The World Bank has drawn attention to the agency problem of state
ownership in China. A new World Bank report entitled
Corporate
Governance and Enterprise Reform in China: Building the
Institutions of Modern Markets was released in Beijing today at
an international conference on corporate governance reform in
post-WTO China co-sponsored by the World Bank Group, the
Development Research Center of the State Council, and the National
Accounting Institute. The study demonstrates how the universally
complex issue of corporate governance is further complicated by the
weaknesses of partially reformed state ownership.
In
view of the gradual nature of China's reform of state ownership, it
recommends three sets of actions:
First, aligning the incentives of local governments and the
managers of state-owned enterprises with national interests;
Second, separating the control rights of the state from its cash
flow rights by modifying the nature of state equity claims;
Third, reducing state ownership gradually.
The report says that the new institutions of corporate governance,
developed in response to partial reforms in China's state
enterprise sector, are likely to remain imperfect in the context of
dominant state ownership and political control over managers. But
improved corporate governance practices are necessary for China to
develop fully functioning factor markets.
Speaking at the corporate governance conference in Beijing, World
Bank Group President James D. Wolfensohn said: "As China begins to
implement its commitments under the WTO, the policy focus on
corporate governance sends a signal that the government is
committed to further reforms. This, in turn, provides a strong
reassurance that the remarkable gains that China has made in
development and poverty reduction over the last two decades will be
sustained and enhanced."
"Complex reform issues, including corporate governance, often pose
difficult trade-offs," Mr. Wolfensohn said to conference
participants including Chinese senior policy makers, company
directors and executives, academics and accounting professionals in
Beijing as well as others in Yinchuan, Ningxia who were able to
participate through the World Bank's Global Distance Learning
Network -- with the financial support by the Australian government.
"It is important, as problems are being addressed, to keep a
balance and not to undermine some of the key elements of a
functioning market system. For example, it is important not to
sacrifice financial stability and efficiency in attempts to
mitigate the social costs of restructuring."
The report offers an empirical snapshot of the latest stage of
China's reforms and illustrates the complexity of
institution-building for better corporate governance. It emphasizes
that an effective corporate governance system should be capable of
identifying weaknesses before they develop into systemic problems,
by taking prompt corrective action, and learning from failures. To
this end, an effective corporate governance system needs to contain
a multiplicity and a certain redundancy of control mechanisms. This
implies that priorities in corporate governance reforms should be
given to mechanisms that are relatively underdeveloped or
altogether missing from a country's institutional arsenal and
exhibit strong synergies with other existing corporate governance
mechanisms, says Stoyan Tenev, the study's leading author and a
principal economist at the International Finance Corporation.
In
this context, the report identifies a wide range of policy actions
to be taken by the government, including, for example, enhancing
regulatory capacity by realizing the enormous potential in the
areas of self-regulation and mobilizing civil society in the
enforcement process; developing an institutional investor base by
improving the regulator's ability to supervise institutional
investors and the corporate governance of institutional investors
themselves; and strengthening the role of creditors in corporate
governance by a range of actions, such as, introducing new
legislation to transform the bankruptcy process of state
enterprises from an administrative process to a more market driven
one, and enhancing the profit incentives of banks through
corporatization and ownership diversification.
The policy recommendations of the report were described by Vice
President Chen Qingtai of the Development Research Center of the
State Council, as "constructive and valuable." He wrote in a
preface to the report that the study has reached the "core of the
problems China is now facing at the microeconomic level." "Focusing
on the building-up of enterprise related institutions, the report
provides clearly articulated overall concepts as well as strategies
and approaches for solving particular problems," wrote Vice
President Chen.
The study was conducted by the World Bank and the International
Finance Corporation in collaboration with the Development Research
Center of the State Council. It reflects the increasing emphasis
the World Bank Group is placing on improving corporate governance
practices as part of the general effort to support the development
of market institutions needed for sustained growth and poverty
reduction.
The full text of James D. Wolfensohn's speech
CORPORATE GOVERNANCE AND THE CHALLENGE OF
DEVELOPMENT
James D. Wolfensohn
President
The World Bank Group
Good morning. Thank you Minister Wang, and President Liang for
co-hosting this important event. Thank you all for coming. It is a
pleasure for me to be here today and to have this opportunity to
address such a wonderfully diverse audience comprising policy
makers, company directors and managers, academics; representatives
of the media, chief accountants of large companies. I am
particularly pleased to have this opportunity to interact and
exchange ideas with the participants in the campus of Ningxia
University, who have joined us through the Global Development
Learning Network facilities. The Global Development Learning
Network is an initiative that I have a strong personal interest in
and it is great to take advantage of the network today to reach
this wonderful audience in Yinchuan city.
I
would like to share with you some ideas about corporate governance
and development. Let me start by thanking the Development Research
Center for their partnership and support for the successful
completion of this study on corporate governance. We appreciate
very much DRC's role and achievements in promoting good policies in
corporate governance and enterprise reform and look forward to
continued fruitful cooperation in this and other fields.
It
is hard to think of a more appropriate venue to discuss the topic
of corporate governance than the National Accounting Institute.
Within the broad framework of corporate governance, transparency
and information disclosure are absolutely central for well informed
investment decisions and the protection of small investors.
Transparency and adequate disclosure can not, however, become
established business practices without well trained, competent, and
honest accounting professionals. The National Accounting Institute,
our co-host today for this event, is an excellent example of the
type of institutions that are needed to support improvements in
corporate governance practices. We in the World Bank are very proud
to be associated with the work done by the National Accounting
Institute and the Chinese Institute of Certified Public Accountants
through the assistance we provided in the Accounting Reform and
Development Project. Although the National Accounting Institute
opened just a year ago, many professional CPAs and financial
managers from both public and private sectors have already
benefited from its high quality training programs and many more
will follow.
The establishment of this Institute and the strong demand for its
services is an indication of the growing public awareness in China
of the importance of good corporate governance. The Institute is
one among a number of recent important initiatives such as the
establishment of a system of independent directors for Chinese
listed companies and the introduction of a code of corporate
governance, which reveal the increased importance given by the
authorities to the improvement of corporate governance practices in
China. As China begins to implement its commitments under the WTO,
the policy focus on corporate governance in China sends a strong
signal that the government is committed to further market reforms.
This in turn provides a strong reassurance that the significant
gains that China has made in development and poverty reduction over
the last two decades will be sustained and enhanced.
China's impressive achievements in improving the living standards
of its people are well recognized throughout the world. Given
China's success in generating growth and reducing poverty, one may
ask the question what drives China's recent focus on corporate
governance reforms.
The policy focus on corporate governance in China reflects new
external realities. China has made a major step towards a greater
involvement and a more prominent role in the global community with
its membership in the World Trade Organization. However, the crisis
in Asia indicated that integration into the global economy without
the proper institutions of governance can create vulnerabilities
that can partially reverse gains in development and poverty
alleviation. Thus good corporate governance institutions are
critical for sustainable growth, development, and poverty
alleviation in a highly interdependent world because good
institutions of corporate governance are central to the ability of
getting money and resources to countries to create opportunities
for jobs and lift people out of poverty. It is very impressive that
China has learned from the crisis in Asia and has intensified its
efforts to develop the institutions of modern corporate
governance.
The current focus on corporate governance also builds on past and
ongoing market reforms and should be viewed in the context of the
natural progression of market reforms in China. It reflects the
fact that market reforms in China have deepened and progressed to
the stage of so-called second generation of reforms, where there is
a need to tackle issues in a more integrated and comprehensive
manner.
Reform issues typically become more intertwined and complex at this
stage. For example, corporate governance issues are closely linked
with issues of corporate restructuring, and corporate restructuring
can not be separated from the soundness of the financial system and
the social security issues related to layoffs in the context of
restructuring. Complex reform issues, including corporate
governance issues, often pose difficult trade-offs. It is
important, as problems are being addressed, to keep a balance and
not to undermine some of the key elements of a functioning market
system. For example, it is important not to sacrifice financial
stability and efficiency in order to mitigate the social costs of
restructuring by shielding companies from market discipline and
pressure.
It
is important to keep in mind that legal reform is part of these
interrelated and complex issues. Sound legal rules in company laws
and securities regulations are a first step towards effective
corporate governance. Here, comparative practice can be quite
helpful, and today's conference is an opportunity for just this
sort of exchange of views among practitioners and thinkers from a
world of experience.
But rules on the books are not enough. Corporate directors, public
accountants and government regulators alike must believe that these
rules reflect commonly-shared and socially-reinforced values. So we
see that compliance by private parties with corporate governance
rules depends in part on a country's legal culture and respect for
rule of law, reinforced by a belief that the rules have
"teeth."
At
the same time, more effective regulation will require increased
enforcement capability for regulatory bodies, which, in turn, means
greater reliance on legal instruments and the ability to enforce
them. Thus, the problems faced by many judicial systems -- quality
of judges, weak enforcement of judgments, government interference
and corruption -- can stand in the way of stronger market
regulation.
Permit me to take a moment here to recognize China's decade of
achievement in developing the legal framework for its market
economy, putting in place the building blocks on which corporate
growth and governance rest, such as company law, securities law,
banking laws. The next stage, already underway -- implementation --
can often be even more challenging, as it will require changed
roles and behaviors by institutions, enterprises and individuals,
faced with new rules and new incentives. The Bank has had the
opportunity to assist China in its legislative developments over
this period, and we are ready to continue to provide advice and
support to the ongoing transformation of the institutions of its
legal system.
The fact that corporate governance reforms are complex reforms
implies a strong need for countries to share experiences,
knowledge, and lessons learnt while maintaining full ownership of
reforms. China's experience is a case in point. While China has
followed a unique path in market reforms, it has also creatively
borrowed and applied market concepts and lessons from the
experience of other countries. China has shown a great capacity to
learn and modernize in the area of corporate governance as
well.
On
the other hand, China's experience also offers valuable lessons for
other countries struggling with reforms. China has shown that
grafting of imported concepts and institutions into old and
traditional institutions is possible and can result in improved
functioning of market institutions. China's approach also
illustrates that imperfect, but functioning institutions are to be
preferred to institutional vacuum. We have seen the negative impact
on growth, poverty alleviation, and the legitimacy of the market
order of institutional vacuum created by shocks and rapid change in
some transition countries.
For the World Bank Group, the generation and dissemination of
knowledge, and building capacity in developing countries in
partnership with domestic and international institutions is at the
core of our mission. Our partnerships with a number of government
agencies in China in the area of corporate governance have produced
good results. I already mentioned our cooperation with the
Development Research Center on the production of this study on
corporate governance.
IFC and the World Bank have been working with the Chinese
Securities Regulatory Commission, which is one of the most active
champions of corporate governance reforms in China, to develop
capacity to improve corporate governance practices in the
securities industry and to train independent directors of Chinese
listed companies.
Creditors have a key role to play in corporate governance, and in
this context the work of the People's Bank of China on regulating
and supervising commercial banks is of central importance. The
World Bank has been supporting the efforts of the Central Bank to
strengthen the corporate governance of commercial banks through
studies and policy notes.
At
the company level, IFC is playing an important role in bringing
Chinese companies closer to international standards in corporate
governance through technical assistance, institution building in
the area of financial markets, and incentives embedded in financial
instruments.
I
don't want to finish, however, without emphasizing that while
corporate governance reforms are central to development, they are
part of a much broader framework of development. Corporate
governance needs to be viewed as an essential element in terms of
job creation, in terms of distribution of resources, in terms of
the spreading of wealth, in terms of integration into the
international community. But it is also a part of a broader
paradigm of development and it should be looked at in this way. The
World Bank Group follows a holistic approach to development. It
emphasizes the interdependence of all elements of development --
social, structural, human, governance, environmental, economic, and
financial -- and builds on partnerships for its implementation. We
in the World Bank Group look forward to working with you on the
challenging issues of development in China. Thank you very
much.
(www.h5a3.com May 26, 2002)