Party and the board: Who is the boss?

December 18, 2017 10:09
The Communist Party of China wants to tighten its control over state-owned enterprises. Photo: Reuters

A growing number of Chinese state-owned enterprises (SOEs) have redrafted their by-laws to put Communist Party of China (CPC) organizations at the top of their corporate governance structures, according to news reports. Foreign investors and businesses have raised concerns about this development, noting, among other things, that it could undermine the authority of an SOE's board of directors. In view of this development, foreign investors are advised to take into consideration the party organs when planning due diligence on a state firm.

Redrafting by-laws

Since 2016, China has intensified efforts at party building in SOEs. In October 2017, Qi Yu, deputy head of the CPC Organization Department, said that by the end of last year, 93.2 percent of some 147,000 SOEs had already set up CPC organizations. As part of the party-building efforts, SOEs redrafted their by-laws to add clauses that give core roles to party committees in their governance structure. Since 2016, numerous national and local SOEs, including more than 30 SOEs listed in Hong Kong, have completed redrafting their by-laws.

The added clauses institutionalize the involvement of party committees in two most important functions in corporate governance: decision-making and appointments. The board of directors of an SOE is now required to seek advice from the company’s party committee prior to making important decisions.

In addition, a party committee is to consider and propose opinions on managerial candidates nominated by the board of directors and the general manager, or to simply directly recommend nominees.

Although in appearance the amended by-laws just give party organizations mainly consultative roles, we believe that in reality, the board would just follow the party's wishes.

CPC’s perspective

The CPC views the enhanced party-building efforts as a revival of the party's already marginalized oversight over SOEs. The weakened party influence is largely the result of the decades-old economic reforms, which have seen SOEs increasingly leaning towards Western-style, overly profit-oriented management philosophy and being plagued by rampant corruption.

As expected, SOEs have expressed their support for the party-building efforts. Yi Huiman, chairman of Industrial and Commercial Bank of China, told state-run newspaper Global Times that this “organic combination of party construction and company governance” would create more returns for shareholders.

Foreign investors’ concerns

While the promise of better returns remains to be seen, foreign investors and businesses have largely been unsettled by the CPC's growing influence in SOEs as well as their joint ventures with state firms.

For foreign investors, elevating the status of the CPC in SOEs and their joint ventures could signify that China was backpedaling from modern corporate governance, in that the board of directors could be overshadowed by a group of party members who are not accountable to shareholders. This creates confusion among investors as to who is heading an SOE – the party organ or the board?

Who heads a state firm?

Although in most cases the chairman of an SOE is also the head of the company’s CPC committee, not every party committee member is a board member. Take China Everbright Group as an example. On the company website, the group introduces the nine members of its leadership team. They are predominantly party committee members, with only four of them also sitting on the board of directors. Notably, one of the leadership team members, Xie Zhibin, has no executive role other than as a party cadre at the firm, according to the website.

To further complicate the leadership identification issue, party committee membership is not necessarily explicitly mentioned in corporate profiles and literature. This time we have Everbright Securities in sight. On the company’s management webpage, chairman Xue Feng’s parallel role as the head of the company’s party committee is not mentioned, nor does the governance diagram on the site includes the role of the party committee – even though the firm just added party-building clauses in its by-laws in October 2017.

Implications on due diligence

The SOE leadership question, stirred up by the elevated authority of the CPC, calls for investors to take extra caution when undertaking due diligence.

Prior to establishing a business relationship, a company or an investor conducts due diligence on the corporate counterparty and its senior management, who are – in normal circumstances – members of the board of directors and the chief executive officer. In China, however, investors and due-diligence specialists could no longer cast aside the influence of party organizations in SOEs.

As such, we are encouraged to first review an SOE’s by-laws to understand the operations of its party organization, through which an educated decision could be made on whether any background checks should be undertaken on party committee members.

With CPC’s efforts to tighten control on SOEs, we foresee that more due diligence would be undertaken on party members.

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Founder of Richard Ip Consultancy, a due diligence and sanctions compliance advisory business, the writer is a global political and compliance risk consultant with a special focus on Asia.