Transcript Document 7353291

A Brief Review of Corporate Governance Issues
in the People's Republic of China
Michael E. Burke, Honorary Fellow, Asian
Institute of International Financial Law, Hong
Kong University
November 10, 2003
2003 U.S.-China Legal Exchange
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Defining Objective Corporate Governance Standards
Defining corporate governance:
Corporate governance relates to the internal means by which
corporations are operated and controlled.
Objective standards:
The corporate governance principles promulgated by the Organization for
Economic Cooperation and Development (OECD), available at the OECD’s
website (www.oecd.org) are recognized as an influential, objective set of
corporate governance principles and represent the first initiative by an intergovernmental organization to develop the core elements of a good corporate
governance regime.
The Principles can be used as a benchmark by governments as they evaluate
and improve their laws and regulations. They also can be used by private
sector parties that have a role in developing corporate governance systems
and best practices.
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OECD Principles
The Principles are divided into five (5) themes:
The corporate governance framework should protect shareholders’
rights.
The corporate governance framework should ensure the equitable
treatment of all shareholders, including minority and foreign
shareholders. All shareholders should have the opportunity to obtain
effective redress for violation of their rights.
The corporate governance framework should recognize the rights of
stakeholders as established by law and encourage active co-operation
between corporations and stakeholders in creating wealth, jobs, and
the sustainability of financially sound enterprises.
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OECD Principles, Cont’d
The corporate governance framework should ensure that timely and
accurate disclosure is made on all material matters regarding the
corporation, including the financial situation, performance,
ownership, and governance of the company.
The corporate governance framework should ensure the strategic
guidance of the company, the effective monitoring of management
by the board, and the board’s accountability to the company and the
shareholders.
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General Observations About Corporate Governance in
China:
Much has been accomplished but there is still much to do; in
some areas, Chinese regulation predates similar U.S.
regulation.
Corporate governance has moved to the center stage of
Chinese enterprise reform:
The Fourth Plenum of the Chinese Communist Party's 15th Central
Committee held in September 1999 adopted a decision that identifies
corporate governance as the core of the modern enterprise system.
Commitments under the World Trade Organization add some
urgency to tackle corporate governance issues in a comprehensive
and systematic manner.
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General Observations About Corporate Governance in
China:
legal framework has limited shareholder protection;
corporations with concentrated ownership predominate;
small shareholders are inactive in company oversight;
government influences management appointment and
corporation operations;
too much power is concentrated in the hands of a few
shareholders; and
at times, a lack of accountability for corporate actions or
omissions.
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Concentrated Ownership
Three largest shareholders held, on average, about 58% of total
shares in listed Chinese companies.
Average shareholding of the largest shareholders is about 47%.
In almost 49% of sample firms, the three largest shareholders accounted
for 60 to 80% of all shares.
In PRC listed companies, the largest shareholder accounts for
slightly less than 50% of all shares but controls more than 50%
of board seats.
Directly or indirectly, the State selects almost 70% of all directors of all
PRC listed companies.
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Concentrated Ownership, Cont’d
Other jurisdictions recognize the duty of fair dealing by
majority shareholders in relation to minority shareholders.
Fiduciary duties of controlling shareholders are not stipulated
in relevant law, their liabilities in relation to losses incurred by
minority shareholders are not clear.
Recent PRC regulations implicitly introduce this principle without,
however, spelling out liabilities, penalties, and procedures.
Documented abuses by controlling shareholders:
soft loans from listed companies on a long-term basis;
use of listed companies as guarantors for bank loans; and
the sale of assets at unfair prices, usually without an appraisal by an
independent evaluator.
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Board Issues
Directors’ incentives may not be linked to their companies'
return on equity or earnings per share growth.
Directors can not be dismissed (prior to the expiration of their
term) without "cause," although such concept is not defined.
Directors owe the duties of good faith and due diligence and
care towards the listed company and all the shareholders,
although relevant law does not define these concepts further or
create an enforcement mechanism.
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Board Issues, Cont’d
Compared with practices in other markets, Chinese boards have less
decision-making power within the existing legislative framework,
while government ministries and commissions and securities
regulatory authorities have substantial decision-making power.
The Company Law does not stipulate any disclosure obligation on the
part of directors or any specific liabilities assumed by directors who
fail to perform their obligations.
Chinese corporations still lack nominating committees for directors
and corporate governance committees and listed companies do not
disclose their procedures for nominating directors or their corporate
governance principles.
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Board Issues, Cont’d
A 1999 survey showed that only 3.1% of all directors had some degree of
independence; in 2003, average listed company has 3 independent directors.
On August 16, 2001 the China Securities Regulatory Commission (CSRC) issued
the Establishment of Independent Director Systems by Listed Companies Guiding Opinion
(the Guiding Opinion), requiring 1/3 of Board directors to be independent.
Most listed companies do not have a system in place for establishing board
committees.
Only 5.4% of surveyed listed Chinese companies have established any committee
under the board of directors, and only 14% plan to set up such committees.
In those companies that do have committees, the committees are usually an
investment or finance committee, an audit committee, a financial management
committee, and/or a strategy committee.
The main functions of the committees focus on decisions concerning major
investment projects, while their supervisory and auditing functions are at an early
stage of development.
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Shareholders’ Issues
The Company Law requires every company to establish a
shareholders' general meeting.
While every shareholder may attend a shareholders' general
meeting, recent data indicates that most attendees are state
representative and representatives of legal persons.
Not all companies have established a shareholders' general
meeting, and there are indications that some boards of
directors simply ignore the meeting's decisions.
Shareholders' general meeting sometimes will vet proposed actions with
the Board before taking action.
Only about 20% of company actions are voted on at the shareholders'
general meeting.
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Shareholder Protection Issues
The Supreme People's Court allows courts to hear only a very
limited class of securities-related claims.
The remedy the Company Law provides to minority
shareholders is that they may apply to the courts to prevent the
continuation of unlawful conduct by directors and majority
shareholders.
Existing laws and regulations do not specify penalties for corporations and
officers that obstruct shareholders’ rights to access information.
Securities Law is unclear as to whether investors can take civil
action against directors and investment professionals for false
or negligent disclosures that resulted in losses.
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Shareholder Protection Issues
On January 9, 2003, the PRC Supreme People's Court (the SPC) promulgated the
Trial of Civil Damages Cases Arising from Misrepresentation in the Securities Market
Several Provisions (the Provisions), which entered into effect on February 1, 2003.
The Provisions extend the Questions Concerning the Acceptance of Civil Tort Dispute
Cases Arising from Misrepresentation in the Securities Market Circular (the Circular)
issued and effective January 15, 2002.
The Provisions discuss acceptance of cases and jurisdictions, methods of bringing lawsuits,
determination of misrepresentation, liabilities determination and exemption, joint tort
liability, calculation of loss and miscellaneous. As defined in the Provisions, misrepresentation
can include fraudulent records, misleading statements, material omissions and improper
disclosure.
The Provisions deal only with misrepresentation made by public companies and not
share price manipulation or insider trading.
The Provisions exclude a class action litigation as a permitted channel for investors to
bring a lawsuit.
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Disclosure Issues
Financial reporting, accounting practices, and disclosure are
oriented toward satisfying the information needs of taxation
authorities.
Separate reporting for tax and accounting purposes does not exist.
Inadequate disclosure of related party transactions, line
segment information, accounting policies, impact of
extraordinary items, contingencies, capital commitments, and
effects of changes in government policies.
The regulations do not require the distribution of annual
reports to shareholders.
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Disclosure Issues, Cont’d
Disclosure in annual reports is governed by detailed
requirements that focus on short-term rather than long-term
objectives and strategies, do not sufficiently emphasize
business opportunities and risks, are lenient on segment
reporting and corporate governance, and discourage the use
of projections.
Multiple bases for preparing and auditing financial
statements also affects the quality of information.
Some companies follow IAS, others use U.S. GAAP, and still others
follow domestic standards.
Variable quality of audits by certified public accountants.
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