On July 24, the Asian Corporate Governance Association (ACGA) released its report, “Awakening Governance: The evolution of corporate governance in China“. The report provides an in-depth review of existing Chinese corporate governance practices while highlighting general dichotomies between local practices compared to the expectations of foreign investors, particularly in corporate leadership structures, ESG and M&A. As for corporate leadership, the report discussed a recent practice of the Chinese Government entrenching a state apparatus – the Chinese Communist Party – within listed companies through “Party Committees”. Notably, these committees can influence boards of directors and/or supervisors and have greater access and are able to influence boards, more so than foreign shareholders or “H-shareholders”. Glass Lewis worked with ACGA to identify the outcome of 17 shareholder meetings where H-shareholders voted against proposals relating to Party Committees in varying degrees between 5.64% to 17.09% of H-shares held.
Likewise, corporate leadership remains an issue, especially as boards are dominated by executives and founding families, despite less stringent oversight from a board of supervisors or even from independent directors. In the case of independent directors, the report indicated that their role has not reached its potential owing to factors such as attendance, a small number of independent directors on boards, insufficient professional and practical experience, or even friendships between independent directors and non-independent directors, which imperils independent thought and action. Taken together, these local practices may have the negative impact on governance practices, as seen, for instance, on ensuring independent oversight of audit committees and audit processes, which foreign investors place a premium on.
The report also delved into ESG disclosure and M&A transactions. For ESG, Chinese disclosure practices are a work-in-progress. Despite advances in reporting, brought on by advances in foreign market disclosures, the quality of ESG reporting remains an area for growth as companies have tended to report in a manner that improves reputation while avoiding issues that could be critical in nature. As for M&A, there have been attempts to increase transparency in transactions. But, given ownership structures, there has been a propensity for groups and transactions to lead to “backdoor listings” of shell companies. Additionally, unless local regulations change, certain transactions involving joint ventures essentially empower the board chair over boards, which, compared to foreign practices, creates an agency issue. Overall, while Chinese companies are seeking increased foreign investment, until there are further substantial changes in local practices from leadership through ESG and M&A disclosure, foreign investors will likely need to continue to temper their expectations on Chinese practices as change comes through evolutionary processes. At the same time, Chinese companies will not be able to put off future calls for further improvements and opening up of local corporate governance practices. How these dichotomies are resolved will be at the forefront of Chinese corporate governance going forward.
Du is a manager covering Asian markets, including China.