China’s Newest Export

It is a fact of life that western companies are weary of doing business in China because corporate governance is still a largely marginalized issue. However, the regulatory landscape in China may change soon, as Chinese professional investors are growing more and more frustrated with corporate governance, or lack thereof, in their country.

Institutional Shareholders Services Inc. (ISS), a world’s leading provider of proxy-voting services, just did a survey among 320 money managers in 18 countries. According to the survey, 90% of these investors in China voted corporate governance as “extremely” or “very” high on their agenda. Globally, that average is at about 70%. Also, 93% of investors into China believe that governance will become even more important in the near-term, while global average sits at about 63%.

The study also found that almost all of the surveyed money managers believed share ownership structure is at the root of corporate governance concerns in China. Currently, Chinese government owns most of the publicly traded companies, but through non-tradable shares. Note that such ownership structure allows insiders a controlling position in many issues, including profit sharing, but at the detriment of minority investors. Also, boards of directors are densely populated by insiders, who, first and foremost, protect their own interests, rather than those of minority shareholders.

What particularly concerns Chinese investors are boards of directors without independent members, as well as non-existence of basic protective measures for investors. There are also concerns about simple disclosures, since investors still have to call companies directly to obtain even the very basic information that is normally publicly available in western economies.

Notably, many things we take for granted in North America and Europe are a serious growth impediment in China. To illustrate, although Chinese economy grows at an explosive rate, market capitalization of publicly traded companies actually declined by 50% up until the end of June last year. Only in the last ten months or so did they begin recovering. This only strengthens the view that many investors in China associate the level of corporate governance with a company’s market performance and higher returns.

Perhaps this is also why 93% of investors believe that wanting and maintaining better market performances will deliver higher level of corporate governance. That same belief is shared by on 33% of investors worldwide.

Thankfully, Chinese government is slowly, but surely, realizing that without improved corporate governance, “They [investors] will [not] come.” Among the proposed changes, non-tradable shares will have to be converted into tradable shares. To further ensure a level playing field, non-tradable shares will no longer be available through public offerings.

Also, the term “independent director” will be redefined, while mandatory quarterly and annual disclosures will become a norm. Among other things, key executives will have to receive stock- based remuneration in order to bring their own interest into the same line with those of shareholders. In fact, 73% of Chinese investors want to see this particular change take place, in comparison to the global average of 23%.

If things were to go according to plan, China could become a corporate governance model of the 21st century. And, as such, that very same model could become the country’s number one export.

In other words, if an economy burdened with communism, the world’s largest and farthest reaching bureaucracy, as well as an inherent reluctance to disclose even basic information, can design a working corporate governance model, so could everyone else, particularly other emerging economies in Asia.