Intent Declared Summary

In China, a system of corporate governance has emerged as a result of enterprise, legal, institutional and regulatory reforms. In January 2001, the China Securities Regulatory Commission (CSRC) issued the Code of Corporate Governance for Listed Companies in China. Based on the "comply or explain" principle, the Code has “strictly followed” the Organization for Economic Cooperation and Development Principles of Corporate Governance, according to a 2003 article Violet Xing. Revisions to the Company Law and Securities Law in 2006 have also strengthened minority shareholder rights and disclosure requirements for listed firms. The publication of Basic Standard for Enterprise Internal Control in 2008, to be implemented over time, signals another important step towards enhancing corporate governance. However, highly concentrated ownership structure, the dominance of state-owned enterprises, and the resulting weak minority shareholder protection remain as major obstacles to develop a corporate governance culture in China. Lu et al. also note that the gap between good and poor corporate governance among listed companies is significant. Various recommendations are being put forth to improve corporate governance in China, including speeding up share reform, shareholding diversification, reducing government intervention in state owned enterprises, improving minority shareholder rights, and enhancing board structure and responsibility.

General Overview

State-owned enterprises (SOEs) and publicly held companies are the most common type of firms in China. Since the establishment of the Shanghai Stock Exchange (SSE) and the Shenzhen Stock Exchange (SZSE) in 1990 and 1991 respectively, the majority of SOEs have been restructured into listed companies. SOEs account for about 70 percent of total listed companies in China, according to the Institute of International Finance's (IIF’s) 2006 report on Corporate Governance. Corporate governance provisions for listed companies are mainly contained in the Company Law, Securities Law, as well as relevant administrative regulations and the stock exchange listing rules. The China Securities Regulatory Commission (CSRC) was established in 1992 as the executive branch of the State Council Securities Commission (SCSC). As part of the securities reform that led to the promulgation of China's first Securities Law in 1998, the SCSC and the CSRC merged to form a centralized supervisory agency for the securities market, under the direct control of the State Council of the People's Republic of China (i.e. the Chinese government). In January 2001, the CSRC issued the Code of Corporate Governance for Listed Companies in China. The Code is applicable to all listed companies with the aim of protecting the rights and interests of investors, and is based on the "comply or explain" principle. According to Violet Xing's 2003 article, "the Code has strictly followed the Organization for Economic Cooperation and Development (OECD) Principles of Corporate Governance" (p. 377). Xing notes that the Code of Corporate Governance for Listed Companies "is more like an administrative regulation rather than a self-regulatory code" (p. 393). Efforts to improve corporate governance of listed companies include imposing internal governance requirements, strengthening monitoring of corporate management, and introducing a system of independent directors and board committees.

Major revisions to the Company Law and Securities Law took place in October 2005, and came into effect in January 2006. In 2007, the CSRC issued Regulations on Information Disclosure of Listed Companies to further regulate information disclosure and protect rights of investors. The Ministry of Finance, CSRC, National Audit Office, China Banking Regulatory Commission and China Insurance Regulatory Commission jointly published the Basic Standard for Enterprise Internal Control (the Standard) in 2008, after years of preparation, to “increase the effectiveness of internal controls in listed Chinese companies, thus reducing risks for companies and their stakeholders,” according to a 2009 article by Raymond. The Standard requires listed companies to conduct self-evaluations of their internal controls, publish an evaluation report and hire qualified agencies to audit the effectiveness of their internal controls. The start date of this regulation has been postponed from July 1, 2009 to potentially January 1, 2010, in order to give companies sufficient preparation time.

Listed companies in China adopt a two-tier board structure, comprising a board of directors and a supervisory board. In practice, however, the board of directors is the main decision-making authority. A study by Violet Xing published in the 2003 Bond Law Review, indicates that the majority of listed companies, which have been restructured from traditional SOEs, lack an adequate corporate governance culture. The separation of ownership and managerial control has also given way to potential conflicts of interest among stakeholders. Another dominant feature of the Chinese corporate governance model is large institutional shareholdings, including state legal person shares and legal person shares. State legal person shares are shares held by other state owned institutions. Conversely, legal person shares are shares held by non-state owned institutions.

Two reports published by Lu Tong et al. in 2009, “How Good is Corporate Governance in China?” and “Corporate Governance Assessment Summary Report on the Top 100 Chinese Listed Companies for 2009,” attempt to evaluate the progress of corporate governance reform in China by assessing the 100 largest Chinese listed companies (by market value on June 30, 2007 and June 30, 2008 respectively) against a corporate governance index based on the Organization for Economic Cooperation and Development (OECD) Principles of Corporate Governance. The two reports find that Chinese companies have been making progress in corporate governance with regard to disclosure and transparency, partly due to the efforts of regulatory bodies, financial institutions and stock exchanges. Meanwhile, state-owned enterprises have also showed “initial signs of success” (Lu et al. 2009b, p. 83) in improving their corporate governance. Further, as mentioned earlier in the report, with the publication of Basic Standard for Enterprise Internal Control in 2008, Chinese listed companies have started to establish internal control systems. Revisions to the Company Law and Securities Law in 2006 have strengthened minority shareholder rights and disclosure requirements for listed firms. Investors have been more actively involved in exercising and protecting their rights, and the pilot share reform program is also a step in the right direction.

However, there is still much room for improvement, especially in terms of ownership structure, minority shareholder rights, board responsibilities, and enforcement effectiveness. The IIF's 2006 report concludes that given the large number of SOEs listed on the SSE and the SZSE, "improvements in China's corporate governance culture are possible only if corporate governance in [SOEs] is improved" (p. 4). The IIF's 2006 report stresses that government intervention in Chinese companies needs to be seriously addressed for effective progress to take place. This echoes the views of Mintz and Krishnan in their 2009 article that government agencies as shareholders should be disassociated from SOEs daily management and decision-making process, and eventually be fully disassociated from the SOEs under their control. The 2008 Review of Corporate Governance by Li et al. further concludes that "without strict enforcement, corporate governance rules and regulations lack any credible role in the domestic market" (p. 14).

Similarly, the 2009 Lu et al. and 2008 Li et al. reports conclude that highly concentrated ownership structure (mostly by the government) also results in poor minority shareholder protection, insider trading, and market manipulation. Franklin Allen concurs in his 2005 paper that strong government intervention, low transparency, and weak investor protection hinder the development of a corporate governance framework in China. Moreover, while the quality of board of directors has increased, the functioning of boards of supervisors needs further improvement, and the significant increase in senior management remuneration is a serious cause of concern, according to Lu et al.’s 2009 reports. Chinese listed companies also show weaknesses in stakeholder participation and lack of employee participation. In addition, the gap between good and poor corporate governance remains large among listed companies, with SOEs still at the medium level and monopoly companies “significantly lagging behind” (Lu et al. 2009a, p. 18).

The above-mentioned reports have put forth various recommendations to improve corporate governance in China. Lu et al. recommend speeding up the pace of split share structure reform and shareholding diversification and promoting market competition. They also state that minority shareholder rights protection should (and has) become a top priority for improving Chinese corporate governance. Further, the board of directors should strengthen its responsibility in overseeing the appropriate remuneration of senior management. The 2008 Review of Corporate Governance by Li et al suggests clarifying and strengthening the functions of the board of directors and supervisory board. The establishment of specialized committees (e.g. nomination committees, remuneration committees, and auditing committees) composed solely of independent directors is also encouraged. Finally, there is a need for well functioning laws to address investor protection, and more efficient legal enforcement systems. Recommendations of the 2006 IIF report include reducing government intervention in SOEs; strengthening judicial enforcement for the protection of shareholders' interests; increasing participation of institutional investors; and promoting investor education. The IIF further encourages introducing specific corporate governance best practices for SOEs by strictly enforcing a Code of Corporate Governance.

The main stock exchanges in China, the Shanghai Stock Exchange and the Shenzhen Stock Exchange are directly governed by the CSRC. The SSE is the leading stock market in mainland China. According to a 2009 U.S. Department of Commerce report, in recent years Chinese regulators have encouraged both state-owned and private Chinese firms to list on domestic markets. In terms of market capitalization, the SSE is Asia's second largest stock exchange, and ranks fifth worldwide. As of December 31, 2007, as stated on the SSE website, there were 860 listed companies on the SSE with a combined market capitalization of USD3.95 trillion. Conversely, the SZSE has a market capitalization of around USD146 billion, and provides a direct financing platform for hi-tech or rapidly growing small and medium enterprises with competitive core businesses. However due to the financial crisis in 2008, only RMB 222 billion was raised on the A Share market in 2008, including RMB 73 billion from initial public offerings compared to almost RMB 438 billion in 2007. The China Financial Futures Exchange was inaugurated in September 2006 in Shanghai, as China's first exchange specializing in derivatives trading, according to the Institute of International Bankers' 2007 Global Survey. China's new regulations on futures trading were enacted in April 2007.

In April 2005, the CSRC initiated a pilot share reform program requiring all non-tradable shares in SOEs to be converted into tradable A-shares. As of April 2006, nearly 66 percent of listed companies, accounting for 70 percent of the stock market capitalization, had implemented the reform program. A-shares are common shares issued by the SSE and SZSE in Chinese currency. The 2008 report by Larry Li et al. states that the State-owned Assets Supervision and Administration Commission (SASAC), established in 2003 under the State Council, has a key role in reorganizing the SOEs. The SASAC is responsible for appointing top executives at SOEs, approving mergers or sales of stock or assets, as well as drafting laws related to SOEs. According to Lu et al. in their 2009 report “How Good is Corporate Governance in China,” Chinese capital markets began to operate as a full circulation markets in 2007 and that “the split share structure reform basically complete” (p. 83). However, Larry Li et al. note at the time of their 2008 report that “the reform is still far from the final stage” (p. 19)

In the joint World Bank and International Bank for Reconstruction and Development 2010 Doing Business report, which was published in 2009, investor protection in China scores slightly below the regional mean and below the average achieved by member states of the Organization for Economic Cooperation and Development. The Investor Protection Index is a subcomponent of the World Bank's Doing Business Indicators, and consists of three dimensions of investor protection: transparency of transactions (Extent of Disclosure Index), liability for self-dealing (Extent of Director Liability Index), and shareholders' ability to sue officers and directors for misconduct (Ease of Shareholder Suits Index). The indices range between 0 and 10, with higher values indicating greater disclosure, greater liability of directors, greater powers of shareholders to challenge the transaction, and better investor protection. While China scores 10 in the disclosure index, against a regional average of 5.1 and an OECD average of 5.9, it only scores 1 in the Director Liability Index, against a regional average of 4.6 and an OECD average of 5. Finally, it scores 4 in the Shareholder Suits Index, against a regional average of 6.3 and an OECD average of 6.6.

The Principles

IIPrinciple I: Ensuring the Basis for an Effective Corporate Governance Framework

Two reports published by Lu Tong et al. in 2009 attempt to evaluate the progress of corporate governance reform in China by assessing the 100 largest Chinese listed companies (by market value on June 30, 2007 and June 30, 2008 respectively) against a corporate governance index based on the OECD Principles of Corporate Governance. They find that Chinese companies have been making progress in corporate governance with regard to disclosure and transparency, partly due to the efforts of regulatory bodies, financial institutions and stock exchanges. In January 2001, the CSRC issued the Code of Corporate Governance for Listed Companies in China. The Code is applicable to all listed companies with the aim of protecting the rights and interests of investors. In January 2004, the CSRC issued the Provisional Code of Corporate Governance for Securities Companies, applicable to all listed companies. The Provisional Code focuses on the operations of securities companies to promote shareholder and stakeholder protection. Revisions to the Company Law and Securities Law in 2006 have also strengthened minority shareholder rights and disclosure requirements for listed firms. In 2007, the CSRC issued Regulations on Information Disclosure of Listed Companies to further regulate information disclosure and protect rights of investors. The Ministry of Finance, CSRC, National Audit Office, China Banking Regulatory Commission and China Insurance Regulatory Commission jointly published the Basic Standard for Enterprise Internal Control (the Standard) in 2008, after years of preparation, to “increase the effectiveness of internal controls in listed Chinese companies, thus reducing risks for companies and their stakeholders,” according to a 2009 article by Raymond. The Standard requires listed companies to conduct self-evaluations of their internal controls, publish an evaluation report and hire qualified agencies to audit the effectiveness of their internal controls. The start date of this regulation has been postponed from July 1, 2009 to potentially January 1, 2010, in order to give companies sufficient preparation time.

Despite important improvements in China's securities regulatory regime, the legal system remains underdeveloped, constraining progress in the enforcement of shareholders' rights. The 2008 Review of Corporate Governance by Li et al. concludes that "without strict enforcement, corporate governance rules and regulations lack any creditable role in the domestic market" (p. 14). The 2005 study by Allen et al. further argues that China lacks an independent and effective judicial system with sufficient qualified legal professionals. In addition, a strong and unified insolvency regime has yet to be established. Despite the information provided above, there is insufficient information publicly available addressing China's compliance with this principle.

NCPrinciple II: The Rights of Shareholders and Key Ownership Function

Pursuant to the Code of Corporate Governance for Listed Companies, according to Xing's 2003 article, shareholders' rights include the right to be informed and participate in major decisions of the company, and vote in the general shareholder's meeting. Shareholders are further encouraged to protect their interests and rights through civil litigation. The Provisional Code of Corporate Governance for Securities Companies, promulgated in 2004, focuses on the operations of securities companies to promote shareholder and stakeholder protection. According to the CSRC's 2007 report on China's Securities and Futures Markets, the major institutional investors in China include 104 securities companies, 58 securities investment fund management companies, 52 Qualified Foreign Institutional Investors, insurance companies, corporate annuities and the National Council for Social Security Fund.

The Lu et al. 2009 report “How Good is Corporate Governance in China?” states that shareholders’ meetings in Chinese listed companies are basically “routine formalities with limited real accomplishments” (p. 93). The 2003 report by Standard and Poor's on Corporate Governance in China states that "shareholders do not have equal rights in terms of profit sharing, participation in shareholder meetings in person or via proxy, voting, and monitoring/ questioning/making recommendations to the management" (p. 11). Shareholders also have pre-emptive rights under the Law, which might prevent the issuance of shares to new shareholders. In turn, this might make it increasingly difficult to dilute existing shareholder's ownership stakes and voting rights. In this regard, the IIF's 2006 report recommend allowing new listings of A-shares on the SSE and SZSE. Further recommendations of the IIF include increasing the participation of institutional investors to form a broader share ownership structure, as well as promoting investor education. Finally, the IIF encourages strengthening judicial enforcement for the protection of shareholders' interests.

NCPrinciple III: The Equitable Treatment of Shareholders

Revisions to the Company Law and Securities Law have strengthened minority shareholders' rights, states the IIF's 2006 report. In practice, however, minority shareholders have little influence over management. Lu et al. and Li et al. concur in their 2009 and 2008 reports that the highly concentrated ownership structure has resulted in poor minority shareholder protection, insider trading, and market manipulation. Lu et al. state that minority shareholder rights protection should (and has) become a top priority for improving Chinese corporate governance. The IIF report recommends improving the alignment of management interests with those of minority shareholders, by notably bringing executive remuneration more in line with overall company performance.

IIPrinciple IV: The Role of Stakeholders in Corporate Governance

Pursuant to the Code of Corporate Governance for Listed Companies, according to Xing's 2003 article, listed companies should "respect the legal rights of banks and other creditors, employees, consumers, suppliers, the community and other stakeholders" (p. 388). The Provisional Code of Corporate Governance for Securities Companies, promulgated in 2004, focuses on the operations of securities companies to promote shareholder and stakeholder protection. Lu el al mentions in their 2009 report “How Good is Corporate Governance in China” that “Chinese listed companies lack robust corporate governance frameworks with adequate participation from employees” (p. 94). Nevertheless, there is insufficient information publicly available addressing China's compliance with this principle.

IIPrinciple V: Disclosure and Transparency

The 2003 article by Xing states that under the Code of Corporate Governance for Listed Companies listed companies should "truthfully, accurately, completely and timely disclose information as required by laws, regulations and the company's articles of association" (p. 388). The Code further imposes restrictions and disclosure requirements on related party transactions. As stated on the ACGA website, China's regulatory regime requires quarterly financial reporting, and various regulations and directives to improve disclosure among listed companies. The revised Securities Law has also strengthened disclosure requirements for listed firms. The CSRC's 2007 Securities and Futures Markets report indicates that information disclosed by listed companies falls into three main categories. The first category--public offering information--includes prospectuses, stock and bond listing announcements, and bonds issuance scheme. The second category--periodic reports--comprises annual reports, interim reports and quarterly reports. Finally, listed companies are required to submit an ad hoc report to the CSRC in the occurrence of a major event.

The China Accounting Standards Committee under the Ministry of Finance (MoF) is the advisory body for setting Chinese accounting standards. According to the IIF's 2006 report, revisions to the Company Law provide that financial and accounting reports be audited. The Law also clarifies conditions regarding the appointment and dismissal of external auditors. In February 2006, the MoF formally issued 38 basic Accounting Standards for Business Enterprises (ASBE) with effect from January 1, 2007. Starting in 2008, according to the Deloitte & Touche IAS Plus website, all SOEs will also be required to use the ASBE standards. The same will apply to large and medium-sized companies as of 2009. While the IIF's 2006 report welcomes the Chinese authorities' efforts to bring financial reporting in China more in line with IFRSs it stresses that China's accounting and auditing practices, as well as disclosure of financial information remain weak. Lu et al. compared the annual reports of the top 100 listed companies by market capitalization over the past five years and find that “the quality of annual reports improved year on year” (p. 11).

The Ministry of Finance, CSRC, National Audit Office, China Banking Regulatory Commission and Insurance Regulatory Commission jointly published the Basic Standard for Enterprise Internal Control (the Standard) in 2008, after years of preparation, to “increase the effectiveness of internal controls in listed Chinese companies, thus reducing risks for companies and their stakeholders,” according to a 2009 article by Raymond. The Standard requires listed companies to conduct self-evaluations of their internal controls, publish an evaluation report and hire qualified agencies to audit the effectiveness of their internal controls. The start date of this regulation has been postponed from July 1, 2009 to potentially January 1, 2010, in order to give companies sufficient preparation time. Despite the information provided above, there is insufficient information publicly available addressing China's compliance with this principle.

IIPrinciple VI: The Responsibilities of the Board

Pursuant to the Code of Corporate Governance for Listed Companies, according to Xing's 2003 article, directors should "faithfully, honestly and diligently perform their duties for the best interest of the company and all the shareholders" (p. 386). At least two independent directors must sit on the board, and independent directors should represent no less than one third of the board members. Listed companies in China adopt a two-tier board structure, comprising a board of directors and a supervisory board. In practice, however, the board of directors is the main decision-making authority. A 2006 study on the independence of directors in China by Donald Clarke stresses that "the supervisory board has no significant powers to monitor the daily business operations and appoint senior management members" (p. 8). The duplication and overlap of functions between the board of directors and the supervisory board create inefficiencies in the corporate governance structure, states the IIF's 2006 report. Shortcomings also remain regarding the independence of directors. Although the overall performance of board of directors has improved, the functioning of boards of supervisors needs further enhancement, and the significant increase in senior management remuneration is a serious cause of concern, according to Lu et al.’s 2009 reports. Revisions to the Company Law clarified and made more permanent the role of the supervisory board. In addition, the CSRC has issued specific guidelines about qualifications of independent directors of listed companies. Nevertheless, there is insufficient information publicly available addressing China's compliance with this principle.