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Ethical Issues in the Evolution ofCorporate Governance in China

Ethical Issues in the Evolution ofCorporate Governance in China



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Published by: Ichbinleo on Apr 24, 2008
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ABSTRACT.China is establishing its corporategovernance structures by emulating the stylizedAnglo-American model. However, the country doesnot yet have the necessary formal and informalinstitutions, or the financial infrastructure to makethese structures work effectively. Corruption, stockmarket manipulation, tax cheating, fraudulent dealing,all manners of plundering of state assets and the lackprotection of shareholders’ rights are some of themore conspicuous manifestations of the ethical issuesthat have emerged in this mismatch. This study showshow these issues arise in the context of the charac-teristics of country’s economic and corporate gover-nance development. It evaluates various potentialpolicy responses that may be implemented to improvegovernance effectiveness and diminish the damagefrom those problems.KEY WORDS: China, corporate governance,economic reform, shareholders rights, stock market
1. Introduction
During the last two decades, momentous changesin China’s economic system and business envi-ronment have occurred. The price mechanismhas been allowed to increasingly replace thecentralized 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 institutionsand 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 unitswithin 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 independenteconomic agent and the development of theincorporated form of business organization haveprofound implications for the shape and dynamicsof the society, polity and economy of China. Ina country where the state had owned andoperated work units that encompassed nearlyevery aspect of the life of an individual, thistransformation changes the rules and incentivesgoverning the actions and interactions among alleconomic agents including the state and itsinstrumentalities at various levels. These changeshave produced the expected growth benefits andimprovements in living standard for the majorityof the population. However, it is clear thatelements of both the formal and informaleconomic-social institutions from the pastcontinue to influence and sometimes obstruct the
Ethical Issues in theEvolution of CorporateGovernance in China
On Kit Tam
 Journal of Business Ethics
: 303–320, 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 of International Programs of the Faculty of Business and Economics, and Director of the China Research Centre,Monash Asia Institute. Professor Tam has written exten-sively on China’s economic and financial reform, and corporate governance development. He organised and chaired China’s 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 comparative evaluation of corporate governancne performance.
way economic activities are conducted in thefledging market-oriented business regime.While facets of modern market institutionsand instruments have now been adopted exten-sively from mature market economies, they haveto operate under an environment where thesocial and economic preconditions for their effective functioning are at times lacking or underdeveloped.
This may be an inevitableconsequence of China’s gradual approach toeconomic 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 aresome of the more conspicuous manifestations. Inmany ways, nowhere are such new ethical issuesbrought into sharper focus than in the develop-ment of corporate governance in China’s listedcompanies, the country’s supposedly mostmodern 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 willcertainly be faced by participants in other areasof the country’s transforming social-economiclandscape.As a result of the more rapid pace of corpo-ratization and
de facto
privatization of state ownedenterprises since the early 1990s, corporategovernance has assumed an increasing promi-nence in the country’s reform agenda as theChinese government tried to promote enterpriseperformance and to look after its ownershipstakes in various forms. The widespread andpersistent financial distress experienced by manystate owned enterprises has added to the urgencyof getting the country’s corporate governanceright.This article shows that the business ethicsissues associated with China’s corporate gover-nance arrangements are the product of severalinteracting factors. They stem firstly from thestruggle between the desire to install “modern”institutions and instruments, and the imbalancedprogress in the development of complementarysocial, political, legal and economic infrastruc-tures. Another equally important factor can beattributed to the approach taken by the Chinesegovernment to establish a corporate governancesystem based on the stylized Anglo-Americanmodel. In investigating the key ethical issues inthe context of China’s corporate governancedevelopment, the paper aims to examine howthey can be realistically addressed to producemore desirable outcomes.This paper is organized as follows.
Section 2
examines what corporate governance develop-ment in China is about and its salient featuresand major trends. It will briefly outline the recenthistory of the creation of corporations andinvestigates the meaning of corporate governanceand its relevance for China’s reform and devel-opment.
Section 3
identifies and explains theemerging ethical issues in the context of thecountry’s evolving macro environment as well asits corporate governance arrangements.
Section 4
discusses the government’s policy responses toresolving such issues and evaluates their effec-tiveness. Some conclusions are also provided.
2. Challenges of corporate governanceII.development
Introduction – the birth of companies and 
stock exchanges
Optimizing allocative efficiency and distribu-tional equity, and the way these two goals maybe balanced are always basic issues of economicpolicy in any country. In China’s economicreform, the government has certainly tackledthese issues in a fundamental way but has alsopersisted with a desire to preserve its perceivedessential trait of socialism by means of main-taining the prominence state ownership in keysectors of the economy. This state ownershipstricture has complicated economic policymaking and its outcomes. Many have argued thatit has hurt the effectiveness and pace of thecountry’s economic reform.
In reality, however, the ownership mix hascontinued to shift towards a diminishing statesector. The rising degree of marketisation andopenness in the economy, and the need to dealwith many financially distressed SOEs have304
On Kit Tam
contributed to a continuing process of redefiningthe meaning of public ownership.
The progres-sively more liberal interpretation of the meaningof state ownership, the
de facto
partial andcomplete privatization of state enterprises, andthe 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,
thesubstance of what constitutes corporate gover-nance in the West has become increasinglyimportant in China although the notion of corporate governance was little known then.Under the central planning regime before thereform, China’s industrial and commercial enter-prises were not autonomous economic entity butwere really workshops and production units withno independent decision making power. Thecentral plan replaced the function of the marketand the conditions for the existence of a firm asis understood in market economies were absent.All means of production are nominally owned bythe 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 thefirm level.The emergence of the company as a basiceconomic entity was accompanied by a processof financial reform that has turned the newlycreated or reorganized state-owned banks intothe primary provider of finance for Chineseenterprises, replacing the old system of statebudgetary grants. Shareholding companies weresoon formed when grass-root efforts to developChina’s capital market began spontaneously in themid 1980s.
Various forms of shares and bondswere issued by state and collective enterprises toraise funds and informal securities trading couldbe found in most major Chinese cities. China’sfirst 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 branchesof China’s central bank. By 1991, China’s twoofficial stock exchanges in Shanghai andShenzhen were ready for full operation. Thecountry’s corporate finance and developmenthenceforth entered a new era.Chinese listed companies, the focus of studyin this paper, are in the main partially privatizedstate owned enterprises (SOEs). That is, their major shareholder is the state in its various formsincluding other state owned enterprises. Indeed,at the end of 2000, of the 1088 companies listedon 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 bythe state or state enterprises (Table II). Of the851 listed companies in 1998, 75 per cent werein fact majority owned and nominally controlledby the state or state owned holding companies.
It should be noted that all forms of state ownedshares
are not allowed to be traded in the stockexchanges, only shares held primarily by indi-viduals can be traded.Another important characteristic of China’slisted companies is that, up to 2000, approval for a company to obtain listing has been determinedby the government on the basis of an annualquota broken down to each province and min-istries which then select the companies to filltheir allocated quotas. Therefore the listing of acompany is usually decided not on commercialmerits but on political and sectional considera-tions. Clearly this aspect alone has created fertile
Ethical Issues in the Evolution of Corporate Governance in China
Figure 1. The emergence of company as a businessorganisation.

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