May 19, 2005 Beijing Corporate Governance of the State Controlled Listed Companies in China:...

May 19 , 2005 • Beijing

Corporate Governance of the State Controlled Listed Companies in China: Problems ,Progress and Prospects

Dr. Ruyin HUDirector of Research Center , Shanghai Stock Exchange

May 19,2005 • BeijingPolicy Dialogue on Corporate Governance in China

Corporate Governance

General Situation of Shanghai Securities Market

Capital Stock and Market ValueMay 12th, 2005

Total Capital Stock (a hundred million)Total Market Value （ a

hundred million）Negotiable Capital (a

hundred million)Negotiable Market

Capitalization (a hundred million)A Share

B Share

Total up

Total Share A Share B Share Sampling

PE Ratio

Market Size May 13th, 2005

Public Offering unity (unit) Securities Trader unity (unit) Investors unity( ten thousand)

Total Total Total Accumulative Accounts Open

SharesA ShareB Share

Member CompaniesLocal Member CompaniesNonlocal Member

Companies

Operating A Share

TangibleIntangible

Investors of A ShareRetail InvestorInstitutional Investor

National DebtMerchandise on HandBuy-back

Securities Traders of B Shre

DomesticAbroad

Operating B ShareDomesticAbroad

Investors of B ShareRetail InvestorInstitutional Investor

Securities Investment Fund New Account of Current Month

New Account of Current yearOther Funds

Convertible Bond

Enterprise Bond

the Number of Listed Companies

Unit:pieceseat



SSE Historical Data

Market Value for Stocks (RMB100 Mil.) No. of Listed Companies No. of Investors(10 thousand)

1991 29.43 8 11

1992 558.40 30 111.23

1993 2206.20 106 423.51

1994 2600.13 171 574.89

1995 2525.66 188 685.20

1996 5477.81 293 1207.87

1997 9218.07 383 1713.31

1998 10625.91 438 1999.41

1999 14580.47 484 2281.12

2000 26930.86 572 2957.84

2001 27590.56 646 3419.84

2002 25363.72 715 3566.60

2003 29804.92 780 3632.06



SSE Composite Index Movement(1990.12.19-2005.5.13)

SSE Index

amplitude

Ask

BidSusp.

UpDown

Unchanged (Share Price)

Ls. Avg.

Chg.

Chg.%

Amt.

Vol.

NowV

PD Clo.

Open

High

Lowquantity ratio

taken given



Data of China Securities Market



Stat. Data of Chinese Securities MarketDomestic Listing Companies

A Share, B Share(home)

Market Capitalization （RMB100 Mil.)

Negotiable Market

Capitalization (RMB100 Mil.)

Total Capital Stock

(RMB100 Mil.)

Funding Sum

(RMB100 Mil.)Turnover (RMB100

Mil.)

No. of Investors Account Opened (Ten

thousand)

Stamp Duty (RMB100

Mil.)



Highlights of China Equity Market (2005.4.19)

Market Cap. (trillion)

Market Value (trillion)

Number of Listed Companies

Number of Investors Accounts Opened (million)

SSE 2.48 0.695 838 37.2

SZE 1.06 0.423 539 34.8

Total 3.54 1.118 1377 72



The Chinese Characteristics of Ownership Structure and Organizational Structure of Listed Companies

Ownership Structure of Listed Companies Chinese listed companies have three types of shares:• the state owned shares• the legal person shares• the public (tradable) shares The state and legal person shares cannot be traded in the secondary market, and are called non-tradable shares. The tradable public shares include A shares (shares that are denominated in RMB and listed on mainland exchanges.), B shares (shares that are denominated in US Dollar or Hong Kong Dollar and listed on mainland exchanges).




Ownership Structure of Listed Companies

Shares of Chinese Listed Companies

Domestic Shares Foreign Shares

The State Owned

Shares

The Legal Person

Shares

The Tradable

A Shares

B

Shares

H

Shares

N

Shares




Ownership Structure of Listed Companies Ownship structure of Chinese companies have 4 charateristics:

an overwhelmingly large percentage of non-tradable shares

an excessive concentration of non-tradable shares in one big shareholder

an overly dispersed ownership of tradable shares and a tiny percentage of institutional investors

usually the largest shareholder is a shareholding company instead of a natural person




Ownership Structure of Listed Companies A prominent characteristic of Chinese listed companies is an overwhelmingly large percentage of non-tradable shares, which represents about 2/3 of all the listed companies’ combined equity. The tradable shares represent the remaining 1/3. A majority of listed companies’ non-tradable shares are 60%-80% of their total number of shares. A few companies even have more than 90% shares not tradable. About 6% of all the listed companies have more than 40% of their total equity in tradable shares. Only 0.4% of all listed companies have only tradable shares. On average, the larger the size of the company, the higher the percentage of state shares, which demonstrates that large listed companies are essentially state-owned.




Ownership Structure of Listed Companies in SSE Market (2004.12.31)

State OwnedShares

58%Legal PersonShares etc.

14%

Tradabl eshares

28%




Ownership Structure of Chinese Listed Companies(1999)

Legal PersonShares

26%

Others2%

A Shares26%

B Shares5%

H Shares4% State Shares

37%




Ownership Structure of Listed Companies The second characteristic of the shareholding structure is an excessive concentration of non-tradable shares. In the end of 2001, the average largest shareholder of an A share company owns 44.26% of all the company’s shares; above 40% of the largest shareholders owns more than 50% of their companies’ shares; in 74.4% of all the A share companies, the top five shareholders own more than 50% of their company’s shares. According to statistics based on the 2002 annual report of 734 companies listed on the Shanghai Stock Exchange as of June 20, 2003, in the end of 2002, in 40.9% of all the companies (a total of 300 companies) the largest shareholder owns more than 50% of the company’s shares; in 32.8% of all the companies (a total of 241 companies) the largest shareholder owns between 30% to 50% of the companies’ shares; the average largest shareholder owns 44.3% of its company’s shares.




Ownership Structure of Listed Companies

Concentration of Shares in Largest Shareholder in Shanghai Stock Exchange

(As of Dec.,2002)

Sample Largest Shareholder Holding

40.9% of all the companies

(a total of 300 companies)



All the companies(734 companies)

Over 50%

30%-50%

44.3% on average

Concentration of Shares in Largest Shareholder in Shanghai Stock Exchange

(As of Dec.,2002)

Sample Largest Shareholder Holding





All the companies(734 companies)

Over 50%

30%-50%

44.3% on average




Ownership Structure of Listed Companies The third characteristic of the shareholding structure is an overly dispersed ownership of tradable shares and a tiny percentage of institutional investors. In the end of 2002, the number of accounts opened at Shanghai Stock Exchange stands at 35 million, of which 99.5% belongs to individual investor and only 0.5% belongs to institutional accounts.




Ownership Structure of Listed Companies The above mentioned ownership structure of Chinese listed companies is

problematic:

The institution for implementing state shareholder’s rights is unsatisfactory. Either the government exerts too much influence on listed companies, or there is a lack of monitoring on management.

The parallel or pyramid shareholding structure induces and facilitates related-party transactions that impair the interest of listed companies.

Lack of direct control of public shareholders on the listed companies

Hostile takeover is nearly impossible.

The stock prices in the secondary market are distorted




Ownship Structure of Listed Companies in SZE Market

Ownership Structure of Negotiable Capital of Investors in2004

Retail Investor

79. 52%

QFI I0. 65%

Dual Trader

1. 15%Common Organizations

6. 36%

National Social SecurityFund 0. 86%

Securities InvestmentFund

11. 46%




Ownship Structure of Listed Companies in SZE Market

Structure of Stock Exchange of Investors in 2004

Retail Investor

89. 04%

Securities InvestmentFund

5. 31%

National SocialSecurity Fund

0. 28%

CommonOrganizations

3. 74%

Dual T rader

1. 45% QFI I0. 18%



Current Corporate Governance Environments in China Insider control in corporate affairs and the key person model

• Insider control, or the key shareholder control, is one of the main characteristics of China’s corporate governance.

• If the controlling shareholders are individuals or other enterprises, the insider control problem is frequently associated with the phenomenon of family-type enterprises; if the controlling shareholder is the state, the problem is associated with conflicting political and enterprise objectives.

• Insider controller is a synonym for the key person. The key person has a large discretionary power and is frequently endowed with the power of control, execution, and supervision. He or she easily controls and manipulates the company’s general shareholder’s meeting, board meeting, and the supervisory board meeting, making them essentially “rubber stamps”



The Characteristics of“ Key Person Model”

Chinese Listed Companies

High Ownership Concentration Diversified Ownership

Strong Blockholders

Weak Minority Interest

Strong Executives

Weak Outside Shareholders

The Blockholder Representative Controls the Corporation

Insiders Control the Corporation



Serious Problem of “ Key Person Model” Interest Conflicts between Blockholders/Managers and Minority

Shareholders Insiders,Including Blockholders, Expropriate Interest of Minority

Shareholders through Related-Party Transactions Lack of effective monitoring Poor decision making and risk controlling



Current Corporate Governance Environments in China A Legal Framework with Poor Shareholder Protection Lack of effective legal punishment on wrongdoers. Legal self-enforcement is inadequate, and investors face obstacles in

seeking legal protection• Laws and regulations stress the use of administrative and criminal punishment on

violators in securities market. They relatively neglect the civil liability and compensation.

• In the punishment of securities market violation, administrative orders often replace legal discipline.

• The country’s legal system has not adopted the highly effective class action widely used in the US and the derivative suits in the hearing of civil compensation cases related to securities market violations.



Current Corporate Governance Environments in China The quality of disclosure not guaranteed• From the perspective of majority public shareholders, the information

disclosed by Chinese listed companies is not reliable enough. For the listed companies, the form of disclosure is far more important than the substance. Some even don’t bother to comply with the form and they may falsify financial statements.

• The main reasons for poor quality disclosures are: lack of effective legal punishment for disclosers; improper administrative intervention and lack of competition in the capital market; lack of proper internal control system for disclosure within the companies.



Current Corporate Governance Environments in China

Direct or indirect Party appointment of the chairmen and

CEOs of the state controlled listed companies Each state controlled listed company and its chairman and CEO

have a specific official grade or rank Strong political incentives,weak business incentives: to serve the

desire of higher rank party officials other than the best interests of investors



Steps Taken to Improve Governance in China

Today,through SSE’s initiatives and persevere effort,Corporate governance has been very high in China’s policy agenda. There has been a remarkable progress both in the regulatory framework and implementations over a few years. A mandatory independent director system has been introduced and will be strengthened. The Chinese code of corporate governance was successfully formulated in early 2002 and a series of educational initiatives have been taken for the better understanding of corporate directors. The authorities have also been taking a severe attitude to impose sanctions on wrong-doings of the listed companies.




SSE and CSRC has been in the forefront of promoting corporate governance in China and has taken vigorous actions to improve corporate governance of listed companies Independent directors on board SSE Guidelines for Corporate Governance(2000) Code of Corporate Governance ： The Binding Code of Corporate

Governance for Listed Companies issued by CSRC and State Economic and Trade Commission on January 7, 2002.

Better Rules and Practices of Disclosure Take-over Code and market for corporate control Enhancing Legal reform to protect shareholder through lawsuits Stronger Enforcement




SSE and CSRC has been in the forefront of promoting corporate governance in China and has taken vigorous actions to improve corporate governance of listed companies

Higher Standards of Ethics of Directors:the New Listing Rules Require Each Director to Have a Formal Declaration and Undertaking in the Performance of His ／ Her Duties

Safeguard Conflicts of Interest : Rules of Related-Party Transactions Disclosure; the Use of Human,Financial and Physical Resources of a Listed Company Is Separated from That of Its Controlling Company

CSRC: Regulations on enhancing institutionalshareholders right (2004)

Cumulative voting rules, online SGM and voting Training




Independent Directors Overhaul the insider-controlled board structure by

promulgating a regulation requiring each listed company to have at least one-third of the board to be independent directors by June 2003. The regulation was issued in August 2001.

About one-third of the independent directors are accounting profession, and almost all companies have at least one accounting professional to be independent director .




Independent Directors The specific Roles and Responsibilities of Independent Directors

Protect shareholder rights and the interests of the company, paying particular attention to minority shareholders protection

Major related party transactions have to be approved by independent directors

Serve as chairs of the auditing, compensation, and nomination committees. Independent directors must consist of a majority of these committees




SSE Guidelines for Corporate Governance(2000)




Code of Corporate Governance for Listed Companies in China Mandatory for all listed companies Issued and Enforced by CSRC and State Economic and Trade

Commission on January 7, 2002. Proxy voting is encouraged in the Code




Disclosure Listed companies required to publish an audited annual report as

well as half-year report. Starting in 2002, listed companies required to disclose unaudited quarterly reports

Disclosing the controlling shareholder or the actual controller of the company

Online disclosing




Enhance Legal Reform Lawsuit against directors and management: the Supreme Court issued an

Ordinance last year on the the procedures for shareholders suing directors and management in case of losses due to false disclosure by the company. The Courts have accepted cases

SSE: Suggestions to the Governance Lawmaking and Reform of Listing Companies. (2004)

SSE Helps to revise the Company Law ， the Securities Law ， the Restructure Plan for the Proposed Listing Company, Code of Practice for High Management in Listing Company (Drafting), Oversighting Ordinance of Listing Company.

SSE emended and issued the Exchange Listing Rules.




Stronger Enforcement and Frontline Regulation SSE Makes public reprimands of listed companies for

violations of their listing rules In the year of 2002, SSE strengthen supervising on listing companies;

made format guidelines for listing companies temporary bulletin, regulated disclosure, and further implemented the questioning supervision. SSE sent listing companies over 500 Afterwards Auditing Advices and 105 Supervision Letters. Made public reprimands to 19 companies, inside notice of criticism to 49 companies or high managers. had SCRC special audited or checked 21 companies. Established inside information knower database. Checked the share-holding situation and illegal close-out among high managers. Advocated 37 companies to announce a proposal letter on perfecting corporate governance, actively advanced listing companies for regulating disclosure of governance structure, and strengthened the legal system training and trust education of directors and auditors.




Stronger Enforcement and Frontline Regulation SSE MakeS public reprimands of listed companies for

violations of their listing rules 2003 ， SSE made further implementation of questioning supervision and

strictly managed listing companies which have violation activities: 33 companies were circulated by

a notice of criticism ， 11 companies were made public reprimand, 10 listing companies were put to SCRC for special check. In the period of check after the periodically report, SSE issued 480 Afterwards Auditing Advice Report and 142 Regulatory Letter , and urged listing companies to publish 169 the Complementarity to Periodical Reports or Correct Announcement. On regulating the secondary market, SSE tried best to survey and stop the suspecting controlling market activity and insider trade (even the sign )by high technical support and soft & hard means.




Stronger Enforcement and Frontline Regulation SSE MakeS public reprimands of listed companies for violations of

their listing rules SSE continued to promote listing companies for improving their corporate:

SSE strongly punished violation and illegal activities by totally issued 42 inside reporting comments, 21 public condemns, 143 oversighting letters. There are 11 listing companies suspended for continuous loss. And *ST Beeda Technology, *ST Goldenstar and *ST Anshan Co-operation was suspended in Dec.2004. Other 8 companies was recovered. SSE made special treatment to 19 listing companies, made special treatment suspension to 7 companies; implemented The regulations of the caution of risks in backing from the market on 28 companies, and 19 companies suspended; issued the Report of Chinese corporate governance (2004), and the Suggestions to Chinese corporate governance; held successfully the Policy Dialogue on Corporate Governance in China and the International Conference on corporate governance in China; and great promoted trust-building of listing company. Worked out the Implementing Rules of Net-Voting for Listing Company Shareholder Meeting to promote listing companies perfecting their corporate governance.




Stronger Enforcement and Frontline Regulation SSE Makes public reprimands of listed companies for

violations of their listing rules In the year of 2005:

SSE Net-Voting System for Listing Company Shareholder Meeting has been in well-running.

SSE has connected with bank’s reference system (records of reprimand receivers).




Experimentation reform of equity division kicked off From May 9th,2005, 4 listed companies have

been put into trial scheduled for non-tradable shares to resume sales



The Next Steps to Improve Governance in China

Four Steps to Improve the Corporate Governance

Strengthen Legal Rules and Enforcement Diversify the Ownership Maintain the Independence and Effectiveness of Board of Directors Make the Market Efficient




Strengthen Legal Rules and Enforcement

Legislate to Improve Minority Shareholders Protection Stronger sanctions against violations on laws and regulations(revising

Criminal Act,Company Law and Securities Law) Strengthen directors’ civil and criminal responsibilities and reinforce the

oversight on majority shareholders.




Diversify the Ownership

Reduce or Sell Off the Shares held by the Governments Introduce other Forms of Sizeable Outside Shareholders Including Closed-End &

Open-End Mutual Funds,Insurance Companies,Pension Funds,QFII and Other Institutional Investors

Our empirical studies show that there is a positive relationship between Tobin’s q ratio and level of concentration of the largest five shareholders (also the largest ten shareholders), but not in the case of the single largest shareholder. In addition, we find strong impacts of balanced power sharing among a few large owners on firm value. Our results suggest that the institutional concentrated ownership may provide an efficient way of resolving agency problem in firms with less investor protections and outside legal enforcement.




Maintain the Independence and Effectiveness of Board of Directors

Encourage More Independent Directors to Enter the Board of Directors Strengthen Audit Committee,Nominate Committee etc. to Curb the Power of

Blockholders/Executives Enhance Duties and Liabilities of Directors

On the basis of reinforcing the disclosure regulatory, SSE will establish the Code of Conduct for Board Chairman (has been drafted out) and strengthen board’s trust and responsibility.




Make the Market Efficient

Enhance management market and avoid direct political interference into it: depoliticized the management market for the state controlled listed companies;enhance managerial ownership by equity-based incentive or remuneration system

Our empirical studies show that the executives shareholdings in the state controlled listed companies are positively related to firm value.

Building up effective price discovery mechanism in equity market Stop market manipulation and insider trading Deregulation of the market Developing the market for corporate control

May 19, 2005 Beijing Corporate Governance of the State Controlled Listed Companies in China:...

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