Taking China’s SOEs Back to Their Roots; The giant companies were originally owned by the people, and recent graft scandals show the need for a return to that ideal

09.10.2013 17:16

Taking SOEs Back to Their Roots

The giant companies were originally owned by the people, and recent graft scandals show the need for a return to that ideal

By Wang Yong

A recent corruption scandal that brought down Jiang Jiemin, head of the regulator of state-owned assets, is but another reminder of the alarming corruption problem at state-owned enterprises (SOEs). If left alone, the trend will eventually lead to a breakdown. The central government’s current iron-fisted approach is essential to preventing the problem from spreading. However, it is not a solution to the underlying problem.The corruption problem is closely related to SOEs complicated implicit functions in the present political context, which means their governance is inevitably flawed. Defects in the governance structure lead to structural corruption. There are three main issues: blurred line between politics and business, the top-down approach to management and a lack of financial transparency.

The slogan “separation between politics and business” has been around since the Communist Party’s 12th National Congress in 1982. But “political business” still haunts SOEs today, especially those owned by the central government and ones that enjoy monopolies positions in certain fields. In these enterprises, human resources and corporate governance need to serve political functions. The implicit functions of SOEs at times outweigh their economic functions, making SOEs less like enterprises and more like political entities. In this scenario, SOEs’ first obligation is to politics and not profit. A top-down approach to management suits the distorted functions of SOEs, while a democratic and balanced corporate structure has no appeal. In the end, SOEs become black holes of credit.

These defects in governance structure make SOEs especially vulnerable to corrupt officials. They use the state-built platform to channel enormous profits to private use and steal state-owned assets from the people. Conservatives often play the “privatization” card when opposing SOE reform, citing concerns about strengthening the private sector at the expense of the state. Here’s the irony: corrupt managers have been slowly “privatizing” SOEs for years.

False Comparisons

The recent corruption scandals all share a common trait: most misconduct involves asset acquisition. Some market manipulators are based at home but more operate from abroad. They appraise target assets higher than market value. The more cautious type profits from an acceptable margin of error in asset appraisal, but corrupt officials in the most recent cases had bigger appetites. They merely used the appraisal as a cover for stealing state money. The amount depends on the position of the officials. The extent to which regulation has failed is beyond imagination.

This is the grim reality of corruption in SOEs. Academic discussions on this problem have drifted far from reality. Some economists study the economic implication of SOE monopolies, but this is not an economic problem. SOEs have simply become interest groups’ channels for their profit. SOEs monopolize public resources and the interest groups controls SOEs.

Supporters of SOE monopolies use examples in the United States to try to prove they are indispensable, citing the U.S. government’s decision to green light McDonnell-Douglas’ merger with Boeing and its decision to keep Microsoft intact after an anti-trust verdict. However, these examples differ fundamentally from the SOE monopolies in the Chinese context. Chinese SOEs are unique in that they directly use state authority to monopolize natural resources.

SOE monopolies, numerous government approvals and government investment have become three major hotbeds for corruption. Reforms cannot be put off any longer.

Returning Resources

The real solution lies in understanding the fundamental role of SOEs. We should re-emphasize that SOEs are enterprises “owned by the people.”

Since the Company Law was adopted in 1993, the definition of SOEs has shifted from an “enterprise owned by the people” to “corporate enterprise.” This is seen as a step forward in corporate governance. However, in terms of political ideology, the transition places emphasis on the state and the other aspects of the nature of SOEs’ are slowly forgotten. This is a tragedy. Chinese SOEs, especially natural resource monopolies, should return to the “owned by the people” model.

The concept of “the people” has always been a political term rather than a legal one. But in recent years international human rights law has increasingly focused on granting people the right to fair access to their natural resources. Although constructing “the people” as legal subjects faces considerable difficulties, politicians and scholars have tried to find a way to give the people in countries such as Iraq and Nigeria their fair share of natural resource.

In Iraq, the oil revenues are put into a separate fund, a trust for the Iraqi people. The trust only invests in index funds around the world, which are a low-risk investment. The Iraqi people can freely trade and buy back their shares. The oil wealth fund in Nigeria is an improved version of the Alaska Permanent Fund. The latter pays every resident of the northern U.S. state an equal dividend based on oil revenue. The fund serves as a catalyst for economic development. Additionally, Norway’s large oil wealth fund acts as an active investor.

China should try this approach with SOEs involved in the country’s natural resources. The current anti-corruption storm should signal a new wave of SOE reform. We should break SOEs’ monopolies over natural resources and put the revenues into pension funds to benefit the masses. In addition, legislative bodies should make regulations and laws that specify the amount of dividends and rents for state-owned resources. The goal is to incorporate rents and dividends on state-owned assets into the calculation of the government’s budget, increasing transparency.

The author is a professor of civil and commercial economic law at China University of Political Science and Law

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: