Chinese Corporate Organizations Since 1978: A Journey of Explorations
Abstract: The market economic system is an economic system of corporate organizations. China’s sustained and rapid economic development over the past four decades of reform and opening-up was supported by the emergence of its business community. During this period, China’s corporate organizations increased, expanded and developed from strength to strength, serving as a solid micro-level basis for the prosperity of the socialist market economic system. Having achieved significant progress, China’s corporate ownership restructuring led to the common development of enterprises with various forms of ownership. An institutional factor that undergirded corporate prosperity was China’s choice of a corporate system characterized by the interplay between market competition and government administration. How China’s corporate organizational system will evolve in the future is determined by (1) how efficiency varies among firms with different ownership systems, and (2) external institutional pressures facing firms in their rapid internationalization process.
Keywords: corporate organizations, SOEs, system, reform JEL classification code: L25; L33; O12
DOI: 1 0.19602/j .chinaeconomist.2018.07.04
At the micro level, China’s relentless economic growth over the past four decades of reform and opening-up since 1978 is manifested in the rise of firms. Corporate growth enlivened and reinforced the vitality of the economic system, which in turn contributed to the prosperity of China’s business community.
1. First-Wave Corporate Growth and Subsequent Changes
Chinese firms increased in number for the first time during the late 1970s and the mid-1980s. In 1978, there were 348,400 industrial enterprises at the township level and above in China, excluding numerous village businesses, urban-rural cooperative businesses and individual businesses. This number 1 increased to 377,300 in 1980 and 437,200 in 1984 (see Figure 1). Over 98% of the nearly 90,000 new
industrial enterprises were enterprises of collective ownership. By 1986, the number of China’s industrial enterprises was close to 500,000, which was an increase of more than 100,000 over the eight-year period. The newly emerged collective enterprises and individual businesses in cities and the countryside2 not only created jobs for China’s rural surplus labor and urban educated youth who returned to cities after the “down to the countryside” movement but also invigorated China’s burgeoning market system and created competitive pressures for state-owned enterprises, forcing them to reform.
The increase in the number of enterprises was accompanied by a steady rise in the share of large industrial enterprises. The implication is that large enterprises developed rapidly in the process of China’s market- oriented reform. In 1984, reform pressures on large enterprises started to emerge, and lasted until the early 1990s. Back then, most large SOEs were still subject to tight control, and new challenges emerged before old problems were solved. In August 1984, the Institute of Industrial Economics (IIE) of Chinese Academy of Social Sciences (CASS) organized a workshop to discuss how large enterprises should compete with thriving small businesses (Xu, 1984). The workshop was attended by 25 large enterprises including Shougang Group, Daqing Oilfield, First Automobile Works (FAW),
Shanghai Jinshan Weihua, Beijing Yanshan Petrochemical and Shanghai Machine Tools Plant. At various localities, small and medium-sized enterprises poached key personnel at manufacturing and technical positions from large enterprises by offering lucrative compensation and benefits (Zhou, 1984).
In the late 1980s, the central government raised the market access threshold to enhance the results of reform and opening-up in the earlier stage. While the number of industrial enterprises remained stable at around 500,000, large enterprises continued to increase in proportion and expand in size. In 1987, an affiliate of Management World launched a ranking of China’s large enterprises for the first time referencing similar overseas rankings (China Enterprise Evaluation Center, 1989). Back then, China’s largest industry enterprise was Daqing Oilfield with annual sales revenue of 6.3 billion yuan; annual sales revenues for industrial enterprises ranked 30th to 100th ranged from 400 million yuan to 1 billion yuan. China’s top 100 industrial enterprises recorded gross industrial output in excess of 100 billion yuan, accounting for 7.7% of China’s total. Some 10,000 large and medium-sized industrial enterprises accounted for 41.8% of China’s total gross industrial output value. In the meantime, the business climate worsened for most industrial enterprises, especially large industrial SOEs. Since 1988, all industrial enterprises reported significant profit reductions. In the first half of 1990, China registered an industrial growth rate of 2.2%, while state-owned industries dominated by large enterprises only grew by 0.5%, which was significantly below the growth rates of township industries and other types of industries (An, 1990). More and more people began to realize that given their importance to China’s economy, large enterprises should be the top priority of China’s economic reforms and were essential to improving China’s fiscal revenues and macroeconomic operation (Ma, 1991).
2. Second-Wave Corporate Growth and Subsequent Changes
Comrade Deng Xiaoping’s policy remarks during his tour to southern China ushered in the secondround growth of Chinese firms. In 1993, China’s industrial enterprises increased to 520,000, up 20,000 after seven years of stagnation. In 1995, this number spiked to over 590,000. In 1996 and 1997, large and medium-sized industrial enterprises continued to increase in number and share despite a sharp decrease in the overall number of industrial enterprises. Figure 1 shows the number of industrial enterprises at the township level and above during 1978 and 1997 and the growth of large and medium-sized industrial enterprises. Since non-state-owned industrial enterprises with sale revenues below 5 million yuan were excluded from the NBS statistics since 1998, statistics before and after 1998 are not comparable, and Figure 1 only shows the data of 20 years before 1998.
During 1998 and 2000, large and medium-sized industrial enterprises slightly reduced in their absolute number and share, which was unprecedented since reform and opening-up in 1978. During this period, China suffered setbacks from the Asian Financial Crisis. More importantly, challenges facing domestic economy forced China to reform its SOEs and address structural contradictions that built up in earlier stages. In 2001, large and medium-sized industrial enterprises started to increase in absolute number. Their share also slightly increased at first, but continuously declined after 2002 due to faster growth in the number of small industrial enterprises.
Since the mid and late 1990s, China has expedited the reorganization of large enterprises, which helped expand their size. The size of corporate organizations in a country or region is often measured by its number of Fortune Global 500 firms. In 1996, only three Chinese firms were on the list. At the turn of the century, this number rose to 11. Initially, Chinese firms underperformed the average level of Global 500 firms. In 2000, China’s 11 companies on the list reported an average profitability of 4.99%,
3 exceeding the average level of Global 500 firms for the first time. In 2001, the dot-com crash dealt a
heavy blow to Global 500 companies, but Chinese companies were less affected. More importantly, China’s large enterprises generally outperformed the average level of Global 500 companies in terms of growth indicators such as assets, operating revenue and profit growth. This implies that large Chinese firms expanded with great development potentials during this period.
In 2002, the China Enterprise Confederation (CEC) released the “Top 500 Chinese Enterprises” list for the first time. In the same year, the National Electric Power Corporation ranked first, with 1,346.3 billion yuan and 400.4 billion yuan in total assets and operating revenue respectively. China’s Top 500 companies had total operating revenues of over 6 trillion yuan and total profits of 300 billion yuan. Their average assets stood at 52 billion yuan, or less than 1/15 of the level of Global 500 companies. In the same year, Walmart ranked first on the Global 500 list, with operating revenues of 220 billion US dollars. In this stage, large Chinese companies were still smaller in size and less innovative and efficient compared with other Global 500 companies.
3. Third-Wave Corporate Growth and Subsequent Changes
In 2004, Chinese enterprises started to embrace the third round of growth. During 2004 and 2005, there was an increase in the share of large and medium-sized industrial enterprises. However, this increase relatively lagged compared with more rapid growth of the total industrial enterprises above the designated scale. After 2005, the share of large and medium-sized industrial enterprises started to decline once again4. Such decline did not abate until 2009. During this period, corporate operations were affected by the eruption of the global financial crisis in 2008 and the subsequent countermeasures adopted by the Chinese government.
After 2009, China’s economic aggregate increased rapidly. As China overtook Japan to become the world’s second largest economy, Chinese corporate organizations also substantially increased in size. First, the average size of Chinese companies increased. In 2010, the threshold for China’s Top 500 companies list was raised to 11 billion yuan. Meanwhile, the average size of large industrial enterprises exceeded 6 billion yuan, and that of medium-sized industrial enterprises also reached around 500 million yuan. On the other hand, the absolute number of large and medium-sized industrial enterprises increased significantly for five years in a row. In 2011, the NBS made another adjustment to the definition of large and medium-sized industrial enterprises from annual revenue from primary business in excess of 5 million yuan to annual revenue from primary business over 20 million yuan. Although the threshold was raised, large and medium-sized industrial enterprises sharply increased from 46,600 to 61,300 in the same year.
It was not until 2014 that the absolute number of large and medium-sized enterprises started to fall - a real indication of economic contraction. In 2016, the number of industrial enterprises above the designated scale reduced for the first time in almost two decades. Except for the economic turbulence in the late 1980s, early 1990s and mid and late 1990s, such reduction was rare.
For this stage, two factors warrant our attention. First, the service sector replaced production industry as the largest sector of China’s economy. Second, the Chinese government introduced a “mass entrepreneurship and innovation” campaign to promote emerging economic sectors spearheaded by the Internet economy. According to the State Administration of Industry and Commerce, there were 60.6238 million market entities in China by the end of 2013. In the recent few years, the number of market entities increased by 10 million on an annual average basis. By early 2018, the number of market entities
5 in China exceeded 100 million.
For the above reasons, it is natural for the number of China’s industrial enterprises to shrink after rampant growth. But such contraction is also attributable to deep-seated structural contradictions, as well as challenges and pressures in pursuing high-quality development.
4. Economic Restructuring throughout Corporate Growth Journey
Developing and improving the socialist market economy with Chinese characteristics is the theme of China’s economic development and reform. At the micro level, the reform is intended to transform China’s planned economy into a market- based one, and develop enterprises of various ownership systems.
4.1 Falling Share of the State Sector of Economy: From 78% to 28%
At the end of the 20th century, China’s state sector gave way to enterprises of other ownership systems in terms of the share of gross output. This became a defining feature of China’s economic restructuring since reform and opening-up in 1978. In the early 1980s, SOEs and collective enterprises represented a lion’s share of China’s industrial output. From the late 1970s to the mid-1990s, collective enterprises as a share of China’s industrial output increased. In 1978, SOEs and collective enterprises accounted for 77.63% and 22.37% of China’s gross industrial output respectively. In 1994, SOEs as a share of China’s gross industrial output reduced to 37.34%, which was smaller than the share of
collective enterprises (37.72%) for the first time. The gross industrial output value of other enterprises increased to 25% from scratch. In 1996, collective enterprises as a share of China’s gross industrial output peaked at almost 40%. Afterwards, however, the role of collective enterprises in China’s economy
6 diminished. In 1997, state-owned and state-controlled enterprises as a share of China’s gross industrial output significantly decreased to a level below enterprises of other ownership systems for the first time. In 1998, state-owned and state-controlled enterprises as a share of China’s gross industrial output dropped below 30% for the first time. Figure 2 shows how SOEs as a share of gross output reduced from 78% in 1978 to 28% by the end of the 20th century.
4.2 Economic Ownership Restructuring
During 2000-2004, SOEs as a share of industrial output continued to decline rapidly. During 20042005, the retreat of the state sector as a share of the economy relative to advancing private sector sparked heated debates. Subsequently, the downward trend of SOEs in terms of shares of assets, revenues and profits in total industrial enterprises was curbed. However, after a couple of years, these indicators continued to decline at a slower pace.
Figure 3 shows changes in economic indicators of enterprises of different ownership systems during 2006-2016. As can be seen from the chart, the total assets, operating revenues and profits of state-owned and state-controlled enterprises accounted for 38%, 21% and 17% respectively in 2016, down from 46%, 32% and 44% in 2006. The assets, operating revenues and profits of private enterprises accounted for 22%, 35% and 35% respectively in 2016, up from 14%, 21% and 16% in 2006. The assets, operating revenues and profits of foreign-funded enterprises and enterprises invested by Hong Kong, Macao and Taiwan combined, known as overseas-funded, accounted for 20%, 22% and 24% respectively in 2014, down from 26%, 32% and 28% in 2006.
Over the past couple of decades, China achieved remarkable progress in restructuring economic ownership, which led to a diversification of its previously SOE-dominated economy. Today’s China boasts an economic system characterized by the interplay between dominant public ownership system and economic elements of various ownership systems. Market mechanism plays a pivotal role in China’s economic system. According to Andrew Szamosszegi and Cole Kyle (2011), China’s SOEs accounted for an estimated 38% to 40% share of industrial value-added. If the state-related portion in other ownership systems is included, this percentage is roughly estimated to be 50%. A more widely accepted empirical estimate is that SOEs contributed to 25% to 30% of China’s industrial output. For a rather long period of time, the state sector of economy played a pivotal role in China’s economic system. So far, there is no indication that China is developing towards a complete or free market economy or desires to create a market economic system dominated by private ownership.
In China’s diverse economic system, enterprises with different ownership systems play different roles in the economy. Among them, SOEs demonstrate an “assets-heavy” characteristic. With their assets accounting for almost 40% of all enterprises, their revenues and profits only accounted for about 20%. On the contrary, private enterprises accounted for 35% of total corporate revenues and profits despite their smaller share of assets slightly above 20%. Foreign-funded enterprises and enterprises invested by Hong Kong, Macao and Taiwan combined accounted for more balanced shares of assets, revenues and profits in the range of 20% to 25% of all enterprises. Other enterprises accounted for similar shares, i.e. about 20% of all enterprises. With less than 20% of total assets, the overseas-funded enterprises created
over 20% of total corporate revenues and profits in China.
5. Delicate Balance between Government and Market Roles
Growth of Chinese firms in terms of number, size and ownership diversification is a manifestation of China’s corporate sector reform. In the course of China’s economic reform, China’s corporate organizational system experienced a gradual but dynamic learning process. At the beginning, China attempted to overcome the constraints of the planned economy to its social and economic development through complete market-oriented and corporate joint-stock reforms. After the global financial crisis in 2008, however, Chinese policy-makers became aware of the drawbacks of free-market philosophies, and strove to avoid, mitigate and overcome the negative social and economic externalities of a free-market system. Today, China chooses to pursue corporate development within a dual institutional framework characterized by the synergy between the “decisive role of market” and the “more effective government functions”.
5.1 Transition from Administrative Affiliates into Market-Based Corporate System
At the inception of reform and opening- up in 1978, Chinese enterprises still operated like government affiliates, and hosted social functions such as schools and hospitals for their own employees. They formed a closed structure where resources, including human resources, could not be shared with
each other (Lu Feng, 1989). In the late 1970s and early 1980s, independent market entities started to emerge and thrive in the form of collective and individual economy free from administrative intervention.
At a critical juncture in the 1990s with respect to the choice of corporate organizational system, China chose to modernize its corporate system to be compatible with the modern market economic system in line with international practices. These fundamental institutional reforms vastly unlocked China’s economic potentials, allowing China to pursue industrialization and create market-based modern enterprises based on the experience of advanced economies.
In the mid and late 1990s, China hesitated about whether it should learn from the British-American or German-Japanese corporate governance system. At first, Chinese firms tended to adopt a GermanJapanese corporate governance structure consisting of a board of directors, management and board of supervisors, and considered enhancing the role of banks in corporate governance based on the experience of both countries. As China’s capital markets came into shape after the dawn of the new century, China thoroughly turned to the British-American corporate governance system, which highlights the roles of independent directors and professional committees under the board of directors. It was widely discussed whether the positions of board chairman and general manager should be assumed by two different persons or the same person, and the diversity of board membership was highlighted as well.
5.2 Corporate Organizational System Compatible with the Socialist Market Economic System
In the socialist market economy, the market and government are supposed to fulfill their respective roles and responsibilities. The government plays an essential role in China’s socialist market economic system. SOEs represent an important form of government institutions that participate in market economic activities. In creating and improving market-based corporate systems, Chinese enterprises and especially SOEs have retained certain institutional elements of government administrative systems.
Historically, Chinese enterprises created the “old three institutions” ( Party committee, the employees’ congress and the trade union) as the setup of power. A question is how these institutions should be aligned with new institutions created in modern corporate governance reform, i. e. shareholders’ meeting, board of directors and board of supervisors (“new three institutions”). In practice, Chinese companies have developed specific institutional arrangements to improve the administrative powers under market and administrative systems. For instance, they created overlapped positions between the “old three institutions” and the “new three institutions”, particularly between the Party committee and the board of directors. While the positions of board chairman and general manager should be assumed by different persons, Party secretary and board chairman can be the same person. Employee representatives serve as directors or supervisors. There are other examples as well.
In recent years, SOEs’ organizational system continued to evolve towards two different institutional directions. First, they created independent boards of directors with greater authorities in accordance with corporate governance rules. As a critical institutional arrangement, SOE boards of directors were given the authority to appoint senior management - this arrangement aims to strike a balance between the principle that cadres should be appointed by the Party and the market-based selection of corporate managers. On the other hand, SOEs enhanced the Party’s leadership and involved Party committees in their decision-making of key matters. Specifically, SOEs wrote critical institutional arrangements into their articles of association, established decision-making procedures, and balanced the relationship between the political leadership of Party organizations and the board’s executive power.
5.3 Effectiveness of Change in China’s Corporate Organizational System
At the beginning of reform and opening-up in 1978, China’s state-run enterprises did not follow market-based rules of operation, and used resources inefficiently. Through reform and opening-up,
China’s corporate organizations increasingly came to terms with market institutions at all levels. Under the interplay between market- based competition and government- led administration, institutional changes occurred within numerous corporate organizations - the cumulative effect of these changes induced systematic transformations of China’s corporate organizational system.
In the socialist market economic system that China pursues today, companies that do not innovate and skillfully adapt to an ever-changing environment will not survive. Even if they do, their legitimacy may be deprived by government administrative power. Companies that survive must not only secure political support from the government but also acquire all types of resources from market competition. They must engage in productive activities instead of purely consuming resources.
Chinese companies operate under a delicate balance between competitive market mechanism and government administration. Public memory has also evolved with changing times. The level of sophistication demonstrated by Chinese companies is rare in the world. The complexity is manifested in the sense that the specific type of system at work is often indiscernible. In different situations, the “mastermind” system at play may not be the same (Dame Mary Douglas, 2013) - whether it is the competitive systems that promote business ideas or administrative systems that defend the Party committee as a political organization, they all fight for people’s “structural forgetfulness” for other forms of systems and justify their own glory and correctness under the banner of “undisputed legitimacy”.
6. Organizational Transition of Chinese Enterprises: Future Directions
This section attempts to identify the factors that influence the organizational system of Chinese firms. Given the subjectivity of administrative systems, our analysis will focus on how market systems as a hard constraint affect corporate efficiency for companies with different ownership systems. In addition, we will also examine the external institutional pressures from the international community facing Chinese companies in their internationalization process.
6.1 Possibility for Market Competition and Corporate Efficiency Differences to Induce Change
At the end of the last century, China’s SOEs were confronted with two conundrums: “insider control” due to a lack of supervision over the owners and the “soft budgetary constraint” arising from their dependence on government finance. Over the past two decades, these problems have abated but are far from resolved.
These problems can be best solved by a combination of market system and administrative supervision. Ideally, while the market system prevents insider control or soft budgetary constraint, administrative supervision under the Party’s leadership will remove companies or insiders with bad behaviors. Also under desirable conditions, companies may derive political advantage to enhance their economic competitiveness.
Nevertheless, the reality is far more complex since the dual-system arrangement may also give rise to a conflict of interest. Under the new institutional framework, the “insider control” and “soft budgetary constraint” problems will continue to exist in new and more tacit forms. It takes tremendous time and efforts to prevent these problems through supervision, reducing the resources otherwise available to firms for market-based production activities. As a result, companies will have to operate with exorbitant institutional costs to the detriment of their efficiency and debt-to-assets ratio.
As Figure 4 shows, with each unit of assets, China’s industrial enterprises created 1.07 units of revenue from primary business and 0.07 units of profits in 2016, while state-owned and state-controlled enterprises only created 0.57 units of revenues from primary business and 0.03 units of profits. Compared with the beginning of this century, there has not been much change in the absolute efficiency of SOEs, but gaps between SOEs and industrial enterprises overall in terms of efficiency have widened.
When China endeavored to help SOEs overcome their difficulties in the late 1990s, the debt-to-
assets ratio of China’s industrial enterprises reached a high level of over 60%. In the most difficult year of 1997, this ratio approached the warning line of 65%. This ratio dropped to 55.87% in 2016. But the debt-to-assets ratios of SOEs and state-controlled enterprises increased to a high level of 61.58%. Among various types of state-owned and state-controlled enterprises, the debt-to-assets ratio of solely statefunded companies climbed to a high level of 63.53%, as shown in Figure 5. According to data released by the Ministry of Finance at the end of March 2018, the debt-to-assets ratio of SOEs approached 65%, and overall SOE liabilities exceeded 100 trillion yuan.
Foreseeably, different forms of institutional arrangements will lead to differences in corporate operational efficiency that will continue to accumulate and create pressure and momentum for deepening SOE reform.
6.2 Institutional Pressures in the Internationalization Process
China’s reform and opening- up is not an isolated process. In a global context, Chinese firms have always sustained great pressures from the international community. At the dawn of the new century, Chinese companies ended their isolation from the rest of the world by embracing the WTO, and accelerated their internationalization process. With the rapid development of new technology and new economy, the diversity of corporate systems in different countries was greatly tolerated in the international market system; such tolerance is essential in a world of diversity. External institutional pressures serve as another important driver of change in China’s corporate organizational system.
Today, as important international investment entities, Chinese companies have embarked upon a fast track of internationalization. Chinese companies are increasingly integrated into the world market based on an intricate system of international rules. China is under growing international pressures to stay abreast with the system of international market rules. If Chinese companies are able to cope with external institutional pressures, they will be able to secure organizational legitimacy and greatly reduce transaction cost for entering the international market. In reality, however, it is not uncommon for institutional pressures to contradict corporate behaviors. In April 2018, the US Department of Commerce activated an export ban on ZTE, a top Chinese telecom equipment company, crippling its business operations. The official reason for the ban is ZTE’s violation of US export restriction, attempt to evade supervision, false statements, and non-compliance with the settlement agreement.
Behind the ZTE ban is a growing concern of some countries for Chinese companies. There is no doubt that the ownership structure of Chinese companies is improving over the years. However, the concern for their alleged non-market operations is unabated. From the perspective of fair business competition, some countries are opposed to the credit support, subsidy and preferential government procurement policies offered by the Chinese government to its domestic enterprises. Some people are concerned with China’s “state-owned” enterprises or simply “Chinese” companies, and believe that
among both Chinese private and state-owned companies are the ones that have “grey areas” where they do not fully comply with market laws. Nevertheless, there are still some rational and objective voices that Chinese companies, regardless of their ownership nature, should be treated equally as long as they respect and comply with international rules.
These concerns may not be dispelled overnight, so, we should consider seriously the reasonable doubts about the commercial operating activities of Chinese corporations.
Based on experience, the following basic positions should be clarified. First, companies should benefit from extensive international cooperation as a motivation for compliance with international rules. Only motivations for long- term cooperation will drive companies to make decisions that restrict and change their behaviors. Second, companies must understand “the way policymakers reflect upon international laws and standards and the political discourse they use” ( Powell and DiMaggio, 2008) in participating in and changing the system of international market rules. In understanding and accepting their preferences and power structure, companies should influence the preferences and power structure in the existing system. As can be seen from experiences, positive and effective response to institutional pressures from the international community is likely to unleash companies’ institutional potentials.
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