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INTRODUCTION
Prior to 1978, private enterprise had been effectively eliminated in China as a result
of central (state) planning of the economy. Recent years have, however, seen a
transformation. The economic reform process, which began in 1978, has led to
fundamental changes in enterprise organisation, a re-definition of the role of the state
and recognition of a role for private capital and private enterprise. The main elements
of that process have been the introduction of company and securities law, conversion
of state-owned entities into companies and listing of these companies on the Stock
Exchanges. From this process, there has emerged a group of public listed
companies, which represent a substantial part of China’s economy. A more recent
development has been the introduction of Corporate Governance Guidelines for
listed companies.
The creation of the legal and institutional framework which supports listed companies
in China raises a number of interesting issues. First, as company and securities law
had to be created ab initio so as to allow for the participation of private capital in the
economy, China provides a real example of the choices available in the design of a
corporate governance framework. A number of basic issues had to be addressed.
One was definition of the rights of shareholders and other stakeholders. Another was
the structure of the legal rules and in particular the balance between mandatory and
default rules. The rights of minority shareholders were also an important
consideration if private capital was to participate in the newly formed stock
exchanges. Second, the Chinese experience in establishing a regulatory regime for
listed companies provides some indication of the extent to which convergence
towards international norms is a significant force in corporate governance. This is of
particular interest in China, in view of the stated objective of the company and
securities law of promoting a “socialist market economy”. In particular, the experience
in China may provide some guidance as to elements of the corporate governance
Â
The Law School, University of Aberdeen. Research for this article was undertaken during a term of
sabbatical leave spent in Hong Kong and China. I am grateful to the Leverhulme Trust for financial
support; to the Hong Kong Baptist University for the provision of research facilities; to Alex Lau of
HKBU for translating Chinese legal materials; and to the many LLM alumni of Aberdeen University
who provided valuable assistance, particularly Zhou Xinguo, my research assistant.
This paper aims to examine the emergence of listed companies in China from the
perspective of these issues. It begins by reviewing the current debate on comparative
corporate governance. This is followed by a short history of enterprise reform in
China and identification of the main features of the corporate and securities laws,
which were introduced as part of the reform process. The role envisaged for private
capital and shareholders in the Chinese system is then analysed. This leads on to a
discussion of the manner in which the state regulates the operation of financial
markets and directly influences listed companies through its role as controlling
shareholder. An important element of the state’s control over listed companies is the
legal framework for the operation of the board of directors, which is analysed from
the perspective of the structure, composition and role of the board of directors.
Finally, the paper considers the role of minority shareholders in Chinese listed
companies in the context of recent research demonstrating close links between
minority shareholders’ rights and the development of capital markets.
1
For a justification of such an approach see A. K. Sundaram and A.C. Inkpen, “The Corporate
Objective Revisited” at ssrn.com.
2
See S. Worthington, “Shares and shareholders: property, power and entitlement (part 2)” 22(2)
Company Lawyer 307 (2001).
3
See M. Blair, Ownership and control: rethinking corporate governance for the twenty-first century,
Brookings Institute, Washington DC (1995).
4
See J. Parkinson, “Company Law and Stakeholder Governance” p149 in G. Kelly, D. Kelly & A.
Gamble (eds.) Stakeholder Capitalism (Macmillan 1997). Parkinson’s proposals for reform of UK
Corporate Governance include (a) the reformulation of directors’ duties to accommodate stakeholders’
interests and (b) the introduction of a two-tier board to facilitate a stakeholder approach. See also G.
Kelly and J. Parkinson, “The Conceptual Foundations of the Company: a Pluralist Approach” in J.
Parkinson, A. Gamble & G. Kelly (eds.), The Political Economy of the Company, (Hart Publishing,
2000).
5
See J. Hill, “Visions and Revisions of the Shareholder” 68 Am Jnl Comp Law 39 (2000).
6
See generally, M. Bradley, C. Schipani, A. Sundaram and J. Walsh, “The Purposes and
Accountability of the Corporation in Contemporary Society: Corporate Governance at a CrossRoads”
62(3) (1999) Law and Contemporary Problems 9.
7
A Berle and G Means, The Modern Corporation and Private Property (Transaction Publishers NJ
1991)
8
See H. Demsetz and K. Lehn, “The Structure of Corporate Ownership: Causes and Consequences”,
93(6) Jnl Political Economy 1155 (1985).
9
See N. Dimsdale and M. Prevezer, Capital Markets and Corporate Governance (Clarendon Press,
1994) for an extensive discussion of the relative roles of banks and financial markets in the UK,
Germany and Japan. See M. Maher and T. Anderson, “Corporate Governance: Effects on Firm
Performance and Economic Growth” in Renneboog L., McCahery J., Moerland P. and Raaijmakers T.
(eds.) Convergence and Diversity of Corporate Governance Regimes and Capital Markets (OUP 2000).
10
F. Easterbrook and D. Fischel, The Economic Structure of Corporate Law (Cambridge MA, Harvard
University Press 1991).
11
In its most extreme form, the “Chicago school” explanation of corporate governance formulated by
Easterbrook and Fischel is an irrelevance theorem in which there is no need for the law to intervene in
corporate governance structures as market forces will require them to evolve to their most efficient
form. A milder version of this view is provided by Andrews, “Corporate Governance Eludes the Legal
Mind” 37 U Miami L. Rev. 213, 214-21 (1983).
12
See M J Roe, “A Political Theory of American Corporate Finance” 91 Colum L. Rev. 10 (1991).
13
See C A Dunlavy, “Corporate Governance in Late 19th Century Europe and the United States, The
Case of Shareholder Voting Rights” in Hopt, Konda, Roe, Wymeersch, Prigge (eds) Comparative
Corporate Governance (OUP, 1998).
The extent to which there is, or should be, convergence in national systems of
corporate governance towards one model is a matter of some dispute. Some
commentators have argued for the superiority of the “shareholder value” system of
corporate governance in the United States, pointing to its increasing acceptance
worldwide and predicting its eventual worldwide hegemony.17 Others have adopted a
much more cautious view of convergence, recognising that there are unique
institutional and cultural factors operating at the national level which preclude the
importation of foreign governance systems. Put another way, for convergence to
occur, features of corporate governance within one system must be detachable and
so capable of transfer from one system to another: the more they are embedded in a
unique institutional or cultural setting in one country the less detachable they will
be.18 To the extent that convergence is predicted, the main driving force identified is
efficiency in governance structure, at least as viewed by investors in the global
capital market in which the “shareholder value” model dominates. A broader view,
however, would regard convergence in corporate governance as a sub-set of a more
14
See LLSV, “Legal Determinants of External Finance” 52(3) Jnl of Finance 1131 (1997); “Law and
Finance” 106(6) Jnl of Political Economy 1113 (1998); “Investor Protection and Corporate
Governance” at ssrn.com (update reference).
15
See L.A. Bebchuk and MJ Roe, “A Theory of Path Dependence in Corporate Ownership and
Governance” Columbia Law School Center for Law and Economic Studies Working Paper no 131 at
ssrn.com.
16
See A N Licht, “The Mother of All Path Dependencies, Towards a Cross-Cultural Theory of
Corporate Governance Systems” at ssrn.com.
17
See H. Hansmann and R. Kraakman, “The End of History for Corporate Law” at ssrn.com.
18
See W. Bratton & J. McCahery, “Comparative Corporate Governance and the Theory of the Firm:
The Case against Global Cross Reference” 38 Colum. J. Transnat’l L. 213, who present a useful matrix
for comparative corporate governance analysis at p17. See also E B Rock, “America’s Shifting
Fascination with Comparative Corporate Governance” 74 Wash U.L.Q. 367.
If some degree of convergence can occur, what form will it take? Gilson provides a
useful categorisation of the different forms of convergence that occur in the field of
corporate regulation. Formal convergence involves change in the legal infrastructure
and therefore requires political support and resort to the legislative process. This type
of convergence is often associated with international harmonisation in the form of
treaties, conventions or legislation made by supranational bodies.20 The most
significant step in this direction to date has been the limited harmonisation of
company and securities law in the European Union although the proposals made by
IOSCO for International Disclosure Standards may well represent a more significant
future development for listed companies.21 Functional convergence occurs without
any formal legal change in circumstances in which the existing regulatory
mechanisms are sufficiently flexible to respond to new circumstances without the
need for formal change. The process by which the Combined Code of Corporate
Governance has been developed and implemented in the United Kingdom could be
cited as an example of such a process: the development occurred outside the formal
legal and regulatory framework and the Code itself is appended to but does not form
part of the UKLA Listing Rules. Contractual convergence occurs when the existing
regulatory framework lacks the flexibility to adapt to new circumstances without
formal changes and an ad hoc solution is adopted through the medium of contract.22
Contractual techniques can move relatively easily from country to country without any
19
See S. Strange, “The Future of Global Capitalism; or, will divergence persist forever?” in C. Crouch
& W. Streeck, Political Economy of Modern Capitalism, Mapping Convergence and Diversity (Sage
Publications 1997). Associated with the process of convergence, in Strange’s view, are (a) a decline in
state sovereignty (b) asymmetry of regulatory power among states (with the USA predominant) (c)
denationalization of firms, who adopt a multinational perspective (d) increased government reliance on
financial markets as a result of the latter’s role in funding current spending through government bond
issues.
20
Proposals for formal convergence can also emerge from private sources: see e.g. Black &
Kraakman’s proposal for a self-enforcing model of corporate law, developed from models adopted in
the privatization process in eastern Europe (B. Black and R. Kraakman, “A Self-Enforcing Model of
Corporate Law” 109 Harv. L. Rev. 1911). See also J. Coffee Jnr. “The Rise of Dispersed Ownership:
The Role of Law and the Separation of Ownership and Control” at ssrn.com.
21
The proposal aims to establish minimum international standards for listing particulars and
prospectuses, thereby making possible multiple listing based on a single document. See D W Arner,
“Globalization and Financial Markets: An International Passport for Securities Offerings?” ???
22
Gilson cites as an example the contract terms that are typically adopted in venture capital limited
partnerships providing for distribution of the proceeds of investments that become liquid and the
liquidation of the partnership after a fixed period.
23
See J. Gordon, “The Mandatory Structure of Corporate Law” (1989) 89 Columbia Law Review 1549.
24
The inherent pragmatism of China’s reform process is typified by the analogy used by Deng
Xiaoping in 1962 to refer to reform of the system of production. He used a popular Sichuan saying, “It
does not matter if it is a yellow cat or a black cat as long as it catches mice.” While this may have
lacked resonance in the 1960’s (Deng was purged during the Cultural Revolution), it later came to
typify the post-1978 reform process. See Lan Cao, “The Cat that Catches Mice: China’s Challenge to
the Dominant Privatization Model” (1995) 21 Brook. J. Int’l L 97.
Practical development occurred first in the form of authorisation being given for
individual businesses to engage a maximum of five employees.27 The 1982
Constitution recognized the role of individual business by providing for the protection
of its lawful interests. In association with reform of the rural economy, in which the
majority of the Chinese population is employed, the relaxation of state control
resulted in the emergence in the 1980’s of a new and rapidly growing non-state
sector in which Town and Village Enterprises (TVEs) 28 and joint ventures with foreign
capital participation played a significant role. By 1988, the acceptance of the role of
private business was sufficient to result in an amendment to the Constitution so as to
refer expressly to the role of the private economy as a complement to the socialist
economy.29 Later in 1988 the State Council30 provided a basis for the authorisation
25
For a review of the ideological context within which enterprise reform in China has been pursued,
see G. Crane, “Globalization in China” 4(2) New Political Economy (1995) 215.
26
See A W Connor, "To get Rich is Precarious: Regulation of Private Enterprise in the People's
Republic of China", Journal of Chinese Law, Spring 1991 1.
27
For a discussion of these regulations and more generally on the history of the emergence of private
business in China see W. Kraus, Private Business in China (University of Hawaii Press 1991).
28
TVEs are collective enterprises under the ownership and nominal control of governments at the local
township, provincial and village level. They emerged as the post-1978 reforms permitted local
governments to promote and engage in business. For an assessment of their significance to the Chinese
economy, see H G Broadman, “The Businesses of the Chinese State” at ssrn.com. On TVE ownership
structure, see H. Williams, “Property Rights and Legal Reform in Township and Village Enterprises in
China” 2 Asia-Pacific Law and Policy Jnl 227 (2001).
29
The relevant article (11) was subsequently amended in 1999 to provide greater emphasis to the
private sector. The words “The individual economy of urban and rural working people, operating
within the limits prescribed by law, is a complement to the Socialist public economy” was replaced by
the words “the non-public sector, including individual and private businesses, is an important
component to the socialist market economy”. See the Constitution of the PRC at
http://www.qis.net/chinalaw and J. Chen, Chinese Law, Towards an Understanding of Chinese Law Its
Nature and Development (Kluwer 1999) Chap 3 (Constitutional Law).
This policy was pursued in four different ways.33 First, the introduction of business
autonomy: the State Enterprise Law of 1988 recognised SOEs as legal persons
separate from the state and defined the operational spheres of autonomy of SOEs
while a "contract responsibility system" was introduced to enhance the accountability
of SOE management. 34 This was followed by the introduction of fourteen
autonomous rights for SOEs in 1992, intended to enhance the autonomy of SOE
managements. Second, the transformation of SOEs into shareholding companies, a
process generally referred to as “corporatization”. This policy was implemented by a
series of administrative measures which recognised and created mandatory standard
forms for two types of company: Limited Liability Companies, which are broadly
comparable to private companies in the UK and Joint Stock Companies which are
broadly comparable to public companies in the UK.35 Corporatization had the effect
30
The State Council is the executive body of the National People’s Congress (NPC), which is the
“supreme organ of state power” (article 57 of the PRC Constitution). It includes the Premier, Vice-
Premier and Ministers. As the NPC meets only once a year for several weeks, much of the detail of law
making is delegated to the State Council.
31
State-owned enterprises are those with at least 51% state ownership and annual sales of at least RMB
5m (US$0.6m approx). In principle, this definition can include listed companies but the term is most
commonly applied to state enterprises that have not been listed.
32
For a discussion of the problems which had in the past plagued SOEs and held back progress in the
Chinese economy see Mai Yinhua & F. Perkins, China's State Owned Enterprises, (EEAU Briefing
Paper No 7, Dept. of Foreign Affairs and Trade Australia 1997). For an assessment of the current
position of SOEs in the Chinese economy see H.G. Boardman, “The Business (es) of the Chinese
State” at ssrn.com.
33
See China's Management of Enterprise Assets: The State as Shareholder (World Bank Country
Report, 1997 Washington DC).
34
The contract responsibility system, which had already been introduced prior to widespread
corporatization with objective of improving accountability, improved SOE performance. See Groves,
Hong, McMillan & Naughton, "Autonomy and Incentives in Chinese State Enterprises" 109(1)
Quarterly Journal of Economics (1994). See also Lan Cao (above n24) for a discussion of the system
in rural reform.
35
The relevant measures were mainly (1) The Measures for Experimental Joint Stock Enterprises (May
15, 1992) issued jointly by the State Commission for the Restructuring of the Economic System, The
State Economic Planning Commission, the Ministry of Finance, the People’s Bank of China (The
Central Bank) and the Production Office of the State Council (2) The Opinions for the Standardization
of the Experimental Joint Stock Companies (May 15, 1992) issued by the State Commission for the
Restructuring of the Economic System (3) The Opinions for the Standardization of the Limited
Mass privatization, in the form pursued in Russia and other "eastern-bloc" countries40,
has not been a feature of the re-organization of state owned enterprises in China
Liability Companies (May 15, 1992) issued by the State Commission for the Restructuring of the
Economic System.
36
See Lan Cao (above n24).
37
By 1996, bank deposits represented 56% of GDP; see R Gordon and Wei Li, “Government as a
Discriminating Monopolist in the Financial Market: The Case of China” Darden Graduate School of
Business Administration, University of Virginia Working Paper No 01-20 at ssrn.com.
38
Regulations Governing the Supervision and Management of State-Owned Enterprises' Property
(1994).
39
The World Bank commented in 1997 (above n33 at p38) on the confusion of the role of government
as shareholder and regulator "Overall, in the absence of more substantive "separation", these
[ownership] structures face inherent internal contradictions between governmental and shareholder-
ownership incentives. In such circumstances, the scope of reform they can accomplish is very narrow."
40
See J. Nellis, “The World Bank, Privatization and Enterprise Reform in Transition Economies: A
Retrospective Analysis” (at ssrn.com), for an account of privatization in Poland, Czechoslovakia and
Russia. The rationale for such mass privatization is explained by Wardle and Towle as follows: ".. it
serves the political purpose of entrenching the break with the past by giving each citizen the
opportunity to have a personal stake in their country's income-producing assets, thereby reducing
support for any future attempts to nationalize. It also provides an expectant public with a tangible sign
of the political changes and compensation for past hardship and deprivation of individual rights" (D.
Wardle and N. Towle, "Global Privatization" in International Privatization p7 (eds. D. Campbell and B.
Hollywood, Kluwer, London 1996).
41
The conventional wisdom was evident in the approach of the World Bank and was supported by a
background of successful privatization in developed economies such as the UK Canada and New
Zealand as well as a growing academic literature linking privatization with improved financial
performance. See J. Nellis (above, note?) and S Djakov and P Murrell, “The Determinants of
Enterprise Restructuring in Transition Economies” World Bank. September 2000. (see p76 of Nellis
Article).
42
For a discussion of the potential effects of privatization on the economy, see A. Schipke, Why do
Governments Divest? The Macroeconomics Of Privatization (Springer-Verlag, Berlin-Heidelberg,
2001) and J.J. Laffont and J. Tirole, "Privatization and Incentives", 7 Journal of Law, Economics and
Organization 84-105.
43
For a general discussion see Lan Cao (above n24).
44
While SOE’s share of the output of Chinese industrial enterprises fell from 47% to 28% between
1993 and 1999, the share of individually owned enterprises rose from 8% to 18%, collectives
(including TVEs) from 34% to 35% and “others” (including companies with either a minority or no
state shareholding) from 11% to 26%. See H G Boardman (above n32).
45
For an assessment of the company law see K.T. W. Ong and C.R. Baxter, "A comparative study of
the fundamental elements of Chinese and English Company Law" 48 ICLQ 88 (1999); N.C. Howson,
"China's Company Law: One Step Forward, Two Steps Back? A Modest Complaint" 11:1 Columbia
Journal of Asian Law 127 (1997); Png Cheong Ann, "Some concerns about Chinese company law",
17(7) Company Lawyer 199 (1996); Lawrence Liu, “Chinese Characteristics Compared: A Legal and
Policy Perspective of Corporate Finance and Governance in Taiwan and China” at ssrn.com.
46
These were the administrative regulations that preceded the Company Law. See footnote 35 above.
47
See Fang Liufang, “China’s Corporatization Experiment” (1995) 5 Duke J. Comp. & Int’l L. 149.
Companies created under ad hoc administrative measures in the 1980’s and the 1992 "Standard
Opinions" are the subject of a "grandfathering" provision in article 229 of the company law, which
provides that such companies shall continue to be recognized but are required to meet the requirements
of the company law within a timescale set by the State Council.
48
The Shanghai and Shenzhen Trial Measures (sometimes referred to as the Interim Measures).
49
Shenzhen was one of five SEZs, the others being Xiamen in Fujian Province, Zhuhau, Shantou in
Guangdong Province and (later) Hainan Island. The purpose of the SEZs was to facilitate interaction
with the global economy on a limited basis.
50
See S. Breslin, “Decentralization, Globalization and China’s Partial Re-engagement with the Global
Economy” 5(2) New Political Economy (2000) 205 for a discussion of this process.
51
See article 77 (approval) and article 73 (conditions) in respect of JSCs. The relevant government
departments are the State Administration of Industry and Commerce (SAIC) or the Ministry of Foreign
Trade and Economic Co-operation (MOFTEC) for foreign-owned companies.
52
See Ong and Baxter (above n45) p119.
53
Article 4.
54
On this issue, and its implications for rights on winding-up, see Howson (above n45) p142 and Png
Cheong Ann, “Some Concerns about Chinese Company Law” (1996) 17(7) Co Law 199,200.
55
On models of company law and the structure of its rules see I MacNeil, “Company Law Rules: An
Assessment from the Perspective of Incomplete Contract Theory” 1 Jnl Corporate Law Studies 107
(2001). Greater use of mandatory rules in transition countries has been justified by reference to the
need to protect minority shareholders and creditors: see J. Avilov, “General Principles of Company
Law for Transition Economies” 24 J. Corp. L 196 (1999).
56
Article 11 of the Company Law.
57
The articles for companies listed on a domestic exchange are contained in the China Securities
Regulatory Commission (CSRC) measure “Guidance on the Articles of Association of domestic listed
companies” (16 Dec 1997). The overseas provisions are contained in measure “Mandatory Provisions
in Articles of Association of Companies Listed Overseas” (promulgated 27 Aug 1994 by the Securities
Committee of the State Council, reproduced in I A Tokley and T Ravn, Company and Securities law in
China, Sweet & Maxwell Asia 1998, p219).
58
Article 10 of the domestic articles and article 7 of the overseas articles.
59
The potential difficulties arising from this provision are discussed by Tokley and Ravn (above n57 at
p100).
60
Howson (above n45), p150, notes that the 1992 Standard Opinion provided for liability for those
parties responsible for companies acting outside of their registered scope of business. The Company
Law has no such provision.
61
Article 124 of the Company Law.
An examination of the securities law67 reveals much less in the way of adaptation to
Chinese circumstances than in the case of the company law. The extensive
regulation of the process of listing and issuing securities is the most obvious
difference between China and the west. While all countries regulate this process,
62
Article 121 of the Company Law. This represents a dilution of the power previously held by workers
in SOEs, such as the right to dismiss directors subject to government approval. See Ong and Baxter
(above n45) p114.
63
The Shanghai Stock Exchange (SSE) was established in 1984 and officially opened in December
1990. The Shenzhen Stock Exchange (SZE) was established in 1987 and officially opened on 3 July
1991. Lan Cao (above n24) notes that officials of the Shenzhen Special Economic Zone decided
unilaterally to open a Stock Exchange without Beijing’s approval. Beijing’s response was not to stop
the process but simply to delay the opening for a few months.
64
Two notices gave effect to the procedure. First, the Notice of the Central Office of the State Council
Concerning Problems in Share System Experiment Enterprises Issuing Stock to the Public, 1990,
stating that "Other than the two stock exchanges at Shanghai and Shenzhen which have already been
permitted to issue shares to society, all others which have been approved by local governments but
which have not been through the approval procedures of the concerned ministries and agencies of the
central government, must within the designated period report to the State Commission on Reform of
the Economic System, the State Bureau for the Management of State Property, and the People's Bank
of China to once again undertake approval procedures."
Second, the Notice of the State Commission on Reforming the Economic System Concerning
Renewed Approval for Share System Experiment Enterprises Issuing Shares to Society, reprinted
Collection of Policies, Laws and Regulations for Share System Experiments (Shanghai Office for
Reform of the Economic System ed., 1992).
65
See Fang Liufang, “China’s Corporatization Experiment” 5 Duke J. Comp. & Int’l L 149 (1995).
66
These regulations were not repealed following the introduction of the Securities Law and in practice
are still followed by securities lawyers.
67
See generally Zhu Sanzhu, Securities Regulation in China (Simmonds & Hill Publishing Ltd., 2000).
In other respects, the Chinese securities law follows very closely the pattern of
western models. This characteristic may be inherent in the nature of securities law.
To the extent that it represents entry into the global capital market, there is less room
for adaptation than in the case of company law. The tendency towards convergence
with western models becomes even more apparent at the level of stock exchange
listing rules where convergence with international norms is even more evident.72 As
noted elsewhere73, there appears to be a pyramid structure in corporate regulation in
which there is some room for adaptation at the lowest level (company law) less in the
68
Article 7 of the Securities Law. On the constitutional position of the CSRC and SCSC, see Zhu
(above n67) chapter 3. The regulatory structure is complicated by the existence of local securities
commissions and the involvement in securities markets of the State Commission for Restructuring the
Economic System, the State Planning Commission and the State Bureau for the Administration of State
Assets.
69
See Chapter 10 of the Securities Law in Zhu Sanzhu, Securities Regulation in China (Transnational
Publishers, 2000).
70
Article 6 of the Securities Law now gives effect to the policy of separate regulation of each financial
sector.
71
An example of cross-ownership of different financial activities is the Pinan Group based in Shenzhen,
which operates in the trust, insurance and securities sectors.
72
See A Lau, “The new Shanghai Stock Exchange Listing Rules: an egg hatched or an egg within an
egg?” (1999) 20(7) Co Law 243.
73
See I MacNeil and A Lau, “International Corporate Regulation: Listing Rules and Overseas
Companies” 50(4) ICLQ 787 (2001).
74
The Notice Concerning the Announcement of Corporate Governance Guidelines for Listed
Companies, promulgated by the CSRC on 7 January 2002 and effective from that date.
75
I refer to the role “allocated” to shareholders to so as to recognize the significance of law in defining
that role. For a discussion of this issue in the context of the historical development of the ownership
rights of shareholders in England see P. Ireland, “Company Law and The Myth of Shareholder
Ownership” 62(1) Modern Law Review 32 (1999).
76
It would be wrong to say that there is no recognition of stakeholder interests in China, as there are
formal mechanisms (discussed below) for the representation of employees. The point is that the limited
type of stakeholder interest recognized in China has already been operating in countries such as
Germany, which do not share the same objective of a “socialist market system” (in the Chinese sense).
77
Article 1 of the Guidelines.
78
See S Worthington (above n2).
Second, it is evident in the regulatory regimes for both domestic and foreign capital
that a primary concern was to protect the control of the state over the economy.80
The presence of the state as controlling shareholder in most listed companies in
China made the adoption of a “shareholder primacy” model of corporate governance
relatively attractive because it provided continuity with the previous system in which
the state directly owned and controlled SOEs. Perversely, and in contrast to the
historical developments from which it emerged in the United Kingdom, the
“shareholder primacy” model was a mechanism by which the state could pursue the
“socialist market objective” through its controlling interests in most listed companies.
It leaves open the question, however, if there will be any substance left to the
“socialist market objective” when (as seems likely) the state reduces or even
completely ends its direct ownership of shares in listed companies.81
79
See Teemu Ruskola, “Conceptualizing Corporations and Kinship: Comparative Law and
Development Theory in a Chinese Perspective” 52(6) Stanford Law Review (2000) 1599.
80
See the constitutional provisions discussed at note 29 above.
81
This is discussed in more detail below.
82
The State Enterprise Law of 1988 recognised SOEs as legal persons, but they were still at that stage
wholly owned by the state and had not yet been corporatized.
83
This was the conventional view articulated in Communist Party Policy and endorsed by international
advisers such as the World Bank. Others regarded the property rights issue as less significant. Simon
took a pessimistic view of the effect of corporatization on property rights (W H Simon, “The Legal
Structure of the Chinese ‘Socialist Market’ Enterprise 21 Iowa J. Corp L. 267). He argued that property
rights in the SOE and TVE structures of the 1980's were relatively clear, with managers and workers
having strong control and income rights but relatively weak capital rights, the latter being preserved for
the benefit of the society at large. He saw the main problem as that of enforcing the rights against, for
While, in the main, the rights of shareholders are made clear by the company law,
there remain some problems. First, the ownership rights of the state in respect of
assets owned by SOEs that have been coporatized is not entirely clear. Article 4 of
the Company Law provides that “The State assets of a company belong to the State”.
Howson described this provision as “nonsense” and noted that there was no similar
provision in the Standard opinion that preceded the Company Law.85 It is difficult to
disagree with this conclusion as it does not seem possible for assets that belong to a
company, as a separate legal person, to be owned by another entity at the same time.
The provision confuses the direct ownership rights previously held by the state over
SOE assets with the ownership rights now held by the state in the form of
shareholding.86It does not, however, appear to have given rise to much practical
example, managers who abused their position. Simon argued that the western experience in developing
company law to facilitate the participation of many small investors in an enterprise was of little
relevance to China where the expectation is that the state will remain the controlling shareholder in
most listed companies. It was therefore not surprising that the rights of minority shareholders remained
weak and uncertain even after the introduction of the company law, as the main objective of the
company law was to reduce the state shareholding while still leaving the state in control. Lan Cao,
CAT article, (above n24) discussing TVEs, also argued that the clarification of property rights was not
a critical issue.
84
As discussed below, some of this concern was misplaced as it resulted from a failure to recognize the
fundamental change in ownership structure resulting from corporatization, which replaced direct state
ownership of assets with shareholdings.
85
See Howson fn p 142.
86
It is an explicit example in Chinese law of an implicit tendency noted by Ireland in respect of English
company law, whereby the conflating of shareholders’ ownership of capital paid into the company and
of the company’s assets has led to the emergence of the view that companies should be run exclusively
for the benefit of shareholders (see P. Ireland, above n75 at p49).
Second, the system of landholding in the PRC does not allow private ownership of
land. Land users (including companies) can only acquire a land-use right for a
specific time period and there are limits on the transfer of such rights.87 The result is
that major assets of a company, represented by land and buildings, are not directly
owned by the company.
Third, the presence of the state as controlling shareholder creates some difficulty in
defining the rights of other shareholders. Two factors are relevant. The first is the
constitutional and ideological support for the role of the state as controlling
shareholder and the second is the regulation of marketability of shares.
While neither has a direct bearing on the rights of shareholders as defined in the
Company Law, they have important implications for corporate governance because
they effectively entrench the position of the state as controlling shareholder and
confine non-state shareholders to a minor role. This issue is discussed in more detail
in part E below.
The dominant role of the state is also evident in the development of the regulatory
regime in respect of foreign capital’s participation in Chinese business. It reflects the
concern that China's economy, especially in strategically important industries, should
not fall under the control of foreign investors.88 Foreign capital has been invested
mainly in joint-ventures, which can be organized either as limited liability companies
or contractual joint ventures.89 The main source of foreign capital has been Hong
Kong90 and it has been targeted mainly at cities on China’s eastern seaboard.91
87
See Png Cheong Ann, (above n45).
88
One commentator viewed the position as follows: "..the PRC struck a compromise which continues
to animate China's policy and laws respecting foreign investment and corporate law: China would
strive to absorb enough foreign capital to bring about desired developmental benefits, while at the same
time maintaining state control over the terms of such investment through a system of approval controls,
taxation policy, access to foreign exchange and production and distribution requirements": see N C
Howson, "China's Company Law: One Step Forward, Two Steps Back? A Modest Complaint" (11) 1
Columbia Journal of Asian Law 127,133.
89
See generally, Guiguo Wang, Business Law of China chapter 8 "Organizations with a foreign
interest" (Butterworths Asia, 1999). The shares of foreign direct investment into China represented by
different forms of business enterprise between 1979-1997 was as follows: equity joint ventures 46%;
contractual joint ventures 23%; wholly foreign-owned enterprises 30%; joint resource exploration 1%.
(Source: OECD Financial Market Trends No 77, pp105-121 October 2000).
90
On the role of Hong Kong as a bridge between global markets and China see D. Crawford,
“Globalization and Guanxi: The Ethos of Hong Kong Finance” 6(1) New Political Economy (2001) 45.
91
See S. Breslin (above note 50) pp212/13 for details.
92
See Wang pp258-261.
93
See Table 4 in the Appendix, which shows foreign equity capital and foreign bonds as a percentage
of total foreign investment in China.
94
On the rationale for this policy, see Gordon and Wei Li (above n37), who show that the Chinese
ownership restrictions are equivalent in their economic effects to taxes on income from equity.
95
See Table 1 in the Appendix.
96
B shares listed in Shanghai are denominated in US dollars, while B shares listed in Shenzhen are
denominated in HK dollars. The regulatory framework is contained in the "Listing of Foreign Firms in
China by a Company Limited by Shares Provisions". See Tokley and Ravn (above n57) p197.
97
The restrictions on domestic investors owning B shares were partially lifted in February 2001 and
completely removed in June 2001.
98
See Table 1 in the Appendix.
E. FINANCIAL MARKETS
Financial markets, and in particular the legal and regulatory environment in which
they operate, are closely related to the development of national systems of corporate
governance.101 At the most basic level, there is a clear relationship between the
presence of strong investor protection and well-developed financial markets.102
Beyond that, there are more specific influences such as disclosure obligations for
major shareholdings, takeover regulation and ownership restrictions (e.g. on banks’
ownership of equity).The manner in which market participants are regulated is also
significant as it may influence the pattern of shareholding in a country.103 So too is
the relationship between ultimate investors and intermediaries (banks, fund
managers, pension funds) in respect of issues such as voting rights over shares held
by intermediaries.104
99
See Wang (above n89) pp304-312 for a discussion of the enabling regulations contained in the "Joint
Stock Company with Foreign Investment Provisions".
100
Some change in this policy on the part of the CSRC seems likely in the near future. See "Foreign
firms gain rights to China listing" South China Morning Post 9-11-2001. On 11 January 2002, the
CSRC published on its website for public consultation rules governing information disclosure in a
prospectus relating to a FICLB.
101
See LLSV, “Legal determinants of external finance” 52 Jnl of Finance 1131-1150 (1997) and A.
Shleifer and R. Vishny, “A survey of corporate governance” 52(2) Jnl of Finance 737-783 (1997).
102
See LLSV, “Investor Protection and Corporate Governance” at ssrn.com (update reference).
103
See M Roe (above n12) arguing that (politically –driven) regulation in the USA has been the main
factor shaping the modern system of corporate finance. (Political roots etc article)
104
See R. Buxbaum, “Institutional Owners and Corporate Managers: A Comparative Perspective” 57
Brook. L. Rev. 1 (1991) for a comparison between the USA and Germany on this issue.
105
This term has been used extensively since its adoption in 1992 at the 14th National Congress of the
Chinese Communist Party.
The confusion between the different roles of the state is also evident in the complex
manner in which marketability of shares is regulated. An examination of the
provisions of the Chinese company law relating to share types and transfer rights
suggests, at first glance, a relatively simple picture. Article 130 provides that the
conditions and price of shares issued as part of the same issue shall be the same
and article 143 provides that shares may be transferred in accordance with law.
106
For comparable data on the relative size of stockmarkets see Maher and Anderson, “Corporate
Governance: Effects on Firm Performance and Economic Growth” at ssrn.com. See also
www.FIBV.com, the website of the Federation International des Bourses de Valeurs.
107
The control of the state was reinforced when, in October 2001, Premier Zhu appointed two former
vice-chairs of the CSRC to head the national exchanges.
The different types of share and shareholder require some explanation, as the rules
on transfer are formulated by reference to both. The concept of different share types
relates essentially to the marketability of shares held by different shareholders rather
than to different rights attaching to different types of share. Shares held by the state
(category 1) are held either by the state (through agents at the national, provincial or
local level) or by state legal persons. The latter are legal persons established with
state capital and directed by the State.111 Domestic promoter legal person shares
(category 2) are shares held by the promoter involved in the formation of a JSC
(either by way of promotion or by way of public offer for subscription). The "domestic"
descriptor distinguishes this type of promoter from a foreign promoter.112 It is possible
for shareholders in category 2 to be state legal persons and therefore such
shareholders can appear in either category.
The limits on marketability within these two categories are also more complex than
suggested by their designation as non-marketable . As discussed below113, state
shares can be transferred in several ways, an outcome referred to rather obliquely by
article 148 of the company law which simply refers to the possibility of state-owned
investment institutions selling state shares and buying shares held by others in
accordance with the law and administrative regulations. The non-marketable nature
of state shares is a matter of state policy regarding its ownership rather than an
108
The Provisional Regulations on the Administration of Issuing and Trading Shares (April 22, 1993)
and The Provisional Regulations on the Administration of State Equity in Companies Listed by Shares
(3 Nov, 1994).
109
The terms marketable and non-marketable refer to whether or not the relevant shares can be traded
through the stock exchanges in Shanghai or Shenzhen. Some authors use the terms transferable/non-
transferable or negotiable/non-negotiable to refer to the same distinction. However, as non-marketable
shares can be transferred outside the recognised exchanges, it is submitted that the more accurate
distinction is between marketable and non-marketable shares.
110
Title to shares is recorded in electronic form. Paper copies of the record distinguish transferable
from non-transferable shares.
111
See article 4 of the Opinion on the Implementation of the management of state-owned shareholdings
in experimental JSCs, March 11 1994, State Assets Administration Bureau.
112
Article 75 of the company law provides that half of the promoters must reside in the PRC
There are three share types that are designated marketable. They differ only in
respect of the currency in which the shares are traded and who is entitled to hold
them as the rights attaching to the shares are the same. A shares are denominated
in RMB and can be held only by domestic investors. B shares are denominated in
RMB, traded in foreign currency and until recently could only be held by foreigners.
Recent changes to the regulations have permitted B shares to be held by domestic
investors.115 In overall terms, B shares represent a relatively small part of listed
companies' capital.116 H shares are shares issued by PRC incorporated JSCs to
foreign investors through a listing on a foreign market. The most common option is to
issue in Hong Kong (hence the H designation) although several issues have also
been made in other markets.
The implications of this system of regulation of the market and marketability are
considerable. The dual role of the state as regulator and controlling shareholder
113
See section F for further discussion of the state shareholding.
114
The restrictions on marketability are supported by the electronic systems in which legal title to
shares is recorded: non-marketable shares are identified as such and this is shown on paper versions of
the electronic record.
115
One result of the change in regulations was that the value of B shares rose sharply and is now closer
to that of A shares - see Table 5 in the Appendix.
According to the Chinese company law, a JSC can be formed either by the promotion
or public subscription method. The promotion method involves the sale of all the
116
See column B in Table 4 in the Appendix for capital raised through B share issues.
117
On the structure of corporate regulation see I MacNeil and A Lau (above n73). The Shanghai and
Shenzhen exchanges each have their own listing rules, which are very similar. While the CSRC
controls admission to listing, the Stock Exchanges are the front-line supervisor for monitoring
compliance on the part of listed companies. The structure and content of these listing rules is similar to
western models. They include financial disclosure rules, shareholders' approval for major transactions,
overriding disclosure rule relating to "material information", restrictions on controlling shareholders
voting on related transactions, general duty of honesty imposed on directors: see A. Lau (above n72).
118
In the UK, a decision made by the UKLA to decline a listing application may be appealed to the
Financial Services and Markets Tribunal (s76 FSMA 2000). In Hong Kong an applicant can appeal a
refusal to grant a listing application to the Listing Appeals Committee.
Overseas listing125 cannot circumvent the control of the CSRC as, although the
overseas Stock Exchange controls admission to listing in these circumstances,
119
Zhu (above n67) at p181 comments “.. the criteria which determine which companies are allowed to
issue shares and to be listed are not always commercial criteria. Government priorities and political
considerations are often as relevant.”
120
Council Directive 89/298 [1989] OJ L124/8. Article 2 provides that the provisions of the Directive
do not apply “where transferable securities are offered to a restricted circle of persons”.
121
An exception is made in the case of SOEs converting to a JSC when only one promoter is required.
122
In the past the CSRC also set the listing price for IPOs according to a formula based on
price/earnings ratio (a P/E of 15.0 was adopted). This meant that irrespective of other aspects of a
company's financial position and record, the issue price was fixed according to this formula. An
examination of the average P/E ratio for the two markets over recent years shows clearly why new
issues generated such a frenzy of activity among investors: on average, it could be expected that when
a new issue commenced trading in the secondary market the price would at least double in order to
bring the valuation up to prevailing market levels. See Su D. and Flesiher B. “An empirical
investigation of underpricing in Chinese IPOs” 7 Pacific Basin Finance Journal 173-202 (1999), who
show that in a sample of 308 IPOs the mean one-day return was 948.6%.
123
See Table 6 in the Appendix, which shows that 27% of capital raised through public issues in 2000
was in the form of rights issues.
124
See Tokley and Ravn (above n57) par 5.16.
125
Generally on overseas listing see I. MacNeil “Competition and Convergence in Corporate
Regulation: The Case of Overseas Listed Companies” and J. Coffee “The Coming Competition among
Securities Markets”, both at ssrn.com.
126
Article 29 of the Securities Law. The regulatory regime for overseas listing is contained in the
Special Regulations of the State Council Concerning Share Offerings and Listings Outside the People’s
Republic of China of Joint Stock Limited Companies (August 4, 1994). These Regulations refer
specifically to issuing shares outside the PRC and there has been some doubt over their application to
foreign issues of bonds.
127
Chinese company listings on the NYSE and LSE are in the form of depositary receipts. This
involves a bank holding shares of the (foreign) issuer and issuing depositary receipts to local investors
in local currency. It avoids the more onerous listing requirements associated with a conventional
secondary listing of shares.
128
See Table 5 in the Appendix.
129
In particular Article 47 of the Mandatory Provisions, which are published in I A Tokley and T Ravn,
Company and Securities Law in China (Sweet and Maxwell Asia 1998).
130
See articles 161 and 162 of the Company Law.
131
The ability to mortgage state-owned land is a significant step in the history of the PRC. Article 2 of
the 1988 Amendment to the Constitution permits the transfer of a land-use right. Before 1988, no
organization or individual could appropriate, buy, sell, lease or otherwise engage in the transfer of land.
See Guanghua Yu, "Towards a market economy: security devices in China" 8 Pacific Rim Law &
Policy Journal (1999) 1.
132
See Hung-Gay Fung and Wai Kin Leung, "Chinese Financial Liberalization, Implications for
Corporate Governance" 34(1) The Chinese Economy 5-14 (2001).
133
See Table 3 in the Appendix for data on China.
134
See Gordon and Wei (above n37) for historical data on the relative pricing of A and B shares.
135
See K M Wong, “Securities Regulations in China and their Corporate Finance Implications on State
Enterprise Reform” 65 Fordham Law Rev. 1221(1996).
136
See A Shleifer and M Vishny, “Large Shareholders and Corporate Control” 94 Jnl of Political
Economy (1986) 461-488 and D Leech and J Leahy, “Ownership Structure, Control Type,
Classification and the Performance of Large British Companies” Economic Journal vol 101 pp1418-
1437.
137
See M Maher and T Anderson (above n9).
138
See R Buxbaum (above n104).
139
It has also, of course, limited the principal/agent problems that are more closely associated with
widely held systems of share-ownership than with systems in which controlling shareholders are
prevalent.
140
There is around RMB70bn (US$8.5bn) invested in closed-end investment funds and RMB11.7bn
(US$1.4bn) in open-ended investment funds, which have only recently been authorised by the CSRC.
(Year-end 2001 figures from CSRC).
141
Source: 2000 Yearbook of the China Securities Association.
142
Figures presented by the CSRC at the Conference “The PRC, Taiwan, and Hong Kong: Developing
the Greater China Corporate Governance Model” (Hong Kong University, 2&3 Nov. 2001), on file
with author. Investment funds represented 4.17% of year-end 1999 market capitalization but accounted
for 7.9% of turnover.
As shown in Table 1 in the Appendix, the state is the dominant shareholder in listed
companies in China.145 The state's shareholding is held in three ways. First, state
shares in listed companies are held by the Ministry of Finance or agents acting on its
behalf at the national, provincial or local level. Second, state legal person shares are
held by entities directed by the state (typically other listed companies). Both these
types of shareholding are included in category 1 in Table 1 in the Appendix. Third,
state-owned entities are included among domestic promoters (category 2) and social
legal persons (category 4). The former are involved in the initial establishment of
JSCs and are required to take up shares in companies they promote.146 The latter
are legal persons other than those in which the state has a majority shareholding:
they include LLCs and joint venture companies as well as co-operatives and TVEs.
143
See Franks and Mayer, “Hostile takeover and the correction of managerial failure” 40 Jnl of
Financial Economics 163-181 (1996) and Maher and Anderson (above n9) at pp29-32.
144
The legal framework for takeovers in China is contained in the Provisional Regulations on the
Administration of Issuing and Trading of Shares (1993) and Chapter 4 of the Securities Law, which
largely follows the model of the UK Takeover Code. See B. Chun, “A Brief Comparison of the
Chinese and United States Securities Regulations Governing Corporate Takeovers” 12(1) Colum Jnl of
Asian Law (1998) 99.
145
The figures in Table 1 show the aggregate position for listed companies as a whole, but they disguise
the fact that there are a significant number of listed companies in which the role of the state is limited
to state legal person shares or in which the state has no shareholding whatsoever. At the end of 1999,
121 of the 484 companies listed on the Shanghai Stock Exchange had no state shareholding of any kind
(source: Shanghai Stock Exchange Statistics Annual 2000).
146
The shareholding they are required to take up under the Company Law varies according to how the
company is formed: if it is by the public subscription method, the prompters are required to take 35%
of the shares, whereas if it is by the promotion method they are required to take up 100% of the shares.
147
LLSV, “Corporate Ownership Around the World” 54(2) Jnl of Finance (1999) 471.
The effect of ownership structure on the ability of shareholders to monitor the Board
of Directors is more difficult to judge. At the theoretical level, the proposition that a
diversified shareholding structure would be negative for corporate performance (as a
result of inferior monitoring of management by comparison with a concentrated
shareholding structure) was implicit in Berle and Means analysis.148 This proposition
was later challenged by economic theory149 and by empirical studies showing a link
between concentrated ownership and superior firm performance.150 In respect of
Chinese listed companies, Xu and Wang found that firms' performance was positively
and significantly correlated with the fraction of shares held by legal persons but was
either negatively or uncorrelated with the fractions of state shares or (transferable) A-
shares.151 Concentrated shareholdings in hands other than the state therefore seem
to help performance. The disproportionate influence of the state on board
composition must therefore be regarded as a negative influence for corporate
governance in listed companies, because the state does not appear to be as
effective a monitor as the legal person. Reduction in state shareholding,
accompanied by a transfer of that shareholding into the hands of legal persons would
appear to be a positive move for Chinese listed companies.152 So too would a
limitation of the influence exerted by controlling shareholders, which is likely to result
from the recent introduction of Corporate Governance Guidelines for listed
148
See Berle & Means (above n7).
149
See H. Demsetz and K. Lehn, "The structure of Ownership: Causes and Consequences" 93(6)
Journal of Political Economy 1155 . The factors identified by Demsetz and Lehn as determining
ownership structure are (a) the value-maximizing size of the form (taking account of economies of
scale) (b) the degree of control required by reference to market conditions (stable markets require less
control) (c) the presence of regulation which provides subsidized monitoring and disciplining of
management (d) the amenity potential of control (non-financial considerations such as the power to
dictate strategy, prestige, media image).
150
See C. Holderness and D. Sheehan, "The Pole of Majority Shareholders in Publicly held
Corporations: An Exploratory Analysis" 20 Journal of Financial Economics 317-346 (1988); J.
McConnell and H. Servaes, "Additional Evidence on Equity Ownership and Corporate Value" 27
Journal of Financial Economics 595-612 (1990). See also Maher and Anderson (above n9) p24/25 for
a review of studies on this issue in a number of countries and industries.
151
See Xiaonan Xu and Yan Wang, “Ownership Structure, Corporate Governance and Firm
Performance: the case of Chinese Stock Companies” 10(1) China Economic Review 75-98 (1999).
152
This was the conclusion reached by Xu and Wang (above n 151) and the World Bank Report of
1997 (above n33).
153
See H. Boardman (above note 32) who quotes President Jiang Zemin’s stated position in autumn
1997 (“ even if the state-owned sector accounts for a smaller proportion of the economy, this will not
affect the socialist nature of the country”) and his later clarification of the position in summer 1998
(“without a state-owned industrial sector, there can be no socialism”). See also Lay Hong Tan, "The
Legal and Regulatory Framework of Securities Markets in the PRC" (1999) Asia Pacific Law Review
69.
154
New issues of capital made by listed companies in China are generally in the form of rights issues
despite there being no pre-emptive rights included in the Company Law or the (standard) Articles of
Association.
The result of the operation of these techniques was that, in effect, non-marketable
shares were being sold (albeit indirectly) in the market at the prevailing price for
transferable shares. The negative impact of this practice on the market was
confirmed when, on the day that the CSRC announced that the policy of reducing the
state shareholding (and the associated practices) would be suspended, both the SSE
and SZE rose sharply.155 A similar situation occurred in January 2002, when the
CSRC indicated that the state would not, for the time being, sell its shareholdings
and would in any event take account of market stability in structuring any future sale
programme.156 It remains to be seen what will happen in the future. There are two
separate issues. The first is the issue of marketability of shares. The possibility of
allowing all shares to become freely marketable is recognized as a long-term
possibility by the CSRC.157 Shorter-term there are two possibilities: (a) foreign
investors being permitted, following China’s entry to the WTO158, to invest in funds
which hold A shares and (b) the introduction of a qualified foreign investor scheme
which would allow certain foreign investors to buy A shares. The second issue is
what will happen to state shareholdings in an environment in which all shares are
freely transferable. That remains unclear. On the one hand, it can be argued that
ownership is not necessary for the state to exercise control over the corporate sector
155
Both markets rose by 10% in response to the announcement. Source: China Daily report, “Stock
Market Policy needs consistency”, 26 October 2001.
156
See South China Morning Post of 29 January 2002, quoting CSRC chairman Zhou Xiaochuan as
follows, “Any market reform measures can only be carried out based on market stability and the
protection of the rights of shareholders. We must correctly assess the importance of the securities
markets to the national economy, and protect and take care of these markets.” The report also refers to
Premier Zhu Rongji stating in December 2001 that Beijing should find a way to resolve the problem of
raising cash needed for key programmes such as social security and reducing the state’s role in the
market without jeopardizing the interests of shareholders.
157
Th economic rationale for such a change is considered by Gordon and Wei (above, n37). They view
the current situation as one in which the government extracts monopoly rents from domestic investors
(equivalent to taxes on income from equity) by restricting the supply of domestic shares and
prohibiting foreign investment. As state ownership of listed companies declines those rents are shared
with other investors and therefore there is an incentive to move towards a system of explicit taxes on
equity income (and abandon ownership restrictions).
158
See South China Morning Post, China Stockmarket Report of 2-11-2001 quoting Laura Cha Shih
May-lung, vice-chairman of the CSRC.
China has adopted a two-tier Board structure, in which the supervisory board is
mandated for JSCs and formally charged with supervision of the Board of Directors
159
See for example K. Reiserer and V. Boll's discussion of privatization in Germany in International
Privatization p7 (Eds. D. Campbell and B. Hollywood, Kluwer, London 1996) which classifies
privatization into four techniques: organizational, operational, asset and functional. The first and last
techniques allow ownership to remain with the state. The first corresponds to the "corporatization"
stage in China's reforms in which SOEs are transformed into companies wholly owned by the state
prior to a public offer of shares. The last refers to the execution of functions undertaken by government
being delegated to private organizations.
160
See M C Jensen and W H Meckling, "Theory of the Firm: Managerial Behaviour, Agency Costs and
Ownership Structure", Journal of Financial Economics 3, no 4 (1976): 305-360.
The term “composition” is used here to refer to the interests that are represented by
members of the board, in recognition of the fact they may represent different interests.
Shareholders should be concerned to ensure that collectively, the Board prioritises
the interests of the company. The presence of independent directors168 on the board
can help to ensure this outcome.169 It also promotes a separation between the
161
See Article 126 of the Company Law and Yongxin Song, "Some Special Features of The Organs of
Governance of Chinese Business Corporations" 24 Cap. U.L. Rev. 207 (1995).
162
See article 126 of the company law.
163
For a discussion of the composition and role of German supervisory boards see K J Kopt, “The
German Two-Tier Board: Experience, Theories, Reforms” in Hopt, Konda, Roe, Wymeersch and
Prigge (eds) Comparative Corporate Governance (OUP, 1998).
164
See Company Law articles 113 and 22(9).
165
See Wang Business Law of China p273.
166
Article 119.
167
Meir-Schatz (below n169, p5) takes the view that the Chinese company law rules relating to the
manager perform the same function as delegation rules in western (enabling) systems of company law
by recognizing that in reality the board of directors is performing a supervisory function rather than the
managerial function envisaged by the traditional corporate governance model.
168
Provide definition of independent from the Cadbury Code.
169
For a review of the literature linking board composition with company performance see C. Weir, D.
Laing and P.J. McKnight, “An empirical analysis of the impact of corporate governance mechanisms
As in the United Kingdom, there are no provisions in the Chinese Company Law
relating to the composition of the Board of Directors. Research shows that boards of
directors in Chinese listed companies have been dominated by representatives of
state and legal person shareholders, to the effective exclusion of representatives of
individual shareholders.174 Frequently, Board members of Chinese listed companies
on the performance of UK firms” at ssrn.com. Weir et al report that UK boards have an average of 42%
independent directors and USA boards 76%. See also Gompers et al, “Corporate Governance and
Equity Prices” at ssrn.com. For an account of the development of the role of the independent director in
the USA, UK, Germany and elsewhere see C J Meier-Schatz, “Corporate Governance and Legal Rules:
A Transnational Look at Concepts and Problems of Internal Management Control” 13 J. Corp. L. 431
(1998).
170
Part 2, Section 1, provision A.3.2 of the Combined Code provides that "the majority of non-
executive directors should be independent of management and free from any business or other
relationship which could materially interfere with the exercise of their independent judgment". For a
discussion of the structure and role of the board of directors in the UK see CA Riley, "The
juridification of corporate governance: is it inevitable? is it desirable?" {SPTL Company Law Section
paper Sept 2001, published yet?}
171
This risk becomes particularly real in countries such as China, where cumulative voting is not used
to elect directors. Cumulative voting can reduce the extent to which controlling shareholders can fill
the Board of Directors with their nominees. Shareholders are allocated votes in proportion to their
shareholding. A vote allocated to the election of one director reduces the total available for the election
of other directors. Minority shareholders can more easily elect directors under this system than under
the voting system used in the UK in which a majority shareholder can control the election of all
directors. For a discussion and examples of the operation of cumulative voting in the USA see R.W.
Hamilton, The Law of Corporations pp 263-70 (West Publishing, 2000). The recently introduced
Corporate Governance Guidelines in China will require the use of cumulative voting in listed
companies in which a single shareholder holds 30% or more of the shares. This will require a change in
the articles of association of such companies.
172
Of course, to the extent that all directors within a controlling-shareholder system are the
representatives of controlling shareholders, it is false to distinguish between independent and executive
directors.
173
See Fama and Jensen, “Separation of Ownership and Control” 26 Jnl Law & Econ 301-349 (1987).
174
See Xianonian Xu and Yan Wang, "Ownership Structure, Corporate Governance, and Firms'
Performance: The Case of Chinese Stock Companies" (above, note 151), who present data based on the
1995 annual reports of listed companies. At that time there were 323 companies listed on the two
The role of the Board of Directors in Chinese listed companies is generally more
limited than in their UK counterparts.179 One reason for this is that concern to protect
state property from appropriation by managers resulted in the real decision-making
power being located in the shareholders' meeting, with the Board of Director's
exchanges compared with 1088 at the end of 2000. For companies in which either the state or legal
persons were the largest shareholders, they held respectively over 70% of the board seats on average.
Government officials filled half of all board positions, a proportion significantly higher than the state's
shareholding (held in the form of state-owned shares). As noted by On Kit Tam (The Development of
Corporate Governance in China, Edward Elgar Publishing, 1999) p74, one of the obstacles facing
active participation by individual shareholders in electing directors is that many companies restrict
participation in the shareholders' meeting by reference to a minimum level of shareholding. See also P.
Mar and M.N.Young, "Corporate Governance In Transition Economies: A Case Study of Two Chinese
Airlines", 36(3) Journal of World Business (2001) 280.
175
See On Kit Tam (above n174) who categorizes executive positions held by directors in Shanghai
listed companies. The largest category (34%) held no executive position.
176
See On Kit Tam (above n174, pp79/80).
177
The CSRC currently requires that all listed companies have 2 independent directors. From 2003, one
third of the directors must be independent. See CSRC Notice 102 (2001) to all Listed Companies with
respect to the Announcement of the Guiding System Concerning the Establishment of an Independent
Directors’ System in Listed Companies. According to the notice an independent director means a
director who does not take up any other positions in the appointing company, and he does not have a
relationship, which may interfere with his reaching an independent objective judgment, with the listed
company that appoints him and its major shareholders. The Corporate Governance Guidelines will also
require a listed company to establish a system of independent directors.
178
See chapter 3 of the SEHK Listing Rules. If the size of the Board or other circumstances justifies it,
the SEHK may require more than two independent directors.
179
See CA Riley (above n170) re the role of the Board of Directors in United Kingdom companies.
Directors’ legal liabilities are significant for corporate governance because they can
be expected to affect the manner in which directors’ act. This should hold true in both
180
Yongxin Song, "Some special features of the organs of Governance of Chinese Business
Corporations", 24 Capital University Law Review 207 (1995).
181
See Article 112 of the Company Law.
182
All domestic-listed companies must adopt the standard articles contained in the CSRC’s “Guidance
on the Articles of Association of Domestic Listed Companies” (promulgated 16 December, 1997). The
Articles do not alter the powers of the Board of Directors contained in the Company Law.
183
See The Companies (Tables A to F) Regulations (SI 1985/805), reproduced in British Companies
Legislation (CCH 2001). Table A contains the standard articles for a public company.
184
See article 103 of the Company Law. The powers given to the Board of Directors appear to be
mandatory provisions, precluding variation in the articles. However, even if they are viewed as default
rules, the requirement that listed companies adopt standard articles effectively precludes variation of
the powers of the board of a listed company in the articles.
185
See On Kit Tam (above n174) chap 6.
186
For the composition of supervisory boards, see Xu and Wang p13. For a survey of the functioning of
supervisory boards, see On Kit Tam (p87) who found that 78% of supervisors were not prepared to
investigate company affairs. Interviews with lawyers and professional investors indicated that the
position has not changed since Tam's survey. This is in line with the experience of supervisory boards
in Germany, in respect of which Meir-Spatz comments “The supervisory council tends either to
become the extended lever of the dominant shareholder or to degenerate into an advisory body without
influence on the executive unit” (see above n169, p13).
187
Chinese company law (as is the case in the United Kingdom) makes no distinction between
executive and non-executive (or independent) directors for the purposes of legal duties and liabilities.
The CSRC notice on independent directors (article 2) emphasizes that an independent director owes a
fiduciary duty and due diligence duty towards its listed company and all shareholders.
188
Fiduciary duty in the common law context imposes three main obligations on directors: (I) to act in
good faith for the benefit of the company (ii) to exercise their powers of office only for proper purposes
(iii) to avoid possible conflicts of personal and company interests. Howson (above n45) notes that the
Standard Opinion that preceded the Company Law did refer specifically to a concept of fiduciary duty
(Chengxin Zeren). This resulted from the Hong Kong securities authorities insisting that directors of
companies making ‘H’ share offerings be bound by some credible notion of fiduciary duty. Zhu Sanzhu
(above n67, p150) notes that this concept was specifically incorporated into the Articles of Association
of the first nine PRC companies that made H share offerings in Hong Kong. The new Corporate
Governance Guidelines refer to independent directors owing a fiduciary duty towards the company and
all shareholders.
189
See M I Nikkel, “Chinese Characteristics in Corporate Clothing: Questions of Fiduciary Duty in
China’s Company Law” 80 Minn. L. Rev. 503.
190
See articles 59 to 63 of the Company law.
191
See articles 112-116 of the MPs.
192
See Yongxin Song, “Some Special Features of the Organs of Governance of Chinese Business
Corporations” 24 Cap U.L. Rev 207, who takes the view that the absence of any relevant provisions is
a "serious loophole of the corporate law" (p10). However, interviews indicated that it is common for
directors' service contract to contain restrictive covenants which limit competition with the company
Another consideration is the absence from the company law or domestic articles of
association193 of any standard required from directors in the performance of their
duties. While it is true that this does not form part of the Companies Act in the United
Kingdom it is made clear (albeit in an unsatisfactory manner) by the common law
relating to the duty of care and skill.194 The articles for overseas listed companies do
include a provision (article 115), which is quite similar in its formulation to the
common law position in the UK.
The provisions of the Chinese Company Law relating to directors’ liabilities are
formulated very narrowly. Article 63 refers to directors being liable to the company if,
in performing their duties, they violate the law, administrative regulations or the
articles of association. Article 118 refers to directors being liable for resolutions
passed by the board, which violate the law, administrative regulations or the articles,
subject to the proviso that a director whose objection to the resolution is recorded in
the minutes of the board meeting may be exempted from liability. Thus, it can be
concluded that the duty of care is limited to illegal acts and resolutions and does not
require directors to meet the standard of a reasonable person or to exercise the
standard of care required by the "business judgment rule" in the United States.195
should the director resign. Articles 80-91 of the standard articles for domestic-listed companies also
deal with the performance of directors' duties but do not refer to misappropriation of opportunity.
193
The CSRC Notice "Guidance on the Articles of Association of Domestic Listed Companies" (16
December 1997) sets out mandatory provisions to be contained in the Articles of companies with a
listing in China. Companies that adopt the "Mandatory Provisions in Articles of Association of
Overseas Listed Companies" (CSRC Notice of August 27 1994) are exempt from the domestic
requirements.
194
The Company Law Review Steering Group in the UK has proposed a statutory statement of
directors’ duties incorporating an objective standard of liability. See Modern Company Law for a
Competitive Economy: Developing the Framework (London, DTI, March 2000). See also CA Riley
(above n?).
195
This is the conclusion reached by Yongxin Song (above n?), p11.
196
See LLSV, “Legal Determinants of External Finance” 52(3) Jnl of Finance 1131 (1997).
197
See LLSV, “Law and Finance” 106(6) Jnl of Political Economy 1113 (1998).
198
See LLSV “Investor Protection and Corporate Governance” at ssrn.com.
199
See K. Pistor, M. Raiser and S. Gelfer “Law and finance in transition economies” 8(2) Economics of
Transition 325-368 (2000).
200
See M J Roe “The Quality of Corporate Law Argument and its Limits” Columbia Law School
Center for Law and Economic Studies Working Paper No 186 at ssrn.com.
201
Coffee “Privatization and CG: The Lessons from Securities Market Failure” 25 J. Corp. L. 1
202
See Howson (above n45, p147) who refers to the absence in the Chinese Company Law of (a) a
quorum requirement for the general meeting of shareholders and (b) any differentiation between
general and special resolutions. He regards this as evidence of a lack of concern for minority
shareholders on the part of the drafters of the Company Law. The Standard Opinion preceding the
Company law had contained such provisions. See Avilov (above n55) for a discussion of rules that can
be adopted in the company law of transition economies to promote minority shareholders’ rights.
As a civil law jurisdiction, China would be expected to fall into the investor-unfriendly
category of countries identified by LLSV.206 An examination of the components of
LLSV’s "antidirector rights index" shows this to be the case. The index 207 is intended
to act as an indicator of the level of minority protection in different countries and is
calculated by adding one when each of the following occurs (the actual value for
China being shown in brackets, based on the position of domestic listed companies)
(a) Shareholders can mail their vote to the company (China, zero).
(b) Shareholders are not required to deposit their shares prior to the AGM (China +1).
(c) Cumulative voting or proportional representation of minorities in the board of
directors is allowed (China, zero).
(d) An oppressed minorities mechanism is in place (China, zero).
(e) The minimum percentage of capital that is necessary for shareholders to call an
EGM is equal to or less than 10% (China, +1).
(f) Shareholders have pre-emptive rights that can only be waived by a shareholders
vote (China, zero).208
203
The point has been made, however, that Article 111 of the Chinese Company law may serve a
similar purpose to a derivative action. It allows shareholders to seek a court injunction preventing
implementation of a resolution (of the shareholders’ meeting or board of directors) that violates laws,
regulations or shareholders’ legitimate interests. See Lawrence Liu (above note 45) at p46.
204
Article 40 of the Standard Articles for domestic listed companies.
205
For a review of these cases see I. MacNeil, “Shareholders’ Pre-Emptive Rights” 2002 JBL 78.
206
China is not included in the extensive analysis in LLSV, "Legal Determinants of External Finance",
52(3) Journal of Finance 1131(1997). In principle, China would fall into the German-origin civil law
jurisdictions in that analysis.
207
See La Porta et al, "Law and Finance", Journal of Political Economy 106, 1113-1155. For a
lawyer’s critique of the index see M J Roe, “The Quality of Corporate Law Argument and its Limits”
Columbia Law School Center for Law and Economic Studies Working Paper No 186 at ssrn.com. For
an alternative view of essential minority protections, see Avilov (above n55, p8).
208
The reference here is to pre-emptive rights over new issues of shares by the company. The position
in respect of shareholders' pre-emptive rights is that they are not recognized by the company law in
The legal position of minority shareholders changes when one looks at overseas
listed companies and takes into account the articles of association that are mandated
for those companies. The mandatory provisions for overseas listed companies
comprise 166 articles (compared to 230 for the company law and 194 for the
standard domestic articles), which must be incorporated into the articles of
association prior to an overseas listing. Two of the provisions relevant to minority
protection are contained in both the mandatory provisions for overseas companies
and the standard articles for domestic companies. They are:
(a) Shareholders representing 5% or more of the company's voting rights may
propose motions for discussion at the AGM (article 54 of the articles for overseas
companies and 42 for domestic companies).
respect of JSCs, but can be included in the Articles. They are not included in the standard articles
although article 22 provides that the shareholders’ meeting can decide that a new share issue can be in
the form of a rights issue. For an alternative to LLSV’s view of the centrality of pre-emption rights to
the protection of minorities, arguing that shareholders pre-emptive rights are not are inherent element
of shareholders’ ownership rights, see I. MacNeil, “Shareholders Pre-Emptive Rights” 2002 JBL 78.
209
See generally Donald C Clarke “Power and Politics in the Chinese Court System: the Enforcement
of Civil Judgments” 10(1) Columbia Jnl of Asian Law (1996).
210
Notice Concerning Suspension of lawsuits for civil compensation related to Securities, Sep 21 2001,
Famingchaun [2001] No. 406. The notice requires any claim of wrongdoing to be based on evidence
provided by the CSRC’s investigation of the matter.
211
Dated 15 Jan 2002.
212
The South China Morning Post of 29 January 2002 reported three such cases being filed against
Shanghai-listed companies.
However, there are also important provisions contained in the mandatory provisions
for overseas companies that are not contained in the standard domestic articles.
They are:
(a) Shareholders have enhanced rights to information and disclosure of the financial
position of the company (article 45).
(b) The duties of directors are formulated in greater detail (articles 114-118). There is
an additional provision (article 118) relating to the obligations of directors subsequent
to their term in office.213
(c ) Controlling shareholders voting rights are restricted (article 47)214. There are
three restrictions. A controlling shareholder cannot exercise its voting rights to (I)
relieve a director/supervisor from his/her responsibility on the basis that it is in the
best interests of the company (ii) to approve that a director or supervisor expropriate
company property using any means including any commercial opportunity which is
open to the company215 (iii) to approve that a resolution or action of a director or
supervisor divests any other shareholder of their individual rights and interests
including any right to dividend and voting rights (other than under a company
reorganisation approved by the shareholders' meeting in accordance with the
articles).
213
The substance of this provision is not entirely clear. The prohibition against disclosing confidential
information subsequent to the term in office is clear enough but the provisions relating to the duration
of other obligations is rather obscure. It states "The duration of other obligations shall be determined in
accordance with the principle of fairness and shall depend on the length of time between the occurrence
of an event and the time such post is terminated and on the circumstances under which such director,
supervisor, manager and other senior management personnel ended their relationship with the
company."
214
A controlling shareholder is defined in article 48 of the Mandatory Provisions as (1) a shareholder
who can elect a majority of directors either in its own right or when acting in concert with others (2) a
shareholder who can exercise more than 30% of the company's voting rights either in its own right or
when acting in concert with others (3) a shareholder who holds more than 30% of the company's issued
shares either in its own right or when acting in concert with others (4) a shareholder who can exercise
actual control of the company in any other way either in its own right or when acting in concert with
others.
215
The presence of this provision in the Mandatory Provisions supports Song's argument (above n180)
that the company law does not prohibit that misappropriation of corporate opportunity. If it did, there
would be no need for this provision in the Mandatory Provisions.
Amendment of the articles of association in line with the Mandatory Provisions does
not appear to generate any systematic response in the share price of the relevant
companies.218 This runs contrary to the conventional wisdom embodied in the recent
law and finance research, which regards the governance structure as a significant
factor in the pricing of shares, by markets.219 It also runs contrary to the "bonding"
thesis in respect of overseas listing, which holds that overseas listing in jurisdictions
with higher regulatory standards than the home country will generate a positive
response in share price.220 The amendment of the articles to correspond with the
MPs should be viewed as a considerable enhancement of the governance structure
by comparison with domestic-only listed Chinese companies. However, the closed
nature of the Chinese A-share market, combined with the low percentage of
marketable shares makes it difficult to reach conclusions. Shares in the A Share
market generally trade at levels significantly higher than foreign capital shares
(issued by the same company and carrying the same rights) traded in overseas
markets.221 Moreover, there is at present no linkage between shares traded in the A
share market in China and those traded in overseas markets.222
216
This tends to support Roe’s argument that the index is a very crude measure of minority rights.
217
See article 163, which provides for the dispute to be referred to the China International Economic
and Foreign Trade Arbitration Commission or the Hong Kong Arbitration Centre. The laws of the PRC
apply to the arbitration unless otherwise stipulated in relevant laws and regulations.
218
The observation is based on responses generated by interviews with fund managers, lawyers and
regulators, as the author has not been able to carry out event studies on relevant companies share prices
before and after amendment of the articles.
219
For the general theoretical background see Easterbrook and Fischel, The Economic Structure of
Corporate Law.
220
See I. MacNeil "Competition and Convergence in Corporate Regulation: The Case of Overseas
Listed Companies" at ssrn.com.
221
Data on the relationship between share prices in the A and H share markets can be found in
Xiaoqing Eleanor Wu, "Market Structure, Volatility, and Performance of H Shares", 34(1) The Chinese
Economy. This shows that for the 17 Chinese companies which had issued both A and H shares by the
end of 1997, the average discount of the H to the A shares had moved to 85%. The most significant
State control of the capital markets has involved the substitution of regulation for
market forces in several areas of the capital market. The most obvious example is
state regulation of listing and share issuance, which has moderated in recent years
but is still much more extensive than in the west. The result is that, while there
appears to be reliance on the market to allocate capital between competing uses, the
reality is that the state is still very much in control. This raises the basic question of
the function of the financial markets in China. They were developed primarily to
assist in the re-structuring of SOEs, through the introduction of private capital, but
have not yet developed an extensive role as a forum for trading shares in private
enterprises. For that to occur, two developments are necessary. First, there needs to
movement was between 1994/95 when H shares moved from a premium of 15% to a discount of 47%
relative to the corresponding A shares as international investors reacted negatively to the PRC
government's austerity programme.
222
Wu (above n222) shows that there is strong intraday transmission of information between B shares,
H shares and Hong Kong shares and weak contemporaneous transmission between A and H shares.
This is in line with previous research (prior to the opening of the B share market to domestic investors)
on the relationship between the A and B share markets which had found segmentation and limited
information transmission between A and B shares, with B shares being more sensitive to the listed
company's fundamental profitability (see HG Fung, W Lee and W.K. Leung, "Segmentation of the A
and B Share Equity Markets", 23 Journal of Financial Research 179-95 (2000)).
Disposal of the state shareholdings in listed companies now seems likely in the
medium term. Ideological or constitutional constraints on the withdrawal of the state
from a key ownership role in the economy have been overcome in the same
pragmatic manner evident in the whole reform process in China. Attention is now
focused on the more practical problem of how to dispose of large state shareholdings
without depressing the values of the relatively small proportion of shares currently
held by the public. Underlying this process is a more fundamental concern on the
part of regulators and policy makers that it is essential to preserve confidence in the
operation of the capital market in the early stages of its operation.
The legal framework relating to the board of directors and minority shareholders’
rights facilitates state control of listed companies, through shareholdings typically
below 50%. Boards lack real decision-making power, which is located in the
shareholders’ meeting. The absence of cumulative voting provides disproportionate
power to major shareholders in electing the board. Supervisory boards, which in
principle might dilute the interests of the state through promotion of the interests of
employees, are generally weak. The introduction of independent directors will help to
limit the control over board decisions by major shareholders. Minority shareholders
enjoy relatively little protection in China, although the position does improve in the
case of those companies who list overseas and are then required to incorporate
additional minority protection into their articles.
(1) State 39 35 32 34 36
(2) Domestic promoter
Legal Person 16 18 23 21 19
(3) Overseas legal person 1 1 1 1 1
(4) Social legal person 7 8 7 6 6
(5) Staff (employee) 0 1 2 2 1
(6) Other (convertible) 1 1 1 1 1
Total Non-Marketable
Shares 64 65 65 66 65
(7) A Share 21 22 23 24 26
(8) B Share 7 6 6 5 5
(9) H Share 8 7 6 5 4
Marketable Total 36 35 35 34 35
Number of Securities
Investment Funds 0 0 6 23 34
223
Source: CSRC. Social legal persons include securities companies who hold shares as principals,
other companies who hold shares and organisations such as co-operatives. Shares held by institutional
investors on behalf of the individual domestic investors (e.g. through investment funds managed by a
professional manager) are shown in category 7 (marketable A shares).
224
Figures are in RMB 100m.
225
Includes initial and subsequent issues.
226
This column shows the ratio of domestic raised capital to newly increased fixed asset investment. It
provides an indicator of the significance of the stockmarkets in providing finance for new investment.
227
Figures are in RMB100m. Source: China Securities and Futures Statistical Yearbook. Foreign
equity capital comprises the proceeds of B, H and N share issues. The sharp rise in foreign capital
raised in 2000 is due to tenfold increase over 1999 in the number of H and N shares issued. Figures for
foreign issued bonds in 2000 are not available.
228
For negotiable shares. Source : China Securities and Futures Statistical Yearbook. Turnover is
calculated as the annual value of turnover over year-end market capitalization.
Listed only in
Hong Kong 42
NYSE 1
LSE 1
Singapore 1
Dual listing in
USA and UK 10
Hong Kong and UK 3
229
Source: CSRC