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Why Corporate Governance is So Important to China
forbes:
Ask most what is the biggest economic risk facing China today and you will probably hear about food inflation, property prices, or growing imbalances between the rich and working class in society.
Those are all worthy challenges, which the Chinese government has been acutely focused on in the last year. They just raised interest rates another quarter point this morning to deal with inflation.
However, there’s an area which has been getting much less attention, yet which could be more dangerous to China: problematic or lax corporate governance.
Corporate governance has to do with how organizations are run. Organizations with proper corporate governance have accountability and transparency. People in authority at those organizations know that their actions will be seen and judged by others. Therefore, those leaders are more likely to act in ways that benefit the organization’s stakeholders. They are also less inclined to act in ways that benefit themselves personally at the expense of the organization.
China has always been a country that celebrates hard work and success in business. To succeed in China, the winning companies face enormous competition domestically to get to the top and stay there. They are generally not able to be incompetent or corrupt and succeed in the long-term.
But there is a growing crisis in China involving bad corporate governance that needs to be addressed immediately in order to prevent a major economic crisis in the future.
Last year, there were several Chinese-based companies who had previously chosen to go public in the United States via a process called a reverse take-over (RTO), who were accused of fraud. In the last month, two such companies — China Media Express (CCME) and China Agritech (CAGC), who both had market capitalizations over $500 million last year — were delisted from NASDAQ because they are assumed by that exchange to be somewhat fraudulent.
Although there are at least a dozen other similar small RTOs with clouds hanging over them and who might be delisted in the future, most in China have never heard of these companies. Most Americans have generally thought these kinds of frauds are not prevalent among larger Chinese companies.
But recently, two larger Chinese companies, who went public in the United States via more traditional IPO methods and with the help of more prestigious investment bankers, have also been accused of fraud by short sellers.
Sky-Mobi (MOBI) went public last December and saw its shares immediately drop 25%. The Hangzhou-based mobile applications provider went on to announce several partnerships with large portal companies in China and its stock price increased 400% very quickly. But it was then accused of fraud by American short-seller Citron
Research a month ago and its stock price has taken a major hit (although it’s recovered in the last week).
More worrying are recent accusations against New York Stock Exchange-listed Longtop Financial (LFT). This financial software company was taken public by no less than Goldman Sachs (GS) in 2007. It has a large roster of well-known American hedge funds as major investors and a multi-billion dollar market capitalization.
Short-sellers recently accused Longtop of inflating its margins by hiding operating costs. The stock has been halted for weeks, pending clarifications from the company.
If Longtop gets delisted like a much smaller RTO company (which seems very likely), it will send shockwaves through the American investor community.
In May, the National Audit Office of China published financial problems at 17 state-owned enterprises (SOEs). The allegations included overstating earnings, understating asset values, forging invoices, and paying excessive executive bonuses. Companies involved in the accusations include China Three Gorges Corp and China Unicom (CHU).
Finally, in recent weeks, there has been a major uproar in the United States involving Yahoo!’s (YHOO) investment in Alibaba Group. Yahoo! claims that they were only recently notified by Alibaba Group that Alipay had been transferred to Jack Ma’s personal control last year to comply with requirements by the Chinese government.
According to Yahoo!, neither they nor Softbank (Alibaba Group’s other major investor) were compensated for the loss of Alipay.
As Yahoo! investors had come to place a good deal of hope in the future growth of Taobao and Alipay as reasons to own Yahoo!, the abrupt news immediately caused the American internet company to lose 10% of its value.
Yahoo! claimed — even though Jerry Yang sits on the Alibaba Group board — that they had been deceived. Alibaba Group denies this strongly. The parties now say they are in discussions to settle the matter.
The bottom line is that American investors feel nervous about all these matters — and the recent decline of major Chinese Internet stocks like Sina (SINA) and Baidu (BIDU) this month have also spooked them.
There are increasingly voices within the United States cautioning investors against buying Chinese stocks because their financials and the rules of the game for doing in business cannot be trusted.
Most of my Chinese friends can spot over-sensitive American patriotism a mile away and realize that it usually doesn’t have much effect on Sino-American relations.
However, these recent lapses in Chinese corporate governance are worth paying attention to.
There are too many “isolated incidents” to not conclude there is potentially a more concerning systemic problem to be addressed.
We hear the Chinese government often discussing how important “social harmony” is to the Chinese society. That’s why a property bubble that makes basic home ownership for the working class is a problem. That’s why food inflation is important. Equally important though is corruption. Poor corporate governance leads to corruption. It must be rooted out where it exists.
The elites of business cannot be allowed to take advantage of the workers through paying themselves excessive bonuses or overstating the earnings. If there continues to be evidence of more widespread fraud at large and well-known Chinese companies, there will eventually be a crisis of confidence in Chinese businesses.
Not only is there a risk of foreign investors not trusting Chinese companies if there is not sound corporate governance but all Chinese people. They could also pull their capital out of the stock market.
If there are problems at large Chinese companies, they must be dealt with now. Microblogging tools from Sina and Tencent should be used to identify where there are problems to be corrected.
CEOs of Chinese largest companies must also take steps to ensure their own financial statements are clean and push their peers to do the same.
Crises tend to come from places you are not on guard against. Everyone has been so concerned about a property real estate bubble bursting over the last year but the steps to deal with it have worked. There’s yet been a concerted effort to improve the quality of Chinese corporate governance but there should be.
Two months ago, if asked about fraud in China, I would have said it’s only in the domain of the small reverse take-over companies. I can’t say that any more.
A small brush fire has now grown larger. The problem can still be dealt with if it’s given appropriate attention. However, I fear it is being ignored.
I worry one day we’ll wake up and find a lack of confidence in Chinese corporate governance will lead to a run on these companies’ stock inside and outside of China.
Investors will judge investing in China is similar to investing in a country like Russia, where rules can change routinely and arbitrarily.
As we saw in 2008, when confidence goes, Chinese stocks’ values can decline by more than 90% – and relatively quickly.
It is not too late, but proper oversight is required from the board of directors of every organization. I hope each of these Chinese boards’ have sufficiently strong-willed and knowledgeable directors who are willing to challenge their CEOs to ensure that everything is as it appears to be at these companies.
有兴趣的朋友可以复看本文中文版：改善公司治理对中国至关重要 http://t.cn/apdMYV
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