Best behavior

The investigation of Huang Guangyu is still underway, but its impact is already being felt. The former chairman of consumer electronics retail giant Gome – and one of the richest men in China – was detained in November as part of a police investigation into alleged share manipulation.

The specifics of the investigations concerned suspicious movements in the share prices of two companies. But for China’s securities markets, the specifics matter less than the investigation, which may indicate a new aggressiveness in Beijing’s attempts to promote good corporate governance.

An aggressive approach may have a mixed impact – it is rumored that Huang was targeted for personal reasons – but there’s no doubt that corporate governance is a thorny issue for China’s regulators.

The challenge these regulators face is to create an environment that encourages corporations to develop effective internal governance on their own.

"These are inter-linked," said Frank M. Song, director of the Research Institute of China Finance at the University of Hong Kong. "If we do not have effective regulations, a good corporate governance system may not develop well."

Policy action

As the Huang investigation shows, Beijing is happy to step in when needed. It is not confining itself to investigations. A series of reforms have gone some way toward providing the level of oversight required for good corporate governance.

Among these is the non-tradable share reform, which, when fully implemented, will eliminate a quirk of the market: Holders of non-tradable shares cannot profit from rising shares and therefore have little incentive to push for firms to create value for shareholders.

Accountability will also be strengthened by new initiatives toward creating stricter accounting standards. On January 14, it was announced that insurers listed in both Hong Kong and Shanghai would be required to adopt an updated, uniform accounting standard. It is a step in the right direction, but simply introducing new standards is not enough.

"There are a lot of new initiatives," said Dr Chen Chung-Hsing, head of Xinhua Finance Ratings. "What I am concerned about is implementation. Will they do it in a way that is satisfactory? That is another story."

Within the companies themselves, shareholders could also benefit from a trend toward performance-based pay for executives. High corporate profits in China have frequently been spurred by government policy rather than executive decisions, Chen noted.

Even a simple emphasis on improving transparency could go a long way toward enhancing monitoring of the market, says Song. Similarly, opening China’s market up to increased competition, both internally and externally, would create pressures for companies to reform their internal operations.

Effective regulation will require a balanced approach.

"It’s between growth and stability; development and stability; innovation and stability. There’s always a trade-off," said Song.