Ethical Issues in the Evolution ofCorporate Governance in China

8/14/2019 Ethical Issues in the Evolution ofCorporate Governance in China

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ABSTRACT. China is establishing its corporate

governance structures by emulating the stylized

Anglo-American model. However, the country does

not yet have the necessary formal and informal

institutions, or the financial infrastructure to make

these structures work effectively. Corruption, stock

market manipulation, tax cheating, fraudulent dealing,

all manners of plundering of state assets and the lack

protection of shareholders rights are some of the

more conspicuous manifestations of the ethical issues

that have emerged in this mismatch. This study shows

how these issues arise in the context of the charac-

teristics of countrys economic and corporate gover-

nance development. It evaluates various potential

policy responses that may be implemented to improve

governance effectiveness and diminish the damage

from those problems.

KEY WORDS: China, corporate governance,

economic reform, shareholders rights, stock market

1. Introduction

During the last two decades, momentous changesin Chinas economic system and business envi-

ronment have occurred. The price mechanismhas been allowed to increasingly replace the

centralized system of resource allocation, andthere has also been a concomitant and funda-

mental transformation of how production, con-

sumption, investment and saving are organized.Completely new forms of economic institutions

and organizations have emerged, both at themacro and micro level. One of the most impor-

tant creations is in fact the firm as a businessentity. Replacing the workshop/production units

within the central input-output planning matrix,business enterprises with independent legal status

(regardless of ownership composition) have nowbecome the primary form of productive organi-

zation.The emergence of the firm as an independent

economic agent and the development of the

incorporated form of business organization haveprofound implications for the shape and dynamics

of the society, polity and economy of China. Ina country where the state had owned and

operated work units that encompassed nearlyevery aspect of the life of an individual, this

transformation changes the rules and incentives

governing the actions and interactions among alleconomic agents including the state and itsinstrumentalities at various levels. These changes

have produced the expected growth benefits and

improvements in living standard for the majorityof the population. However, it is clear that

elements of both the formal and informaleconomic-social institutions from the past

continue to influence and sometimes obstruct the

Ethical Issues in the

Evolution of Corporate

Governance in China On Kit Tam

Journal of Business Ethics 37: 303320, 2002. 2002 Kluwer Academic Publishers. Printed in the Netherlands.

On Kit Tam is Professor of International Business, Facultyof Business and Economics, Monash University,Melbourne, Australia. He is currently Director ofInternational Programs of the Faculty of Business andEconomics, and Director of the China Research Centre,Monash Asia Institute. Professor Tam has written exten-

sively on Chinas economic and financial reform, andcorporate governance development. He organised andchaired Chinas first international conference on corpo-rate governance in Shanghai in 1995. In addition to hisvarious academic appointments in Australia and overseas,he has also served as a manager in the private sector, anofficer of the Treasury of the Australian Government,and consultant to international corporations and organ-isations. His present research focus is the comparativeevaluation of corporate governancne performance.


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way economic activities are conducted in the

fledging market-oriented business regime.While facets of modern market institutions

and instruments have now been adopted exten-sively from mature market economies, they have

to operate under an environment where thesocial and economic preconditions for theireffective functioning are at times lacking or

underdeveloped.1 This may be an inevitableconsequence of Chinas gradual approach to

economic reform, but the asymmetrical progresshas also paved the ground for the emergence of

a variety of issues in business ethics. Corruption,stock market manipulation, tax cheating, fraud-

ulent dealings, all manners of plundering of stateassets and the lack of shareholders rights are

some of the more conspicuous manifestations. Inmany ways, nowhere are such new ethical issues

brought into sharper focus than in the develop-

ment of corporate governance in Chinas listedcompanies, the countrys supposedly most

modern and market-oriented business organiza-tions. This study will examine the key corpo-

rate governance and ethics issues associated withthis type of companies. Similar problems will

certainly be faced by participants in other areasof the countrys transforming social-economic

landscape.As a result of the more rapid pace of corpo-

ratization and de facto privatization of state ownedenterprises since the early 1990s, corporate

governance has assumed an increasing promi-

nence in the countrys reform agenda as theChinese government tried to promote enterprise

performance and to look after its ownershipstakes in various forms. The widespread and

persistent financial distress experienced by manystate owned enterprises has added to the urgency

of getting the countrys corporate governance

right.This article shows that the business ethics

issues associated with Chinas corporate gover-

nance arrangements are the product of severalinteracting factors. They stem firstly from the

struggle between the desire to install moderninstitutions and instruments, and the imbalanced

progress in the development of complementary

social, political, legal and economic infrastruc-tures. Another equally important factor can be

attributed to the approach taken by the Chinese

government to establish a corporate governancesystem based on the stylized Anglo-American

model. In investigating the key ethical issues inthe context of Chinas corporate governance

development, the paper aims to examine howthey can be realistically addressed to producemore desirable outcomes.

This paper is organized as follows. Section 2examines what corporate governance develop-

ment in China is about and its salient featuresand major trends. It will briefly outline the recent

history of the creation of corporations andinvestigates the meaning of corporate governance

and its relevance for Chinas reform and devel-opment. Section 3 identifies and explains the

emerging ethical issues in the context of thecountrys evolving macro environment as well as

its corporate governance arrangements. Section 4discusses the governments policy responses toresolving such issues and evaluates their effec-

tiveness. Some conclusions are also provided.

2. Challenges of corporate governanceII. development

2.1. Introduction the birth of companies and2.1. stock exchanges

Optimizing allocative efficiency and distribu-tional equity, and the way these two goals may

be balanced are always basic issues of economicpolicy in any country. In Chinas economic

reform, the government has certainly tackledthese issues in a fundamental way but has also

persisted with a desire to preserve its perceivedessential trait of socialism by means of main-

taining the prominence state ownership in key

sectors of the economy. This state ownershipstricture has complicated economic policymaking and its outcomes. Many have argued that

it has hurt the effectiveness and pace of the

countrys economic reform.2

In reality, however, the ownership mix hascontinued to shift towards a diminishing state

sector. The rising degree of marketisation and

openness in the economy, and the need to dealwith many financially distressed SOEs have

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contributed to a continuing process of redefining

the meaning of public ownership.3 The progres-sively more liberal interpretation of the meaning

of state ownership, the de facto partial andcomplete privatization of state enterprises, and

the vigorous growth of the non-state sectors haveled to the outcomes.

Since the Chinese government allowed pro-

ductive enterprises, including state owned ones,to become separate legal person in 1987,4 the

substance of what constitutes corporate gover-nance in the West has become increasingly

important in China although the notion ofcorporate governance was little known then.

Under the central planning regime before thereform, Chinas industrial and commercial enter-

prises were not autonomous economic entity butwere really workshops and production units with

no independent decision making power. The

central plan replaced the function of the marketand the conditions for the existence of a firm as

is understood in market economies were absent.All means of production are nominally owned by

the state, contracts and market transactions werenot needed for organizing production activities.

As Figure 1 show, the economic reform haschanged that system of resource allocation at the

firm level.The emergence of the company as a basic

economic entity was accompanied by a process

of financial reform that has turned the newlycreated or reorganized state-owned banks into

the primary provider of finance for Chinese

enterprises, replacing the old system of state

budgetary grants. Shareholding companies weresoon formed when grass-root efforts to developChinas capital market began spontaneously in the

mid 1980s.5 Various forms of shares and bondswere issued by state and collective enterprises to

raise funds and informal securities trading couldbe found in most major Chinese cities. Chinas

first securities and brokerage company wasestablished in Shenzhen in 1987. In the following

year, securities companies were set up in everyprovince under the auspices of the local branches

of Chinas central bank. By 1991, Chinas twoofficial stock exchanges in Shanghai and

Shenzhen were ready for full operation. The

countrys corporate finance and developmenthenceforth entered a new era.

Chinese listed companies, the focus of studyin this paper, are in the main partially privatized

state owned enterprises (SOEs). That is, theirmajor shareholder is the state in its various forms

including other state owned enterprises. Indeed,at the end of 2000, of the 1088 companies listed

on the two stock exchanges (Table I), over 90per cent were originally transformed from SOEs.

More significantly, over two thirds of the issuedshares of the listed companies are in fact held by

the state or state enterprises (Table II). Of the

851 listed companies in 1998, 75 per cent werein fact majority owned and nominally controlled

by the state or state owned holding companies.7

It should be noted that all forms of state owned

shares7 are not allowed to be traded in the stockexchanges, only shares held primarily by indi-

viduals can be traded.

Another important characteristic of Chinaslisted companies is that, up to 2000, approval fora company to obtain listing has been determined

by the government on the basis of an annualquota broken down to each province and min-

istries which then select the companies to fill

their allocated quotas. Therefore the listing of acompany is usually decided not on commercial

merits but on political and sectional considera-tions. Clearly this aspect alone has created fertile

Ethical Issues in the Evolution of Corporate Governance in China 305

Figure 1. The emergence of company as a business

organisation.


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grounds for many forms of rent-seeking activi-

ties that could give rise to significant ethical

issues.In contrast to the privatization experiences in

former centrally planned economies such asRussia and the Czech Republic, there was no

mass privatization in China. Indeed the Chinese

government has for ideological reason eschewedthe use of the terminology. Despite this, thenumber of listed companies, many of which are

partially privatized SOEs, has grown quiterapidly. Table I shows that the number of listed

companies has risen from 14 in the year when

Chinas two stock exchanges commenced oper-ation in 1991 to over 1000 by the year 2000. As

far as the de facto privatization process is con-cerned, it is worth noting that over half of the

Chinas 512 officially designated key SOEs havenow been listed and thus partially privatized. The

Russian and Czech experience of mass privati-zation has resulted in the company insiders

gaining controlling equity interests,8 which werethen used as the means to expropriate and

plunder company assets for their private gains.

The partial privatization through listing ofstate owned enterprises in China has producedquite different outcomes of shareholder and

control profile. As Table II indicates, while thenumber of investors has risen markedly over the

last nine years, the dominant shareholder group

remains the state and its SOEs, which togetherhold over two third of the total issued shares. As

shown in another study by this author, despitethe negligible proportion of shares held by the

306 On Kit Tam

TABLE I

Number of listed companies in Chinaa

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

A-Shares only 14 35 140 227 242 431 627 727 822 0955B-Shares only 00 00 006 004 012 016 025 026 026 0028

A & H Shares 00 00 003 006 011 014 017 018 019 0019

A & B Shares 00 18 034 054 058 069 076 080 082 0086

Total 14 53 183 291 323 530 745 851 949 1088

a A-shares are restricted to Chinese investors, B-shares were up to 2000 nominally restricted to foreign indi-

vidual investors and can only be bought and sold with foreign currency, H-shares are listed and traded in the

Hong Kong Stock Exchange. The total number of listed companies in the Table excludes Chinese companies

that are listed only on the Hong Kong Stock Exchange (as of the end of 2000, there were 33 companies issuing

H-shares only).

Source: China Securities Regulatory Commission.

TABLE II

Characteristics of Chinas Stock Market (percentage)

1992 1993 1994 1995 1996 1997 1998 1999 2000

Number of investors (as %

of urban population) 00.7 02.3 03.1 03.6 06.4 09.0 09.7 11.5 NA

Market capitalisation/GDP 03.9 10.2 07.9 05.9 14.5 23.4 24.5 320. 500.

Value of tradeable shares/total

shares 26.1 27.0 29.1 29.7 29.5 31.0 33.5

Average number of investors/

company (in thousand) 40.9 42.5 36.4 38.5 43.5 44.7 45.6 47.2 53.3

Source: Chinese Statistical Yearbook various issues; China Securities Regulatory Commission.


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that has been based on a decentralized process

of experimentation.However, there have also been considerable

confusions over what corporate governance is inthe Chinese context. It is not uncommon to find

that corporate governance is understood by manyChinese managers and officials as being just amodern way of organisational management, or a

set of structures and procedures for regulators andowners of enterprise to supervise managers.17

The reasons are multifaceted. Partly, the Chinesetranslation for corporate governance, farenzhili-jiegou, may convey a notion more focused onadministering and supervision.18 Another

problem may be the tendency among some com-mentators and practitioners in China to simply

view corporate governance as one of themodern management tools that could be

applied independent of the social-economic/

regulatory/financial context.It is not the purpose of this paper to present

a complete taxonomy of the worlds majorsystems of corporate governance, it is however

important to cast Chinas attempt to develop itscorporate governance arrangements against the

model which it emulates. It is therefore instruc-tive to contrast the salient features of the stylized

Anglo-American corporate governance modelswith the characteristics of Chinas present cor-

porate governance arrangements. The analysis ofthese contrasting features provides a basis for

examining the questions of what and how key

ethical issues have been created or exasperated.Table III presents a comparison between

Chinese corporate governance arrangements andthe stylized Anglo-American model on which

Chinas system is based. To provide a broadercomparative perspective, the generalized features

of the insider-based models of Germany and

Japan are also summarized. The description ofthe two stylized models in the table is meant tobe a simple and convenient reference for high-

lighting Chinas approach and is not intended tobe an exhaustive account of all of their specific

differences and commonalities.19

The first five features in Table III basically

relate to the business, social and regulatory

environment under which each system ofgovernance operates. The way the banking

system and the securities market have developed

in the Anglo-American system has created ahighly liquid capital market that facilitates an

active market for corporate control to helpalleviate the agency problems created by the

separation of ownership and control. With thedispersed share ownership that came with thedevelopment of financial capitalism, the problem

of aligning the interest of the professionalmanagers to that of the companys shareholders

has traditionally been a key governance issue inthis system. Because of the dispersion of

ownership, the numerous individual minorityshareholders do not have an economic incentive

to participate actively in the governance of thecompany they invest in but can certainly exercise

their voting rights and as a last resort vote withtheir feet by exiting through divestment. The

protection of minority shareholders interest is

accorded top priority in this system.The current Chinese situation is that the state

is the major shareholder in the highly concen-trated ownership pattern from the countrys

partial privatization. However, despite itsmajority ownership, the state does not exercise

effective control over their companies. It hasbeen shown elsewhere by this author20 that

control of Chinas companies rests pr imarily withthe insider-managers who are often in turn con-

trolled and supported in various forms by theirCommunist Party and ministerial associates. The

states ownership interest is poorly representedand monitored. Whereas the mass privatization

in other transitional economies such as Czech

Republic and Russia has led eventually to theinsider gaining control of the companies through

their success in raising their concentrated own-ership stake,21 Chinese insiders normally have

insignificant share ownership.

Because shares owned by the state and bystate-owned enterprises are not permitted to betraded, movements in stock price are generated

mainly by the trading of shares among individualshareholders (as against state owned shares and

legal person shares). Because of the high rate ofsaving and the very limited range of investment

instruments available in China, individual

investors in the stock market have from thebeginning exhibited a highly speculative

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tendency with very short investment horizon.The average daily rate of share turnover was over

60% in 1997, and the average amplitude offluctuation of the Shanghai index was 170%

during the period 19921995.22

Listed companies in China, in spite of the factthat they are independent legal entities subject to

the countrys Company Law, still operate underthe strong influence of the government. For

instance in the area of appointment to theposition of the board chairman and members,

chief executives and supervisory board, the

Chinese government and the Party organizationcan exert a critical influence. Many company


TABLE III

Characteristics of corporate governance models

Anglo American model German-Japan models Chinese system

0(1) Dispersed ownership Concentrated ownership with Concentrated ownership with thecross shareholding among state as majority shareholder

investors

0(2) Investors usually free riders Investor, banks and employees Control primarily by insider

with little interest in the participate actively in the control managers supported by their

exercise of control except for of companies Party-ministerial associates

some active institutional

investors

0(3) Investment horizon of Investment horizon of Investment horizon of individual

shareholders usually short shareholders usually long term shareholders usually short term

term and highly speculative

0(4) Shareholder as the primary Multiple stakeholders interests Ineffective shareholderstakeholder in setting represented in company representation but company

company objective; objectives that incorporate objectives subject to government

primacy of the protection of social and employment goals interventions

minority shareholders rights

0(5) Reliance on securities market Reliance on bank credit for Reliance on bank credit from

financing corporate financing state owned banks

0(6) Active market for corporate Absence of active market for Absence of active market for

control, with highly liquid and corporate control corporate control

transparent securities market

0(7) Arms length transactions A greater extent of network Rampant insider and government

and alliance dealings directed transactions

0(8) Active market for senior Less active market for senior Obstacles to development of

managerial manpower managerial manpower active market

0(9) Executive remuneration linked Executive remuneration less Executive remuneration not

to corporate performance linked to corporate performance linked to corporate performance

(10) Board with majority of Insider dominated board Insider-manager dominated board

outside directors with appointments influenced

by the authorities

(11) Active monitoring role of Monitoring role performed Weak or absence of monitoring

professional organizations and mainly by banks and cross role by banks, professional

the mass media shareholders organizations and the mass media


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executives may still have affiliation to their

previous state organizations. Although the ideaof offering stock options as executive compen-

sation has been the subject of debate in late 2000,the conditions for this to take effect are not

available and managerial remuneration in Chinais generally not linked to performance.

It is commonly accepted that the Anglo-

American model of corporate governance ispredicated on a number of conditions such as the

existence of active markets for corporate control,managerial manpower and product markets; a

high degree of transparency and disclosure; armslength transactions; independent board of direc-

tors, active and independent monitoring role ofthe mass media and professional bodies such as

accounting and legal service providers. Withoutthese complementary factors, it is difficult to

imagine how the system can function effectively.

China has adopted the stylized features of theAnglo-American model of corporate governance,

but it does not yet have an active market forcorporate control. There have been a few

sporadic episodes of takeover battles since the twostock exchanges were established. There has even

been a recent spate of takeovers bids for ailingcompanies. However, most of these takeover

attempts are by enterprises seeking a backdoorlisting to obtain the benefits of cashing in on the

buoyant market and Chinas version of high techboom. China will not have an active market for

corporate control until more non-state controlledenterprises are listed in the stock exchanges and

until full privatization is implemented.

For listed companies with the state as amajority shareholder, the pool for appointment

to the positions of chief executive, most seniormanagers and a high proportion of the directors

on the company board is restricted and subject

to government influence or direct intervention.23The role of a competitive market for managerialmanpower to complement the function of an

active market for corporate control is not yetavailable in China. There are few independent

directors in Chinese companies and in most casesthe company board is made up of executive

directors. In the absence of effective representa-

tion from the state as the majority shareholder,the board of directors is dominated by the insider

managers. It should be noted that the ownership

interest of the state as the majority shareholderis supposed to be expressed primarily through the

specifically delegated organisations such as theState Administration of State Property. However,

the actual influence over the company wouldmore likely come from the Party organization

or the companys previous supervising ministry.24

In the Chinese system, companies operatingunder the countrys Company Lawhave a two-tier board. In addition to the board of directors,which in theory carries similar responsibilities as

a board in the Anglo-American system, Chinesecompanies also have a supervisory board. The

supervisory board is small in size25 and usuallyhas labor union and major shareholder represen-

tation. However, it only has a loosely definedmonitoring role over the board of directors and

managers. Though being part of a two-tier board

structure, the establishment of Chinese supervi-sory board shares no common social and philo-

sophical considerations that underlay thesupervisory board in the German codetermina-

tion model of corporate governance. The super-visory board in China has so far not played any

effective governance role.The rule of law and the principle of arms-

length transactions provide a cornerstone for theAnglo-American model of corporate governance.

The legal system based on common law is oftenconsidered to be superior to the more prescrip-

tive continental civil law system in governanceoutcomes because the former is seen as more

efficient and enabling although such a belief is

not without challenge.26 In China, rampantgovernment interventions in commercial activi-

ties particularly at the sub-national level, and theimportance of personal network relationships in

business are well known. Corporate law and

securities law have only been introducedrecently.27 It is ironic that in a country where therule of law is generally regarded as rudimentary,

the approach to corporate governance develop-ment has largely been a top-down legalistic one.

In addition to the effective enforcement oflaws and regulations, high standards in corporate

transparency and accountability in the Anglo-

American model are backed by a highly devel-oped securities industry with independent

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professional organizations such as accounting

and brokerage firms as well as a watchful andindependent mass media sector. They help

reduce the cost of monitoring for shareholdersand put pressure on company directors and

managers to disclose timely and accurate infor-mation on corporate performance. While therehas been progress in developing accounting

standards, professional organizations and mediareports on company activities in China, it is still

a long way from achieving the degree of effec-tiveness and independence that is required for the

Anglo-American model to work.In summary, Chinas listed companies face a

very different ownership, business and financialenvironment from the Anglo-American system.

The institutional conditions for the successfuloperation of that model are either absent or

undeveloped. A cursory examination of Table III

may suggest that Chinas corporate governancehas more in common with Germany and Japan

than with the Anglo-American model. Thebusiness environment and the social and

economic conditions are seemingly similar. YetChina has patterned its corporate governance

system primarily on the Anglo-Americansystem.18 Some may have argued that the Anglo-

American model is indeed the paradigm to whichall others corporate governance system will

converge.29 Nevertheless the differences betweenthe Chinese environment and the Anglo-

American conditions are substantive. The fol-lowing section will examines the governance and

ethical implications of this mismatch in the

context of Chinas approach to privatization andcorporate governance under the reform process

for the countrys industrial and financial sectors.

3. Ethical issues in Chinas corporate3. governance

In the West, under what terms companies shouldbe allowed to possess power is regarded as a non-

trivial question because of the enormous influ-ence the corporate sector has on the life on

ordinary people.30 Chinas attempt to develop a

modern corporate sector in the last decade hasbeen conducted under the governments primary

goal of raising productivity and maintaining

political stability and economic growth. Despitethe fact that the traditional SOEs provided nearly

cradle-to-grave services to most urban workersand their families, their transformation into

corporate entities to compete in open marketshas basically been a technical exercise of gettingthe prices right and making the enterprises finan-

cially viable. Hence, the narrow instrumentalistview of corporate governance is not a surprise.

In opting for the stylized features of theAnglo-American model of corporate governance,

the Chinese government has not given priori-ties to such soft issues as corporate culture or

business ethics. It has placed the Party organiza-tion as the means to exercise influence over the

newly emerged corporations but the concern isperhaps more with political power and control

than how a company should behave. The neglect

in developing the right informal institutions andbehavioural norms however raises the transaction

cost of all parties involved in the governance ofa company.

For instance the concept and obligationsassociate with the fiduciary duties of directors

and executives are fundamental to the func-tioning and governance of modern corporations

in the Anglo-American system. The notion offiduciary duties was quite alien to the newly

evolving corporate sector in China. It was only

when the Chinese government was preparing forthe listing of its SOEs on the Hong Kong Stock

Exchange that the notion was formally intro-duced and given some meaning in late 1994.31

Carrying out such duties in practice is howeverproblematic and complex.

In the Anglo-American system, fiduciaryduties are not specified in complete details as

there could be an infinite repertoire of events and

responses, and because their fulfillment has torely on trust and judgments albeit on the basisof an appropriate set of incentive and regulatory

mandates. China clearly does not yet have sucha corporate history, commercial environment and

business culture for such duties to be an integral

part of the governance routine and be effectivelyperformed. Moreover, the dominance of the state

as a major shareholder in the partial privatization,coupled with the pervasive influence the gov-



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ernment still holds over the listing of companies

and their business conduct and governance, hasnot contributed to the clarification of what is

considered proper action for the members ofthe company in the context of fiduciary duties.

As a result, opportunistic and strategic behav-iour by directors and managers to advance theirinterests at the expense of the companys share-

holders and other stakeholders has been a majorgovernance and ethical issue. Such behaviour has

even taken the form of illegal activities such aslooting of company assets and various forms of

corruption within and outside the company.Furthermore, as discussed in the preceding

section, the Anglo-American model of corporategovernance require certain conditions which

include for example a high level of transparencyand accountability, protection for minority

shareholders, an active market for corporate

control, and independent board of directors andprofessional organizations. A key element of that

model is to protect shareholders wealth byreducing the agency cost from having professional

managers by way of aligning their interest withthe company and by the threat of the conse-

quence of merger or takeover by anothercompany. The presence of these conditions in the

system does not by itself eliminate unethical andfraudulent activities. However, their absence will

certainly raise serious concern over the systems

efficacy to deal with such issues. This section ofthe paper will examine through a number of

cases below some major ethical issues critical tothe development of effective corporate gover-

nance in China.

3.1. Protection of shareholders rights

The current ownership structure of Chinas listedcompanies, the constraints and interventionsexerted by the state on them, and the inability

of the government to effectively exercise its rights

as the majority shareholder combine to producea multitude of governance and ethical issues for

policy makers, investors as well as company boardchairman and chief executives. First, the state is

the majority shareholder but is not exercising itsownership rights effectively. Instead the insider

managers and their Party-ministerial associates

who personally have negligible shareholding hold

the control of the company. Thus, in reality thegovernance and the purpose of the firm are

determined by the insiders, often involving

government agencies other than the designatedholder of the state shares.

In the Czech and Russian privatization

process, the insiders rapidly gained concentratedownership. This has not happened in China.

However, the corporate regulatory regime inChina is in principle geared to accommodate

diverse share ownership as the Anglo-American

model is the object of emulation. Unfortunately,it has been shown that the primary purpose for

Chinese state enterprises going public is to raise

capital, not to transfer ownership from state toprivate citizens.32 Indeed raising capital from the

capital market can mean survival for many of theSOEs that have been partially privatized in this

manner.

From an analytical perspective, the board ofdirectors can be interpreted as a security feature

in support of the contract for equity finance,33

but Chinas partially privatized listed companies

are in a peculiar position as the individualminority shareholders that actually provide much

of the equity finance are quite powerless in theentire governance scheme. As the state share-

holders cannot manage their equity investmentbecause their shares are not tradeable on the

market, and because state budgetary constraint

means they will have little access to fiscalresources to participate in capital augmentation

such as rights issues, their ownership stake ishighly constricted.

The result is that, even if there were no self-serving strategic behavior on the part of direc-

tors and managers, there will be the difficult issue

of resolving the different interests and pursuitsof the central and sub-national levels of govern-ment in setting the goal and direction of a

companys business and governance aspirations.Examples of such conflicting interests may

include employment creation and maintenance,

welfare for workers, social stability, and govern-ment revenue collection. The actual reality in

China where the rights of the numerous indi-vidual minority shareholders are often dis-

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regarded does not help in providing directors and

executives a basis for the resolution of this issue.A conclusion that can be drawn from the above

discussion is that given the circumstances inChina, the protection of minority shareholders

interest is ironically a precondition for the stateto better manage its own majority shareholderinterest.

3.2. Insider trading, self dealing and collusion in3.2. market manipulation

It was after the Securities Lawcame into effect in July 1999 that the Chinese authorities (notablythe China Securities Regulatory Commission

[CSRC]) began a more active campaign toinvestigate cases of insider trading and market

manipulation.34 Although details are not alwaysreadily available, such activities seem rampant and

persistent as evidenced by the revelations made

in recent prosecutions and by the popularity ofbooks on how individuals can take advantage of

such activities. The common practice seems toinvolve a company, either acting on its own or

in collusion with others. Borrowed or own fundsare channelled through a large number of

factitious or personal investor accounts to engagein buying and selling of its own shares (i.e., self

dealing) or other companies shares to influencemarket prices and trading volume to attain

personal financial gains. Clearly such activities

would have been detected quite easily shouldthere be effective corporate governance arrange-

ments and regulatory surveillance and enforce-ment mechanisms. Consider the following cases

as examples that highlight the nature if not theextent of this issue.

[a] During a 9-month period from March

1997, a listed property development company inShanghai was reported in Chinas premierbusiness newspaper to have utilized 46 individual

investor accounts (44 in personal names and 2in legal persons name) to engage in self dealing

and insider trading in shares of a related

company.35 By December 1997, the company was

alleged to have employed over RMB 180 million

yuan to acquire 29% of target companys stocks,manipulating the latters share price from

RMB 9.50 per share at the beginning of this

period to RMB 18.97.[b] A tourism development company in

Hunan Province, through its branch office inChangsha City , set up 15 accounts (14 personal

accounts and 1 account in the name of theChangsha branch) to make a series of purchasesof the companys own shares on the market over

two and a half months (2 September18November 1996).36 After accumulating nearly

RMB 41 million yuan worth of shares and wasbelieved to have therefore pushed up the market

price, the company began unloading the sharesthree days before the board of directors

announcement of bonus share issue on 22November. The company was reported to have

therefore made a profit of RMB 12 million yuan.The Hunan Securities Exchange Centre was

alleged to have actually supplied 15 million yuanto help finance these activities.

Market manipulation activities of this nature

would be difficult to succeed without the consentor cooperation of securities investment firms or

brokerage companies. Chinas fledging securitiesindustry is certainly under-developed and has on

many occasions not been able to deliver thesupporting governance role expected of them.

More significant is the fact that some of thesecurities firms actually engaged on their own

in similar kind of activities on an even granderscale. The recently reported case of the alleged

market manipulation and corruption by a provin-

cial branch head of a major securities andbrokerage firm is indicative of the problem.37 The

manager in question was alleged to have opened900 factitious investor accounts in the name of

her associate to apply for new scr ibes from IPOs,using company funds and unauthorized mortgage

credits. Since most IPOs in China are under-

priced,38 success in getting scribes is thereforealmost a certain way of making quick profits.This may indeed be an important factor that has

contributed to the tendency of some companiesto falsify financial statements to gain new listing

or to expand share issues.



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3.3. Falsification and fabrication of financial data

As discussed earlier, obtaining a public listing for

many companies can means survival. Moreimportantly, it is often regarded, quite accurately

under Chinas current conditions, as a cheap wayof finance that will also bestow enormouslegitimate and illegitimate benefits to a companys

managers and employees. Because the listingprocedures are based on a national quota system,

regional and sectional interests may dominatecommercial considerations in the selection of

companies. The standards and integrity of pro-fessionals such as accounting, legal and securi-

ties firms are seriously compromised whenfalsification of a companys financial performance

occurs. Chinas formal and informal institutionsneeded to support its corporate governance

system are still at a very early stage of develop-

ment. Because of the asymmetrical nature ofthese institutions to the needed development of

some of the prerequisites of the Anglo-Americancorporate governance model, issues such as the

above are bound to inflict damages. Someexamples are given below.

[a] An established state owned television man-ufacturer planned to modernise with new injec-

tion of funds and sought successfully to obtainlisting in May 1997. In its application for listing,

the company was alleged to have falsely reported

an annual profit of RMB 54 million yuan whilein fact it had incurred a loss of RMB 103 million

yuan.39 It raised RMB 410 million yuan in theIPO. After its listing, it was reported that the

company had again falsified its income statementsby claiming a profit when there was a loss, and

reporting a much lower loss than was the actualfigure. The company was alleged to have utlilized

only 16.5% of the raised capital according to its

share prospectus, with 34% being diverted tospeculating on the stock market through 200personal investor accounts. Misleading

accounting and legal opinions were said to havebeen obtained from various major professional

firms in Chengdu City. Even the local bureau

responsible for state asset administration wasalleged to have for material gains fraudulently

backdated key documents to allow the companyto complete the procedures for its public listing.

[b] In its submission for listing (which was

successfully granted in May 1996), a companyin Shenyang city was alleged to have falsified the

amount of bank deposits by claiming a non-

existent increase in bank deposit of RMB 27

million during 1995 (the claimed amount wasequivalent to 62% of the companys bank balanceat the end of 1995).40 It was alleged that in the

same submission, the company also inflated thevalue of its assets by RMB 11 million yuan, and

had unilaterally reduced by 20 per cent thenumber of shares in the company without ever

disclosing the change.[c] A petrochemical company established in

Heihongjiang Province in 1996 sought to obtainlisting on the Shanghai Stock Exchange in 1997.

Because Chinas listing requirement stipulated acompany must have a prior record of three years

of profit, the company simply fabricated a total

profit of RMB 162 million yuan for the years19941996.41 Major professional organizations

(including accounting firms, law firms, securi-ties companies, share underwriters) are reported

to have colluded in that exercise by providingfalse audit report, legal opinions, and certificates

confirming the companys fabricated sharecapital, reserves and financial statements. The

company got its listing in May 1997. Because thewhole affair was also said to have involved over

officials from over 70 central and provincialgovernment departments and organizations as

well as Party cadres, the investigation of this

fraudulent case was reported to have beenconducted with direct participation by the

Disciplinary Committee of the CentralCommittee of the Chinese Communist Party.

The above three examples show the strongmotivation of company executives under the

current business and social environment to gain

advantage from the most blatant unethicalactivities. The formal governance structures havebeen completely ignored. As the above case has

demonstrated, it is not just the company man-agement but also a wide spectrum of professional

and government organizations that had colluded

in making such activities happen. This outcomeis perhaps not surprising as it really affirms the

weakness of the state as the majority shareholderand controller of a company. The failure to

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delineate property rights and accountability for

the key participants has contributed to thisoutcome. It is also the consequence from the

absence/ineffectiveness of the complementaryformal and informal institutions that are needed

to support the functioning of an Anglo-American type of corporate governance systemgeared towards the protection of minority share-

holders.

4. Policy responses and conclusion

If corporate governance is the means by which

to infuse order, thereby to mitigate conflict andrealize mutual gains,42 then the current arrange-

ments in China will need to undergo morefundamental changes and development before

those very important and relevant objectives canbe achieved. Corporate governance structures in

the Anglo-American system are already highly

developed and the standards of practice andenforcement are usually high. Corporate gover-

nance may not make much difference in corpo-rate performance among firms operating in those

mature market economies under that system,43

but in times of corporate crisis, corporate gov-

ernance has mattered even there. For China,given the severity of financial distress afflicting

many state firms and the problems discussed inthe preceding sections, getting the corporate

governance right is clearly critical.The Chinese government has taken a variety

of responses and measures to counter some of the

major ethical and governance issues that haveemerged in recent years. Until recently, most of

the initiatives are reactive in nature to givenproblems, or replicas of practices in the West that

are perceived to be modern and effective. These

included technical measures such as standardizingdisclosure requirements, extending the adminis-trative network of CSRC to the whole country,

more efforts to monitor the activities of com-panies and intermediaries serving the securities

industries, to the introduction of executive stock

options, and more detailed laws and regulations.Even ignoring their actual viability in practice,

while all these measures may be necessary, theyare not sufficient conditions for Chinas formal

corporate governance structures to accomplish

the desired outcomes. As argued earlier, there arecertain complementary formal and informal

institutions and market infrastructure that con-

stituted the functioning Anglo-American model

of corporate governance, and many of these are yet to be developed in China. A particularlyencouraging recent sign is the willingness of the

CSRC to allow legal challenges to its decisionsas in the case of the widely reported case of a

company in Hainan taking the CSRC to courtover the latters treatment of the companys

application for listing.45

Some of the measures of the Chinese govern-

ment have gone beyond the technical andadministrative to the more market oriented ini-

tiatives to induce systemic changes. For instance,the idea of promoting the development of

institutional investors such as managed funds is

seen by many to provide not just a new vehicleof investment but a catalyst for professionalism,

sophistication, efficiency and even increasedstability in the market and the industry. Irregular

and unethical practices are expected to diminishwith the growth of institutional investors who

will take an active governance role. After all,institutional investors are now the dominant type

of shareholders in the worlds largest capitalmarket in the United States and some of them

have been active participants in the governanceof companies they have invested in. The rise of

shareholders activism is closely associated with

these institutional investors. They are thereforeregarded in China as a desirable symbol of

modernity and market maturity. Unfortunatelythese expectations are yet to be realized in China.

Indeed, the relatively short experience ofChinese individual investors in managed funds

has on the whole been less than inspiring.

The publication by a popular businessmagazine at the end of 2000 detailing findingsfrom an internal report of the Shanghai Stock

Exchange alleging collusive stock market manip-

ulation activities by the countrys ten largestlicensed funds management companies has caused

serious concern and some heated debates.45 The

endemic disregard for shareholders rights,

whether they belong to the state as majorityowner or to the numerous individual minority



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shareholders, is therefore reaffirmed if the alle-

gations were true.Regardless of the validity of the specific claims

and counterclaims, a number of useful observa-tions can be made. First, managed funds have

become an important investor in Chinas stockmarket.46 Two, contrary to the expectations by

many in China, this new form of institutional

investors have not been able to play the antici-pated role in lifting corporate performance nor

instilling an element of stability in Chinas oftenvolatile stock market activities. Third, the

Chinese mass media is increasingly showing thatit is willing and capable of utilising its potential

as an outside monitor on the corporate gover-nance performance of listed companies, a role

that the Western counterpart has played tosupport the viability of the Anglo-American

system of corporate governance.47

Another major development may be the recent

increase in merger and takeover activities (usually

categorized as capital reorganzation in China).Certainly the existence of an active market for

corporate control is integral to the Anglo-American model of corporate governance.

However, as discussed earlier, since full privati-zation is not an immediate policy objective and

the state continues to hold majority shares thatare not allowed to be traded, the development

of a market for corporate control is inevitablyretarded.

Of the estimated 426 listed companies thatwent through a capital reorganization between

1992 and November 2000, 140 of them occurred

during the months of October and November2000. However, only about 4% of these activi-

ties actually involved a significant degree ofmerging and exchange of company assets.48 Most

are paper exercises aimed at creating favourable

impressions and presentations for the purpose offinancial gains in the stock market. Indeed, suchactivities have acted as the impetus for stock price

movements and for backdoor listings. Listedcompanies that are poorly performing and facing

threats of delisting and bankruptcy are thefavorite target for merger and takeover.

It is interesting to note that the two stock

exchanges in China have created a ST board(Special Treatment) and later PT (Particular

Transfer) for listed companies facing various

degrees of financial difficulties that would haveled to their suspension but were allowed to

remain listed under some restrictions.49 As of theend of 2000, there were 58 companies with these

labels. The moral hazard problem created by suchconcessions and special treatment for poorlyperforming companies would have only added

fuel to the widespread opportunistic behavior ofthe insiders at the expense of other stakeholders

specially the shareholders.While irrational exuberance may not accu-

rately describe Chinas stock market during thelast decade since wild fluctuations are frequent,

the sentiments of the ordinary individualinvestors for much of that time are not far from

that description. As in other emerging marketsparticular those in transition economies, a

companys reputation of integrity and perfor-

mance is often not required to raise capital inthe stock exchange. Indeed, wild movements

generated by market manipulation may in factat times be applauded by some investors who

hope to profit from such speculative waves andare eager to follow the winners. The result is

that the incentive for investors to take an interestin corporate governance and monitor company

management performance would be loweredfurther. Given the dominant nature of insider

control in Chinese companies, the weak pressure

exerted by shareholders on company manage-ment would only exasperate the problems of

governance and ethics.An encouraging sign in terms of new policy

development is perhaps the emerging redirectionin the Chinese governments approach to regu-

latory administration and development of thesecurities market, and in its focus on promoting

corporate governance standards. Various pro-

nouncements and actions by the CSRC in recentmonths suggest that the Chinese government isslowly moving away from a highly centralized

interventionist approach to one that puts moreemphasis on enhancing the protection of share-

holders rights, and installing and enforcing the

rules of the game for market participants.50

One of the most important new initiatives is

the planned discontinuation of the quota systemfor selecting firms for listing on the stock

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exchanges. Provided the listing procedures to be

administered by the stock exchanges are trans-parent and independent,51 this move will remove

much of the grounds for non-productive rentseeking activities and will have a positive effect

on the quality of companies that will go public.Equally significant is the broad intention that thegovernment will allow more private enterprises

to be listed on Chinas stock exchanges. Anincreasing proportion of non-state owned com-

panies will eventually help the development of amore balanced and liquid securities market in

which property rights are more clearly delineatedand corporate governance practices can be more

standardized and market oriented. However,unless state owned shareholdings can also be

freely traded on the market, the stranglehold onsuch a development will remain for some time.

In conclusion it is clear that specific ethical

issues such as protection of shareholders andother stakeholders rights, corruption, plundering

of state and company assets, and fraudulentdealings are the product of weaknesses in Chinas

corporate governance structures as well theasymmetrical development in formal and

informal institutions under which all companieshave to operate. China has patterned its formal

corporate governance structures on the Anglo-American model but lacks the required institu-

tional and market conditions. These institutions

will take some time to develop to suit thecountrys particular economic, financial and

political circumstances. Ethical issues that havearisen in the process of the countrys reform and

development are path dependent and intertwinedwith the formal and informal aspects of the

economy, society and polity.To make the formal governance structures

work better, improving the effectiveness of the

regulatory regime by itself can deliver somedesirable outcomes. As the corporate governancesystem has been developed in a prescriptive top-

down manner, a similar approach to induce more

long term and market-compatible changes anddevelopment may indeed be needed to set the

process on the right course. However, it is alsotrue that merely relying on improving the formal

regulatory system will not be sufficient.Effective corporate governance will require all

the complementary conditions to be in place,

conditions that are integral to the Anglo-American model as well as those that are needed

for Chinas own set of social and economic

circumstances. For the latter, they need to

include for example the resolution of the issueof full privatization, a redefinition of the role ofthe government and the Party as major stake-

holders, the establishment of truly independentjudiciary and professional framework and mech-

anisms, the balancing of equity and efficiencyconcerns, and the fostering of a business culture

that is consistent with the demand of marketiza-tion and internationalization. For instance, it is

not clear if the compensation for managers and

government official were significantly lifted,

would the kind of dysfunctional and unethicalbehaviour now prevalent be vastly reduced? Oris strengthening the formal disclosure and

accountability procedures a more effective andimmediate alternative? Obviously improving

shareholders rights protection and civil libertycan also significantly reduce whatever negative

impacts from the ethical issues that have emergedin the development of the countrys corporate

governance and economic systems. All theserepresent areas that require more research to

come up with some answers.

Given Chinas social, political and economicconditions, it is necessary to continually assess

and reconsider what kind of corporate gover-nance arrangements are best suited to achieve

which economic and social prior ities. Before anygovernance or its associated ethical issue can be

addressed properly, there is also a need toexamine the purpose of a firm and how it can

account for what its does and who it serves withrespect to its major stakeholders, including the

shareholders. Therefore the future development

of corporate governance in China presents manyeconomic, political and ethical issues for policy

makers, shareholders, managers, key stakeholdersand the community as a whole. The basically

strong performance of the Chinese economy andthe overall upward trend of its securities market

have combined to mask the severity and negativeimpacts of the problems and issues discussed in

this paper. However, the expected furtheropening up of the economy and the financial



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sector, particularly after the expected entry into

the WTO, will no doubt increase the urgencyof resolving those problems. Only through a

better understanding of how they arise in theproper context will effective policy response will

identified and formulated. This paper hasattempted to show why some of the key issueshave emerged in the hope that they can be

therefore better addressed.

Notes

1 Examples abound. For instance, China has created

a central bank based on features from the West and

is charged with a similar responsibility to conduct

market based monetary policy to promote stability.

However, it has to perform its role under a predom-

inantly state owned banking system with invasive

government interventions, and in the absence of

developed financial markets.2 The retention of pervasive state ownership and role

of private property rights in Chinas transformed

economic system have attracted much debates within

and outside the country.3 The Fifteenth Congress of the Chinese Communist

Party held at the end of 1997 represented an impor-

tant milestone in that process. It adopted a more

liberal and open interpretation of the meaning of

public ownership reform. Public ownership wasofficially recognised to include a mixture of state

ownership and collective (group) ownership.

Therefore, what would have been labelled as partially

privatised companies in the West could thus be

included as part of the public economic sector. A

perceived cornerstone of socialism would accordingly

be preserved.4 Article 41, The General Civic Law of the PeoplesRepublic of China (effective 1 January 1987).5 For discussion of these developments , see, On Kit

Tam (ed.), Financial Reform in China (London and

New York: Routledge, 1995), On Kit Tam, CapitalMarket Development in China, World Development,Vol. 19, No. 5, 1991, pp. 511532.6 China Securities Regulatory Commission, 1999Report of Development of Securities Market in China (inChinese), Beijing, CSRC, p. 37.7 There are two major types of shares in a listed

company that are not allowed to be traded on Chinas

stock exchanges: state shares and legal person shares.

State shares are held by the Chinese government

through organisations such as the State Asset

Administration Commission or state owned holding

companies. Legal person shares are investment made

by other state owned enterprises. For detailed

discussion on these shares, see, Tam, On Kit, 1999,

The Development of Corporate Governance Development

in China. Cheltenham, U.K. and Northampton, MA,U.S.A.8 For discussion of the Russian experience, see,

Black, Bernard, Reinier Kraakman, and Anna

Tarassova, 2000, Russian Privatization and Corporate

Governance: What Went Wrong?, Stanford LawReview, Vol. 52, pp. 17311808; Fox, Merritt B., andMichael A. Heller, 1999, Lessons from Fiascos in

Russian Corporate Governance, University ofMichigan Law School William Davidson Institute Paper#99-012.9 Tam, On Kit, 1999.10 Coffee, John C. Jr., 1999, Privatization and

Corporate Governance: The Lessons from Securities

Market Failure, Journal of Corporation Law, Vol. 25,pp. 13911 Third Plenum of the Fourteenth Congress of the

Chinese Communist Party, Decisions on Some Issues inEstablishing the Socialist Market Economic System,November 1993.12 This 1993 CCP Decisions called for the first time

the establishment of modern corporation as a key

enterprise reform measure, placing emphasis on reor-

ganising large and medium SOEs into legal entities

through corporatisation, and on the clarification of

property rights. The World Bank and some promi-nent Chinese economists/policy makers (Wu and Xie,

1994; Zhou, 1994a) have advocated for the setting up

financial intermediaries as holding companies, or

some forms of debt equity swap between various

classes of SOEs according to their bank loan repay-

ment and profit performance. Experimental modern

corporate forms are being set up across the coun-

tries to provide experiences.13 This definition was first adopted in the 1993 CCPDecisions and reaffirmed in the 1999 Decisions.14 For detailed discussion and relevant rules and reg-

ulations, see, Tam (1999).15 Thus, corporate governance is often taken by

Chinese economists and policy makers to mean theorganisational structure consisting the owner, board of direc-tors and senior managers. A check and balance relationshipis formed within that structure, through which the ownerentrust its capital to the board of directors. The board ofdirectors is the highest level of decision making of thecompany and has the power to appoint, reward and penalise,and dismiss senior managers. See for example, Wu, Jinglian (1994), Xiandan Gongsi Yu Qiye Gaige

318 On Kit Tam


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(Modern Companies and Enterprise Reform).

Tianjin: Tianjin Renmin Chubanshe, p. 184.

In recent years, some of the myths of this stylised

model have come under increasing challenges. See for

example, Corporate Governance An International

Review(Oxford: Blackwell), various issues.16 Tam (1999).17 Certainly the development of corporate gover-

nance arrangements in the external market based

Anglo-American economies and the role that corpo-

rate governance has played, and should serve, are

themselves the subjects of intense debates. Measures

to improve the function and effectiveness of the

corporate governance system in these countries are

premised on certain economic, commercial and social

norms and conditions, and are essentially the product

of market interactions and regulatory responses. For

instance, information disclosure requirement can be

expected to work if there are complementary factors

such as the existence of competitive markets and a

well functioning system of commercial and contract

law, and independent professional legal and

accounting services.18 The Chinese term now commonly used in China

first appeared in 1994. In the 1999 Decisions, the

term, farenzhilijiegou, was officially adopted by thecentral government. For discussion on alternative

Chinese terms, including this authors, see, Tam

(1999). It is interesting to note that the Chinese term

(qiye dudao zhizi) created by this author in 1993, was

now regarded as superior by one of the creator ofthe now official Chinese term and is adopted in his

recent article. Zhou Xiaochuan (1999), The

Concept of Micro Institutions in Economics,

Comparative Economic and Social System (Beijing), No.4.19 This is particularly relevant in the description of

the generalized German-Japan system in which sig-

nificant differences exist between the two. There is

now a rich literature on different governance systems.

See for example, Aoki, M., and H. Patrick (eds.),

1994, The Japanese Main Bank System (New York:

Oxford University Press); McCathery, J., S. Picciottoand C. Scott (eds.), 1993, Corporate Control andAccountability (Oxford: Clarendon Press); Dimsdale,N. and M. Prevezer (eds.), 1994, Capital Markets andCorporate Governance(Oxford: Clarendon Press); Roe,M. J., 1994, German Populism and the Large

Public Corporation, International Review of Law andEconomics, Vol. 14, pp. 187202.20 Tam, On Kit, 1999, The Development of CorporateGovernance Development in China. Cheltenham, U.K.and Northampton, Mass, U.S.A.

21 Coffee, John C. Jr., 1999, Privatization and

Corporate Governance: The Lessons from Securities

Market Failure, Journal of Corporation Law, Vol. 25,pp. 139.22 China Securities Regulatory Commission, China

Securities and Futures Statistical Yearbook 1998. Beijing:China Financial and Economic Publishing House, pp.

3 and 1423 On Kit Tam (1999), Much of the discussion on

the actual Chinese corporate governance outcomes in

this section is based on findings presented in this

book.24 On Kit Tam (1999).25 The number of supervisors could be just one or

two for small limited liability companies, for listed

companies it is usually over three.26 For discussion of the opposing views see, Coffee

(2000).27 Chinas Company Law, for certain types of com-panies, came into effect in 1994; and the Securities Lawwas introduced only in 1999.28 Although the Chinese government initiated in

1996 a limited experiment with the introduction of

Japans main bank system o f governance in a few

selected enterprises.29 Hansmann, Henry, 2000, The End of History for

Corporate Law, Yale Law School Working Paper No.235.30 See for example, Parkinson, J. E., 1994, CorporatePower and Responsibility Issues in The Theory of

Company Law (Oxford: Clarendon Press); Monks,R. A. G. and N. Minow, 1995, Corporate Governance(Cambridge, MA: Basil Blackwell Inc.).31 State Council of the Peoples Republic of China,

Special Regulations for Offshore Share Placement andListing by Limited Liabilities Joint Stock Companies, 4August 1994.32 Su, Dongwei, 2000, Leverage, Insider Ownership,and the Underpricing of IPOs in China. Department ofEconomics, University of Akron, Ohio.33 This is a transaction cost economics interpretation.

For discussion of this theoretical approach, see,

Williamson, Oliver E., 2000, Why Law, Economicsand Organization ?, UC Berkeley School of Law PublicLaw and Legal Theory Working Paper No. 37.34 Chinas Securities Law (Section 71) describes severaltypes of market manipulations which include: (1)

Acting individually or in collusion with others in

using advantages in funding, shareholding or infor-

mation to continually or collectively buy and sell

stocks to manipulate prices (2) In conspiracy with

others, on pre-determined time, prices and methods

to trade shares with each other, or to trade shares



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that the parties do not own, in order to influence

trading volume and market prices (3) Trading with

oneself, self buying and selling without changing

ownership of shares, to influence prices and trading

volume (4) Other means to manipulate market prices,

including spreading rumors and incorrect informationto raise or lower market prices.35 Zhengjuan Shibao (Securities Times, Beijing), 4June 1999.36 This case was reported by Li Zhang (Office of

Economic System Reform, State Council of the

Peoples Republic of China), Exposing 39 Major

Illegal Incidences in the Stock Market, BeijingQingnianbao (Beijing Youth Daily), 11 November2000.37 The case was reported by Zhongxinshe (China

News Agency) on Chinas major website: sina.com.cn,

20 January 2001.38 Su Dongwei, 2000.39 Zhongxinshe (China News Agency), sina.com.cn,

20 January 2001; Zhongguo Jinyingbao (China BusinessNews), 5 December 2000.40 Li Zhang, Beijing Qingnianbao (Beijing YouthDaily), 11 November 2000.41 Li Zhang, Beijing Qingnianbao (Beijing YouthDaily), 11 November 2000; Zhongguo Jinyingbao(China Business News), 5 December 2000.42 O. E. Williamson, 2000, p. 12.43 Black, Bernard, 2000, Does Corporate

Governance Matter? A Crude Test Using Russian

Data, Stanford Law School John M. Olin Program inLaw and Economics Working Paper No. 209, December.44 China Youth Daily, 30 October 2000; CaijingShibao (Finance and Economics News), 1 December2000. The CSRC has exhibited a more open and

market oriented approach to its regulatory functions

than other government organisations. It has appointed

the former Chairman of the Hong Kong Securities

and Investment Commission, Anthony Neoh as its

Chief Adviser, and is planning to appoint a Deputy

Chairperson from the same Hong Kong securities

watchdog, Laura Cha, as its Deputy Chairman (which

is understood to be at a vice ministerial rank). Both

appointments are a first in China because such senior

official posts had been filled only by local Chinese in

the past.45 The Dark Scandal of Managed Funds The

Interpretation ofThe Research Report on the Behaviour

of Managed Fund, Cai Jing[Finance and Economics,Beijing], October 2000. The Research Report inquestion was said to be an internal report produced

by the Shanghai Stock Exchange. The Research Reportinvestigated stock market dealings the 22 securities

investment and brokerage companies owned by

Chinas ten funds management companies during the

period from August 1999 to April 2000.46 By the end of 2001, the total 33 investment funds

totaled RMB 56 billion yuan. Zhengjuan Shibao(Securities Times), 16 January 2001.47 For discussion of this role of the mass media in the

Anglo-American system, see, Lowenstein, Louis 1999,

Corporate Governance and the Voice of the

Paparazzi, Columbia University School of Law, Center for Law and Economics Studies Working Paper No. 132.48 Stop the fake capital reorganization, GongshangZaijing (Industry, Commerce, Finance andEconomics), Sohu.com, 5 December 2000.

Significant is defined as involving 70% or above of the

total assets.49 Beijing Qingnianbao (Beijing Youth Daily), 16December 2000.50 Zhengjuan Shibao (Securities Times), 16 January2001, 24 November 2000; China Securities

Regulatory Commission, China Securities and FuturesStatistical Yearbook 1998.51 Chinas two stock exchanges are supervised by and

administratively accountable to the CSRC.

Department of Management,Faculty of Business and Economics,

Monash University,Caulfield, Victoria 3145,

Australia,

E-mail: [email protected]

320 On Kit Tam

Ethical Issues in the Evolution ofCorporate Governance in China

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