SHAREHOLDERS’ RIGHTS IN CHINA
| Citation | (2000) 12 SAcLJ 428 |
| Published date | 01 December 2000 |
| Author | JULIE LI-YUEH HUAN |
| Date | 01 December 2000 |
AN ANALYSIS OF PRIVATE EQUITY IN FORMER STATE-OWNED ENTERPRISES
“If socialism wants to win the edge over capitalism, it must be bold to absorb and learn all civilized achievements created by human society and all advanced forms of operation and management which reflect the laws governing modern socialized production practiced in various countries around the world today, including developed capitalist nations.”
Excerpt from Deng Xiao Ping’s “Southern Journey” speech,
February 1992
In 1978, the People’s Republic of China (“China”) embarked on a bold journey towards a socialist market economy. Since then, the term “socialist market economy” has become synonymous with China. Essentially, it refers to a structure where the state engages in economic planning on a macro level, while allowing market forces to regulate the economy.1 China’s commitment to market reform was re-affirmed in 1992 when China’s former senior leader, Deng Xiao Ping made his famous “Southern Journey” speech. While maintaining that “there is market under socialism”, Mr. Deng emphasized the importance of market reforms as a tool for socialism to “win the edge” over capitalism.
The market reform movement derives in part from China’s experience with its debt-ridden state-owned enterprises (“SOEs”).2 In order to improve their productivity through restructuring, additional funds were needed. This need was ingeniously converted into a new investment opportunity for local and foreign investors. In the late 1980’s China began to corporatize SOEs, resulting in new shareholding structures and public offerings on foreign and domestic exchanges. This in turn necessitated
the formation of the China Securities Regulatory Commission (“CSRC”) and the promulgation of a national Securities Law in July 19993. In the area of core company law, the national Company Law of the People’s Republic of China was issued in 1993 (“CCL”).4
The CCL provides a framework under which this modern enterprise system is to operate. The interpretation of the CCL is aided by a set of “Guidelines on Articles of Association for Listed Companies” issued by the CSRC on December 16, 1997 (“CSRC Guidelines”).5 Local and foreign investors (collectively called “private shareholders”) look to the CCL and the securities laws for legal protection of their rights and interests. Especially in China’s socialist economy, where the state retains a controlling shareholder interest in these former SOEs, shareholder rights are essential.
This paper provides a critical analysis of the introduction of private shareholders in former SOEs and the protection of their rights under the CCL. China’s recent history in corporate development is first examined, together with the underlying motivation for corporatizing SOEs. Thereafter, the shareholding structures of some listed SOEs are studied and the practical relevance of shareholder rights considered. Specific shareholder rights under the CCL (and where applicable, the CSRC Guidelines) are discussed, with comparisons made to Delaware and Singapore law. The author concludes that while the CCL has entrenched some fundamental shareholder rights, there is room for improvement.
A proper understanding of the current corporate environment requires some familiarity with China’s recent history in corporate activity.
The corporate form of business is not new to China. After the Opium war of 1840, foreign companies established a strong presence in China with significant production and marketing activities. Aware that their
presence posed a threat to local businesses, the Qing dynasty promoted the creation of Chinese companies and promulgated its own company law in 1904.6 This trend continued even after the Nationalists came into power, with a new company law being codified in 1929.
When the Chinese Communist Party (“CCP”) assumed leadership in 1949, a whole new scenario emerged. Although Chinese private companies were initially allowed to remain in operation, they were soon nationalized or collectivized in the early 1950’s7. Thereafter, state-owned enterprises (“SOE”) were operated wholly by the CCP’s directives and Marxist ideologies.
As at 1998, China has over 7 million industrial enterprises which comprise approximately 118,000 urban SOEs, 60,000 “township enterprises” (smaller rural commercial entities) 1.47 million collectively-owned enterprises (rural agricultural entities with an increasing number becoming urban business entities) and 5.7 million “private enterprises” (family or individually owned enterprises with no more than 7 employees).
In 1989, it was reported that a majority of the SOEs was in the red, with total losses amounting to 77% of losses incurred by all enterprises.8 The failure of SOEs has been the subject of much literature and discussion.9 Briefly stated, it has been attributed to four factors. First, inefficient management owing to excessive state planning to the exclusion of market forces; second, high indebtedness with no enforceable obligation to repay; third, the heavy burden of providing social welfare; and fourth, competition from collective, private enterprises and the recently introduced foreign investment enterprises.
The losses of these SOEs were perceived as a threat not only to the economic development of China, but also to its social and political stability. Given that the SOEs were the largest employer in the country10 and, as at 1996, held 65% of all assets of the country,11 this perception is not overstated. Therefore, a key to reform was the revitalization of these
SOEs. The CCP sought to achieve this through the establishment of a Modern Enterprise System.12 The main features of this system were decentralization of decision making and introduction of private share ownership in the capital structure of the SOEs.13
Private equity in SOEs provides additional funds for the SOEs’ massive restructuring plans. Unlike debt, equity financing does not carry the burden of interest payments14 and obligation to repay.
In the context of China, the introduction of private share ownership in SOEs is even more significant since it allows the state to tap underutilized personal domestic wealth, often termed “mattress money”. As at 1995, the Chinese savings rate was about one-third of the country’s gross domestic product, making the Chinese some of the biggest savers in the world.15. Chinese citizens had $361 billion in personal savings16, which could serve as useful capital to boost economic development.
Moreover, foreign investors view the acquisition of a shareholding stake in SOEs as a viable alternative to the traditional forms of investment which were introduced in 1978. Joint ventures with SOEs involve extended negotiations and complicated government approval procedures. Due diligence and asset selection to ensure the profitability of the joint venture raise transaction costs and pose additional risks. While direct acquisition of shares in SOEs was not permitted or attractive in the past (due to inefficient management), the new restructuring and public listing of SOEs have made it an attractive investment. Indeed, substantial sums of foreign capital have been injected into China’s economy through this investment vehicle.17
As at November 1996, close to 13,000 of the 118,000 SOEs have been organized as share issuing companies. Among these, 451 have A shares
in one of the two major domestic exchanges, 84 have issued B shares in which foreign investors may invest and 24 have been listed on a foreign exchange.18
Under the laws of China, A shares are further divided into three categories dependent on the holder of the shares. These are i) state shares held by the state, ii)legal person shares held by Chinese legal enterprises and iii)individual shares held by Chinese citizens.19 Foreigner investors, whether natural or legal persons are entitled to purchase B shares issued on PRC domestic exchanges or H shares listed on the Hong Kong stock exchange or N shares listed on the New York Stock Exchange. As for A shares, while they are currently not open to foreigners, the CSRC has recently announced that it is considering allowing foreign investors to buy such A shares through a qualified foreign institutional investor scheme.
Shares in listed companies are typically held by the state, Chinese legal enterprise and the remaining investors in an approximate ratio of 5:2:320. However, in a detailed study of 10 listed companies by Professor Fang Liufang, a Professor of law at China University of Political Science and Law, and a member of the academic panel consulted on the drafting of the CCL by the Legislative Affairs Commission of the National People’s Congress,21 interesting results have emerged. While Prof. Fang’s study is limited by the actual number of companies surveyed, given the importance and accuracy of his work,22 it serves as useful insight into the shareholding structure of these companies.
In examining the state’s interest in these companies, Professor Fang found that only 4 out of 10 companies had the state owning more than 50% of shares. In the other 6 companies, the state held a stake of between 21% to 48%, with the average hovering at 29.5%23. Notwithstanding the
minority stake, it was still the largest shareholder and clearly the controlling shareholder. State ownership was largely vested in 1 single state entity, with only 1 out of the 10 companies having two state entity shareholders.24
The presence of the state as controlling shareholder provides an ideological justification for permitting private share ownership. It allows the CCP to draw on the Marxist principle that so long as the state retains a dominant share in the company, the company remains in the “people’s hands”. The basic principle of Marxism that the “ownership of the means of production must remain in the hands...
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