China's Special Ownership Structure and Corporate Governance Research
Zuo Jiaxuan1*
1 1. Universiti Teknologi MARA, Shah Alam, Selangor, Malaysia
*Corresponding Author: [email protected]
Received: 15 March 2023 | Accepted: 1 May 2023 | Published: 1 June 2023
DOI:https://doi.org/10.55057/ijaref.2023.5.2.2
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Abstract: This research discusses the impact of China's unique ownership structure and corporate governance on ownership concentration. China has a unique ownership structure with a large number of state-owned enterprises and concentrated ownership in the hands of a few controlling shareholders. This ownership structure has significant implications for earnings management and managerial opportunism. This paper aims to investigate the effects of corporate governance on ownership concentration in China, as well as the factors that influence ownership concentration. Numerous studies have shown that good corporate governance can mitigate the negative effects of ownership concentration on corporate performance by enhancing the effectiveness of internal checks and balances. The factors that influence ownership concentration include the level of state ownership, the presence of large controlling shareholders, and the lack of protection for minority shareholders. This paper concludes by discussing the implications of these research findings for policymakers and managers in China, emphasizing the need to strengthen corporate governance and promote equity diversification.
Keywords: Special ownership, corporate governance, China
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1. Introduction
Corporate scandals such as Enron in the US and Satyam Computer Services in India have led to increased academic interest in accounting manipulation, euphemisms for "earnings management". Research in this field has increased dramatically since the collapse of Enron in 2003. Over the years, there have been scandals caused by earnings management. For example, in 2015, the Japanese multinational conglomerate Toshiba overstated its profits by $1.2 billion over several years. In 2017, South Africa-based retailer Steinhoff International was found to have overstated its profits and assets. China's Rising Coffee overstated sales by $300 million in 2019 to manipulate earnings. Management often chooses to adjust earnings within the accounting discretion allowed and tries to avoid detection by investors. In order to reduce the speculative behavior of management and protect the interests of investors, it is necessary to pay attention to the internal governance environment of the company.
Unlike the two-tier supervisory and management boards in Germany, the internal-dominated boards in Japan, and the mixed boards in the United States (Charkham, 1994), corporate boards in China are essentially one-tier, although all companies have a so-called supervisory board. In particular, in the United States, boards are controlled by management (Mace, 1971; Jensen, 1993), while in China, the board of directors is in the hands of large state-owned shareholders.
Why are there significant differences in corporate governance between China and other developed countries? Unlike in the United Kingdom and the United States, ownership is fairly fragmented (Shleifer and Vishny, 1997). In China, the ownership of listed companies is highly concentrated in the hands of major state-owned shareholders. They control the board of directors and make corporate governance a rubber stamp in China's supervisory boards, and independent directors are the facade (Xue, 2001).
Previous studies on corporate governance have mostly focused on the US and UK. Few people pay attention to China. Given the huge differences in ownership structure and corporate governance between the US and China, China is a special case worth studying.
2. Ownership structure of listed companies in China
Most listed companies in China are usually made up of three groups of shareholders: the state, legal persons and individual investors, with each group holding about one-third of the company's shares on average. The first two classes of shareholders hold non-tradable shares.
1Shares held by individual investors can be publicly traded on two stock exchanges.
Chinese companies are unique in that until the 1990s, most were state-owned. Until China's economic reforms involved corporatization of state-owned enterprises (soes) and the adoption of profit targets, such as the introduction of contract responsibility. Although the government has given managers of corporatised state-owned enterprises more autonomy, it is reluctant to give up ownership. Political interference in the running of firms is rife and the autonomy of managers is diminished (Firth et al., 2002). As a result, the performance of state-owned enterprises has fallen short of the government's expectations, and equipment and technology are relatively backward. To bring in more money, state-owned enterprises began to be partially privatised and their shares sold to the public. At the same time, however, the government and its related holding entities usually retain enough shares to maintain voting control. It's the government's unwillingness to give up control.
China is a socialist country where national interests come first. The fundamental goal of establishing a stock market is to finance the restructuring of state-owned enterprises. Inevitably, most listed companies in China are state-owned. The government holds more than 10 percent of the direct and indirect voting rights in 43.8 percent of the companies. The government holds more than 50 per cent of the voting rights and absolute control of 31.4 per cent of listed companies. But it is clear that the reforms are working. In 2017, there were 102 state-owned
1 The non-tradable shares of listed companies can be divided into state-owned shares and social legal shares. When a business corporates ahead of an initial public offering, the owners of those shares are usually sponsors. With the approval of the China Securities Regulatory Commission and the Ministry of Finance, state-owned shares can be transferred to non-state-owned enterprises or overseas institutions and become social legal shares.
State-owned shares of a company include state shares and state-owned legal person shares. State shares are the shares that state organs or departments on behalf of the central government inject capital into a joint-stock company or obtain in accordance with the law. State-owned legal person shares refer to the shares that state- owned legal persons, institutions or other enterprises invest in independent joint-stock companies with their own legal assets or acquire according to law.
Social legal person shares refer to shares acquired by non-state-owned legal persons as shares invested by their legal persons or transferred by agreement with other institutions. If they are sponsors of the company, their shares cannot be transferred to another entity until three years after the IPO. As mentioned above, if a state-owned enterprise transfers its state-owned shares to a non-state-owned enterprise, the state-owned shares will be converted into social legal shares after the transfer. Unlike state-owned shares, the transfer of social legal shares is much easier. No joint approval from the Ministry of Finance and the China Securities Regulatory Commission
enterprises in the Fortune Global 500 (FG500), accounting for 22% of the total revenue of all FG500 companies ($27.7 trillion). 75 of the 102 FG500 soes are from China. In addition to the 75 large state-owned enterprises in FG500, there are more than 150,000 state-owned enterprises in China。
3. Chinese state-owned enterprises and non-state-owned enterprises
In China, the ownership structure of state-owned enterprises is very different from that of non- state-owned enterprises. Due to the large proportion of state-owned enterprises in China, the ownership structure is more complex than in other countries. In this case, ownership control of soes is usually controlled by government departments or state capital, which means that political factors and national interests usually play a role in corporate governance structure and business decisions. China's corporate ownership structure is characterized by the dominance of state-owned enterprises, and marriages and restructurings between state-owned enterprises are more common. In addition, soes often have special ownership structures such as political networks and regional alliances. So unlike other countries, China tends to classify companies only as state-owned and non-state-owned.
In U.S. public companies, the largest shareholder typically owns less than 10 percent of the company, according to a study by Azar (2018). But in China's A-share listed companies, the largest shareholder holds more than 30 per cent of the company's shares on average. Therefore, ownership concentration is a common phenomenon in our country, which will have a great influence on earnings management. At the same time, Jiang and Kim (2015) found that the shareholding amount of Chinese investment institutions is usually small and they are not major shareholders at the company level, which is far less than state shareholding or family shareholding. A large number of Chinese ownership literature divides Chinese enterprises into state-owned and non-state-owned enterprises for research, and family ownership is generally regarded as the main body of non-state-owned enterprises. The main reason is that China's state-owned enterprises (SOEs) and non-state-owned enterprises often have very different political and social goals compared with those of US and European countries. In China, when the Chinese government acts as a shareholder and economic manager, it will actively intervene in enterprises to pursue social and political goals instead of maximizing shareholder wealth (Du, 2016). Second, Beijing sees state-owned enterprises, which have other tasks besides making profits, as a secondary way to maintain social stability. There are obvious differences between state-owned enterprises and non-state-owned enterprises in the motivation and means of earnings management.
Therefore, the quality of accounting information and corporate governance structure of Chinese enterprises may be affected by political and national factors. Especially in state-owned enterprises, where the government is often the sole shareholder, it is also common for government officials to serve as company executives and board members. These factors make the corporate governance structure of state-owned enterprises more complicated, and also make the relationship between ownership concentration and corporate governance structure more complicated. For state-owned enterprises, the influence of political factors on corporate governance is often more significant. Research shows that political factors have a great influence on ownership concentration and corporate governance structure of state-owned enterprises. Some studies have found that government officials play a key role in the board of directors of state-owned enterprises, and they can control the company's operational decisions and intervene in the appointment and removal of company management personnel (Gao, 2017).
Political factors may also lead to tradeoffs in financial and business decisions of soes being influenced by political objectives rather than commercial considerations (Li and Gao, 2015) 4. The influence of corporate governance
According to the research of Zou Yong (2011), there is a U-shaped relationship between corporate governance structure and ownership concentration, that is, when ownership is too decentralized or too centralized, corporate governance problems will occur. This conclusion comes after the reform of China's shareholding structure. After the reform, the degree of ownership concentration in Chinese companies has been significantly improved, but at the same time, corporate governance problems also keep emerging. Song Yan and Li Zhao (2013) found that when ownership is too decentralized, corporate governance is often affected by information asymmetry, decision-making lag and other problems. When ownership is too centralized, enterprises often face such problems as too centralized control and unsound supervision mechanism. Therefore, in China, maintaining an appropriate degree of ownership concentration needs to be achieved through a sound corporate governance mechanism.
In addition, state-owned enterprises and non-state-owned enterprises differ in the degree of ownership concentration and corporate governance structure. It is found that state-owned enterprises have more serious ownership concentration problem than non-state-owned enterprises, and their corporate governance structure also has defects. State-owned enterprises are often controlled by the government or government agencies and have a high concentration of ownership. In this case, corporate governance is often interfered by political factors and the supervision mechanism is not perfect, leading to inadequate information disclosure, decision- making lag and other problems.
In enterprises with good corporate governance structure, ownership concentration has relatively little influence on corporate performance and financial status. Specifically, a sound corporate governance mechanism can help enterprises achieve better performance and financial performance under a moderate degree of ownership concentration. Zeng et al. (2019) studied listed companies in China and found that the influence of corporate governance structure on ownership concentration is complex, but under a good corporate governance structure, ownership concentration will not have a negative impact on corporate performance. However, in the enterprises with poor corporate governance structure, the degree of ownership concentration will have a negative impact on corporate performance. It also shows that the influence of corporate governance structure on ownership concentration is very important.
At the same time, the quality and transparency of corporate governance structure are closely related to ownership concentration. When corporate governance structures are better and more transparent, ownership is often less concentrated and the company's management and operational decisions are more democratic and fairer. On the contrary, when the corporate governance structure is not good, the degree of ownership concentration may increase, which may lead to a certain degree of bias and injustice in the company's management and operation decisions.
In addition, state-owned enterprises and non-state-owned enterprises differ in the degree of ownership concentration and corporate governance structure. In China, state-owned enterprises are often controlled by the government or government agencies and have a high concentration of ownership. In such cases, corporate governance is often interfered with by political factors.
In non-state-owned enterprises, corporate governance structures are usually more transparent
and standardized, and ownership concentration is relatively low. Research shows that compared with state-owned enterprises, non-state-owned enterprises pay more attention to the standardization of corporate governance, including efficient board of directors, sound internal control mechanism and fair and transparent information disclosure. For example, Liu et al.
(2014) studied the corporate governance structure and ownership concentration of China's listed companies and found that in non-state-owned enterprises, the board of directors and internal control mechanism have a more significant impact on corporate performance. But at the same time, some non-state-owned enterprises in China also have family ownership structure, which may affect corporate governance. In these enterprises, family members usually have important decision-making rights, and the interest entanglements among family members may also lead to the imperfect corporate governance structure and affect the quality of accounting information.
The research shows that in enterprises with good corporate governance structure, the degree of ownership concentration has relatively little influence on corporate performance and financial status. Specifically, enterprises with a good corporate governance structure can better protect shareholders' rights and interests, avoid information asymmetry, conflict of interest and other problems, thus reducing the influence of ownership concentration on corporate operation.
Therefore, a sound corporate governance mechanism can help enterprises achieve better performance and financial performance under a moderate degree of ownership concentration.
In addition, the quality of corporate governance structure is also closely related to the quality of accounting information. The quality of accounting information refers to the accuracy, timeliness, reliability and comparability of accounting information. In the case of better corporate governance structure, companies usually pay more attention to the disclosure and transparency of accounting information, improve the quality of accounting information, and help to improve the trust and satisfaction of investors and other stakeholders. When the corporate governance structure is poor, the quality of accounting information may also be affected, leading to a decline in the trust and satisfaction of investors and other stakeholders to the company. The better the corporate governance mechanism, the higher the quality of enterprise accounting information disclosure. Corporate governance can play a better role in supervising and constraining the opportunistic behavior of corporate management. With the implementation of good corporate governance, the company's management will earnestly implement the accounting standards, reduce earnings management or profit manipulation and other statements washing window, improve the quality of accounting information.
Good corporate governance structure can also improve the quality of accounting information disclosure, thus enhancing investors' confidence in enterprises and investment intentions. By strengthening internal control and improving the transparency and comparability of financial statements, corporate governance can effectively reduce the degree of accounting information distortion and increase the reliability and accuracy of accounting information. For example, the study found that the accuracy and reliability of accounting information of enterprises with high corporate governance level is higher than that of enterprises with low corporate governance level. In addition, if a company can establish an efficient internal control mechanism and audit mechanism, then it can effectively avoid the occurrence of accounting fraud and other irregularities, and further ensure the quality and reliability of accounting information.
Accordingly, the researchers put forward suggestions to improve corporate governance structure and accounting information quality, including establishing reasonable and effective internal control system, improving the supervision mechanism of shareholders and the board
of directors, establishing sound external supervision mechanism, and strengthening the transparency and accuracy of information disclosure.
5. Conclusion
To sum up, the relationship between corporate governance structure and ownership concentration is complex and subtle, especially in a particular context like China's. Political factors, cultural background, legal system and other factors will affect the relationship between corporate governance and ownership concentration. Although studies have shown that corporate governance structure can help enterprises achieve better performance and financial performance under a moderate degree of ownership concentration, for state-owned enterprises, political factors have a more significant impact on corporate governance. Therefore, in China, the government should pay more attention to strengthening corporate governance of state- owned enterprises, especially to regulate political interference and abuse of power. In view of China's special ownership structure, in addition to relying on internal governance mechanisms to improve the quality of accounting information, it is necessary to strengthen the construction of external regulatory mechanisms, strengthen the role of external regulatory mechanisms such as accounting and auditing, to ensure the quality and reliability of accounting information First, the reform of state-owned enterprises needs to be further promoted to strengthen the protection and equity of ownership. Although state-owned enterprises still occupy an important position in Chinese economy, their special ownership structure is also an important factor restricting the development of state-owned enterprises. Therefore, advancing the reform of state-owned enterprises, deepening the reform of state-owned capital investment and operation companies, establishing and improving the corporate governance structure and internal control mechanism of state-owned enterprises, improving the ownership protection system, and strengthening the supervision and restraint of state-owned enterprises will be the direction of future development.
Secondly, it is necessary to establish a sound corporate governance mechanism to enhance the transparency and standardization of enterprises. Corporate governance is one of the key factors to safeguard ownership rights. Establishing sound corporate governance structure, perfecting internal control mechanism, standardizing corporate behavior, improving operating efficiency and market competitiveness are the basis for realizing ownership concentration and optimization. Therefore, we need to establish a scientific corporate governance system, improve the information disclosure mechanism, promote the internal transparency and fairness of enterprises, and prevent the phenomenon of ownership concentration and abuse of power.
Finally, it is necessary to improve the quality of accounting information and enhance the ability of market supervision and supervision. Accounting information is an important basis for corporate governance and investment decisions. If accounting information quality is not high, it will affect the confidence and stability of investors and the market. Therefore, we need to strengthen the quality management of accounting information, promote the improvement and perfection of accounting standards, enhance the professional quality and independence of accounting firms, strengthen the audit and supervision of enterprise financial statements, improve the ability of market regulation and supervision, and guarantee market justice and stability.
The special ownership structure in China brings many challenges and opportunities to the optimization of corporate governance and ownership. We need to continue to push forward reform, strengthen supervision and constraints, establish sound corporate governance
mechanisms, improve the quality of accounting information, and promote the healthy, stable and sustainable development of enterprises. Only in this way can we cope better.
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