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State-Owned Enterprise

State-owned enterprise (SOEs) reforms are focused on tackling two core problems. The first is that these firms have been shielded from competition; the second is corporate governance.

Not much progress has been made in terms of increasing SOE competitiveness, except for allowing SOE mergers under the guise of “improving competitiveness.”

In terms of corporate governance, meanwhile, although most SOEs are effectively controlled by their Chinese Communist Party (CCP) secretaries, the lack of supervision of these “executives” has, in the CCP’s view, led to considerable corruption. The

CCP seems committed to the principle that without external oversight from the state, this management problem will weaken the CCP’s ultimate control while creating enormous potential for fraud.

The CCP, therefore, has proposed a three-part solution. First, the CCP’s role in controlling SOEs will be significantly strengthened. Second, the CCP will appoint additional external board directors for supervision. Third, the CCP insists on “mixed ownership” that allows private investors to hold minority shares in SOEs to improve their corporate governance and financial performance.

DateTitleDescription
07/28/17Implementation Plan for Corporatizing Central State-owned EnterprisesBeijing again attempts to modernize state firms’ corporate governance
Implementation Plan for Corporatizing Central State-owned Enterprises

中央企业公司制改制工作实施方案

AGENCY

State Council; State-owned Assets Supervision and Administration Commission

TAKEAWAYS
  • A modern corporate governance structure will be introduced to all central state-owned enterprises (SOEs).
  • A new board created within an SOE will hold managers accountable for the corporate bottom line.
SUMMARY

Many central SOEs still retain a corporate structure that’s leftover from China’s planned economy era. In an effort to modernize their corporate structure, Beijing now mandates all central SOEs to corporatize by the end of 2017. Currently, more than two-thirds of central SOEs have not gone through this restructuring, and more than 3,000 of their subsidiaries have not done so either.

That means those central SOEs need to be restructured into either a limited liability or joint stock company, with one of the key features being the creation of a board that oversees all major corporate decisions. The board is also meant to supervise SOEs’ top managers, which are Chinese Communist Party (CCP) secretaries who effectively control the firm without any separate supervision.

But there are challenges that could hinder the corporate restructuring process, including dealing with issues of taxation and accounting for SOE assets such as the free land they previously received. These issues matter because they affect the valuation of the state firm down the line if Beijing wants to attract private investors to invest in these SOEs as part of its mixed ownership program. Without sorting out these issues first, Beijing intends to maintain full ownership of these SOEs after the corporate restructuring and not immediately attract private investors.

Creating a board might be the easiest part of this corporatization process, though the policy adamantly reiterates none of this will compromise the CCP’s ultimate control of central SOEs. But as long as a new board can introduce modest independent oversight over SOE management, then that could help improve firm performance.

04/24/17Guiding Opinion on Improving Corporate Governance of State-Owned EnterprisesThe Party takes steps to improve state firm corporate governance
Guiding Opinion on Improving Corporate Governance of State-Owned Enterprises

国务院办公厅关于进一步完善国有企业法人治理结构的指导意见

AGENCY

State Council

TAKEAWAYS
  • Authority is shifting from the state assets regulator to the state firm’s party committee.
  • To catalyze action on state-owned enterprise (SOEs) reforms, SOE executives will not be punished for mistakes or losses incurred during the reform process, as long as they do not deliberately violate existing rules.
  • SOE boards will be stacked with more external directors.
SUMMARY

The Chinese government wants to improve corporate governance by strengthening the Chinese Communist Party’s (CCP) leadership within SOEs. This intent is reinforced in the latest policy as it focuses on empowering the CCP Committee’s leadership and enhancing SOE oversight through external directors. It calls for solidifying the CCP committee’s leadership role by 2020.

To pull this off will be tricky, not least because a CCP committee does not fit well into a typical corporate governance structure. But Beijing’s strategy seems to be twofold.

First, SOEs will bring more external directors onto their boards to better monitor executives. For SOEs that are fully state owned, the majority of directors should be external and should not be employees of the companies. Members of the remuneration and audit committees should also be composed of outside directors. In addition, the oversight committee will have more full-time staff, rather than being populated with employees that may be directly connected to executives they are supposed to oversee. In short, much of this reorganization is aimed at creating more internal checks and balances.

12/30/15Guiding Opinion on Classifying State-Owned EnterprisesReform strategy of state companies will depend on new firm classification
Guiding Opinion on Classifying State-Owned Enterprises

关于国有企业功能界定与分类的指导意见

AGENCIES

State-owned Assets Supervision and Administration Commission; Ministry of Finance; National Development and Reform Commission

TAKEAWAYS
  • State-owned enterprises (SOEs) will be classified as either commercial or public-interest, which will determine their respective reform strategy.
  • Some degree of private ownership will be allowed for commercial SOEs.
SUMMARY

State firms will be categorized into two main types: 1) commercial companies that are primarily focused on profit and 2) public interest entities that do not seek profit maximization. Central and local governments, the ultimate owners of these SOEs, will ultimately determine in which category an SOE belongs. In addition, all SOEs that have not been “corporatized” should be incorporated as limited liability corporations to improve their corporate governance.

For commercially oriented SOEs in competitive sectors, such as airliners, should follow a market-based business model that maximizes profits and the value of assets. For commercial SOEs in strategic sectors such as aviation, aligning with state strategy and serving the national interest will carry greater weight when they are evaluated by their supervisors.

Public-interest oriented SOEs are meant to improve social welfare. This type of SOEs generally fall under existing monopolies such as power grid companies and natural gas suppliers. To ensure these SOEs don’t accrue high profits at society’s expense, the government will still set the prices of their products and services.

11/10/15Opinions on Strengthening and Improving the Supervision of State-Owned Assets to Prevent Their LossState assets put under microscope to avoid profiteering from privatization
Opinions on Strengthening and Improving the Supervision of State-Owned Assets to Prevent Their Loss

国务院办公厅关于加强和改进企业国有资产监督防止国有资产流失的意见

AGENCIES

CCP Central Committee; State Council

TAKEAWAYS
  • Regulators will scrutinize state-owned enterprises’ (SOEs) overseas activities to prevent company insiders from diverting state assets to their personal accounts abroad.
  • Oversight of SOEs’ foreign investments and operations will be ramped up.
  • The Chinese Communist Party’s (CCP) anti-corruption body will be more empowered to monitor the use of state assets.
SUMMARY

A major concern of implementing mixed-ownership reforms is that high-level SOE executives may enrich themselves during the partial privatization process—a situation that occurred in the former Soviet Union when it allowed privatization. To prevent a repeat of the Russian scenario, which created formidable oligarchs that could challenge the political status quo—Beijing is insisting on stringent supervision of state assets, both from external bodies and within the companies themselves.

The guideline calls on SOEs to develop an internal compliance system that oversees the companies’ finance, procurement, sales, and investment activities. The oversight role of the company board will be enhanced through increasing the number of non-executive directors and establishing an audit committee composed of such directors.

Of course, the CCP itself will play a direct role in overseeing the use of state assets. The Party will rely on central and local state‑owned assets supervision and administration commissions to send accountants and inspection teams to regularly audit companies’ financial activities. Previously, auditing did not take place independently but rather relied on SOE executives themselves. In between the audits, the empowered CCP discipline commission will take on the role of monitoring SOE malpractices.

11/4/15Opinions on Reforming and Perfecting the State-Owned Assets Management SystemCommercial returns will be more determinative in state asset allocations
Opinions on Reforming and Perfecting the State-Owned Assets Management System

国务院关于改革和完善国有资产管理体制的若干意见

AGENCIES

CCP Central Committee; State Council

TAKEAWAYS
  • The new model for managing state assets will focus on improving returns for state capital instead of directly managing the daily operations of state-owned enterprises (SOEs).
  • SOEs will expand further into emerging, high value-added, and strategic sectors.
SUMMARY

Part of SOE reforms involves more clearly separating the state’s management of SOE operations and management of state capital. The state will focus more on being a shareholder in SOEs and better managing its investments, which means that returns on investment will become a more important determinant in the allocation of state capital.

Therefore, SOEs will further expand into emerging and strategic sectors, as state assets are currently overwhelmingly concentrated in legacy industries, such as steel and coal, that are seeing stagnant growth. The shift of deploying state capital from traditional sectors to emerging ones will be under the purview of newly created state investment companies, which will be authorized, if necessary, to liquidate state assets in underperforming SOEs. However, during the liquidation process, the asset managers should strive to prevent state assets from being sold at unreasonably low prices.

10/26/15Guiding Opinion on Encouraging and Regulating Non-State Investments in State-Owned ProjectsBeijing continues to promote private investment in state projects
Guiding Opinion on Encouraging and Regulating Non-State Investments in State-Owned Projects

关于鼓励和规范国有企业投资项目引入非国有资本的指导意见

AGENCIES

National Development and Reform Commission; Ministry of Finance; Ministry of Human Resources and Social Security; State-owned Assets Supervision and Administration Commission

TAKEAWAYS
  • Private capital is allowed to control the project in which it jointly invests with state-owned enterprises (SOEs).
SUMMARY

Private capital is being encouraged to invest in specific state projects, in part to spread the risk. Ultimately, the Chinese government hopes such an approach would lead to improved management and business models for SOEs. Each jointly invested project can be viewed as an opportunity to learn and improve SOE corporate governance.

Qualified foreign investors, which could help SOEs expand business overseas, are also encouraged to participate in SOE projects. To incentivize private investment, investors that put money in such projects will have more decision-making and management power. Moreover, SOE ownership in the project can be converted into preferred stocks that have priority in receiving dividends but don’t have voting rights.

09/24/15Opinions on Promoting the Development of the Mixed-Ownership EconomyBeijing reveals details on mixed-ownership reforms
Opinions on Promoting the Development of the Mixed-Ownership Economy

国务院关于国有企业发展混合所有制经济的意见

AGENCY

State Council

TAKEAWAYS
  • The mixed-ownership model is intended to use certain market elements, such as private capital, technology, and better management practices, to improve state firms’ competitiveness and efficiency, but without relinquishing state control of the actual assets.
  • Central state-owned enterprises (SOEs) that operate in strategic sectors or play a key role in public welfare are exempt from participating in mixed-ownership reforms.
SUMMARY

Chinese SOEs have long been laggards in terms of operating efficiency and return on assets when compared to their private sector counterparts. The mixed-ownership reform is aimed at changing this dynamic by bringing in private investment that, in theory, could attract better management and better technologies.

In return, private investors will obtain seats on the board in proportion to their ownership. The hope is that private investor participation in SOEs will get the state a twofer: increase the size of assets ultimately controlled by the state and more efficient utilization of those assets.

But the plan also stipulates that mixed ownership is not appropriate for all SOEs. This program will initially be limited to only second-tier SOE subsidiaries, leaving the parent company untouched. For instance, SOEs that essentially operate commercially in competitive industries, such as airlines, are encouraged to embrace mixed-ownership reforms.

The government insists that it needs to keep a controlling stake in parent SOEs in strategic sectors, such as national defense. Private investors, however, can still co-invest with SOEs in certain projects as a way of experimenting with mixed ownership in areas that are not directly related to the state’s strategic interest.

Finally, the plan also calls for stronger oversight of the privatization process to ensure reasonable pricing of SOE assets and prevent tunneling activities—that is, relinquishing state assets at firesale prices to benefit the buyer—that may result in the misappropriation of state assets.

09/20/15Opinions on Upholding Party Leadership and Strengthening Party Building while Deepening State-Owned Enterprises ReformCommunist Party seeks to reassert its role in state firms
Opinions on Upholding Party Leadership and Strengthening Party Building while Deepening State-Owned Enterprises Reform

关于在深化国有企业改革中坚持党的领导加强党的建设的若干意见

AGENCIES

CCP Central Committee; State Council

TAKEAWAYS
  • State-owned enterprise (SOE) executives will need to pass political loyalty tests, as internal party committees and the organization departments at all levels of government will play stronger roles in selecting and evaluating SOE executives.
  • In the short run, at least, party control is being prioritized over meaningful SOE reforms.
SUMMARY

Following the release of the SOE reform blueprint, the Chinese Communist Party (CCP) seeks to formalize the larger role it will play in state firm governance and control.

Although the CCP will continue selecting SOE executives, it is also shaking things up by mandating all central SOEs to have a full-time deputy party secretary whose sole job is party building. Some SOE executives will hold parallel roles on the internal party committee, and the SOE party secretary is expected to stay for no more than three terms, or about a decade. Moreover, funding for party-affiliated staff cannot be cut.

In a mixed-ownership SOE that is majority owned by the state, the party committee is expected to play an important role in corporate governance. For mixed-ownership firms in which the state is only a minority owner, the party’s role is similar to what already exists in private firms. That is, all organizations in China, including private firms, must have internal party committees if an organization contains more than three CCP members. In the private sector, however, such CCP committees usually do not meddle in corporate governance and stick to general Party affairs.

09/13/15Guiding Opinion on Deepening State-Owned Enterprises ReformBlueprint for reforming the state sector centers on mixed ownership
Guiding Opinion on Deepening State-Owned Enterprises Reform

中共中央、国务院关于深化国有企业改革的指导意见

AGENCIES

CCP Central Committee; State Council

TAKEAWAYS
  • The Chinese Communist Party’s (CCP) control over all state-owned enterprises (SOEs) will be strengthened.
  • The mixed ownership system is meant to improve SOE corporate efficiency and performance without undermining Party control of state assets.
  • The state will act as the shareholders, rather than managers, of SOEs and will not be involved in daily decision-making and operations.
  • During the partial privatization process, SOEs will be closely scrutinized to prevent the loss of state assets, which may in fact reduce the appeal of privatization in the first place.
SUMMARY

Reforming underperforming SOEs is crucial to the broader structural reforms of China’s economy. But this SOE reform blueprint, as it stands, is a mixed bag of allowing some privatization and reasserting party-state control in other respects.

The plan ostensibly aims to enhance SOEs’ efficiency and competitiveness by encouraging private investors to buy stakes in state assets for commercial purposes. This kind of “mixed ownership” model could be considered partial privatization in that it is allowing private capital to manage certain state assets.

To facilitate this partial privatization, the central government will take a more hands-off approach. The state will not be involved in the SOEs’ daily decision-making and will act primarily as the shareholder of SOEs instead of the manager. In other words, the state will now control SOEs through their boards, rather than resorting to direct intervention in their operations. Consequently, the state will focus primarily on optimizing the allocation of state assets across new sectors—that is, shifting the deployment of assets from heavy industries to emerging sectors—by establishing state investment companies that oversee this reallocation.

The new mixed ownership model, however, does not indicate that the state is loosening its grip on SOEs, even as it withdraws from directly managing the companies. That is, the government will maintain controlling stakes in SOEs that either operate in strategic sectors or play a key role in public welfare, which basically applies to all central SOEs.

This plan clearly had undergone considerable political compromises, as it reinforces the CCP’s control over the companies. For instance, the Party’s leadership must be clearly stated in the SOE’s charter, and partial privatization cannot start until the Party’s control has been firmly established.

08/29/14Opinion on Central State-Owned Enterprises Executives Compensation ReformExecutives at central state-owned firms will see pay cuts
Opinion on Central State-Owned Enterprises Executives Compensation Reform

中央管理企业负责人薪酬制度改革方案, 关于合理确定并严格规范中央企业负责人履职待遇、业务支出的意见

AGENCY

Politburo of the Chinese Communist Party

TAKEAWAYS
  • Compensation packages for executives at state-owned enterprises (SOEs) will be reduced to narrow the salary gap between top management and state employees.
  • In evaluating SOE executives, criteria such as party-building and social responsibility will increase in weight.
  • SOE executives will have less economic incentive to improve corporate performance.
SUMMARY

Top management in the more than 100 central-level SOEs and state financial firms will see their compensation slashed, which applies to senior executives including the chief executive officer, party secretary, chairman and chairman of the supervisory board and their deputies. In other words, all positions that are appointed by the Communist Party Organization Department will be affected. Management below that level can still be offered compensation that is competitive with the private sector. Subsidiaries of central SOEs, however, are not required to follow the new rules, though they are encouraged to draft similar regulations.

Currently, central SOE executive pay consists of three parts: the base salary, the year-end performance bonus, and the term-end bonus. Although the basic structure will not change, the new salary scheme now includes a ceiling for each component of top executive compensation. While the base salary is standard, the year-end bonus is determined by both the performance of the executives on the corporate bottom line as well as non-economic factors such as party-building. The term-end bonus is based on the executive’s term review, usually every three years.

According to the new rules, a reasonable base salary for the executives should be just twice the average salary of the firm’s employees. In addition, year-end performance bonuses can be as high as three times executives’ base salary, while the term bonuses should not exceed 30% of total annual compensation (base salary plus performance bonus).

As such, under the new scheme, the maximum total bonus for an SOE executive will be eight times the average salary of employees. This is significantly lower than the previous bonus payout, which could have been as high as 20 to 30 times of the average employee salary. Therefore, from the SOE executives’ perspective, this change amounts to less financial incentive to improve the corporate bottom line.