Since the late 1980s, China’s state-owned enterprises (SOEs) have been undergoing a gradual process of transformation and privatization known as gaizhi. The government has reduced its share in smaller SOEs to as little as 10%. It has also introduced new governance mechanisms for both privatized and non-privatized companies. A study published by the International Finance Corporation—China’s Ownership Transformation (2005)—details the gaizhi process and includes a chapter on the governance implications of changing ownership and new institutions. Ownership has become less concentrated as the state has retreated, although inside managers have increased their stake in companies. Shareholder conferences and boards of directors have been established to increase representation of owners.
One fascinating element of this transformation is the overlap of old and new institutions. Traditional structures such as the workers’ congress and the Party committee have been joined by boards and shareholders’ conferences. Old and new roles, such as secretary of the Party committee and chairman of the board, are commonly performed by the same person.
“This overlap provides a sense of continuity, a sort of translation between the old institutional language and conceptual framework and the new ones. It therefore facilitates adaptation to the new rules. At the same time, the coexistence of the old and new institutions is creating confusion about the division of labor and the procedures to be followed in performing various functions.”
This situation highlights a dilemma of institutional reform in general. Institutions function as part of interconnected systems, so it can be difficult to eliminate old institutions without bringing activity to a halt. On the other hand, gradually introducing limited features of a new system may not produce any of the desired results until all the necessary features are in place. How should this dilemma be resolved? In the case of corporate governance, one has to look beyond the formal structures and consider how actors, such as boards of directors, work in practice and how stakeholder interests are represented.
According to the IFC study, the government has removed itself from involvement in the daily operating decisions of Chinese firms and managerial autonomy has increased. Managers now have greater freedom and incentives to respond appropriately to market conditions. At the same time, boards of directors have acquired significant influence and are assuming the responsibility of monitoring management. A couple of problems remain, however. So long as the Party secretary acts as chairman, incentives may be distorted and ownership rights may be obstructed. The dominance of insiders on boards reflects high levels of insider ownership, but raises the questions of how well outside owners might be represented and whether a market for professional managers will develop.
Published Date: January 11, 2006