Zhou Xiaochuan: Improve corporate governance and develop capital market
Speech by Mr Zhou Xiaochuan, Governor of the People's Bank of China, at the Euromoney "China
Forum: Capital Market and Corporate Governance", Beijing, 1 December 2004.
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Distinguished guests, ladies and gentleman,
Good morning,
First of all, on behalf of the People's Bank of China, I would like to congratulate on the convening of
the "China Forum" sponsored by Euromoney and the exciting topic, namely "capital market and
corporate governance", you have selected for discussion. I also appreciate the support given by the
Industrial and Commercial Bank of China, HSBC, Anst & Young, Hong Kong Stock Exchange and
Moody Asia to this conference.
Corporate governance is crucial to China's development. It involves broad contents and has profound
implications. Hence, I wish to take the opportunity to share with you my observations on this exciting
topic. While the concept of corporate governance was is relatively new in China, we have encountered
many difficulties in this process. At the very beginning, we even disagreed and argued about some of
the very fundamental issues like primary school students. However, as we moved forward,
encouraging progress has been made in establishing sound corporate governance in the country. Of
course, many issues remain to be addressed in this regard and more in-depth research will have to be
done. On today's occasion, I would like to raise 12 issues for discussion and wish the discussion could
have a constructive input to corporate governance development in China.
1. Twelve issues for discussion
(1) The role of government in promoting corporate governance. The concept of corporate
governance was introduced from abroad and there has been a process for us to understand and apply
corporate governance in China. The Third Plenary Session of the Fourteenth National Congress of
CPC in 1993 attempted to include the concept of corporate governance in its communiqué, calling for
a clarified relationship among "shareholders, Board of Directors, management and employees".
However, it was not until 1999 when the concept was formally cited in the major documents published
by the Fourth Plenary Session of the Fifteenth National Congress of CPC. On the basis of international
experiences, it might be helpful for the government to clarify its attitude towards the Five Principles on
Corporate Governance issued by the OECD in 1999 and its role in establishing the institutional and
legal framework for corporate governance. The Revised Principles on Corporate Governance issued
by the OECD in 2004 also attached great importance to this issue. In recent years, some government
agencies, including the China Securities Regulatory Commission and China Banking Regulatory
Commission, have issued some very helpful guidelines on corporate governance. However, what the
government should do to further improve corporate governance remains to be studied.
(2) The selection of corporate governance model. International practices have been
characterized in this regard by different selections. For example, there are Anglo-Saxons model, Lain
River model, Japan-Korea model, and so on. Experiences in the past ten years have shown a trend of
convergence among these patterns, despite differences remaining in many other aspects. In this
consideration, the selection of a corporate governance model suitable to the Chinese situation
remains to be further explored.
(3) The problem of insider control and ownership ambiguity. In early 1990s, China began to
introduce the concept of corporate governance mainly because many enterprises faced serious
problems of insider control and ambiguity in ownership. So far, the problem remains not fully solved
and thus deserves further discussion.
(4) The remaining issues of "debt-equity" swap. A problem closely linked with insider control was
the distortion and irregular transactions created in the process of massive "debt-equity" swap that took
place in 1999, despising the principles of corporate governance. Leaders of the State Council have
also been highly concerned with this issue. Given the mistakes, what should be done to clean up
legacies left over by the debt-equity swap?
(5) Feasible ways to promote corporate governance. In China, companies with the best
corporate governance are generally those listed in the market as they are subject to the guidelines of
corporate governance issued by regulatory authorities and to the supervision of investors, general
public and the market. The practice of listed companies also indicates that joint-stock reform is an
important way out and thus to have large and medium-sized enterprises listed is a crucial and effective
measure to foster corporate governance. Without joint-stock reform and public listing, are there any
other feasible ways to make substantial progress in corporate governance in the enterprises? In my
view, the answer might not be so encouraging.
(6) The role of Party Committee in corporate governance. In China, the Communist Party
Committee, in addition to investors, Board of Directors, management and stakeholders, also plays a
role in corporate governance. The related issues need further study.
(7) The role of stakeholders in corporate governance. We have benefited from many good
experiences in corporate governance from abroad. However, relevant authorities in China have always
been shy from clearly stating their attitudes towards the stakeholders' role in corporate governance.
Compared with the Principles on Corporate Governance issued by the OECD in 1999, the revised
version issued in 2004 stresses more the role of stakeholders in corporate governance. Now, it is an
important topic as to how to accurately define and make people understand the role played by
stakeholders and have them positively contribute to corporate governance.
(8) The protection of stockholders' interests. One of the major weaknesses of China's corporate
governance lies in its negligence over the shareholders' interests. For example, in some old
stateowned enterprises, shareholders have still been barred from dividend distribution. Hence, it remains
an important topic in corporate governance as to how to protect shareholders' interests.
(9) The role of independent directors in corporate governance. An encouraging development in
recent years is the introduction of independent directors in corporate governance. Despite the worries
and skepticism of many people about the introduction of independent directors at the very beginning,
fearing they might not be able to perform their duties properly and such an arrangement is an artificial
system at best, many independent directors have begun to play an increasingly important role in
corporate governance after receiving training and field education. It remains to be studied as to how to
have them better fulfill their duty in the future.
(10) The role of institutional investors in corporate governance. Many new institutional investors
have emerged in China's capital market, such as close-ended funds, open-ended funds, venture
capital funds, industrial investment funds and social securities funds. Given the ambiguity in business
ownership and the prevalence of insider control, should these institutional investors take a passive
approach to corporate governance like those in the United States or involve themselves more actively
in promoting corporate governance?
(11) The role of banks as creditors in corporate governance. Many Chinese enterprises are highly
leveraged. That is, they borrow hugely from the banks and have little capital of their own. In this
context, banks are major creditors. The Principles on Corporate Governance issued by the OECD
attach great importance to the role played by creditors in corporate governance, the mechanism
protecting the creditors' rights and the effective framework of liquidation. It is very important for China's
banking sector to think carefully of their role as creditors in corporate governance.
(12) Corporate governance in non-state enterprises. Last but not least, an important step forward
in China's corporate governance is that it is no longer deemed an issue solely for the restructuring of
state-owned enterprises, but also an equally important topic for other non-state enterprises. In the
past, policy documents usually focused only on corporate governance in the state-owned enterprises
as if it were not an issue for non-state enterprises. Recently, more people have come to realize it
needs to be introduced in the non-state sectors as well. Enterprise reforms actually have much in
common.
These are the twelve issues about corporate governance on which I wish to hear your views. I also
hope the participants, in particular those from China, could take notice of the major achievements of
the Revised Principles on Corporate Governance issued by the OECD in 2004.
2. Major achievements of the Revised Principles on Corporate Governance issued by the
OECD in 2004
The Five Principles on Corporate Governance issued by the OECD in 1999 has attracted widespread
attention from policy makers, investors, companies and stakeholders. With the development of the
macro environment and emergence of new events associated with corporate governance, new
challenges have arisen to the Principles. In this case, the OECD has since 2002 conducted survey
and consultations worldwide on how to guarantee an effective implementation of the principles of
corporate governance such as the strengthening of the independence of the Board in decision making,
enhancing the information rights of the shareholders, improving the independence of auditing and the
transparency of ownership structure, etc. Finally, the Revised Principles on Corporate Governance
was issued in April 2004.
principles
Compared with the version of 1999, the revised of 2004 is advanced in the following five
aspects:
First, a new chapter titled "The foundation for an effective framework of corporate governance" was
introduced. The chapter elaborates the role of government in establishing the overall institutional and
legal framework for corporate governance. It lays out the principles the government should follow in
advocating and establishing the framework of corporate governance, including the enforcement
mechanism of formulating corporate governance principles, the protection mechanism for the parties
involved in corporate governance, and the approach to avoiding rising cost incurred by excess
Principles
supervision, etc. Hence, the of 2004 was expanded to six chapters.
Second, the 2004 version strengthened protection for shareholders' rights. The voice of shareholders
is raised in four aspects: (1) Salaries of the executives are determined by the Board on the basis of
their long-term performance. Shareholders have rights to get access to information on the
compensation policy of executives and Board members. All equity remuneration must be approved by
shareholders. (2) Shareholders have rights to change members of the Board and participate in the
nomination and vote. (3) Institutional investors as fiduciaries shall publish their own corporate
governance policy, procedures of voting and the way to fulfill voting rights in case of interest conflicts.
(4) All the barriers impeding cross-border voting shall be removed.
Third, more emphasis is put on the resolution of interest conflicts. Based on the 1999 version that
stresses disclosure of interest conflicts, the 2004 version requires the interest parties involved to
disclose the way of resolving interest conflicts. In addition, it also takes note of the conflict of interests
existing between the big and small shareholders in the emerging markets. It (1) adds a new principle
that requires rating and research agencies to reasonably handle conflicts of interest when disclosing
information about the company; (2) clarifies auditing responsibility by stating that the auditors shall be
responsible to the Board; (3) strengthens the independence of auditing and defines the steps that
should be taken by the auditors to manage and alleviate potential interest conflicts; and (4) pays more
attention to the protection of small shareholders' interests and states that "the interests of small
shareholders shall be protected and they shall be effectively compensated for any direct or indirect
impairment caused by the controlling shareholders".
Fourth, it puts more emphasis on the protection of stakeholders and whistle blowers. It, to a larger
extent, stresses the rights and role of employees and creditors. (1) It clearly states to establish a
mechanism that "enhances the participation of employees". Stakeholders, including individual
employees and their representatives, shall be able to freely express their views to the Board with
respect to any illegal or immoral activities. Employees' views and their rights to express the views shall
be respected and protected. It shall be ensured that information can flow safely and confidentially to
the Board. (2) Corporate governance shall ensure the enhanced participation of employees, through
which the information of employees' special skills can flow to the management, benefiting the
company directly or indirectly. The examples of employees' participation include increasing
representatives of employees in the Board, adopting the plan of employees holding of stocks and
establishing a profit sharing mechanism such as pension contribution. For instance, pension
contributions can be pooled into an independent fund and the fund manager shall be independent
from the company's management in terms of business operation. (3) It stresses the important role of
creditors in corporate governance and external supervision. It also states that effective and efficient
liquidation framework and credit rights enforcement mechanism are important supplement to effective
corporate governance, ensuring effective protection for the rights of the shareholders. The importance
of employees and creditors is raised in the new version.
Fifth, it further stresses the responsibility of the Board. (1) It stresses the role of the Board in
establishing a high ethical standard, complying with laws and regulations, exercising internal control
and disclosing financial information. (2) It stresses the independence of the Board, which shall not only
be independent from the executive management, but also be independent from controlling
shareholders. (3) It stresses the importance of information disclosure with respect to connected
transactions, resolutions adopted by committees under the Board, procedures of meetings and their
structure, etc.
Principles of Corporate Governance
The revised issued by the OECD in 2004 further expanded the
concept of corporate governance. In the process of transition to a market economy, China has
primarily introduced the concept of corporate governance and its principles. In this regard, further
studies of international experiences in corporate governance need to be conducted to follow any new
development and strengthen relevant perceptions and practices.
The development of China's capital market is, to a large extent, determined by the quality of listed
companies, which is closely linked with corporate governance. With the enrichment of our
understanding and experiences in corporate governance, I am confident of China's capital market
development in the future. Since we have discussed most issues associated with corporate
governance, our understanding of this important issue is very much improved. As we gradually move
to consensus on the residual issues, rules and practices will be definitely improved as well. The
strengthening of corporate governance will lay a solid foundation for the development of China's
capital market, and thus will play an important role in helping transform the relationship between banks
and enterprises.