Government-Business Relationship and Corporate Governance: A Perspective of

Chinese Listed Companies

TONG Daochi

China Securities Regulatory Commission

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Government-Business Relationship of Publicly Listed Companies

• Government as an owner of listed companies—about 70% of listed companies whose controlling shareholders are various levels of governments, and the state owns about half of all the shares in the market

• Government as a securities regulator—CSRC was established in 1992, headquartered in Beijing with 36 regional office around the country

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Government-Business Relationship of Publicly Listed Companies

• Government as industry regulator—some of the industries are heavily regulated, such as telecommunications, petroleum, energy, transportation, automotive, steel, banking, etc.

• Government as law business registrar, tax collector, and auditor

• Government as law enforcement agencies• Government have a very strong and extensive role

on publicly listed companies, which certainly affect their corporate governance practice

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Government as an Owner of Listed Companies

• Listed companies were not completely spinned-off from their parent companies (SOEs) when their initially going public

• The “tunnel” effect: proceeds raised from the stock were channelled to the parent companies without proper cause. By the end of 2004, controlling shareholders and their related parties owe the listed companies more than 50 billion yuan

• Managers of state-controlled listed companies are still mostly appointed by the government.

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Government as securities regulator

• A merit-based system: companies want to go public have to be first approved by CSRC. Only “good” companies can go public and raise funds from the securities market

• Overseeing information disclosure and promoting corporate governance among listed companies

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Corporate Governance Reform in Chinese Listed Companies

• CSRC has been in the forefront of promoting corporate governance in China has taken vigorous actions to raise the corporate governance standards of our listed companies – Independent directors on board– Code of Corporate Governance– Information disclosure– Role of institutional investors, including qualified foreign institutio

nal investors scheme (QFII)– Regulation on Protection of Public Shareholder Rights– Legal reform protecting shareholder rights through lawsuits– Accounting reform and supervision of auditors

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Monitoring Corporate Behavior by Independent Directors

• Overhaul the insider-controlled board structure by promulgating a regulation requiring each listed company to have at least one-third of the board to be independent directors by June 2003. The regulation was issued in August 2001

• By end of 2004, 4,681 independent directors had been elected and appointed by shareholder meetings of the 1,377 listed companies in China. Most companies have reached the target of one-third of the board to be independent directors

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Independent Directors (Cont’d)• About 40% of independent directors are from academic

and research institutions; another 25% from intermediaries such as accounting and legal firms, and investment banks; 15% are executive of other companies; the remaining are 20% are retried government officials and others

• 60% of independent directors aged between 30-50, and 37% of Ids aged between 50-70; 27% have Ph.D degree, and more than 60% have a post-graduate degree

• About one-third of the independent directors are accounting profession, and almost all companies have at least one accounting professional to be independent director

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Profession

43%

24%

13%

7%13%

Professors &Researchers

Lawyers,Accountants, etc

Executives &Managers

Governmentretirees

Others

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Field of Training

54%

11%

15%

20%

Economics &AccountingLaw

Management

Others

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Degree of Education

27%

27%

35%

11%

Doctoral degree

Master's degree

Bachelor'sdegreeOther

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Age distribution of independentdirectors1%

59%

37%

3%

below 30

30-50

50-70

above 70

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Accounting Professional(Yes/No)

32%

68%

YesNo

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Independent Directors (Cont’d)

• CSRC’s regulations require that independent directors must spend enough time on the companies they hold directorship; one person can not hold more than 5 directorship positions concurrently; they must perform the duty of due diligence and can not just act as “flower Vessels”

• Recent survey shows independent directors on average spend about 20 days in a company they hold directorship

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Definition of “Independence”• We define “independence” as independent from

– Controlling shareholder– Management– Major business relations

• The independence qualifications of the candidates for independent directors need to be checked and approved by CSRC first before they can be voted in shareholder meetings

• Candidates for independent directors have to make a public declaration on their independence qualifications and their information need to be publicized on newspapers

• Can not work for more than 6 years in a company

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The Roles and Responsibilities of Independent Directors

• Protect shareholder rights and the interests of the company, paying particular attention to minority shareholders

• Major related party transactions have to be approved by independent directors

• Serve as chairs of the auditing, compensation, and nomination committees. Independent directors must consist of a majority of these committees

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Monitoring by Independent Directors: Does It Work

• Overall, independent directors played important role on monitoring related party transactions between the listed companies and their parent companies

• Checks and balances in the board helped monitoring the behaviour of the management and building a clean corporate culture

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Monitoring Corporate Behavior through Disclosure

• Information disclosure is a ongoing and continuing responsibility of all the listed companies

• All the shareholders have the equal right to receive the correct, timely, and complete information; disclosure through the internet

• Regular disclosure through audited annual report, mid-year report and unaudited quarterly report

• Require disclosure of corporate governance practices in the annual report

• Disclosure of information about the controlling shareholder or the actual controller of the company

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Information Disclosure: Responsibilities of Directors and Officers

• The board of directors, the CEO and CFO are directly responsible for the accuracy and truthfulness of information and financial data disclosed in the annual, half-year and quarterly reports. The board will need to make a declaration on the front page of the reports and will need to sign on the reports

• They will be fined for 30,000 Yuan to 100,000 Yuan for disclosing false information

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Monitoring Corporate Behavior by Shareholders: Role of Institutional Investors

• Expanding the institutional investors base: developing close-end and open-end funds. The securities fund industry started in 1998. There are currently 46 fund management firms, managing over RMB368 billion of client funds.

• Opening stock market for insurance funds and social security funds. Insurance companies are now allowed to directly invest up to 15% of their total investment in the stock market

• Institutional investors started to play important role on shareholder meetings

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Monitoring Corporate Behavior by Shareholders: QFII Scheme

• Opening stock market for foreign institutional investors: Qualified Foreign Institutional Investors (QFII) scheme

• Qualified foreign institutional investors are allowed to enter into Chinese stock market and buy and sell A shares

• To date 27 foreign institutional investors including Fumora Securities, UBS Warburg, Citigroup, Morgan Stanley, Goldman Sachs. Dutch Bank, HSBC, ING, JP Morgan Chase have been approved by CSRC as qualified foreign investors with total investment of up to US$3 billion

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Monitoring Corporate Behavior by Shareholders: Regulation on Protection of

Public Shareholder Rights• The regulation was promulgated by CSRC on

December 7, 2004• Important issues related to the interests of public

shareholders has to be agreed by at least half of public shareholders attended the shareholder meeting

• Companies have to provide electronic voting vehicles when voting for the above issues related to the substantial interests of public shareholders

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Monitoring Corporate Behavior by Shareholders though lawsuits

• Lawsuit against directors and management: the Supreme Court issued an Ordinance on 2003 on the the procedures for shareholders suing directors and management in case of losses due to false disclosure by the company. The Courts have started to accepted cases

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Monitoring Corporate Behavior by Intermediaries: Accounting Reform

• The Ministry of Finance has vigorously revised Chinese accounting standards according to IAS

• Strengthened supervision on auditors. Revoked the license for securities business of the largest auditing firm in China because of its involvement in the scandal. The firm was dismantled in the end

• Rotation of auditors: an auditor/project manager can not provide audit services for the same company for more than consecutive five years.

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Monitoring Corporate Behavior by Regulator: Stronger Enforcement

• Regular on-site inspection on the listed companies on the issues of accounting, disclosure, related party transactions, etc. Last year about 465 firms went through on-site inspection by CSRC’s regional offices, and 28 cases were investigated

• Stronger sanctions against violations on laws and regulations, including public criticism. Stock exchanges were empowered for public reprimands of listed companies for violations of their listing rules. Last year 36 firms received such letters of public reprimands by the two stock exchanges

• Joint Bureau of Investigation for Securities Crime between CSRC and Ministry of Public Security

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Monitoring Corporate Behavior by Through Training

• Monthly training classes for independent directors candidates in Shanghai and Beijing. 30 sessions were run and trained about 8,000 candidates during the last 2 years

• Monthly training courses for directors already on board by the two stock exchanges, to train all the directors in three years

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Our efforts has been paid off…

• Our measures on corporate governance has paid off: the performance has improved and earnings have been growing for three consecutive year. Last year, the semi-annual reports of show that earning per share grew by 34%, far exceed the growth rate of GDP.

• This is partly due to strong economic growth, and partly due to improvement in corporate governance.

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Assessment and Questions for Discussion

• Government has a strong and extensive role over the business sector, including the listed companies, which certainly affect their corporate governance

• CSRC attached great importance on corporate governance reform of listed companies, which may have helped listed companies to become good corporate citizens and reduce rent-seeking activities

• Questions for discussion are:– What is the proper role of regulator over listed companies:

shall we move from a merit-based system to a disclosure-based system?

– What the securities regulator can do to improve corporate governance when the state is the controlling shareholder?

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Outlook for further actions on corporate governance

• Code of conduct for directors and officers• Revising rules on independent directors so that

independent directors are nominated and elected by and more representative of the rights of minority shareholders

• Shareholder meetings: internet voting methods, separate meetings and veto rights for minority shareholders regarding related important issues

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Thank You!!

tongdc@csrc.gov.cn