Abstract
Milton Friedman states in the 2002 preface of his classic “Capitalism and Freedom” that “there is no doubt that the residents of China are freer and more prosperous than they were under Mao — freer in every dimension except the political”.16 This statement rests on the fact that China is uniformly ruled by the Communist Party of China (CPC). Nevertheless, to fully understand the factors that shape economic policy-making in China, the incentives and constraints among the interest groups within China’s political structure need to be considered. In general, opposition has taken place within a three-level state structure: The senior leadership, central government leaders and local government leaders.17
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References
Friedman (2002, p. ix).
For details regarding the organizational structure of the CPC, see Shambaugh (2000, pp. 168–173) and regarding the structure of power within the CPC, see Lieberthal and Oksenberg (1990, pp. 135–168).
Cited after Prasad (2004, p. 2).
See Yusuf et al. (2006, p. 116).
The following section on the current structure of the Chinese economy is derived from an OECD survey of China’s business sector and a World Bank survey on China’s ownership transformation. See OECD (2005a, pp. 81 and 135) and Garnaut et al. (2005, pp. 7–8).
Value added is defined as gross output minus intermediate consumption and equals the sum of employee compensation, net operating surplus and depreciation of capital assets. Firms are separated by the type of controlling shareholder. Private sector includes both domestic and overseas private firms and investment. The public sector includes state controlled (directly or indirectly) and collectively controlled enterprises. The non-farm business sector excludes agriculture, government and non-profit service sectors. It was equivalent to 76 per cent of GDP in 1998 and 79 per cent in 2003. See OECD (2005a, pp. 81 and 135).
Total number of national enterprises covers all state-owned industrial enterprises and enterprises with annual sales of over RMB5million. Return on assets is calculated as operating surplus divided by fixed assets plus inventories. Unless stated otherwise, reported data is for October 2004. See Garnaut et al. (2005, p. 7).
Total factor productivity of directly controlled state firms is less than half that of privately controlled firms based on OECD (2005a, pp. 97–98) estimates using comprehensive industrial micro data.
This section is mostly based on two OECD surveys on domestic policy challenges and enterprise governance in China. See OECD (2002, pp. 12–18) and OECD (2005b, pp. 309 and 312–13). Naughton (1995) provides a detailed discussion on China’s earlier enterprise reforms from a historic perspective.
In particular, the “contract responsibility system” implemented performance contracts between the government and firm management. Shirley and Xu (2001) analyse this institutional arrangement.
Cited after Tenev et al. (2002, p. 28).
See Garnaut et al. (2005, pp. 2–7) for a detailed discussion of the numerous ways that Chinese firms have been exited and restructured.
See Tenev et al. (2002, p. 20); Garnaut et al. (2005, p. 33); OECD (2005a, p. 97) report that “87 per cent of the decline in the number of state held industrial firms in the period 1998–2003 came from the prefecture and county level”.
Several studies relate the incentives given to local officials to different economic factors, such as fiscal decentralization, emergence of local government ownership, or interregional competition in product markets; see Qian and Weingast (1997), Che and Qian (1998), and Li, Li, and Zhang (2000) respectively.
The following section is based on Liu, Sun, and Woo (2006, pp. 2020–2026).
Li and Zhou (2005, p. 1760) analyze turnover data of top provincial leaders between 1979 and 1995 and find that the likelihood of promotion of provincial leaders increases with their economic performance.
The second half of the 1990s witnessed considerable centralization and commercialization of the banking system. Reforms imposed strict targets on China’s four state-owned banks to control their non-performing loans. Coupled with the ongoing banking reform is the largely completed fiscal reform, which has institutionalized the division of tax revenues between the central and local governments. For details on the central-local government fiscal relations and the banking reform see OECD (2002, pp. 53–58).
See Liu, Sun, and Woo (2006, pp. 2022–2023).
The SASAC is under direct authority of the State Council. The priorities for action by the SASAC include the creation and enhancement of the role of boards in SOE, the establishment of a well structured and transparent board nomination process and the restriction of irregular behavior by the state as a controlling shareholder. For a detailed definition of its duties refer to Ling (2004, p. 3) and Chen (2004, p. 2).
See Sun and Tong (2003, p. 187).
In particular, excess labour is generated in rural areas by productivity gains in the agricultural sector and in urban areas by the downsizing of SOE; see OECD (2002, p. 24) for details.
The inter-provincial divergence of GDP per capita has risen dramatically. Most central and western provinces have lost substantially in comparison to 1980. In Gansu province, for instance, per capita income fell from 84% of national average in 1980 to 56% in 1999. See Taube and Ögütcü (2002, p. 3).
Cited after Green (2004, p. 7).
The description of the typical listing process is based on Green and Liu (2005, pp. 113–118).
A-shares are the most actively traded shares in China; see Shirai (2004, p. 1470) for details.
B-shares are held by foreign individuals and institutions and since March 2001 by domestic individuals in China. H-and N-shares refer to listings in Hong Kong and New York, respectively. Other overseas shares include “red chips”. This term refers to Hong Kong registered holding companies into which Chinese assets have been injected; see Wang, Xu, and Zhu (2004, pp. 470–474). See Appendix A.1: List of share categories of China’s stock market, p. 105.
See Groenewold et al. (2005, p. 5).
Since secondary market P/E multiples were commonly higher, share prices would usually rocket on the first trading day. This created huge incentives for the take-up of IPOs and thus fulfilled the governments need to create sufficient IPO demand. See Green (2003, pp. 162–163).
See Pistor and Xu (2005b, p. 7).
These firms are usually also required to issue non-tradable shares to their founding owners. The average float of their total equity at year-end 2002 was 31 per cent; see Green (2003, p. 152).
State-controlled legal entities include publicly listed firms, SOE, unlisted firms and academic institutions. Liu and Sun (2005, p. 48) apply the concept of ultimate control of La Porta et al. (1999, pp. 476–477) to the context of Chinesestyle stock pyramids.
See Jones et al. (1999, p. 230).
Perotti (1995, pp. 855–856) argues that initial sales are likely to be smaller so that the governments could signal to investors that policy reversals are unlikely because the government will bear redistribution costs associated with regulatory interference.
See Huang and Xu (2005, p. 12).
See Green (2003, p. 196).
After agreement over the conversion price has been reached, a 12 month lockup period is established for the holders of tradable shares. In the two years after expiration of the lock-up, a holder of non-tradable shares with more than 5% of the total issued share capital of the listed company is further prohibited from trading on the stock exchange more than 5% (10%) of the company’s total share capital within 12 (24) months. See CSRC (2005) for further details.
See Inoue (2005, pp. 45–53).
Chen and Shih (2002, pp. 62–68) and Green (2004, pp. 137–157) provide extensive discussion on the rise of the CSRC.
Wedeman (1999, pp. 118–119) provides a review of the different channels used by local leaders to defect from central government guidelines.
Huang (1996, p. 656) discusses the administrative control structure among central and local leaders.
For an extensive summary of the legal framework see OECD (2002, pp. 49–53).
See Wilson and Tao (2006, p. 30).
See Walter et al. (2003, p. 67).
This section is primarily based on Green and Liu (2005, pp. 135–137) and Green (2004, pp. 66–74)
According to OECD (2005b, p. 316) this framework is oriented towards protecting investors from ‚fake ‘acquisitions since some deals are aimed at manipulating market prices.
The CSRC’s M&A regulations include a framework for tender offers. According to Green (2004, p. 70) these rules were largely redundant. There were few incentives for launching a market-based takeover since the majority shareholder controlled a much larger stake than could be accumulated on the market.
This section is based on Liu (2006, pp. 418–419). The author provides a first review of the evolving research on corporate governance in China.
Wong, Opper, and Hu (2004, pp. 33 and 40) report that Chinese Communist Party committees retain considerable decision-making power in listed firms over personnel decisions. Furthermore, 56% of listed firms retain ties with the government and ministries.
This report was issued by the CSRC and the State Economic and Trade Commission (SETC); see OECD (2005b, p. 308).
For general surveys of corporate governance see Denis and McConnell (2003) and Shleifer and Vishney (1997). For a review of corporate governance in Asia see Claessens and Fan (2002).
See Kose and Senbet (1998, p. 379).
See Fan et al. (2007, pp. 20–24).
See Bai et al. (2004, p. 613).
According to the guidelines, an individual must meet the following conditions to be considered independent. First, neither the individual nor his or her relatives may work for the listed firm or its subsidiaries. Second, the individual may not directly or indirectly own more than 1 per cent of the listed firm. Third, neither the individual nor his or her relatives may be among the largest 10 shareholders of the listed firm. Fourth, neither the individual nor his or her relatives may work for a company that owns more than 5 per cent of the stock of the listed firm. Fifth, neither the individual nor his or her relatives may work for one of the largest 5 shareholder companies; see World Bank (2002, pp. 83–99).
Kato and Long (2006, pp. 806 and 811).
Interestingly, they find that internationally well-reputed audit firms do not deter corporate fraud any more than other auditors. See Chen et al. (2006, pp. 441 and 445).
Bai et al. (2004, p. 608) report average managerial holdings of only 0.1 per cent.
See Shleifer and Vishny (1994, p. 996) and Boycko et al. (1996, p. 317).
Chang and Wong (2004, p. 619) and Xu, Zhu, and Lin (2005, p. 2) call the incentive problems of managers ‘agency costs’ and the incentive problems of shareholders ‘expropriation’.
However, politicians often maintained formal authority over key personnel and investment decisions and, in particular, over labour decisions; see Xu, Zhu, and Lin (2005, p. 5).
See Chang and Wong (2004, p. 618).
See Xu and Wang (1999, p. 88).
See Tian (2001, pp. 29–30).
See Sun et al. (2002, p. 23).
See e.g. Xu and Wang (1999, p. 92); Wei et al. (2005, p. 98); Sun et al. (2002, p. 22).
See Liu and Sun (2005, p. 52).
See Chang et al. (2004, pp. 619 and 632).
See Xu et al. (2005, pp. 18 and 22).
See Cheung et al. (2005, pp. 25 and 30).
See Jensen (1993, pp. 850–852).
See Jensen and Ruback (1983) for the US and Franks and Mayer (1995) for the UK.
See e.g. Fan et al. (2007, p. 4), Chen et al. (2006, p. 432); Kato and Long (2006, p. 799).
See Cai and Chen (2004, p. 79).
See Chen et al. (2007, p. 20).
See La Porta et al. (1998, p. 1151).
See OECD (2005b, p. 318).
A company is placed in ST category if (1) it has negative net profits for two consecutive fiscal years; (2) the shareholder’ equity is lower than the registered capital; (3) a firm’s operations have been stopped; or (4) if the firm is involved in a damaging lawsuit or arbitration. If a firm is unable to turn around within a certain period, it will be further downgraded to PT and may face de-listing; See Bai et al. (2002, pp. 7–9).
See Green (2003, pp. 188–9).
See Pistor and Xu (2005a, pp. 190–196 and 204).
See Allen (2005, p. 174)
Allen, Qian, Qian (2005, p. 81) report that around 30 per cent of listed firms’ funding comes from bank loans, and that this ratio has been very stable despite the fast growth of the stock markets. See Allen et al. (2005, pp. 76–78 and 80–83) for details of the banking reform and the importance of the banking system in financing the domestic economy.
Jensen (1988, p. 23) views the market for corporate control as a major component of the managerial labour market in which alternative management teams compete for the right to manage corporate resources. Scharfstein (1988, p. 185) interpretes the takeover mechanism as an indirect means for shareholders to renegotiate their contract with management.
See e.g. Bethel et al. (1998, p. 624) for the US and Holmstrom and Kaplan (2001) for a review of the US literature; Köke (2004, p. 68) provides empirical evidence for Germany.
See La Porta et al. (1999, p. 498).
See Shleifer and Vishny (1986, p. 464).
See Köke (2004, p. 75).
Shleifer and Vishny (1997, p. 757).
See Edin (2003, p. 39).
Liu et al. (2006, p. 2029) suggest the average compensation cost per worker as a measure of the importance of labour in the Chinese privatization process. Such data, however, was not available.
Jensen (1986, p. 328) argues that takeovers occur in response to breakdowns of internal control processes in firms and that management is likely to invest free cash flow in inefficient projects of monitoring is not strict enough. Bringing the firm back on track requires to revert these investments through asset sales or lay-offs.
This includes essentially price liberalizations and the removal of entry barriers; see Guo and Yao (2005, p. 216).
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(2008). China’s reform process, stock market development, and testable hypotheses. In: Corporate Control and Enterprise Reform in China. Contributions to Economics. Physica-Verlag HD. https://doi.org/10.1007/978-3-7908-2020-1_2
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