Corporate Governance and a Party (Committee) in the Boardroom

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One of the positive things China expects from the introduction of foreign investment (and the use of overseas listings) is improved corporate governance. However, this requires a big change in the way that Chinese companies operate, as they have often been driven by dictat – with the big boss (and the Party Committee) being all-powerful.

However, the Sunday Times reports that state firms are now starting to give directors more power, and are using the experience of foreign experts to help the process along (see more on the use of senior foreign managers here). The report notes the example of Zhang Chunjiang, Chairman of China Netcom Group (listed in New York and Hong Kong), who recently had his first experience of directorial dissent – from a foreign director, John Thornton (previously President of Goldman Sachs):

    “’This was the first time I had ever encountered opposition’,” said Zhang, a 48-year-old former government vice minister. “’But we had made a real mistake’.” He scrapped his selection [of a financial advisor] and let the committee decide”.

One of the problems foreign executives face in China is that most boards at state companies lack real power, as they are controlled by the Party Committees that operate in the background. However progress is being made and:

    “Outside directors at Netcom outnumber directors who work for the company. Rules drafted with the help of McKinsey & Co require that two-thirds of directors approve major decisions….Netcom hired McKinsey and a Tsinghua expert and asked them to suggest an overhaul of the board’s operations — but not before Zhang delivered a little talk on how China Inc really works. At the first meeting of the project’s working group, Zhang explained the role of the Communist party committee at Netcom. Such committees, usually headed by the chairman and staffed with handpicked executives, essentially run China’s government-controlled companies, channelling state policy into corporate practice. Their role is little understood outside China. American regulatory filings by Chinese companies generally don’t mention the party committees.”

Clearly, these things are done differently in China, and there is no point cutting and pasting western management methods – processes have to be adapted to the reality of local conditions. McKinsey’s Asia-Pacific Chairman, Dominic Barton, is quoted as saying that China needs:

    “something other than a Wall Street model, something that acknowledges that they have other obligations, social obligations. It’s a broader set of stakeholders”.

Adding these corporate governance issues to the billions of dollars that have been investment in China’s banks recently, and what do you get? George Mathewson, The former Chairman of RBS (which invested in Bank of China), says, in The Asian Banker, that:

    “It will be asking too much to ask that to happen overnight. I see it more as a process. I would not expect that to be immediately anything like the U.K.” and that local issues such as “ownership, government ownership and political powers,” will all have an impact. He also notes that “I hear that we’re reasonably impressed by what is happening [at the Bank of China]”.

It seems likely that the corporate governance changes being made in the big, listed state firms, and the newly-invested banks, will serve as a template for the wider market. Ultimately this will improve the business environment, but there should be no great surprise if the learning process includes a few of the headline-grabbing losses / frauds / scandals that we have become used to. Long-term investors should therefore keep their hats on tight, and be prepared to endure a bit of a risky ride before they can (hopefully) collect their rewards.

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