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) Stock Exchanges and Agency Regulation in China, and (B) Voluntary Regulations in China.  

A. Stock Exchanges and Agency Regulation in China

The regulatory body created to administer the Chinese stock exchanges is the China Securities Regulatory Commission (CSRC).  This agency has promulgated two codes: the “Code of Corporate Governance for Listed Companies in China (2001),” and the “Provisional Code of Corporate Governance for Security Companies (2004).”  These codes apply equally to all listed companies, and represent an attempt on the part of the CSCR to standardize operating procedures and promote healthy corporate governance.  

Investors see the level of compliance by Chinese companies with both codes as the best metric for the health of the corporate governance system for a given listed company in China, as discussed in an article by Larry Li, Tony Naughton & Martin T. Hovey.  Li, Larry, Naughton, Tony and Hovey, Martin T., A Review of Corporate Governance in China (August 18, 2008).

The codes flesh out the details of the ideal corporate governance system.  The codes also enumerate the basic behavior, rules and moral standards for members of the governing bodies of the corporation.  Specifically, some of the more important features include: (1) Shareholders and the Annual Shareholder Meeting, (2) Controlling Shareholders, (3) Memorandum of Associations, (4) Board of Directors, (5) Board of Supervisors, and (6) Disclosure. 

•  (1)  Shareholders and the Annual Shareholder Meeting

The codes promote cohesive treatment of shareholders under all of the corporate and securities laws in China and stress that shareholders are to be treated fairly.  The codes also outline the requirements of shareholder communications, and reiterate that corporate management is to bear the burden of compensating shareholders in the event that management breach their fiduciary duties leading to loss on the part of shareholders.  The codes also require that related-party transactions should be undertaken at market value.  Further, qualification standards for management are outlined, and there is a notification requirement where the CSCR must be told of any major changes in the composition of the management team in any listed company.

In addition, the codes reiterate the notion, contained in both the Corporate Law and Securities Law, that the shareholder annual meeting is to be the powerhouse and primary forum for corporate decision-making.  In actual practice, however, Chinese listed companies face the same difficulties with annual meetings that U.S. corporations do; expense, low turn out and lack of dissent.

• (2)  Controlling Shareholders

The codes also lay out the proper relationship of the controlling shareholders to the company itself.  Controlling members must obey all laws in exercising their rights as investors, and they may not harm the company or the interests of a minority shareholder. 

• (3)  Memorandum of Associations

The codes and Corporate Law specify the nature and content of this organizational and governing document.  The Memorandum is similar to a combination of both the Articles of Incorporation and Bylaws in an American corporation. 

• (4)  Board of Directors

The codes provide that election of directors is to be transparent; the identity and qualifications of director candidates are to be disclosed before the annual meeting.  

• (5)  Board of Supervisors

The codes encourage shareholders to appoint members to this unique governing body from the professions of law and accounting, or candidates who possess extensive experience in business or finance.  Their identity and qualifications should likewise be disclosed prior to the annual meeting.  

• (6)  Disclosure

The codes ask for extensive disclosure of major events facing the corporation.  They require the disclosure of information to be widely accessible to the public.  

B. Voluntary Regulation in China

The Chinese corporate governance regulatory structure is sometimes characterized as a Control Model, meaning that affirmative acts on the part of the State, via regulation and investigation, are meant to enforce compliance.  Chi Guotai, Yang Zhongyuan, Zhao Guzngjun, Li Gang, The Trends of Transparency, Laws and Regulations on Chinese Corporate Governance, Dalian University of Technology (China), School of Management.  In other emerging markets, however, compliance with corporate governance principles is merely voluntary.  

Disclosure is one aspect of corporate governance in China that may deviate from the Control Model.  It could be categorized as voluntary, despite extensive disclosure obligations imposed by both the Corporate Law and the CSRC.  For instance, some commentators note that the level of information disclosed by listed companies is far behind that of most international public companies.  See Guotai, Zhongyuan, Guzngjun & Gang, “The Trends of Transparency, Laws and Regulations on Chinese Corporate Governance,” supra.  Much of the disclosure requirements are discretionary, and companies vigorously exercise their discretion not to release important information.  When companies do disclose, some complain that the information is untimely, the necessary information is incomplete, and the public lacks easy points of access to this information.  Interestingly, in China, disclosure is done through appointed print newspapers.  A typical trick is to publish the disclosure in a provincial, instead of the nationally appointed, newspaper to bury the disclosure.  

One commentator illustrates the differences between the CSRC and the functional equivalent in the United States; the Securities and Exchange Commission (“SEC”).  Where the SEC is primarily occupied with the enforcement of disclosure rules, the CSRC affirmatively enforces merit requirements in a public company to ensure investment quality.  Clarke, Donald C., Corporate Governance in China: An Overview (July 15, 2003).  However, the CSRC, unlike the SEC, is engaged in only limited disciplinary actions to enforce compliance with the codes it promulgates. 

A continuation of the BRIC Project’s China series is forthcoming, and discusses regulatory structures in China.  Specifically, the next post will be a discussion of the Board of Directors and the second tier of management of Chinese corporations; the Board of Supervisors.  The next post also examines what “independent director” means in China and the associated difficulties of corporate governance reform from the perspective of the boardroom.