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Group Members

Anjali Chauhan

Avishek

Avik Chattopadhyay

Deepti K.S.

Mukul Attri

SahilSwapnil Bhosale

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DOES CORPORATE GOVERNANCE MATTER IN CHINA'S CAPITAL

MARKETS?

Before we begin, let us take a look at the latest lawsuit filed against PetroChina by US for not

complying with the corporate government practices. The lawsuit alleges PetroChina failed to

disclose that some of its senior officials were in non-compliance with its corporate governancedirectives and code of ethics, and that PetroChina was subject to investigation by the Chinese

authorities.

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Managers had wide discretion in running firms. However, their decisions might not have beenin the best interests of the firms or the shareholders.

Shareholders had limited legal remedies against exploitation by company management or acontrolling shareholder.

Chinas legal framework was still at a nascent stage.

Banks did not provide sufficient oversight of the governance of corporate creditors.

Supervisory board lacked the power to appoint or dismiss directors and managers.

Ownership concentration in most companies was high.

Directors did not understand their duties.

Because of state ownership, insider trading and other factors, no significant correlationexisted between the market value of a company, its intrinsic value and governance.

WHY CORPORATE GOVERNANCE WAS REQUIRED IN CHINAS

CAPITAL MARKETS

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Transparency of informationdisclosure.

Independent non-executive directorsensured that the small groups ofindividuals did not dominate the

boards decision making. They alsoensured that industry expertise was

brought to the board.

Delisting of certain companies that did notfollow corporate governance and were not

transparent in their operational and

financial policies.

The dominance of party was reducedsubstantially in small private companies.

AFFECT OF CORPORATE GOVERNANCE IN

CHINA

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Business formation and Management in China has a

long and winding history tracing back thousands of

years.

In the current stage China has mixed private and

state-owned economic structure.

The CPC( Communist Party Of China) still retains

firm control of all political matters whichunavoidably involves state control of major chinese

industries.

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Having developed against against the backdrop of

unique Chinese culture, the characteristics of

Chinese business management are quite differentfrom the western world.

Example:

1) Confucianism.

2) Preeminence placed on the superior person

in the relationship.

3) Rule of Game GuanXi - meaning personal

connections.

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The chinese government has adopted several

regulations regarding business management and

corporate governance. The major regulations are as follows:

1) The Company Law.

2) The Partnership Law.3) The Sole Proprietorship Enterprise Law.

A comparison of Chinese Company Law with its

American counterpart will give us betterunderstanding of the Chinese Corporate Governance

system.

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Similarities:

1) Criteria for establishing both LLC & Joint stock

limited company.

2) A listed company is under the regulation &

monitoring of State Security Regulatory Authority.

3) Registering the Articles of Association with thestate authorities.

4) As in U.S Corporate Law , Chinese Company Law

also includes sections on piercing the corporate

veil.

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Differences:

1) Application of such principles like piercing the

corporate veil.

U.S courts are often reluctant to pierce the

corporate veil but chinese courts are more eager to

do so.

This results in the less protection of corporateidentity in China as compared to U.S.

2) Chinas Company Law mandates more stringent

minimum capital requirement for both LLC and

Joint Stock Listed Companies.eg: 1,00,000 RMB -> LLC.

1,000,000 RMB-> Joint Stock Listed Com.

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Mandatory appointment of the General Manager by

the Board of Directors for implementing its

resolutions. The General Manager is responsible for the day-to-

day affairs of the company.

Shareholders in the Limited company with

exceptions in small companies should elect BoardOf Supervisors in charge of reviewing and

monitoring the activities of the BOD.

American Corporate governance has function

called Outside Counsel .

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Chinese system states that the Shareholderscommittee is the authoritative organ of a limitedcompany.

In U.S , shareholders only get involved in themajor business decisions like M&A etc.

In China, Shareholders committee gets involved inBoards decision making process.

Resolution approved by the BOD should beapproved by the committee before it can beadopted.

The General Manager is accountable to the Board

of Directors and Supervisory board is a monitoringagency.

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The Chinese Company Law also mandates that all

limited companies establish a Chinese Communist

Party organization in the company for the purpose

of state monitoring. All employees of the limited companies that have

more than 3 employees must have labour union

memberships and elect union representatives.

No public servant is allowed to serve as the

Director, supervisor or the General Manager of the

limited company.

In wholly state-owned companies, no shareholderscommittee is allowed. All decision making power

lies with the state authority.

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Germany

Banks exercise

significant poweras a source offinancing forfirms.

In many private

German firms, theowner andmanager may bethe sameindividual

Two-tiered boardstructures,required for largeremployers

Japan

Bank-based

financial andcorporate

governance

structure

Powerfulgovernment

intervention

CEOs of public

and private

companies receivesimilar levels of

compensation

China

The state is

imposing social goals

on these firms

Firms with higher

state ownership have

lower market valueand more volatility

Corporate

Governance

structures aremoving closer to the

U.S. corporate

governance model

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China had been a communist government and following thecorporate governance standards started very late, Itstarted only when they realized they requiredinternational exposure.

PetroChina Corporate Governance in spite of being one offew companies in China that had more transparency, hadmany risks inherently.

Dividend and Capital Investment Policy:

CNPC held 90% of PetroChina. CNPC ownershipbeing SOE. Any income generated through it would go toCNPC.

Shareholders were not sure if any incomegenerated would be turned towards their favor. In spite ofPetroChina mentioning only 10% would be given to CNPC,shareholders were not sure.

Dividends decisions would be indirectly taken byCNPC.

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Appointment of Directors and CorporateOfficers:

13 board of Directors ( 3 wereindependent, in that 2 of their credibility wasquestioned, as they were some how related to

Government) Many people were part of CNPC andPetroChina which raised suspicions.

CNPC and other government bodies wereactually having a major say in electing the Boardwhich was not a good sign.

Legal Protection for Outside Investors:

Other countries laws are not applicable inChina which was a major concern for investorsoutside China.

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Management Incentive Programme: Managers compensation was dependent on their

performance (30-70% bonus dependent on theirperformance)

PetroChina granted share options and rights to

officers and directors, promised to extend thesame to remaining employees.

Information Disclosure: Relatively high level of transparency.

Delivered financials every quarter. Audit as perIAS got a clean auditors report.

Used to give information about OperatingStats, Stock Information, General Meetingsetc.

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Supervisory Board: It consisted of 7 members including 2

independent Supervisors.

Meetings, Inspection of companys financial

position, compliancy of operations etc..

Policies and Procedures: Complied with the Code of Best Practice

governing companies listed on HKSE. Formulated set of policies regarding

shareholders general and other meetings.

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Steps Taken to Improve Governance inChina

Better Rules and Practices of Disclosure

Safeguard Conflicts of Interest : Rules ofRelated-Party Transactions Disclosure; theUse of Human,Financial and PhysicalResources of a Listed Company Is Separatedfrom That of Its Controlling Company

Higher Standards of Ethics of Directors:theNew Listing Rules Require Each Director toHave a Formal Declaration and Undertakingin the Performance of His Duties

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A Dominant Policy Issue to DevelopMarket Economy in China

Re-construct Thousands of SOEs

Improve the Performance of Stock Markets

Establish the Foundation of the Market

Economy

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Three Steps to Improve the Corporate

Governance

Strengthen Legal Rules and Enforcement

Diversify the Ownership

Maintain the Independence of Board of

Directors

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Strengthen Legal Rules and Enforcement

Legislate to Improve Minority ShareholdersProtection and Make Preparations for theSetting up of the Investor Protection Centre

Adopt More International Accounting Rules

Strengthen Disclosure Requirement

Issue the SSE Guidelines for CorporateGovernance

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Diversify the Ownership

Reduce or Sell Off the Shares held by theGovernments

Introduce other Forms of Sizeable OutsideShareholders Including Closed-End & Open-End Mutual Funds,InsuranceCompanies,Pension Funds and OtherInstitutional Investors

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Maintain the Independence of Board of

Directors

Encourage More Independent Directors toEnter the Board of Directors

Establish Audit Committee,NominateCommittee etc.to Curb the Power ofBlockholders/Executives

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Corporate Governance Reform are Very

Complicated in China, the Solution MayLie on the Interactions among EconomicPerformance,Available GovernanceResources and the Political SystemReform

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