BRIC Project -- China -- Regulatory Structures in China (Part 1 cont.)

Introduction

Part one of the blog’s BRIC Project’s China Series seeks to illuminate the regulatory structures, agencies, and institutions that make up corporate governance (gongsi zhili) in China.  This continued posting on the regulatory structures in China looks at the (A) Board of Directors and the (B) Board of Supervisors in Chinese companies and their role in corporate governance, as well as (C) China’s definition of director independence.  

Required Governing Bodies in Chinese Corporations

A. The Board of Directors 

The Corporate Law of China requires three governing bodies within any listed corporation:  the shareholder, the board of directors, and the board of supervisors.  Noticeably, no other bodies or committees (such as an audit or compensation committee) are required.  However, the Corporate Law was amended in 2006, and now contains strict guidelines for audit and accounting functions within listed companies.  See Cindy A. Schipani & Junhai Liu, “Corporate Governance in China: Then and Now.” 

In Chinese listed companies, the shareholders, however, are meant to exercise the majority of decision-making authority within the corporation via the annual shareholder meeting and any subsequent meeting of the shareholders.  However, the logistics of calling a shareholder meeting for every major corporate event has proved impracticable and cumbersome.  In reality, the majority of power rests with the board of directors, the senior management, and the board of supervisors.

 The board of directors, much the same as the familiar model in the U.S., hires, fires, monitors and compensates management with the goal of shareholder wealth maximization.  The drafters of the Corporate Law originally saw the primary duty of the board of directors to minimize the costs associated with the separation of ownership and decision making authority for the SOE from the State.  See Donald Clarke, “Corporate Governance in China: An Overview.”  Directors serve for a maximum term of three years.  There are two enumerated fiduciary duties owed to shareholders by directors:  the duty of good faith (chengxin) and the duty of diligence (qinmian).

B. The Board of Supervisors

The unique addition to the traditional governing structure is the board of supervisors, and represents the second tier of corporate management.  Supervisors are charged with monitoring the directors and senior management to ensure fulfillment of their responsibilities.  See Takeshi Jingu, “Corporate Governance for Listed Companies in China - Recent Moves to Improve the Quality of Listed Companies.”  However, unlike Germany (which also employs a two-tier governing structure), there is no hierarchical relationship between the board of directors and board of supervisors.  Indeed both are appointed and dismissed via shareholder action, and are meant to equally coexist within the management structure of the Chinese corporation.  

The members of the board of supervisors consist of shareholder representatives (elected by the shareholders), and employee representatives (who work for the CEO).  Some commentators, however, note that the intended supervisory role of the board of supervisors is actually quite low in most listed companies.  This is because the chair of the board of supervisors is typically also the head of the labor union, who in turn is appointed by the in-house Party chief, who in turn is also often times the chairman of the board of directors.  Some argue that the board of supervisors does operate as a sufficient check on the board of directors and senior management as intended.

C. Defining “Independent Director” in China

Chapter IV, Section 5 of the Corporate Law was amended in 2004 to require listed Chinese companies to have some proportion of independent directors.  This amendment was added in response to the “State Council’s 2004 Several Opinions on Promoting the Reform, Opening Up, and Stable Development of Capital Markets” (a.k.a. “The Nine Opinions”).  The CSRC implemented this initiative via the codes it promulgates to require that, by 2003, one-third of all directors sitting on the boards of directors should be independent.  See “Code of Corporate Governance for Listed Companies in China (2001),” and the “Provisional Code of Corporate Governance for Security Companies (2004)”).  Another code revision requires that as directors’ terms expire, non-independent directors should not exceed one-half of the entire board.  See Larry Li, Tony Naughton & Martin T. Hovey, “A Review of Corporate Governance in China.”

The regulatory laws of China define independence as not having a position within the company (i.e. the CEO).  Further qualifications for independent directors include: (1) subjectively meeting honesty and credibility standards, (2) knowledge of securities markets, (3) familiarity with all laws and regulations pertaining to listed companies, (4) five years of relevant experience, and (5) possessing sufficient time to review and having access to all corporate material necessary to do the job.  The CSRC requires that the views and attitudes of all independent directors should be explicitly stated in any board resolution, and related transactions may not close until they are approved by a majority independent of the directors.  Further, two or more independent directors can propose a special shareholder meeting, and can individually report directly to shareholders or regulatory agencies.  Independent directors are, in theory, to be on par with non-independent directors.

However, all of the requirements imposed by the CSRC apply only to overseas-listed corporations.  Domestically listed corporations are not bound by any requirement to have any independent directors on their boards.  They may, however, adopt a discretionary provision in the Memorandum of Associations (which is similar to a combination of the Articles of Incorproation and Bylaws in U.S. corporations) whereby “the listed corporation may appoint independent directors when it deems necessary.”  This leaves most independent directors in domestically listed corporatized SOE’s with a limited role.

The final installment of Part one of the BRIC Project’s China Series is forthcoming, and discusses the ability of a shareholder in China to bring a lawsuit against a listed company, the legal system in China as it relates to shareholder actions and the perceived difficulty of shareholders in China to seek redress for breaches of fiduciary duties by management.