everywhere, in particular by foreign investors, and it will take considerable time and effort to undo the damage. The corrosive effect of doubt begins with a total lack of confidence in the concept of property, both real and intellectual, and how it is defined within the People’s Republic. Can you count on anything really being “yours”? And for how long?
For many Shanghai residents, the demise of Henry’s restaurant, once a well-known and much-loved hangout, is a classic case in point. Formerly located on Xinle Lu, it was enormously popular with both locals and expatriates as an innovative and lively place to go. Until one day, without warning, it was seized by its landlord – probably because of its obvious success – and was run into the ground in a pathetic attempt to sustain, without commitment, all that had made it work. Today, it is only a memory: a dark and shuttered reminder of how fragile ownership can be in China. Talk to most Chinese managers in state-owned enterprises and they will tell you that their days are consumed, not with making managerial decisions, but in meeting with the multitudes of stakeholders, or “mothers-in-law” – ranging from local government officials to retired workers – all of whom believe the SOE to be their property, too.
This is still very much an economy where important things happen off stage and this raises the level of uncertainty to unacceptable levels. It is not only foreigners who object to opacity and backstage deal-making. Many Chinese themselves feel a basic mistrust in concepts of equity and opportunity. We have recently witnessed a number of public demonstrations against perceived iniquities in the Chinese countryside, where rural people have been outraged by poor administration on the part of local, unelected authorities at both the civil and party level.
Governance at the corporate level
What is corporate governance anyway? And, why should Chinese managers be concerned about it? My colleague at IMD, Professor Ulrich Steger, offers a useful definition for such a question: “Corporate governance establishes at the helm of the company clear structures of accountability, responsibility, transparency, and defines the role of boards as well as management.” This seems easy in economies where clarity and openness are taken for granted but, if we dissect this into its component parts, Chinese companies have traditionally fallen short in each and every one.
Historically, Chinese companies have been quite complex in their structure, with deliberate vagueness about both responsibility and accountability. Clear lines of authority have historically not been the norm, and the modern role of the Communist Party within these enterprises has served to reinforce this ambiguity. Nothing is, or has been, transparent. Useful rules of thumb for managing in China would be: “In opacity, there is security; in ambiguity, there is hope.” The establishment – the state, the party, the mothers-in-law– is everywhere, and only in complex situations is there sufficient freedom for Chinese managers and entrepreneurs to manoeuvre past the establishment. But it is this complexity and ambiguity that, from a foreign perspective, earns China its reputation as “a difficult place to do business”.
In fact, China’s present state, or lack, of what we call “corporate governance practices” is the unique result of its actual and historical political, economic and social situations. China has historically been a nation where powerful people have dominated institutions, where “the rule of man” has dominated “the rule of law.” Where “who you know” has been more important than “what you know”.
The force of personality can still be seen throughout the nation, from the topmost leaders down. In the past, particularly under Mao Zedong, this resulted in a “cult of personality”, and led the country into grievous errors. More recently, under the leadership of such influential figures as party chairman Deng Xiaoping, and former premier Zhu Rongji, the power of personality has been reduced, but not eliminated.
In a society where guanxi, or the individual’s web of relationships, forms the primary basis of trust, the role of personality in determining how organisations are governed remains paramount. This should not be surprising. Francis Fukuyama, in his book Trust, identified Confucian societies as being places where the individual could not reliably place their trust in the system, so they placed it in the things that they knew were dependable: friends; friends of friends; kin and neighbours. With this kind of historical and social background, it is not surprising that people overwhelm process in running large organisations. When this happens, the manager – especially if he or she does not enjoy good guanxi – can no longer rely on the system. They are exposed and vulnerable, and are not likely to make bold choices.
Capital markets in the west have been an important factor shaping corporate governance. However, in a country where access to financial markets and availability of the necessary structural elements that underpin these markets is still severely limited, it is difficult to expect much from this factor just yet. For those Chinese enterprises that have listed on foreign exchanges, they have had something of a rude introduction into what the rest of the world expects in terms of transparency and disclosure. Last year, China Life Insurance – the second domestic financial company to list overseas – found itself facing a US Security and Exchange Commission investigation over accounting irregularities and a US stockholder suit over inadequate auditing disclosures, all based around its 2004 IPO.
The problem is not that China lacks the basic regulatory standards for good governance – in fact, it has all of them. Since the promulgation of the Companies law in July 1994, and the establishment by the China Securities Regulatory Commission of a “Code of Corporate Governance for Listed Companies in China” in 2001, China has had a basic and “typical” framework for corporate governance. What it lacks, however, is execution and administration, and of course widespread and faithful adherence to laws and regulations. The result is almost like not having such a framework at all. Investors, for example, will continue to be deterred unless they have some idea of what their funds are acquiring and what their recourse is if an investment goes bad. This continuing confusion has helped to create an image of an economy where nothing is certain.
The internal costs of inadequate governance
Often overlooked in the attention paid to the external character of governance, but perhaps even more important, are the internal consequences of governance inadequacies. Let us start with China’s greatest asset: her people. China is home to a vast population of young, energetic, well-educated young people, who aspire to lives as rich and fulfilling as their western contemporaries. Gone are the old images of a “workers’ paradise” – instead, many up-market parts of today’s China are as hip and energising as anywhere in New York, London, Paris or Bombay. Chinese low-wage labour may well be gaining a lot of attention today, but it is Chinese brainpower that will be the bigger story in the future.
For all that “brainpower” to fulfil its potential, the organisations employing these brains, both Chinese and foreign-invested, will have to change. At the moment, these organisations are largely talent-diminishing rather than talent-accelerating – and that is a failure of governance. The internal governance mechanisms simply do not work to protect the individual and, as a result, they drive behaviour towards safety rather than innovation and energy.
For a young Chinese graduate starting work in a domestic state-owned, or state-influenced, Chinese organisation, or even a joint venture with a foreign firm, the degree of uncertainty with which they have to deal compared with their western peers is staggering. Their jobs and careers are susceptible to interference and unpredictability from a myriad of actors, both apparent and invisible – something that simply doesn’t translate to the western experience. Being innovative and entrepreneurial is difficult enough without having to worry about a lack of clarity on what matters, why it matters, and who decides.
Without adequate transparency in the rules or who judges them, Chinese managers will spend less time managing, and more time paying attention to the countless stakeholders who are lobbying to influence decisions. And anyone with attractive intellectual property is likely to take it somewhere else, where IP is more reliably protected.
Which brings us back to where we started, and that large matter of trust. Chinese corporations are indeed going to have to work hard to earn and keep the trust of foreign investors, the trust of its future employees and the trust of its people. If they can, the rewards are clear – and the dragon will have well and truly emerged.
Bill Fischer is a professor of technology management at IMD.
