To Really Root Out Corruption, Chinese SOEs Need Reform

Corruption involving the country’s state-owned enterprises (SOEs) has hogged the headlines. So far, senior executives at China National Petroleum Corp. have been sacked, former railways officials have been hauled to court and, most recently, news broke that two executives at COSCO are also being investigated.

There has been no shortage of ideas on how to reform the sector. At present, the key lies in adopting a system of modern corporate governance, both in form and in matter.

Major SOEs should be the first to start by setting up a board of directors. Under its leadership, all senior managers including the chief executive should be hired through competitive recruitment. The board’s role is to fulfill its duty of care to the shareholders; it makes the decisions that its managers execute. This separation of powers will improve oversight of the company’s operations.

China has aspired to building a modern corporate culture since the 3rd plenum of the 14th Central Committee 20 years ago. Yet the goal remains elusive. Among the 113 SOEs overseen by the central government, only 57 have set up boards of directors in their group’s holding company. Among these 57, most have the board chairman double as the chief executive. Further, many companies have boards of supervisors that are in name only.

This kind of a system makes dictators of the top managers. By concentrating power in the hands of a few with virtually no oversight, the set-up encourages corruption.

The problem is, too many people in the country regard setting up a board of directors at a SOE as a mere formality. This sentiment has its roots in the fact that state capital is usually the “major shareholder” of the company. Today, listed companies of SOEs have largely adopted more modern management methods in a bid to attract investors. But if their parent companies still pride themselves on sticking to management by administrative planning, the listed companies are bound to suffer.

An effective solution is to allow some institutional investors – such as the National Social Security Fund, the Foreign Exchange Reserve Fund and China Investment Corp. – to take a stake in the company, thus diversifying its shareholder structure.

The social security fund exists to take care of the needs of retired workers. Thus, boosting it is entirely reasonable. Further, there is one unique advantage to letting the fund invest in SOEs. An SOE will prefer to retain its earnings to maximize profit, while the social security fund will seek to maximize dividend payouts so that it will have enough to meet its own obligation to retirees. This tension will spur the fund to more actively scrutinize the management of the company.

It may also result in the fund linking up with other medium-sized and small shareholders to exert influence at the company’s annual meeting. This will not only improve transparency of the company’s operations and decision-making, but also act as a curb on corruption.

Experience elsewhere also shows the benefit of appointing outside directors. Learning from advanced economies such as Britain, Chinese enterprises can increase the size of the board and ensure two-thirds of members are outside directors. Half of them could be retired senior government officials, and the other half could be scholars and experts in different fields.

Outside directors exercise more effective supervision than insiders. This, and appointing a non-executive board chairman, should help improve management.

Currently, the post of vice-president is usually recruited; the top post should be, too. Widening the search for talent through the market will ensure the job goes to the best candidate.

It is time, too, to review the place of Communist Party committees, workers’ congresses and unions in SOEs. For too long, the party committee has become the de facto board of directors, and the party secretary automatically becomes the board chairman. Such arrangements have been the breeding ground for corruption, as the convictions of many errant executives have shown.

Business must be run according to market rules. The shareholders are owners of the company; the board of directors represents shareholders’ interests, chart the company’s strategic direction and supervise its management; a board chairman, as convener of the board, should not be the party secretary, whose main job should be to guide the political ideology of party members.

On the eve of the 3rd plenum of the party’s 18th Central Committee, the country’s decision-makers should seize the opportunity to undertake much-needed reform of SOEs. Restraining their monopolistic behavior in the market and modernizing their governance are the two most important steps.