This content is from: Local Insights

Corporate governance and institutional investors' potential

The central challenge of China's corporations is to deliver results that will satisfy an ownership base that is increasingly comprised of institutional investors. Unlike most of the OECD, China has to reconcile from the outset the twin demands of corporate managerial risk-taking, which is the essence of robust economic growth, and institutional investor prudence, the main pillar of which is liquidity of investment (at least in the same currency).

Such a unique challenge might entail policy responses that are a great leap beyond the traditional theology that corporate fundraising must protect fragmented retail investors and therefore corporate governance must be largely left to presumably more knowledgeable boards of directors.

There should be more freely negotiated deals in the private space (that is, industries where greenfield joint-stock limited companies sponsored by private domestic and foreign investors make sense because no state-owned competitors exist or are planned), with strict scrutiny of simple majority enactment of takeover defences (staggered boards, cumulative voting, special dividends/call options/dilutive issuances, limitations on shareholder meetings, and golden parachutes) and the requirement for cause in removing directors. However, freely negotiated voting rights designed to prevent minority oppression should be encouraged. The catalogue of encouraged, permitted and restricted foreign investments should be reviewed periodically.

In the world of listed Chinese companies that are owned by a mix of holders of listed shares, unlisted shares, and state shares (equity owned by the state), there should be rules to attract new institutional funds to increase the capital base, subject to appropriate determination of the dilution rate of all existing shareholders (under the Company Law), to lessen dependence on state or state-subsidized funding of capital investments. The duties of loyalty, care and business judgment should be expanded (the standard of loyalty contained in the current Company Law in Articles 59-61 is rather low, although Article 123 seems to create a positive duty to "protect the interests of the company" in the context of language regarding loyalty). Under Article 126 of the current Company Law, the supervisory board does have the power (and duty) to request corrective measures with respect to any director that is acting against the interests of the company, but the operative word is "acts" (not omissions).

China needs to build beyond an integrated disclosure system, complete with Regulation SX-like accounting content, first, by CSRC reviewing prospectuses and reports as an institutional investor would so that public offerings, though not negotiated other than by underwriters, who tend to tick boxes in driving home the deal that pays their fees, could achieve communication of terms and risks that are of the essence to an institutional investor. It also needs to promote financial media institutions, unaffiliated with listed companies, that promptly disseminate all material information about listed companies that has already been disclosed.

There should also be other rules to promote leverage on arm's length terms as a method for financing acquisitions of businesses and other capital assets, clarify tax and accounting consequences to all owners for changes in control where Chinese companies are acquired or are acquirors; and make approval of remittance of assets (including cash and stock holdings) abroad for purposes of capitalizing new or acquiring existing companies a transparent process.

Fred Chang

Instant access to all of our content. Membership Options | One Week Trial