We are the (national) champions: understanding the mechanisms of state capitalism in China.

• Author: Lin, Li-Wen
• Position: Introduction through II. National Business Groups, p. 697-734

INTRODUCTION I. UNDERSTANDING CHINESE INDUSTRIAL ORGANIZATION A. Introduction B. Chinese Industrial Organization as a Networked Hierarchy 1. A simple analytical construct 2. A stylized model C. Origins of Chinese Corporate Groupism II. NATIONAL BUSINESS GROUPS A. Components 1. Core (parent) company 2. Listed company 3. Finance company 4. Research institutes B. Membership and Internal Governance C. Networks 1. Intergroup networks 2. Central-local intergroup networks 3. Business group-party-state networks D. Examples 1. China National Nonferrous Metals Industry Group 2. China Datang Group III. THE PARTY-STATE AS CONTROLLING SHAREHOLDER A. SASAC as Controller 1. Control rights in management 2. Control rights in state enterprise assets 3. Cash flow rights B. Consequences IV. IMPLICATIONS AND QUESTIONS A. Implications for Comparative Corporate Governance Scholarship 1. Law and finance 2. Convergence B. Questions for the Future 1. Legal reform? 2. Temasek-ization of SASAC? 3. Great reversal? 4. Dis-integration of the national-champion groups? C. Implications for the U.S. Legal System CONCLUSION INTRODUCTION

China's emergence as a global economic power poses enormous explanatory challenges for scholars of comparative corporate governance. While China appears to present a new variety of capitalism, frequently labeled state capitalism, the features and implications of this system are still poorly understood. (1) Particularly since China's economic system may be in its early stages of development, understanding the mechanisms by which state capitalism currently operates and how they may change as Chinese enterprises globalize is a pressing task for researchers.

One highly distinctive characteristic of state capitalism in China is the central role of about 100 large, state-owned enterprises (SOEs) (guoyou qiye) controlled by organs of the national government in critical industries such as steel, telecom, and transportation. Although only a handful of these firms, such as Sinopec and China Mobile, have become widely known in the West, the state sector dominates major industries in China and is increasingly active in global markets. As the Economist recently noted, "[A]s the economy grows at double-digit rates year after year, vast state-owned enterprises are climbing the world's league tables in every industry from oil to banking." (2) China now has the world's second-largest number of companies (seventy-three) on the Fortune Global 500 list of the world's largest corporations, (3) and the number of Chinese companies on the list has increased at an average annual rate of approximately twenty-five percent since 2005. (4) These globally significant SOEs are China's national champions.

More than half of the Chinese companies in the 2012 Fortune Global 500 are SOEs supervised by an organ of the central government. (5) Excluding major banks (6) and insurance companies, controlling stakes in the largest and most important of the firms are owned, ostensibly on behalf of the Chinese people, by a central holding company known as the State-Owned Assets Supervision and Administration Commission of the State Council (SASAC), which has been described as "the world's largest controlling shareholder." (7) Though the elite firms that serve as the outward face of Chinese SOEs (again, think of Sinopec or China Mobile) are listed on stock exchanges in Shanghai, Hong Kong, or other world financial capitals, they are nested within vertically integrated groups. Each company's majority shareholder is the core (parent) company of the group--which is itself 100% owned by SASAC. The core company coordinates the group's activities and transmits business policy to group members, who are contractually bound to promote the policies of the state. Individual corporate groups are often linked through equity ownership and contractual alliances to groups in the same or complementary industries, to provincial-level business groups, and even to noneconomic state-controlled institutions, such as universities. (8) Top managers of national champions simultaneously hold important positions in the government and in the Communist Party.

Although the basic outlines of this system are now widely known, in many respects the concept of state capitalism in China--particularly the organizational structure and broad governance regime surrounding these national champions-remains a black box. (9) Scholars have explored numerous facets of investment, monitoring, and organization in Western firms, but for Chinese firms, research is only beginning to unpack questions raised by state ownership: How were failing state enterprises transformed into global players, and what foreign models did Chinese economic strategists look to for inspiration? How are nationally important firms related to one another and to their sources of financing, and what links the national champions to government and Party institutions? What incentive structures operate within this system? How does the Chinese party-state behave in its role as controlling shareholder? What are the implications of this system for our understanding of Chinese corporate governance and for the potential future transformation of corporate capitalism in China?

Scholarship to date has provided only fragmentary answers to such questions. In part, this stems from the scarcity of reliable data, but it also results from the way scholars have approached the subject. (10) Most corporate governance scholars working on China, for example, have taken the individual firm--the publicly listed company--as the unit of analysis, even though corporate groups are pervasive in China's state-owned sector and the listed firm is just one part of a complex web of corporate entities and relationships that characterize Chinese state capitalism. (11) Moreover, scholars often begin and end their analyses by benchmarking the governance attributes of Chinese listed companies against global (which typically means U.S.) corporate governance standards and institutions. This approach produces insights, to be sure, but it invariably focuses the analyst's attention on what the Chinese system lacks, not on how it is constructed and actually functions. We believe that, as was the case with scholarship on Japanese corporate governance in the 1990s, (12) real headway in understanding China's variety of capitalism will come by analyzing the system on its own terms rather than principally by reference to something it is not.

In this Article, we explore the mechanisms of state capitalism in China by analyzing the distinctive system of industrial organization in which the country's largest state-owned enterprises were assembled and operate. To aid in the analysis, we expand our focus beyond the usual corporate governance concern with agency relationships and try to understand the relational ecology that fosters production in a system where all roads eventually lead to the party-state. We introduce two simple analytical constructs for this purpose: Networked hierarchy is our term for the way top-down governance features within individual state-controlled corporate groups are coupled with extensive linkages to other state-controlled institutions. Institutional bridging is our term for the pervasive use of personnel-rotation systems, linked equity-ownership structures, and strategic forms of cooperation, such as joint ventures, which serves to unite separate components of the state sector. These mechanisms create networks among businesses and other organs of the party-state, promote information flow, and provide high-powered incentives to actors in the system by linking corporate performance and political advancement. Together, these features can be thought of as means to assemble what Mancur Olson called an "encompassing organization"--a coalition whose members "own so much of the society that they have an important incentive to be actively concerned about how productive it is." (13)

While there is much more to the Chinese economy than the national champions, (14) there are many good reasons to examine the institutional ecology in which these SOEs function. By several measurements, the state sector is a significant part of the national economy. (15) Perhaps more importantly for our purposes, as a scholar recently noted, "SOEs [everywhere] remain surprisingly understudied." (16) China's nationally important SOEs have joined the ranks of the largest firms in the world and are plainly worthy of deep exploration in their own right. The national champions are the fullest expression of state capitalism in China--the global face of China Inc. It is impossible to fully understand the institutional features of the Chinese economy without examining its largest, most central actors. Bigness, as signified by the Fortune Global 500 list, does not necessarily indicate efficiency or innovative capacity, traits that will be key to the long-term success of the national champions in the global economy. But the emergence of large Chinese SOEs as major domestic and global actors may have enormous implications across a range of dimensions. (17) Finally, given the relatively early stage of development of Chinese capitalism, a robust exploration of China's largest and most politically connected firms may provide insights into how the state-directed system may evolve over time--or at least suggest which features of the current system are susceptible to change and the possible directions in which change may occur. (18)

Having defined our task as unpacking the conceptual black box of Chinese state capitalism, we focus on the major SOEs with the tightest connections to the Chinese party-state in its various institutional manifestations--that is, the approximately 100 SOL groups with a core company controlled by SASAC at the national level. (19) Our analytical focus is not an attempt to demonstrate the comparative advantages of state ownership of enterprise; to hold the national...