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18 March 2021

Corporate Governance in China

The economic reforms introduced in the post-Mao era opened China to a wave of foreign investment and entrepreneurship, catalysing China’s rise as an economic superpower and attracting global attention to the Chinese stock market. Until recently, the systems in place by which listed companies were governed and controlled remained a significant barrier to entry for most foreign investors seeking to take advantage of the ever-growing economy.

Prior to the 1990’s, almost all Chinese companies were state-owned and with no established stock exchange or regulatory body to monitor the market, it was difficult for individual investors to get their foot in the door. It was not until the government created the Shanghai and Shenzhen stock exchange, along with the China Securities Regulatory Commission (CSRC), that the first steps were taken to create an oversight mechanism that would work towards international standards of corporate governance. In the past, individual minority shareholders have been discouraged from investing as their interests were not fairly represented; this was due to majority shareholders utilising their position to accumulate shares through in-party transactions. Since then, the introduction of several policies aiming to address the power imbalance between state and individual shareholders have improved the levels of corporate governance among listed companies. Nonetheless, Chinese enterprises are still heavily concentrated with state-ownership compared to other developed economies, which is an important factor to assess before investing in the region.
 
As a direct result of ownership concentration, boards of directors can be subject to government controls surrounding general operations and decision-making. The lack of independence among directors trickles down the business hierarchy, with supervisors unlikely to implement their own management styles and employees having little to no input on business decisions. Innovation within state-owned companies can therefore be limited as the state holds an influence over management while employees are encouraged to focus on their direct roles. It could be argued that this improves efficiency, although such influence presents the opportunity for corruption. It is possible that political objectives replace the maximisation of shareholder value as the indirect principles of management, with a self-interest culture also giving rise to insider trading.
 
On the contrary, state-ownership is not necessarily a disadvantage, as companies are backed by the government it is unlikely they will be left to fail. If necessary, the state will provide financial support and act as a safety net for underperforming businesses. It also allows ease of access to a continuously growing and stable customer base. According to a report in 2019, around 40% of Chinese companies are state-owned, with the rest partially owned or not at all. The implications highlighted will therefore have decreasing levels of impact as the portion of state-ownership decreases.
 
Corporate governance issues also persist in companies that are not owned by the state. One example is Luckin Coffee, which pledged to overtake Starbucks as China’s biggest coffee chain when it went public in 2019 but was soon investigated by the State Administration for Market Regulation, uncovering £250m in fake transactions. The falsification of financial earnings remains an issue, however, it is clear the Chinese government is taking steps to solve complex issues with most listed companies subject to information disclosure rules, internal controls, and a vast improvement of investor relations. Many Chinese companies have also begun to participate in corporate social responsibility to combat the environmental impact they have as a country.
 
Corporate Governance in China
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