Group

Members Anjali Chauhan Avishek Avik Chattopadhyay Deepti K.S. Mukul Attri Sahil Swapnil Bhosale

DOES CORPORATE GOVERNANCE MATTER IN CHINA'S CAPITAL MARKETS?

Before we begin, let us take a look at the latest lawsuit filed against PetroChina by US for not complying with the corporate government practices. The lawsuit alleges PetroChina failed to disclose that some of its senior officials were in non-compliance with its corporate governance directives and code of ethics, and that PetroChina was subject to investigation by the Chinese authorities.

WHY CORPORATE GOVERNANCE WAS REQUIRED IN CHINAS CAPITAL MARKETS

Managers had wide discretion in running firms. However, their decisions might not have been in the best interests of the firms or the shareholders. Shareholders had limited legal remedies against exploitation by company management or a controlling shareholder. Chinas legal framework was still at a nascent stage. Banks did not provide sufficient oversight of the governance of corporate creditors. Supervisory board lacked the power to appoint or dismiss directors and managers. Ownership concentration in most companies was high. Directors did not understand their duties. Because of state ownership, insider trading and other factors, no significant correlation existed between the market value of a company, its intrinsic value and governance.

AFFECT OF CORPORATE GOVERNANCE IN CHINA

Transparency of information disclosure. Independent non-executive directors ensured that the small groups of individuals did not dominate the boards decision making. They also ensured that industry expertise was brought to the board.
Delisting of certain companies that did not follow corporate governance and were not transparent in their operational and financial policies.

The dominance of party was reduced substantially in small private companies.

 Business

formation and Management in China has a long and winding history tracing back thousands of years. In the current stage China has mixed private and state-owned economic structure. The CPC( Communist Party Of China) still retains firm control of all political matters which unavoidably involves state control of major chinese industries.

 Having

developed against against the backdrop of unique Chinese culture, the characteristics of Chinese business management are quite different from the western world. Example: 1) Confucianism. 2) Preeminence placed on the superior person in the relationship. 3) Rule of Game GuanXi - meaning personal connections.

 The

chinese government has adopted several regulations regarding business management and corporate governance. The major regulations are as follows: 1) The Company Law. 2) The Partnership Law. 3) The Sole Proprietorship Enterprise Law.
A comparison of Chinese Company Law with its American counterpart will give us better understanding of the Chinese Corporate Governance system.

 Similarities:

1) Criteria for establishing both LLC & Joint stock limited company. 2) A listed company is under the regulation & monitoring of State Security Regulatory Authority. 3) Registering the Articles of Association with the state authorities. 4) As in U.S Corporate Law , Chinese Company Law also includes sections on piercing the corporate veil.

 Differences:

1) Application of such principles like piercing the corporate veil. U.S courts are often reluctant to pierce the corporate veil but chinese courts are more eager to do so. This results in the less protection of corporate identity in China as compared to U.S. 2) Chinas Company Law mandates more stringent minimum capital requirement for both LLC and Joint Stock Listed Companies. eg: 1,00,000 RMB -> LLC. 1,000,000 RMB-> Joint Stock Listed Com.

 Mandatory

appointment of the General Manager by the Board of Directors for implementing its resolutions. The General Manager is responsible for the day-today affairs of the company. Shareholders in the Limited company with exceptions in small companies should elect Board Of Supervisors in charge of reviewing and monitoring the activities of the BOD. American Corporate governance has function called Outside Counsel .

 Chinese

system states that the Shareholders committee is the authoritative organ of a limited company. In U.S , shareholders only get involved in the major business decisions like M&A etc. In China, Shareholders committee gets involved in Boards decision making process. Resolution approved by the BOD should be approved by the committee before it can be adopted. The General Manager is accountable to the Board of Directors and Supervisory board is a monitoring agency.

 The

Chinese Company Law also mandates that all limited companies establish a Chinese Communist Party organization in the company for the purpose of state monitoring. All employees of the limited companies that have more than 3 employees must have labour union memberships and elect union representatives. No public servant is allowed to serve as the Director, supervisor or the General Manager of the limited company. In wholly state-owned companies, no shareholders committee is allowed. All decision making power lies with the state authority.

Germany
Banks

Japan Bank-based financial and corporate governance structure Powerful government intervention CEOs of public and private companies receive similar levels of compensation

China

exercise significant power as a source of financing for firms. In many private German firms, the owner and manager may be the same individual Two-tiered board structures, required for larger employers

The state is imposing social goals on these firms Firms with higher state ownership have lower market value and more volatility Corporate Governance structures are moving closer to the U.S. corporate governance model

China had been a communist government and following the corporate governance standards started very late, It started only when they realized they required international exposure. PetroChina Corporate Governance in spite of being one of few companies in China that had more transparency, had many risks inherently.

Dividend and Capital Investment Policy: CNPC held 90% of PetroChina. CNPC ownership being SOE. Any income generated through it would go to CNPC. Shareholders were not sure if any income generated would be turned towards their favor. In spite of PetroChina mentioning only 10% would be given to CNPC, shareholders were not sure. Dividends decisions would be indirectly taken by CNPC.

Appointment of Directors and Corporate Officers:

13 board of Directors ( 3 were independent, in that 2 of their credibility was questioned, as they were some how related to Government) Many people were part of CNPC and PetroChina which raised suspicions. CNPC and other government bodies were actually having a major say in electing the Board which was not a good sign.

Legal Protection for Outside Investors: Other countries laws are not applicable in China which was a major concern for investors outside China.

 Management

Incentive Programme:

Managers compensation was dependent on their performance (30-70% bonus dependent on their performance) PetroChina granted share options and rights to officers and directors, promised to extend the same to remaining employees.

Information

Disclosure:

Relatively high level of transparency. Delivered financials every quarter. Audit as per IAS got a clean auditors report. Used to give information about Operating Stats, Stock Information, General Meetings etc.

 Supervisory

Board:

It consisted of 7 members including 2 independent Supervisors. Meetings, Inspection of companys financial position, compliancy of operations etc..

Policies

and Procedures:

Complied with the Code of Best Practice governing companies listed on HKSE. Formulated set of policies regarding shareholders general and other meetings.

Steps Taken to Improve Governance in China

Better Rules and Practices of Disclosure Safeguard Conflicts of Interest : Rules of Related-Party Transactions Disclosure; the Use of Human,Financial and Physical Resources of a Listed Company Is Separated from That of Its Controlling Company Higher Standards of Ethics of Directors:the New Listing Rules Require Each Director to Have a Formal Declaration and Undertaking in the Performance of His Duties

Dominant Policy Issue to Develop Market Economy in China

Re-construct Thousands of SOEs Improve the Performance of Stock Markets Establish the Foundation of the Market Economy

Three Steps to Improve the Corporate Governance

Strengthen Legal Rules and Enforcement Diversify the Ownership Maintain the Independence of Board of Directors

Strengthen Legal Rules and Enforcement Legislate to Improve Minority Shareholders Protection and Make Preparations for the Setting up of the Investor Protection Centre Adopt More International Accounting Rules Strengthen Disclosure Requirement Issue the SSE Guidelines for Corporate Governance

Diversify the Ownership Reduce or Sell Off the Shares held by the Governments Introduce other Forms of Sizeable Outside Shareholders Including Closed-End & OpenEnd Mutual Funds,Insurance Companies,Pension Funds and Other Institutional Investors

Maintain the Independence of Board of Directors

Encourage More Independent Directors to Enter the Board of Directors Establish Audit Committee,Nominate Committee etc.to Curb the Power of Blockholders/Executives

 Corporate

Governance Reform are Very Complicated in China, the Solution May Lie on the Interactions among Economic Performance,Available Governance Resources and the Political System Reform