As China’s economy slowly transitions towards a more market-oriented structure, Chinese management is also making a transition. Part of this process is spurred by increased interaction with Western business leaders and the subsequent exposure to Western styles of management. Legal and structural changes, too, have had a profound impact. The concept of corporate governance, for example, has shifted in China bringing with it changes to management styles. Yet, the transitional nature of these changes mirrors the nature of the economy overall, as the government still maintains strong control over China’s major businesses. This paper will examine the changes to China’s management and corporate governance techniques that have resulted from that nation’s economic shift.
Changes in the System
When Deng Xiaoping set out in 1978 to restructure China’s economy into what became known as a ‘socialist market economy with Chinese characteristics’ (Zhu, 2005), the nation took a series of baby steps. By the 1990s and early 2000s China’s government-owned firms were allowed to sell 1/3 ownership stake to private investors. The rationale for this was that the economy would benefit from the increased efficiency attributed to private enterprise while allowing the government to maintain control. However, the efficiency gains failed to materialize (Green, 2003).
As a consequence, the Chinese economic reforms moved further, to what became known as two-thirds privatization. Changes to economic incentives reduced the ability of state shareholders to profit from manipulating share prices and stripping assets from their holdings, so these shareholders are increasingly selling their shares to private investors, a group which increasingly includes foreign investors (Ibid).
These changes are profound, in that they shift the balance of power in some Chinese companies from state control to investor control (Ibid). This has significant ramifications for the way that these companies are managed. Traditionally through the course of the economic reforms, the Chinese government has considered growth and maintaining high levels of employment as priorities even above profits. This is still the case with many state-owned enterprises today, as the example of Asia Aluminum bonds shows (Foley & Beales, 2009). When investors control the company, however, then the profit motive becomes paramount. This shifts time frames under which managers work; it shifts their priorities; and it shifts the role of building viable long-term strategies in the business model.
The Asia Aluminum example, wherein a firm with falling demand has maintained production levels to the detriment of bondholders who will receive pennies to the dollar, shows how the Chinese economic system must continue to restructure in order to maintain the confidence of potential foreign investors. The country has been successful in attracting investors, but when faced with these types of losses, investors will increasingly demand better protections. These protections will come in a variety of forms, including the installation of the profit motive and the improvement of corporate governance.
There are encouraging signs. There are many private firms in China, and these often are well-capitalized, efficient and able to compete globally (Gang, 2005). Recognizing this value, the government is moving to allow trade in more of the shares of Chinese firms. This would allow for takeovers, which is not presently the case, and would open the door for an increasing acceptance of the profit motive. The current situation, however, has some private firms operating strictly on the profit motive while others are still run by the government with an entirely different set of motives.
Impacts on Management
The good news for Chinese companies is that managers from the state-run system appear to be adaptable to private-sector management (Ibid). The shift towards a profit motive creates changes in management in several areas. The changes place emphasis on competition and efficiency. Additionally, these changes shift the power structure of the companies, yet thus far this shift has not been entirely to a Western-style power structure.
The value of the profit motive is not lost on the new breed of Chinese managers. As they have become increasingly freed from the constraints of state ownership, they have been able to raise capital, forge alliances and joint ventures and compete globally. As Gang notes, Chinese managers have in many cases found little difficulty with the transition between state-run companies and private enterprises. The traditional management style was paternalistic, and often centered around traditional Confucian values, mixed with Communist doctrine. Even the concept of leadership was relatively unknown prior to the onset of economic reforms (Tsui, 2004). As leaders emerged, they have adopted some Western traits, such as increased risk-taking and higher development and leverage of their own personal capital, but often they retain traditional Chinese authoritative, paternalistic leadership styles (Ibid).
Thus, power still comes from formal authority, despite a slight increase in recognition of personal capital. In state-controlled enterprises, substantial power can only be acquired through formal means, and it is the state which makes those appointments. The shift to the profit motive allows room for performance to become a source of power — one can reach positions of power by leading, motivating and otherwise succeeding.
China has backed up these moves with strong shareholders’ rights legislation. While this move in theory protects state interests in majority-private firms, it also has impacts of management as well. Shareholders have the legal right to participate in major decision making and the selection of manager (Yi, 2006). As a result, managers react to shareholders much the same way they would have reacted to the state previously. There is a performance incentive, the only difference being that profit has become the most important metric.
The successes of private enterprise with respect to adapting to the profit motive belie the difficulties that remain for managers in China. Private enterprise has limited options for financing at present. The Chinese government has announced plans to improve access to financing for private enterprises through registration of stock rights (Xinhua, 2009). However, private enterprises not formed through the two-thirds privatization route have limited options to raise capital. They cannot rely on the banks, which have a strong relationship to large government-owned companies. This essentially cuts off bank financing — funded by private deposits — as a means by which private Chinese enterprises can raise funds (Green, 2006). The only way for Chinese firms to grow then is to be entirely self-financed. The implication for management is that self-financing is the only way for management to maintain full control over the firm. Thus, a reliance has developed on families and personal networks for start-up capital and on retained earnings for post start-up capital (Gregory & Tenev, 1999).
If the government’s announced steps to improve access to capital markets for Chinese private enterprise are successfully implemented, this will impact Chinese management as well. These firms currently have little in the way of corporate governance, since it is the principles who have financed the company all along. When these firms become subject to shareholders’ rights legislation, they will need to again shift their approach and begin to adopt a more strict governance regime. As yet, the specific form of the proposed reforms remains to be seen, but the fact that private enterprise will be opened to financing options will bring management style of those firms closer to the management style of publicly-traded Chinese firms as they become subject to many of the same laws.
The introduction of public financing will initiate another new era in Chinese management. As discussed, the present system of management in China still focuses on a paternalistic style, but one in which managers have replaced an omnipresent government with shareholders who are able to exercise operating control of the company. Within private enterprise, the system is more strictly reflective of the profit motive, a strong consideration given that firms must finance themselves internally.
A shift towards public financing for these firms will bring a triangular relationship into play with respect to Chinese business management. Private firms will need to adopt management styles more in line with the expectations of shareholders. This will bring managerial practice of private enterprise back towards that of the 2/3 privatized firms. At the same time, the 2/3 privatized firms and even some of the remaining public firms are in a position where they need to attract foreign investment, a situation exacerbated by the current economic crisis.
The needs of the internal investing community are different than the needs of the domestic investing community. Profit is the defining motive for both, but whereas the domestic investors are willing to take a controlling role in a firm in order to protect their investment, investors in the international community prefer legal system protect their wealth. Failures such as Asia Aluminum will therefore push foreign investors to demand that their interests are as protected as the interests of domestic investors. This leads to a situation where the economic reforms are being pulled towards the development of private enterprise; private enterprise management will move towards a more traditional type of management; and in the partially-privatized firms management will take on aspects of both the international style and the fully-private style.
State Domination and Financial Markets
The Chinese government has characterized its involvement in economic development as “serving rather than supervising the private economy” since 2008 (Xinhua, 2009). With this shift in focus a number of changes to Chinese management can be expected. The paternalistic approach will remain, as it is part of Chinese culture, but there will be further Western influences, particularly with respect to the desire outcomes of management behavior.
In their efforts to serve business, the Chinese government will inevitably work harder to attract foreign investment and to allow business to set the terms by which they can seek investors. This will shift the desired outcomes of management behavior towards those sought by a wider range of investors, both domestic and foreign. Asia Aluminum provides an example of this, as foreign investor outcry over the bond scandal forced the company to consider other options. Management at that point realized the influence that the foreign investor community had over its operations — the outcry had caused the municipal government that backed the bond buyback offer to withdraw its support (Santini, 2009). Management is now faced with more difficult decisions including a total restructuring of the company, which had been operating unprofitably. This shows how Chinese management and corporate governance has been changed by the increase in foreign listing as Western governance standards were implemented against the wishes of the Chinese company’s management. As more Chinese companies are free to seek international investing, they too will find themselves faced with adherence to both Western and Chinese standards of governance and management.
As state domination in many sectors of the Chinese economy lessens, Beijing still maintains strong influence over the yuan, which is on a managed float system. There is little impetus at present for a move towards a free float, but with government involvement in private economic enterprise lessening, that trend will eventually be applied to the currency as well. The implications for Chinese companies of such a move would be dramatic. They would then be forced to compete even more intensely on the basis of efficiency and quality, having lost the competitive advantage their exchange rate currently gives them.
As China continues with its economic reforms, there is a continuous impact on management and on corporate governance. In some ways private enterprise — particularly those firms that are partially privatized, such as the 2/3 firms — operates with shareholders as surrogates for the role that the government once played. Yet the fully private companies are developing an entirely new style of management. Upcoming reforms promise to bring the fully private companies into the same realm and subject to the same laws as the partially-private firms. This will change the dynamic of managers who have until now been motivated almost entirely by the need to generate retained earnings. Thus, management in China is being pulled in different directions by the needs of government, private enterprise and foreign investors. Ultimately, management and governance in China will settle on a system that is very much a socialist market system with Chinese characteristics.
Gang, Fan. (2005). China is a Private Sector Economy. Business Week. Retrieved June 8, 2009 from http://www.businessweek.com/magazine/content/05_34/b3948478.htm
Zhu, Cherrie Jiuhua. (2005). Human Resource Management in China. Retrieved June 8, 2009 from http://books.google.com/books?id=mOBwfLzp7boC&pg=PA1&lpg=PA1&dq=china+management+economic+reform&source=bl&ots=NRJMQ-pIY-&sig=rIgeR5smWqFufALsTdK5P8AHZxY&hl=en&ei=uHktSuLtHo6fsgb2m6meDA&sa=X&oi=book_result&ct=result&resnum=10
Green, Stephen. (2003). ‘Two-thirds privatization’: How China’s listed companies are — finally — privatizing. Royal Institute of International Affairs. Retrieved June 8, 2009 from http://se1.isn.ch/serviceengine/FileContent?serviceID=ISN&fileid=0C55BCE1-85E3-F567-3F79-E6B47296364E&lng=en
Foley, John & Beales, Richard. (2009). A Hard Lesson for Foreign Investors in China. New York Times. Retrieved June 8, 2009 from http://www.nytimes.com/2009/03/02/business/worldbusiness/02iht-views03.1.20523651.html
Tsui, Anne S., Hui Wang, Katherine Xin, Lihua Zhang, P.P. Fu. (2004) Variation of Leadership Styles Among Chinese CEO’s. Organizational Dynamics, Vol. 33, No. 1, pgs. 5-20,
Yi, Zhong. (2006). The Shareholders’ Rights — Revision and Explanation on China Law Article 4. China Business Law. Retrieved June 8, 2009 from http://www.lawcase.org/archives/node/66
No author. (2009). Chinese enterprises are 70% private. Chinaview.cn/Xinhua. Retrieved June 8, 2009 from http://news.xinhuanet.com/english/2009-04/21/content_11228390.htm
Gregory, Neil & Tenev, Stoyan. (1999). The Financing of Private Enterprise in China. Finance & Development. Retrieved June 8, 2009 from http://www.imf.org/external/pubs/ft/fandd/2001/03/gregory.htm
Santini, Laura. (2009). Asia Aluminum Pulls Buyback. Wall Street Journal. Retrieved June 9, 2009 from http://online.wsj.com/article/SB123720641518940621.html
Green, Stephen. (2006). How Long is the Dragon’s Claw? HSBC. Retrieved June 9, 2009 from http://www.hsbc.com/1/PA_1_1_S5/content/assets/news/061009_soas_stephen_green.pdf
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