China's state-owned giants need to enter modern corporate age

Hu Shuli says a professionally run company with an effective board of directors, clear oversight and less party control will help curb graft

PUBLISHED : Thursday, 26 September, 2013, 12:00am
UPDATED : Thursday, 26 September, 2013, 12:02am

Corruption involving China's state-owned enterprises has hogged the headlines. So far, senior executives at China National Petroleum Corporation have been sacked, former railways officials have been hauled to court and, most recently, news broke that two executives at Cosco are also being investigated.

There has been no shortage of ideas on how to reform the sector. The key lies in adopting a system of modern corporate governance.

Major state-owned enterprises should be the first to start by setting up a board of directors. Under its leadership, all senior managers including the chief executive should be hired through competitive recruitment. The board's role is to fulfil its duty of care to the shareholders; it makes the decisions that its managers execute - this separation of powers will improve oversight of the company's operation.

By concentrating power in the hands of a few, the set-up encourages corruption

China has aspired to build a modern corporate culture since the third plenum of the 14th central committee 20 years ago. Yet the goal remains elusive. Among the 113 state-owned enterprises overseen by the central government, only 57 have set up boards of directors in their group's holding company. Among these 57, most have the board chairman double as chief executive. Further, many have boards of supervisors in name only.

This kind of system makes dictators of the top managers. By concentrating power in the hands of a few, with virtually no oversight, the set-up encourages corruption.

The problem is that too many people in China regard setting up a board of directors at a state-owned enterprise as a mere formality.

This sentiment has its roots in the fact that state capital is usually the "major shareholder" of the company. Today, listed companies of state-owned enterprises have largely adopted more modern governance in an effort to attract investors. But if their parent companies still pride themselves on sticking to the outdated system of governance by administrative planning, the listed companies are bound to suffer.

An effective solution is to allow some institutional investors - such as the national social security fund, foreign exchange reserve fund and China Investment Corporation - to take a stake in the company, thus diversifying its shareholder structure.

The social security fund exists to take care of the needs of retired workers. Thus, boosting it is entirely reasonable. Further, there is one unique advantage to letting the fund invest in state-owned enterprises. A state-owned enterprise will prefer to retain its earnings to maximise profit, while the social security fund will seek to maximise dividend payouts so that it will have enough to meet its own obligation to retirees. This tension will spur the fund to more actively scrutinise the management of the company.

It may also result in the fund linking up with other medium-sized and small shareholders to exert influence at the company's annual meeting. This will not only improve transparency of the company's operations and decision-making, but also act as a curb on corruption.

Experience elsewhere also shows the benefit of appointing outside directors. Learning from advanced economies such as Britain, Chinese enterprises can increase the size of the board and ensure two-thirds of members are outside directors. Half of them could be retired senior government officials, and the other half could be scholars and experts in different fields.

Outside directors exercise more effective supervision than insiders. This, and appointing a non-executive board chairman, should help improve governance.

Currently, the post of vice-president is usually recruited; the top post should be, too. Widening the search for talent through the market will ensure the job goes to the best candidate.

It's time, too, to review the place of party committees, workers' congresses and unions in state-owned enterprises. For too long, the party committee has been the de facto board of directors, and the party secretary automatically becomes the board chairman. Such arrangements have been the breeding ground for corruption, as the convictions of many errant executives have shown.

Business must be run according to market rules. The shareholders are owners of the company; the board of directors represent shareholders' interests, chart the company's strategic direction and supervise its management; a board chairman, as convenor of the board, should not be the party secretary, whose main job should be to guide the political ideology of the company's party members.

On the eve of the third plenum of the 18th central committee, the country's decision-makers should seize the opportunity to undertake much-needed reform of state-owned enterprises.

Restraining their monopolistic behaviour in the market and modernising their governance are the two most important steps.

This article is provided by Caixin Media, and the Chinese version of it was first published in Century Weekly magazine.