Ethical differences carry risks

CHINA CONTINUES to see a flood of overseas investment and is now widely acknowledged as the country which will be the driving force of the world's economy in the first half of this century.

International companies have seen the cost benefits of relocating their manufacturing and sourcing operations to the mainland, but have also become sharply aware of some of the risks involved. These often centre on how best to operate in an environment which has long relied on different business practices and operated with ethical standards which are some way from those of the major multinationals.

Despite the opportunities, many joint ventures and acquisitions still fail, and the foreign investors generally come off worst. They complain of lack of transparency, limited market access, obscure regulations, HR and cultural problems, counterfeiting and unfair competition.

At various levels, they also encounter corruption and fraud, sometimes well hidden in a company's auditing and accounting records. As an indication of the problems, China's listed firms score only 44 out of 100 for corporate governance on an international scale.

The story of Bill, a personable Chinese businessman, shows what overseas investors can face. He started out in the car industry and soon developed good contacts with local suppliers, distributors and government regulators. A multinational car parts manufacturer saw his potential and hired him to lead its sales team in China.

When appointed, Bill immediately set up his own company, got his brother to manage it, and secretly began to transfer product technology and manufacturing know-how. The company grew steadily and Bill made full use of contacts made through the multinational to channel business to his brother.

Finally, he even persuaded his employer to form a joint venture with his firm, while carefully disguising his own involvement. It was only when he quit to concentrate on these outside projects that everything came to light. Now, however, he is competing directly with his former employer and selling virtually the same products.

This is a cautionary tale, but firms can avoid similar situations by taking the following steps:

Reference checks As a bare minimum, companies should independently check all references provided by applicants. They should ask for written references from named referees, even when assistance from executive search firms is available.

Personal background checks When hiring senior executives responsible for large sums of money and intellectual assets, companies should also check the candidate's background. They should be on the lookout for forged credentials or inaccurate personal details. If possible, it is useful to verify discreetly why a candidate left previous jobs and if the actual responsibilities were as stated. Past employers and former associates may give new insights into character, track record and integrity. It also pays to check into the possible ownership of any companies.

Screening suppliers and distributors This is to determine whether any of your staff have an interest in these companies. Simple credit checks are not enough.

Due diligence Where there is a lack of transparency and companies have a patriarchal leadership structure, due diligence must go beyond examining the balance sheet. It is vital to take a close and critical look at the people in the company at all levels, especially in cases where it is thought the corporate governance of a potential joint-venture partner or acquisition target is weak.

Code of ethics Multinationals must have a clearly defined code of ethics and tie it to contracts with employees, suppliers, distributors and joint-venture partners. If necessary, the code should be circulated, sent to clients and displayed prominently in reception lobbies and meeting rooms. The code and all contracts must include unequivocal statements about bribery, kickbacks, money laundering, conflicts of interest, intellectual property rights protection and confidentiality. It should be reviewed and updated annually. There should also be ethics awareness training for all staff.

Hiring restrictions Consider a ban on the hiring of close relatives as well as on conducting business with close relatives of staff and managers. Collusion between employees and their friends or relatives, as well as the creation of fake vendors, are increasingly common features of fraud cases occurring on the mainland.

Cultural gap It is easy to make excuses or explain things away by saying Chinese culture is different. However, multinationals must take steps to bridge the language and culture gap. Allowing the possibility of a gap is a risk in itself as it creates an 'us and them' atmosphere, which is open to abuse. The employees of multinationals must learn about local culture, get to know their Chinese staff as individuals, and understand the nuts and bolts of the business. Segregation can lead to alienation from Chinese staff, so a balance is needed between locals and expatriates at management level. Internal policies must encourage inter-cultural understanding.

Peter Humphrey is managing director of ChinaWhys, a private advisory practice dedicated exclusively to promoting transparency and good ethics for multinational operations in China. The company has offices in Beijing and Shanghai.