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1
Corporate Governance of the State Controlled
Listed Companies in China Problems ,Progress
and ProspectsDr. Ruyin HUDirector of
Research Center , Shanghai Stock Exchange
May 19 , 2005 Beijing
2

• General Situation of Shanghai Securities Market

May 12th, 2005

• Capital Stock and Market Value

Negotiable Market Capitalization (a hundred
million)
Total Market Value (a hundred million)
Negotiable Capital (a hundred million)
Total Capital Stock (a hundred million)
A Share
B Share
Total up
Total Share
Sampling
A Share
B Share
PE Ratio
May 13th, 2005
Market Size
Public Offering
unity (unit)
unity (unit)
Securities Trader
Investors
unity( ten thousand)
Unitpiece
seat
Accumulative Accounts Open
Total
Total
Total
Member Companies
Operating A Share
Shares
Investors of A Share
A Share B Share
Local Member Companies Nonlocal Member Companies
Tangible Intangible
Retail Investor
Institutional Investor
Investors of B Share Retail Investor Institutional
Investor
National Debt Merchandise on Hand Buy-back
Operating B Share Domestic Abroad
Securities Traders of B Shre Domestic Abroad
Securities Investment Fund
New Account of Current Month
Other Funds
New Account of Current year
Convertible Bond
Enterprise Bond
the Number of Listed Companies
3

• SSE Historical Data

4

• SSE Composite Index Movement(1990.12.19-2005.5.13)
  

• SSE Index

amplitude
Ask Bid
Susp.
Up
Down
Unchanged (Share Price)
Avg.
Ls.
Chg.
PD Clo.
Chg.
Open
High
Amt.
Vol.
Low
quantity ratio
NowV
taken
given
5
Data of China Securities Market
6
Stat. Data of Chinese Securities
Market
Negotiable Market Capitalization (RMB100 Mil.)
Total Capital Stock (RMB100 Mil.)
Funding Sum (RMB100 Mil.)
Turnover (RMB100 Mil.)
No. of Investors Account Opened (Ten thousand)
Stamp Duty (RMB100 Mil.)
Domestic Listing Companies A Share, B Share(home)
Market Capitalization(RMB100 Mil.)
7
Highlights of China Equity Market
(2005.4.19)
8
The Chinese Characteristics of Ownership
Structure and Organizational Structure of Listed
Companies

• Ownership Structure of Listed Companies
• Chinese listed companies have three types of
  shares
• the state owned shares
• the legal person shares
• the public (tradable) shares
• The state and legal person shares cannot be
  traded in the secondary market, and are called
  non-tradable shares. The tradable public shares
  include A shares (shares that are denominated in
  RMB and listed on mainland exchanges.), B shares
  (shares that are denominated in US Dollar or Hong
  Kong Dollar and listed on mainland exchanges).

9
The Chinese Characteristics of Ownership
Structure and Organizational Structure of Listed
Companies

• Ownership Structure of Listed Companies

Shares of Chinese Listed Companies
Domestic Shares
Foreign Shares
The State Owned Shares
The Legal Person Shares
The Tradable A Shares
B Shares
H Shares
N Shares
10
The Chinese Characteristics of Ownership
Structure and Organizational Structure of Listed
Companies

• Ownership Structure of Listed Companies
• Ownship structure of Chinese companies have 4
  charateristics
• an overwhelmingly large percentage of
  non-tradable shares
• an excessive concentration of non-tradable
  shares in one big shareholder
• an overly dispersed ownership of tradable
  shares and a tiny percentage of institutional
  investors
• usually the largest shareholder is a
  shareholding company instead of a natural person

11
The Chinese Characteristics of Ownership
Structure and Organizational Structure of Listed
Companies
Ownership Structure of Listed Companies A
prominent characteristic of Chinese listed
companies is an overwhelmingly large percentage
of non-tradable shares, which represents about
2/3 of all the listed companies combined equity.
The tradable shares represent the remaining 1/3.
A majority of listed companies non-tradable
shares are 60-80 of their total number of
shares. A few companies even have more than 90
shares not tradable. About 6 of all the listed
companies have more than 40 of their total
equity in tradable shares. Only 0.4 of all
listed companies have only tradable shares. On
average, the larger the size of the company, the
higher the percentage of state shares, which
demonstrates that large listed companies are
essentially state-owned.
12
The Chinese Characteristics of Ownership
Structure and Organizational Structure of Listed
Companies
Ownership Structure of Listed Companies in SSE
Market (2004.12.31)
13
The Chinese Characteristics of Ownership
Structure and Organizational Structure of Listed
Companies

• Ownership Structure of Chinese Listed
  Companies(1999)

14
The Chinese Characteristics of Ownership
Structure and Organizational Structure of Listed
Companies
Ownership Structure of Listed Companies The
second characteristic of the shareholding
structure is an excessive concentration of
non-tradable shares. In the end of 2001, the
average largest shareholder of an A share company
owns 44.26 of all the companys shares above
40 of the largest shareholders owns more than
50 of their companies shares in 74.4 of all
the A share companies, the top five shareholders
own more than 50 of their companys shares.
According to statistics based on the 2002 annual
report of 734 companies listed on the Shanghai
Stock Exchange as of June 20, 2003, in the end of
2002, in 40.9 of all the companies (a total of
300 companies) the largest shareholder owns more
than 50 of the companys shares in 32.8 of all
the companies (a total of 241 companies) the
largest shareholder owns between 30 to 50 of
the companies shares the average largest
shareholder owns 44.3 of its companys shares.
15
The Chinese Characteristics of Ownership
Structure and Organizational Structure of Listed
Companies
Ownership Structure of Listed Companies
16
The Chinese Characteristics of Ownership
Structure and Organizational Structure of Listed
Companies
Ownership Structure of Listed Companies The
third characteristic of the shareholding
structure is an overly dispersed ownership of
tradable shares and a tiny percentage of
institutional investors. In the end of 2002, the
number of accounts opened at Shanghai Stock
Exchange stands at 35 million, of which 99.5
belongs to individual investor and only 0.5
belongs to institutional accounts.
17
The Chinese Characteristics of Ownership
Structure and Organizational Structure of Listed
Companies

• Ownership Structure of Listed Companies
• The above mentioned ownership structure of
  Chinese listed companies is problematic
• The institution for implementing state
  shareholders rights is unsatisfactory. Either
  the government exerts too much influence on
  listed companies, or there is a lack of
  monitoring on management.
• The parallel or pyramid shareholding structure
  induces and facilitates related-party
  transactions that impair the interest of listed
  companies.
• Lack of direct control of public shareholders on
  the listed companies
• Hostile takeover is nearly impossible.
• The stock prices in the secondary market are
  distorted

18
The Chinese Characteristics of Ownership
Structure and Organizational Structure of Listed
Companies
Ownship Structure of Listed Companies in SZE
Market
19
The Chinese Characteristics of Ownership
Structure and Organizational Structure of Listed
Companies
Ownship Structure of Listed Companies in SZE
Market
20

• Current Corporate Governance Environments in
  China
• Insider control in corporate affairs and the key
  person model
• Insider control, or the key shareholder control,
  is one of the main characteristics of Chinas
  corporate governance.
• If the controlling shareholders are individuals
  or other enterprises, the insider control problem
  is frequently associated with the phenomenon of
  family-type enterprises if the controlling
  shareholder is the state, the problem is
  associated with conflicting political and
  enterprise objectives.
• Insider controller is a synonym for the key
  person. The key person has a large discretionary
  power and is frequently endowed with the power of
  control, execution, and supervision. He or she
  easily controls and manipulates the companys
  general shareholders meeting, board meeting, and
  the supervisory board meeting, making them
  essentially rubber stamps

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• The Characteristics of Key Person Model

Chinese Listed Companies
High Ownership Concentration
Diversified Ownership
Strong Blockholders Weak Minority Interest
Strong Executives Weak Outside Shareholders
The Blockholder Representative Controls the
Corporation
Insiders Control the Corporation
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• Serious Problem of Key Person Model
• Interest Conflicts between Blockholders/Manager
  s and Minority Shareholders
• Insiders,Including Blockholders, Expropriate
  Interest of Minority Shareholders through
  Related-Party Transactions
• Lack of effective monitoring
• Poor decision making and risk controlling

23

• Current Corporate Governance Environments in
  China
• A Legal Framework with Poor Shareholder
  Protection
• Lack of effective legal punishment on wrongdoers.
• Legal self-enforcement is inadequate, and
  investors face obstacles in seeking legal
  protection
• Laws and regulations stress the use of
  administrative and criminal punishment on
  violators in securities market. They relatively
  neglect the civil liability and compensation.
• In the punishment of securities market violation,
  administrative orders often replace legal
  discipline.
• The countrys legal system has not adopted the
  highly effective class action widely used in the
  US and the derivative suits in the hearing of
  civil compensation cases related to securities
  market violations.

24

• Current Corporate Governance Environments in
  China
• The quality of disclosure not guaranteed
• From the perspective of majority public
  shareholders, the information disclosed by
  Chinese listed companies is not reliable enough.
  For the listed companies, the form of disclosure
  is far more important than the substance. Some
  even dont bother to comply with the form and
  they may falsify financial statements.
• The main reasons for poor quality disclosures
  are
• lack of effective legal punishment for
  disclosers
• improper administrative intervention and lack of
  competition in the capital market
• lack of proper internal control system for
  disclosure within the companies.

25

• Current Corporate Governance Environments in
  China
• Direct or indirect Party appointment of the
  chairmen and CEOs of the state controlled listed
  companies
• Each state controlled listed company and its
  chairman and CEO have a specific official grade
  or rank
• Strong political incentives,weak business
  incentives to serve the desire of higher rank
  party officials other than the best interests of
  investors

26
Steps Taken to Improve Governance in China

• Today,through SSEs initiatives and persevere
  effort,Corporate governance has been very high
  in Chinas policy agenda. There has been a
  remarkable progress both in the regulatory
  framework and implementations over a few years.
  A mandatory independent director system has been
  introduced and will be strengthened. The Chinese
  code of corporate governance was successfully
  formulated in early 2002 and a series of
  educational initiatives have been taken for the
  better understanding of corporate directors. The
  authorities have also been taking a severe
  attitude to impose sanctions on wrong-doings of
  the listed companies.

27
Steps Taken to Improve Governance in China

• SSE and CSRC has been in the forefront of
  promoting corporate governance in China and has
  taken vigorous actions to improve corporate
  governance of listed companies
• Independent directors on board
• SSE Guidelines for Corporate Governance(2000)
• Code of Corporate Governance The Binding Code of
  Corporate Governance for Listed Companies issued
  by CSRC and State Economic and Trade Commission
  on January 7, 2002.
• Better Rules and Practices of Disclosure
• Take-over Code and market for corporate control
• Enhancing Legal reform to protect shareholder
  through lawsuits
• Stronger Enforcement

28
Steps Taken to Improve Governance in China

• SSE and CSRC has been in the forefront of
  promoting corporate governance in China and has
  taken vigorous actions to improve corporate
  governance of listed companies
• Higher Standards of Ethics of Directorsthe New
  Listing Rules Require Each Director to Have a
  Formal Declaration and Undertaking in the
  Performance of His/Her Duties
• Safeguard Conflicts of Interest Rules of
  Related-Party Transactions Disclosure the Use of
  Human,Financial and Physical Resources of a
  Listed Company Is Separated from That of Its
  Controlling Company
• CSRC Regulations on enhancing institutionalshare
  holders right (2004)
• Cumulative voting rules, online SGM and voting
• Training

29
Steps Taken to Improve Governance in China

• Independent Directors
• Overhaul the insider-controlled board structure
  by promulgating a regulation requiring each
  listed company to have at least one-third of the
  board to be independent directors by June 2003.
  The regulation was issued in August 2001.
• About one-third of the independent directors are
  accounting profession, and almost all companies
  have at least one accounting professional to be
  independent director .

30
Steps Taken to Improve Governance in China

• Independent Directors
• The specific Roles and Responsibilities of
  Independent Directors
• Protect shareholder rights and the interests of
  the company, paying particular attention to
  minority shareholders protection
• Major related party transactions have to be
  approved by independent directors
• Serve as chairs of the auditing, compensation,
  and nomination committees. Independent directors
  must consist of a majority of these committees

31
Steps Taken to Improve Governance in China

• SSE Guidelines for Corporate Governance(2000)

32
Steps Taken to Improve Governance in China

• Code of Corporate Governance for Listed Companies
  in China
• Mandatory for all listed companies
• Issued and Enforced by CSRC and State Economic
  and Trade Commission on January 7, 2002.
• Proxy voting is encouraged in the Code

33
Steps Taken to Improve Governance in China

• Disclosure
• Listed companies required to publish an audited
  annual report as well as half-year report.
  Starting in 2002, listed companies required to
  disclose unaudited quarterly reports
• Disclosing the controlling shareholder or the
  actual controller of the company
• Online disclosing

34
Steps Taken to Improve Governance in China

• Enhance Legal Reform
• Lawsuit against directors and management the
  Supreme Court issued an Ordinance last year on
  the the procedures for shareholders suing
  directors and management in case of losses due to
  false disclosure by the company. The Courts have
  accepted cases
• SSE Suggestions to the Governance Lawmaking and
  Reform of Listing Companies. (2004)
• SSE Helps to revise the Company Law,the
  Securities Law, the Restructure Plan for the
  Proposed Listing Company, Code of Practice for
  High Management in Listing Company (Drafting),
  Oversighting Ordinance of Listing Company.
• SSE emended and issued the Exchange Listing Rules.

35
Steps Taken to Improve Governance in China

• Stronger Enforcement and Frontline Regulation
• SSE Makes public reprimands of listed companies
  for violations of their listing rules
• In the year of 2002, SSE strengthen supervising
  on listing companies made format guidelines for
  listing companies temporary bulletin, regulated
  disclosure, and further implemented the
  questioning supervision. SSE sent listing
  companies over 500 Afterwards Auditing Advices
  and 105 Supervision Letters. Made public
  reprimands to 19 companies, inside notice of
  criticism to 49 companies or high managers. had
  SCRC special audited or checked 21 companies.
  Established inside information knower database.
  Checked the share-holding situation and illegal
  close-out among high managers. Advocated 37
  companies to announce a proposal letter on
  perfecting corporate governance, actively
  advanced listing companies for regulating
  disclosure of governance structure, and
  strengthened the legal system training and trust
  education of directors and auditors.

36
Steps Taken to Improve Governance in China

• Stronger Enforcement and Frontline Regulation
• SSE MakeS public reprimands of listed companies
  for violations of their listing rules
• 2003, SSE made further implementation of
  questioning supervision and strictly managed
  listing companies which have violation
  activities
• 33 companies were circulated bya notice of
  criticism, 11 companies were made public
  reprimand, 10 listing companies were put to SCRC
  for special check. In the period of check after
  the periodically report, SSE issued 480
  Afterwards Auditing Advice Report and 142
  Regulatory Letter , and urged listing companies
  to publish 169 the Complementarity to Periodical
  Reports or Correct Announcement. On regulating
  the secondary market, SSE tried best to survey
  and stop the suspecting controlling market
  activity and insider trade (even the sign )by
  high technical support and soft hard means.

37
Steps Taken to Improve Governance in China

• Stronger Enforcement and Frontline Regulation
• SSE MakeS public reprimands of listed companies
  for violations of their listing rules
• SSE continued to promote listing companies for
  improving their corporate
• SSE strongly punished violation and illegal
  activities by totally issued 42 inside reporting
  comments, 21 public condemns, 143 oversighting
  letters. There are 11 listing companies suspended
  for continuous loss. And ST Beeda Technology,
  ST Goldenstar and ST Anshan Co-operation was
  suspended in Dec.2004. Other 8 companies was
  recovered. SSE made special treatment to 19
  listing companies, made special treatment
  suspension to 7 companies implemented The
  regulations of the caution of risks in backing
  from the market on 28 companies, and 19 companies
  suspended issued the Report of Chinese corporate
  governance (2004), and the Suggestions to Chinese
  corporate governance held successfully the
  Policy Dialogue on Corporate Governance in China
  and the International Conference on corporate
  governance in China and great promoted
  trust-building of listing company. Worked out the
  Implementing Rules of Net-Voting for Listing
  Company Shareholder Meeting to promote listing
  companies perfecting their corporate governance.

38
Steps Taken to Improve Governance in China

• Stronger Enforcement and Frontline Regulation
• SSE Makes public reprimands of listed companies
  for violations of their listing rules
• In the year of 2005
• SSE Net-Voting System for Listing Company
  Shareholder Meeting has been in well-running.
• SSE has connected with banks reference system
  (records of reprimand receivers).

39
Steps Taken to Improve Governance in China

• Experimentation reform of equity division kicked
  off
• From May 9th,2005, 4 listed companies have been
  put into trial scheduled for non-tradable shares
  to resume sales

40
The Next Steps to Improve Governance in China

• Four Steps to Improve the Corporate Governance
• Strengthen Legal Rules and Enforcement
• Diversify the Ownership
• Maintain the Independence and Effectiveness of
  Board of Directors
• Make the Market Efficient

41
The Next Steps to Improve Governance in China

• Strengthen Legal Rules and Enforcement
• Legislate to Improve Minority Shareholders
  Protection
• Stronger sanctions against violations on laws and
  regulations(revising Criminal Act,Company Law and
  Securities Law)
• Strengthen directors civil and criminal
  responsibilities and reinforce the oversight on
  majority shareholders.

42
The Next Steps to Improve Governance in China

• Diversify the Ownership
• Reduce or Sell Off the Shares held by the
  Governments
• Introduce other Forms of Sizeable Outside
  Shareholders Including Closed-End Open-End
  Mutual Funds,Insurance Companies,Pension
  Funds,QFII and Other Institutional Investors
• Our empirical studies show that there is a
  positive relationship between Tobins q ratio
  and level of concentration of the largest five
  shareholders (also the largest ten shareholders),
  but not in the case of the single largest
  shareholder. In addition, we find strong impacts
  of balanced power sharing among a few large
  owners on firm value. Our results suggest that
  the institutional concentrated ownership may
  provide an efficient way of resolving agency
  problem in firms with less investor protections
  and outside legal enforcement.

43
The Next Steps to Improve Governance in China

• Maintain the Independence and Effectiveness of
  Board of Directors
• Encourage More Independent Directors to Enter the
  Board of Directors
• Strengthen Audit Committee,Nominate Committee
  etc. to Curb the Power of Blockholders/Executives
• Enhance Duties and Liabilities of Directors
• On the basis of reinforcing the disclosure
  regulatory, SSE will establish the Code of
  Conduct for Board Chairman (has been drafted
  out) and strengthen boards trust and
  responsibility.

44
The Next Steps to Improve Governance in China

• Make the Market Efficient
• Enhance management market and avoid direct
  political interference into it depoliticized the
  management market for the state controlled listed
  companiesenhance managerial ownership by
  equity-based incentive or remuneration system
• Our empirical studies show that the executives
  shareholdings in the state controlled listed
  companies are positively related to firm value.
• Building up effective price discovery mechanism
  in equity market
• Stop market manipulation and insider trading
• Deregulation of the market
• Developing the market for corporate control