EDITORIAL
Blackwell Publishing Ltd.Oxford, UK
Comparative Corporate Governance:
the experience between China and the
UK
Guy S. Liu*
Introduction
P rincipal-agent theory offers us a very com-
pelling solution to how to induce agent’s
effort and so minimise agency costs in a cir-
cumstance where an owner can make his or
her agent accountable for a state of output. If
the specification of accountability is difficult,
in particular in the situation where there are
multiple owners or principals, such as when
hundreds of shareholders elect a board of
directors as their agent, can we still, or how
should we, apply the theory to minimise the
costs of the agent – the board of directors? This
is essentially where corporate governance
debate is at – how to extend the theory to
understand how effective ownership control
works. The issues we need to understand
include ownership structure, the composition
and accountability of the board, the effective-
ness of incentives to effort, monitoring, and a
role of capital market control in disciplining
the board.
To stimulate debate about such issues from
a comparative aspect, on 10–11 December 2003
the Cambridge Research Unit for Economies
of Greater China at the University of Cam-
bridge hosted an international conference on
the subject of comparisons of corporate gover-
nance between China and the UK. A selection
of the papers presented in the conference
makes up a large part of this special issue.
The issue also benefits from the comments of
anonymous referees to whom we are grate-
ful for their time and support.
Moreover, the conference benefited enor-
mously from the presentation by Professor
James A. Mirrlees, who made the fundamental
contribution to the development of principal-
agent theory. His presentation focused on his
on-going study of a model that intends to
© Blackwell Publishing Ltd 2005. 9600 Garsington Road, Oxford,
OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.
1
CORGCorporate Governance: An International
Review0964-8410Blackwell Publishing Ltd. 2005
January 200513114EDITORIALCORPORATE
GOVERNANCE
solve the principal-agent controlling problem
in the case of multiple principals. In this cir-
cumstance, where is quite different from a case
with one principal to one (or many) agent(s)
that is used for his previous work, theory
becomes much more complicated and there
are many difficulties involved in identifying a
compelling solution to the problem. The diffi-
culty of his on-going research, at least for the
time being, implies that a solution for improv-
ing corporate control is not unique.
Papers in the Issue
The non-uniqueness is expected, because there
are many factors that can shape how corpora-
tions can be controlled for the best interests of
the firm and its owners. One of them is law
and the development of a good legal system.
Law is essential for effective corporate gover-
nance, because it defines the responsibilities of
the parties and ensures enforcement. One dif-
ference between developed economies and
emerging markets is the degree to which the
system of law is complete. Corporate gover-
nance practice in the West has been developed
on the basis of a relatively complete system of
law. Can the practice be effectively applicable
for emerging markets where law is incom-
plete? The paper presented in the conference
by Katharina Pistor and Chenggang Xu
addressed this question. They argue that legal-
based governance mechanisms that have been
applied in the West may not help economies
in transition. The paper suggests that, at least
in the transitional period, administrative-
based governance with a certain degree of * Address for correspondence:
government involvement can be a viable alter- Department of Economics,
Brunel University, Uxbridge,
native to ensure effective governance for cor- Middlesex UB8 3PH, UK.
porations. This argument is advanced with E-mail: guy.liu@brunel.ac.uk
Volume 13 Number 1 January 2005
2 CORPORATE GOVERNANCE
reference to the development of governance
systems for stock markets in China and
Russia.
When law is complete, how can we improve
corporate governance for the sustainability of
a firm? Failures in some large corporations,
such as Enron, Worldcom and Parmalat, have
called us to rethink the question from its very
fundamentals. One key question is to whom a
firm shall be accountable. Prevalently, it is the
shareholders whose interests must be served
as a priority. Why shareholders? Simon
Deakin challenges the question by arguing,
first, that shareholders do not “own the com-
pany” in law; and secondly, that a company is
an organisation that holds a range of corporate
constituencies – employees, suppliers, credi-
tors, communities – to work together for the
interests of all stakeholders; and thirdly, that
the origins of the primacy of shareholders
came from the hostile takeover movement that
has actually failed to result in any significant
improvement in corporate performance in the
companies which are immediately affected by
the takeover. Moreover, Deakin argues, the
primacy of shareholder value can lead the cor-
porations to create negative externalities for
other stakeholders, like creditors, employees
or even a much wider range of parties – so-
ciety. This suggests that the shareholder value
makes the board of directors an agent of (cap-
ital) market, not an agent of society. Can the
firm sustain its business without caring about
the interests of, or gaining the full support of,
society?
To ensure effective corporate governance,
market self-regulation is important. The UK
has recommended successive best practice
guidelines for the self-regulation in the form
of the reports of Cadbury (1992), Greenbury
(1995), Hampel (1998) and Higgs (2003). When
law is relatively complete, we expect that the
self-regulation should be sufficient to effec-
tively discipline the board of directors. Is this
true? Steve Thompson provides a review of
UK reform of executive remuneration in
response to Cadbury’s recommendations and
onwards, in which he sheds some light on the
implication for the question. The objective of
UK corporate governance reforms has been to
make executive pay better reflect corporate
performance. The paper shows some evidence
that industry did respond to the recom-
mended measures, although the response was
limited. For example, reforms have been more
successful in reducing executive tenure – and
hence pay-offs in the event of failure – but the
evidence is not clear about UK corporations’
ability to increase the sensitivity of reward to
performance, which was the intention of Cad-
bury recommendations. His finding suggests
Volume 13 Number 1 January 2005
a view that market self-regulation is to some
extent effective in helping corporate gover-
nance, although it has its limits.
The view is further supported by other evi-
dence that the proportion of non-executives in
UK corporate boards is steadily increasing,
from 34 per cent in 1991 to 49 per cent in 2001,
in response to the recommendations of Cad-
bury and onwards. This change is identified
by Maria-Teresa Marchica and Roberto
Mura’s paper which provides a very compre-
hensive investigation into the evolution of cor-
porate governance in the UK over the last
decade, as well as into ownership structure
and the separations of ownership (cash flow
rights) and control (control rights). For owner-
ship control, two questions are commonly
asked: who owns the firm and how are firms
owned? The authors find that, first, UK com-
panies are owned largely by institutional
investors who hold some 15 per cent of total
shares of the company on average, and the
government has the least ownership of the
company, less than 1 per cent of the total
shares. Second, more than 60 per cent of UK
companies are not owned by a single large
shareholder that holds more than 20 per cent
of its shares. Instead, companies tend to be
widely owned and are likely, as viewed by the
school of Berle and Means, to be controlled by
management. The implication of the UK’s
ownership structure is interesting: when the
system of law is relatively complete, it seems
that management-dominant governance be-
comes viable and prevalent.
In contrast to the UK, the ownership struc-
ture is quite different in China, where the
economy is in transition and the system of
law is incomplete. Guy Liu and Pei Sun’s
paper looks at all Chinese quoted companies
and identified that 81 per cent of them are
ultimately owned by the state, with an aver-
age shareholding of 48 per cent. The highly
concentrated ownership structure also ap-
pears in Chinese private listed companies
that the largest shareholder holds 36 per cent
of shares on average. Moreover, a simple
ultimate state ownership controlling struc-
ture (the state pyramid) has been widely
applied in Chinese quoted companies: the
state employs an intermediate corporate
institution as its agent to control the down-
stream firm. The sharp difference of owner-
ship structure between the UK and China
raises an interesting question for further
research: does the development of a good
legal system matter for ownership and gov-
ernance arrangements? And is it true to say
that shareholder-dominant governance is
more viable for an economy at an earlier
stage of legal development?
© Blackwell Publishing Ltd 2005
EDITORIAL
The reform of ownership structure with the
introduction of the state pyramid in China is
to serve the interest of the state to control large
corporations, and this will inevitably evolve to
the divergence between cash flow and control
rights. Is the divergence good or bad for cor-
porate governance and thus company perfor-
mance? The question is addressed by Julan
Du and Yi Dai in their paper, which uses a
sample of some 1400 companies from Hong
Kong, Indonesia, Japan, Malaysia, the Philip-
pines, Singapore, South Korea, Taiwan and
Thailand to study the relationship between
corporate leverage and the ultimate corporate
ownership structure, particularly the separa-
tion of cash flow rights and control rights. The
study finds that the higher the level of separa-
tion, the more debt the firm takes on to finance
their business. This is because the controlling
shareholder does not want to raise finance at
the expense of its ownership control and,
therefore, the choice of a risky capital structure
is intended. Consequently, the risk-taking ten-
dency decreases the value of a firm. The neg-
ative impact of the divergence on firm value is
also evident in UK companies (see Marchica
and Mura in this issue). Their findings suggest
that the divergence can weaken corporate gov-
ernance, both in terms of risk control and in
protecting minority shareholders from expro-
priation by the largest shareholder who may
gain more control benefits from the voting
rights than dividend benefits from the cash
flow rights.
Crony capitalism is a common feature in
both China and East Asia. In such circum-
stances, together with the on-going pro-
gramme of ownership change from state to
private, can China avoid the negative experi-
ence of divergence, and develop a more diver-
sified and widely held ownership structure via
privatisation for its emerging private compa-
nies? Two case studies, presented by Chih-jou
jay Chen and Laixiang Sun and Damian
Tobin, address the question. Chen’s paper
looks at a case of how township and village
enterprises (TVEs) are privatised to form a
new ownership structure. Sun and Tobin look
at a case of how a state firm – the Bank of
China (Hong Kong) – is partially privatised
and the consequences for corporate gover-
nance. In TVEs, Chen found that the process
of privatisation does not rely on the market
mechanism; rather, it is the result of manipu-
lation by a village clique including village
administrative cadres and firm managers. The
whole process is entirely non-transparent.
A non-transparent privatisation inevitably
results in firms with non-transparent gover-
nance structure dominated by a private family
or a part of the village elites. In contrast to the
© Blackwell Publishing Ltd 2005
3
privatisation of TVEs, Sun and Tobin, in their
case study of listing the Bank of China (HK)
through a open market process, show that an
international listing can provide an effective
mechanism to prevent privatisation from
discretionary policies and managerial oppor-
tunism, which will be conducive to good post-
privatisation corporate governance for more
transparency and independency. An interna-
tional listing helps improve the corporate
governance for companies operating in juris-
diction where law is incomplete.
Finally, Andrew D. Chambers presented an
interesting study in comparing audit systems
between the UK and China. The direct com-
parison shows further evidence on the view
that corporate governance is different at differ-
ent stages of legal development. In the UK,
where the system of law is complete, the mar-
ket plays a dominant role in advancing gover-
nance. In contrast, the government plays a key
role in improving governance in China, where
it is at an earlier stage of legal development.
For instance, the compliance of audit commit-
tees in British quoted corporations is a market-
led voluntary practice, but in China audit
committees in quoted companies have their
regulatory status, which is designed and
enforced by the government departments: the
China Securities Regulatory Commission
(CSRC) and the State Economic and Trade
Commission (SETC).
Conclusions
All of the nine papers in this Special Issue
suggest that the Chinese experience of corpo-
rate governance is different from that of the
UK, because China is at a different stage of
economic and legal development. For the UK,
most corporations have a highly dispersed
ownership structure that is conducive to man-
agement in dominating the governance. The
dispersed ownership allows the market, not
large shareholders, to become influential for
the development of the UK corporate gover-
nance and its enforcement. For this market-
determined governance system, a further
reform is called for consideration of shifting
the central interest of the firm from share-
holder value to stakeholder value. For China,
the system of law is incomplete, and this does
much to explain why there is a highly concen-
trated ownership structure in Chinese corpo-
rations. In China, it is not the market, but the
state, as both the major shareholder and regu-
lator of the firm, that is in more control of the
development of corporate governance and
its enforcement. As a result, the difference
implies that for Chinese firms the best practice
Volume 13 Number 1 January 2005
4 CORPORATE GOVERNANCE

of corporate governance cannot be simply
imported from the West without any adapta-
tion to the local business and political environ-
ment. Chinese corporate governance in the
future should be developed in line with legal
development and ownership reform.
Acknowledgements
I would like to thank the speakers for the con-
ference, the delegates for their contributions
and enthusiasm, and the referees for their
valuable comments. I am also grateful for Mr
Pei Sun and Dr Stephen Green who help pre-
pare the Issue. Finally, I owe a great debt to the
Editor of the Journal, Professor Chris Mallin,
for her support of the Issue, and Dr Wei
Zhang, who offered his enormous support of
both finance and administration for the
conference.
Guy S. Liu obtained his PhD in economics at
the University of Oxford, and he is a senior
lecturer at Brunel University and adjoint pro-
fessor of Sichuan University (China). He was
a guest editor for Economics of Planning and
China Economic Review, and an editor of the
Journal of Chinese Economic and Business Studies.
His main research interests cover comparative
corporate governance, enterprise reform and
industry in China, industrial economics and
firm performance.

“When the share price of a corporation goes into freefall it is clear that something has gone
wrong, but . . . the cause was not one single thing, but a disease or malaise at the heart of
the organisation.” Critical Eye Report on Corporate Integrity

Volume 13 Number 1 January 2005 © Blackwell Publishing Ltd 2005