Implementing better corporate governance among Chinese corporations is a question of culture as much as it is a business problem.
China’s corporate governance environment has developed by leaps and bounds in the last few years but one factor remains virtually unchanged: In China, the concept of corporate governance runs counter to the prevailing culture.
In an annual study done by CLSA, a market research company, and the Asian Corporate Governance Association (ACGA), China ranked last in corporate governance culture in South East Asia behind Indonesia and the Philippines.
"The risk is high, it is still high," said Andrew Hupert, a consultant with long experience in China who has launched a web site to promote due diligence issues in China.
"It’s not just at the top level but it permeates throughout the whole organization. It’s one of the cultural differences? [Chinese businesspeople] think it is nuts to tell people what your corporation is doing.
"They just don’t understand why you would give full disclosure."
The problem, however, is not necessarily that Chinese corporations are resistant to change but rather the lack of a knowledge base to effectively implement corporate governance.
"You do have a regulatory framework that is definitely improving," said Jamie Allen, secretary-general of the ACGA. But he notes that new corporate governance rules give much more power to a theoretical board of directors than a single all-controlling management figure, as was traditionally the case. These boards don’t always know what to do.
"Typically the board of directors in a Chinese company is pretty weak.".
Since China’s entry into the WTO in 2001 new regulations dictating various governance issues have been enacted at a furious pace. That year, the China Securities Regulatory Commission (CSRC) issued rules calling for two non-executive directors in listed companies. New management guidelines came in early 2002.
In late 2004, regulators issued "Provisions to Protect Interests of Public Investors" and followed that up seven months later with "Guidelines for Investor Relations of Listed Companies."
The introduction of these rules was intended to go hand-in-hand with reform of the A-share market.
The veritable flood of legislation poses its own challenges for investors that have to deal with a constantly changing regulatory environment. But the risk is in the tendency among Chinese corporations to fulfill the letter of the law rather than implement change from a belief in the principles of openness and transparency. The generalization may be a little extreme but, in a recap of its efforts in China, the International Finance Corporation (IFC) – the private sector arm of the World Bank group – found a general tendency among Chinese corporations to do the bare minimum.
In its report, the IFC says this lack of motivation to implement better corporate governance has led to a lack of faith among investors around the world. For example, Calpers, the California state employees pension fund and the largest in the US, long kept its money out of China because of poor transparency.
Eluded by accuracy
Transparency aside, investors face a number of other risks that spin out of lackluster corporate governance. Among the most potentially dangerous is the lack of voting power and clarity when it comes to third party transactions and deals between companies in the same family.
However, the constant struggle for better reporting standards may be counterbalanced by spreading knowledge.
"People have increasing awareness of this issue," said Liu Dong, deputy country manager at the IFC. "Anybody who has put money in the stock market is aware of corporate governance."
At the same time, many foreign investors have operated in the country for years and have learnt to deal with the endemic lack of transparency.
"They have learnt their lesson ? you can protect yourself better if you know where things can go wrong," said the IFC’s Liu. "IFC has learnt to be local, has learnt to be China savvy."
Regulations in China are relatively new and – perhaps because they have been phased in so quickly – at times rather poorly defined.
Corporate governance gained public prominence in the US following the high-profile Enron and WorldCom scandals but the country has had legislation in the books for some time.
"In the US, it is volumes of legislation but in China [it may be] one paragraph," said Stephen Lee, partner in charge of risk advisory services at KPMG in Hong Kong.
What’s more, despite the new regulations, there has been no end to the high profile corporate scandals that can leave investors scarred.
The CLSA-ACGA report lists a number of corporate governance "disappointments". Yanzhou Coal "provided a loan to a third party in an attempt to generate a higher return on excess cash. The third party subsequently defaulted on the loan." Beijing Media, turned in a loss in the first half of 2005 just months after launching an initial public offering. China Force Oil & Grains Holdings recorded a loss in the first half of the year due to bad decisions on futures contracts. And then there was Guangdong Kelon, the refrigerator maker that is still suspended from trading. (See: Kelon: Fall of the fraudsters)
Alongside these high profile problems there were some marked improvements. China Life improved its disclosure in 2005. Hopson Development visibly strengthened its investor communications and put in place a new and strong board of directors. Both saw improved returns.
Even though investing in China remains riskier than an investment in a listed company in Hong Kong, the lack of detailed regulations and the culture of opacity in China means that the general level of corporate governance has little place to go but up.
"It can’t get worse. I’m fairly certain that it will improve," said Allen.
Indeed, in many ways it already has. The sheer amount of legislation coming down the pipes may eventually provide detailed direction while the outward push among the new breed of Chinese multinationals and listed companies is forcing many corporations to adopt better practices.
"Ten years ago all they cared about was financials ? now they look at corporate governance issues," said Leroy Yau, director of Risk Advisory Services at KPMG in Shanghai. "There are a lot of triggers pushing China in the right direction."
The big spark for the current popularity of corporate governance in China was the country’s entry into the WTO although, as Lee points out, implementing change is never an exact science. Risks don’t completely go away but morph into other forms; finding one loophole closed, those willing to live outside the law find another.
In this respect, poor corporate governance is not a uniquely Chinese problem. "Are there bad companies in America? It is the icon of best practices and they still have bad apples," Lee said.
Ultimately, the best method of preventing problems may be an old-fashioned one: cross the ‘t’s, dot the ‘i’s and avoid the temptation to make deals based on the potential of 1.3 billion customers.
"If a Chinese investor went into the US, spoke no English and said I will give you US$1 million, he would have a horror story too," Hupert said. "The learning curve for the international community doing business in China has been just as high as the Chinese community [going out] into the world."