Cut State share in SOEs

Fifteen years ago, I told the IMF-World Bank annual meeting that China had to deepen the reform of State-owned enterprises by reducing its State share in their stocks from 100 percent to less than 30 percent. Much progress was made in the five years that followed: most of the small and medium-sized SOEs were reorganized and many SOEs were listed and became very profitable.

Unfortunately, this process is not yet complete. Over the past 10 years, the State has had about 70 percent share in each of the publicly listed SOEs, which enjoy monopolistic privileges in "strategic sectors" such as banking, telecommunications, energy and utilities. Despite their gargantuan size and appetite, (many of them have featured on the Fortune 500 list), they are not seen as globally competitive and are frequently criticized for the privileges they enjoy and the resultant discrimination against private enterprises.

In my article, "Xi's Challenge: Strengthening Property Rights", published in The Wall Street Journal on Nov 22, I suggested that the Chinese government transfer 15 percent of its shares in the listed SOEs to the national pension fund, and sell some to private investors, bringing down its stake to less than 30 percent. (Xi Jinping is the leader of the ruling party).

Delivering a speech in Beijing the next day, Guo Shuqing, chairman of the China Securities Regulatory Commission, came up with an even more aggressive suggestion. He said an additional 30-50 percent of the SOEs' shares should be transferred to the national pension fund, which has been grossly underfunded. His suggestion was widely reported and seen as an important sign of the reform direction Beijing would take.

But why is it important to reduce State ownership in SOEs to 30 percent? Apart from improving corporate governance, there are two reasons that have to be emphasized. First, it would liberate the productivity and innovative power of SOE executives and employees. And second, it would increase the value of State-owned assets, which actually are collectively owned by the people of China.

When the State holds more than 50 percent shares of a company, it has absolute control over the appointment of its executives, the setting of their salaries, the decisions about operation and dividend, and so on. The fragmented bureaucratic checks and balances straitjacket SOE executives, enfeebling the enterprises' competitiveness vis-a-vis private companies unless they are subsidized through low interest rate loans, or enjoy monopolistic privileges.

Such distortions are unfair not only to the public, but also to many SOE employees, who are probably among the brightest and most professionally trained in China. If they cannot put their productivity and innovative power to full use, China's industry cannot compete globally. And if these bright minds invest their energy in protecting their privileges and interests, the distortion and associated social injustice will only worsen.

A dramatic change in the situation will ensue when 70 percent of the shares is held by non-State entities. The State can still nominate and appoint CEOs and make major decisions, but it will be held accountable to the majority and therefore help improve corporate governance and reduce the risk of economically irrational decisions.

A change in the ownership structure could also increase the value of the State-owned assets - projections of future profits based on the productivity and innovation of a company - and thereby benefit the people of China.

In a recent public presentation, Wu Xiaoling, former governor of the People's Bank of China, asked why the share prices of China's listed companies were so low compared to those in other markets, which is odd given the much higher GDP growth in China than in most other markets. The explanations for that are related to the dominance of State ownership in relation to the future market speculation.

First, as explained before, State-ownership restrains SOE managements' response to changing market conditions, dragging down their performance and depressing their share prices in relation to non-State enterprises.

Second, the low-interest loan enjoyed by the SOEs means their profits will suffer when interest rates rise, because their share prices will be depressed.

Third, the current monopolistic privileges enjoyed by the SOEs will disappear with the opening up of markets in the future, which again will depress their share prices.

Reducing State ownership from 70 to 30 percent in a listed SOE might mean less control, but it would also mean a reduced concentration of potential financial liabilities.

More importantly, it would help resolve the State's conflicting roles as a regulator and market participant. At 30 percent, the State could be a passive shareholder with no strong incentives to grant its companies special treatment. And State regulators will have a much easier time managing SOEs.

Internationally, when the State owns only 30 percent of a company, it is much easier for investors to treat it as a normal commercial entity. In other words, if China really wants to be considered a market economy by the West, it has to reduce State ownership in big companies to less than 30 percent, if not lower.

The author is director of research and senior fellow at Fung Global Institute, an independent think tank based in Hong Kong.

(China Daily 01/16/2013 page9)