(By Donald C. Clarke) 

CONTINUED PRESENCE OF STATE CONSIDERATIONS IN CGLI

Despite the reformist ambition animating the corporatization project, state sector considerations remain strong. As the owner of state sector firms, the state may reasonably stipulate how they should be run. But it is not necessary to stipulate at the same time the fine details of how non-state parties should associate. This section will highlight two sample areas in which state sector considerations have worked backwards to shape the Company Law in ways unsuited to non-state enterprises, in one case through prescribing unnecessary or undesirable rules and in the other through failing to do so.

Preference for Mandatory Over Default Rules

One goal of the corporatization project and the Company Law was to make it easier to organize for economic activity. Whether this goal has been achieved is questionable. Take, for example, the basic policy decision of whether to make the applicable rules mandatory or to allow company organizers a degree of latitude to choose the governance rules they feel are most appropriate for their circumstances. The policy choice in the current Company Law is clear: the rules are almost uniformly mandatory. As the corporate law scholar Liufang Fang complained, “The whole Company Law is pervaded with the attitude of ‘making decisions on behalf of the people.’ The legislator shows an excessive self-confidence. It believes it is more intelligent than the parties, and can make arrangements in their stead.”Why should participants in a business not be left to work out their own deal? Part of the answer may lie in the traditional mistrust of Chinas ruling elites for private solutions, and an almost instinctive preference for uniformity over diversity, even it carries no particular benefits. But much of the answer lies, once again, in the Company Law’s overwhelming orientation toward the corporatization of TSOEs. The paradigmatic enterprise — or at least, the paradigmatic CLS — contemplated by the Company Law is not one formed by a group of private entrepreneurs who are attempting to contract among themselves for the optimal set of governance rules. It is the corporatizing TSOE. Thus, it is not surprising that the rules do not leave choices up to contracting parties; there are no contracting parties, realistically speaking, when a TSOE is transformed. TSOE transformation into a CLS is a process that takes place under governmental direction. The contours of the deal that ultimately governs the relations of the initial shareholders are not strongly shaped by market forces: there is no market for corporate control, no market for managers, and no “Wall Street option” for the state investor. Thus, it may be that there is no good reason for thinking that leaving the governance rules to “the parties”in this particular case will have economically efficient results. Indeed, it is conceivable in principle that however rigid and inappropriate some of the rules of the Company Law may be, they are better and less wasteful of state assets than the structure that state officials and incumbent TSOE managers might put together on their own if unconstrained by such rules. At the same time, however, it is hard to see why, when state assets are not involved, decisions on a number of matters could not be left up to the parties involved. The state may wish to impose on its own enterprises, for example, rules about the re-investment of profits  or the minimum and maximum number of directors,  but why should private parties be subject to the same rules?

That legislators are capable of leaving a great deal to participants in some business enterprises is clear from the great, even excessive, latitude shown on questions of enterprise organization where the transformation of large TSOEs is not involved. The Partnership Law, the Village and Township Enterprise Law, and the regulations on stock cooperative enterprises (SCRES, 1997) are all much shorter than the Company Law and prescribe a great deal less. Indeed, there is at least one officially acknowledged form of business enterprise — a wholly-owned subsidiary established by a parent enterprise — with separate legal personality that has no laws or regulations whatsoever governing its internal structure. Its legislative sanction, if it exists at all, does not extend beyond a single cryptic sentence in the Company Law providing that companies may establish subsidiaries. Where the transformation of TSOEs is involved, however, legislators not unreasonably want to have rules about the end result. This is what having a state policy means. The problem is that while it might make sense for many mandatory rules to be limited only to state-owned and state-controlled companies, such a limitation would require the resurrection of a distinction between state-owned companies and non-state-owned companies, a distinction that it was a major purpose of the corporatization policy to erase. Once again, we see that because of the policy of transforming the organizational form of TSOEs into companies, the needs and imperatives of the state sector have hijacked the rules and structure of the Company Law. Instead of the intended effect — that classical company law principles should govern state-owned enterprises in order to make them efficient — the opposite has been achieved: the entire corporate sector has come to be governed, in significant degree, by principles that are needed and applicable, if at all, only to the state sector.

Inability to Establish Uniform Legal Standard for Officers and Directors

Because the state’s policy is not to maximize shareholder wealth, it is difficult to create appropriate uniform standards to which to hold managers and controlling shareholders. If controlling shareholders seek to maximize the value of their shares, the interests of minority shareholders will automatically be served. But if the state uses its control for purposes other than value-maximization, it exploits minority shareholders who have no other way to benefit from their investment.

As long as state policy requires the state to remain an active investor in firms of which it is not the sole shareholder, meaningful legal protection for minority shareholders is going to mean either constraints on the state’s ability to do precisely those things for which it retained control, or else a de facto separate legal regime (at least as far as minority shareholder rights are concerned) for enterprises in which the state is the dominant shareholder. But a separate legal regime will require the maintenance of a strict boundary between state-controlled companies on the one hand and other companies on the other, a boundary that it was precisely the ambition of TSOE corporatization to erase. The failure to face this question squarely makes it extremely difficult to formulate legal rules on the duties of management. Although the Company Law imposes a duty of loyalty,   there appears to be no means of enforcing this duty, and no duty of care is spelled out. Moreover, although maximization of shareholder wealth is quite frequently stated by commentators to be the proper duty of managers and controlling shareholders in non-state-controlled companies, nowhere in the entire corpus of laws and regulations on corporate governance can such a duty actually be found.

PROPOSALS FOR REFORM: POWER OF CONTROLLING SHAREHOLDERS

Probably the most common complaint about the current Company Law is that it gives too much power to controlling shareholders. As discussed above, much Chinese commentary idealizes the Berle and Means model of dispersed ownership, and pictures the corporation almost as a kind of political community, whose members debate policy at shareholder meetings and vote after serious consideration of the issues. Where a controlling shareholder unilaterally calls the shots, shareholder meetings are reduced to a formality, and commentators view this as a perversion of the ideal. Thus, many commentators view the presence of the dominant single shareholder (yigu duda) as a problem, and proposals to reign in their power are not just about attacking their ability to exploit minority shareholders, but about attacking the very idea of stable control over a corporation as such. The first problem with this picture of corporate organization is that it is profoundly unrealistic. A corporation is not a political community and cannot be expected to function like one. Corporate law considers it entirely right and proper that those with more money should have a bigger voice, and it is uneconomical for minority shareholders to spend time educating themselves on corporate issues and physically attending shareholder meetings when their vote will not affect the outcome.

The second problem is that an ideal, however unrealistic, that is thought suitable for companies on the basis of a private ownership model simply cannot be realized in a world of extensive state ownership. The biggest dominant shareholder in China is the Chinese state. An attack on dominant share ownership per se is an attack on state ownership, and cannot be expected to move beyond academic journals into legislative reality.

The third problem with this picture is that it is far from clear that concentrated ownership by itself is a bad thing anyway. Some recent studies of Chinese listed companies have found that in general, corporate performance seems to be positively correlated with concentrated ownership by institutional shareholders other than state agencies, and negatively associated with dispersed ownership. Thus, legal policy should be directed at eliminating abuses, not eliminating concentrated ownership as such.

INSTITUTIONS OF CORPORATE GOVERNANCE

Any system of corporate governance depends on a set of institutions for its implementation. In the United States, for example, corporate governance of public companies depends not only on the existence of markets for equity, debt, managerial talent, and corporate control, but also on intermediate institutions such as the financial press and the legal and accounting services industries and legal institutions such as courts, the Securities and Exchange Commission, and private litigants. We may debate whether these institutions can play the roles assigned to them (compare, for example, Coffee (2002) with Ribstein (2002)), but we have a pretty good idea of what they are. It is similarly critical to any scheme of corporate governance in China that it be informed by a realistic view of the available institutions and their ability to perform the expected task. Too much cannot, for example, be expected of private plaintiff-driven litigation in the courts. Listed companies got that way because they and their officers had political backing; Chinese courts are not politically powerful and are hence reluctant to take cases involving large sums of money and powerful defendants. The Supreme People’s Court allows courts to hear only a very limited class of securities-related claims (Supreme People’s Court, 2003). Thus, if corporate governance reform is understood to mean inserting appropriate private rights of action into the Company Law, it is unlikely to lead anywhere very soon. What about government agencies? The prime candidate here would seem to be the China Securities Regulatory Commission (CSRC). But it is hampered by significant disabilities. First, its staff is small relative to the scale of its tasks.   Consider the respective  tasks of the CSRC and the U.S. Securities and Exchange Commission (SEC) solely in the field of listed company oversight. The main task of the SEC is the enforcement of rules regarding disclosure. It is not expected to be a guarantor of corporate profits. The CSRC, on the other hand, must enforce merit requirements that attempt to ensure the investment quality of the business as well as disclosure requirements. Moreover, its very authority to make and enforce rules regarding corporate governance has been challenged as insufficiently grounded in legislation (Sheng, 2001; Tang, 2001). So far, the challenge has been only academic, but at some point a suitably motivated court might agree.

The need to consider the role of institutions can be demonstrated by looking at the CSRC’s recent regulations requiring listed companies to have at least one third of their board consist of independent directors by June 30, 2003 (CSRC, 2001). The independent directors are said to owe a duty of good faith (chengxin) and diligence (qinmian) to the company and to the entire body of shareholders. But can this duty be made meaningful in China’s current legal system?  The Company Law speaks only of a duty of loyalty, and it is far from clear that shareholders could successfully sue for a breach. It is very unlikely that the CSRC, which does not even have the status of a regular government administrative agency, can by itself create a private right of action for shareholders against directors. It has engaged in a limited number of disciplinary actions against directors,   but any norm that relies  solely on administrative enforcement is going to be of limited value, given the CSRC’s resource constraints.As Mark Roe (2002) has pointed out, corporate governance depends on much more than simply getting the law right. The presence of other institutions is critical. But their presence in China cannot be assumed. The financial information industry, for example, is significantly crippled by the state’s continuing insistence on control over all information. Control over information is a cornerstone of the Chinese Communist Party’s system of political control and is unlikely to disappear much before the Party itself. Other intermediary institutions such as law firms, accounting firms, investment banks, brokerages, and stock exchanges all exist — like any organization in China — only with government permission and cannot simply spring up in response to market demand. There is no real market for corporate control, and the market for managerial talent is still very small.

CONCLUSION

Any discussion of corporate governance in China must take seriously the implications of the state’s policy of continuing and significant involvement in enterprise ownership. Many of the problems the drafters of the Company Law sought to address are not necessarily best addressed by a statute like the Company Law, or even by an institution such as legislation and government enforcement. Where they are state sector issues, it might seem almost perverse to attempt to address them through an institution designed to operate in a universe of freedom of contract and private rights. While the policy of state ownership continues, the only way to clear the road for the development of a corporate governance system appropriate for non-state-owned enterprises is for policymakers to acknowledge that a unified model is neither necessary nor desirable. But getting the model right is not enough. Policymakers must also think clearly about the capacity of the institutions — not just legal, but social and economic — that are needed to make the model function as expected.

(Edited by: China West Lawyer)