Serving two masters? Corporate governance in China
China has come a very long way in a generation. Amazingly, while in 1982 China had no foreign reserves, at the end of 2010 reserves stood at US$2.85 trillion. What China has achieved in 30 years took the West 250 years. 20 years ago, China had no corporations and, consequently, no corporate law – everything was a government bureau. Since then, the country has presented opportunities for explosive value creation; some company start-ups, just a few years old, have reached market capitalizations of US$50 billion in ten years. China has grown so quickly that neither the accounting nor the legal profession in China has had time to catch up.
Corporate governance in India and Brazil Looking briefly at corporate governance among some of the other BRICs, investors make a big mistake by grouping them together. Investors must distinguish between the different high-growth markets, as each has different issues and specific risks. India has many, large, well-managed companies but corporate governance is poor, as evidenced by a rash of business scandals. Nevertheless, investors can conduct effective due diligence in India and the existence of a free press means scandals are aired publicly. Like India, Brazil is dominated by
family-owned companies and business groups reluctant to relinquish control. Where companies are state-owned, the interests of the Brazilian government are quickly released. Brazil has very good corporate governance. Encouragingly, as a strong force for good, the Brazilian stock exchange (Bovespa) has established a separate listing for companies with good, clean corporate structures which has grown significantly in the past five years,
particularly with mid-caps listing on it. Of the major high-growth market regions, Latin America generally shows the most promise in terms of corporate governance.
Chinese corporations: “You don’t know what you don’t know” China is perhaps the most complicated of the high-growth markets and governance there is different. What distinguishes it from these other emerging markets is the interests of serving the state. Investments in China can be grouped into three categories: • Those that appeal to international investors but are not state-owned – large-caps, steel companies and banks;
• Private, entrepreneurial mid and small-caps;
• Companies that provide investors with exposure to China by investing in Chinese assets but are listed in places like Hong Kong, Singapore or the U.S.
By viewing Chinese companies through Western lenses, investors soon discover that, with no disclosure requirements, it’s difficult even to judge their nature. There is a lack of transparency in accounting. Disturbing issues relate to the use of subsidiaries and inter-company loans and an absence of accounting consistency, with no requirement to account for transfers between state-owned companies. Moreover, accounting statements may not serve as a particularly good indicator of how a company is doing, especially as many companies keep three different sets of books. The result is a different reality for different stakeholders. Investors must ask ‘Who is doing the books?’ The information wily Chinese companies
rely upon is often not in their books. Information released is designed, instead, to fool their competitors. ‘Soft’ information is, therefore, often more important than ‘hard’ information. To quote Professor
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