ECONOMIC DEVELOPMENT IN CHINA & EAST ASIA: LESSONS FOR INDIALeslie YoungProfessor of FinanceExecutive Director, Asia Pacific Institute of BusinessThe Chinese University of Hong Kong
Socialism with Chinese Characteristics • Collective (township and village) enterprises. • State owns land, natural resources, key industries and financial institutions • State holds shares in many other industries and institutions. Blocks Russian-style expropriation of state assets. • Entrepreneurship by Overseas Chinese and by investment trusts spun off by many centres of political power: local governments, ministries • Extensive cross-holdings by central government, local government and collectives. Gives political leaders leverage over business performance. • People’s Liberation Army owns Hong Kong taxi company and rents artillery for recreational shooting outside Guangzhou. • All governmental units participate in growth and rewards through tax-sharing formulae that allow them to keep a share of revenue collected. • Political competition within elite channeled into competition in economic performance
Socialism with Chinese Characteristics About one-third of the shares are owned by the State, by individuals (A Shares) and by legal persons. Employee and foreign (B share) ownership is insignificant.
Socialism with Chinese Characteristics Corporate performance improves with: • Lower private ownership: private shareholders have little leverage • Lower state ownership: state administrators concerned with welfare of workforce. • Higher ownership by legal persons, i.e., institutions such as stock companies, securities firms, trust and investment companies, finance companies and mutual funds. Such legal persons have substantial representation on the corporation’s Board of Directors and Supervisory Committee and thus have substantial leverage over management. This leverage they exert to improve corporate performance and thus the payoffs to their own units.
CORPORATE GROUPS IN ASIA Leslie Young Professor of Finance and Executive Director, The Asia Pacific Institute of Business The Chinese University of Hong Kong
EXPROPRIATION, ASIAN STYLE • Many Asian corporate groups are today organized to exploit low transparency and poor shareholder protection. The group structures and styles of expropriation depend on: • The type of entrepreneurship that originally created the surplus to be expropriated • The maturity of the stock markets
MITSUBISHI KEIRETSU • 1. Core. • Mitsubishi Corporation (trading) • Mitsubishi Heavy Industries (manufacturing) • Mitsubishi Gingko (bank) • /Mitsubishi Trust and Banking/Tokyo Marine/Meiji Life • 2. Kinyokai (Friday Club): 25-30 Main companies • 3. Group Companies: several thousand • About 25% of Japanese derive livelihoods from Mitsubishi companies
MITSUBISHI KEIRETSU Core companies: about 3% of equity held by other core companies Kinyokai: about 30% of equity held by core and other kinyokai Group companies: over 50% of equity held by keiretsu members
MITSUBISHI KEIRETSU • Suppose that companies 1,…, 100 each hold 1% of the equity of each of the others. How to take control of company 1? • Control all outside shares (1%) of company 1 and control the shares held by companies 2,3,4,5…,50. • But control of company 2 requires control of all its outside shares plus control of shares held by companies 1,3,4,5,..,50. • Thus to control company 1, must control all the outside shares of companies 1,2,..,50. • But even this might not be enough..
MITSUBISHI KEIRETSU To take control need to attend 50 shareholders’ meetings. At each meeting, argue that you have control because you control all outside shares plus each of the other 49 companies. Why? Because you control each of their outside shares plus each of the other companies. Why? Because you control…. etc. This argument is difficult to press home at any one meeting since it depends on winning the arguments at all the other meetings, which depend on winning the arguments at all the other meetings….. What if all shareholder meetings are held on the same day? What if shareholder meetings are held on different days? … at each meeting hear the sound of one hand clapping….
Figure 1: Ownership, Control and Group Affiliation Ownership of company C = 50% * 10% = 5% Control of company C = Min(50%;10%) = 10% Ownership/Control = 5%/10% = 0.5 B is tightly affiliated to group controlled by A (i.e., at the 20% level) C is loosely affiliated to group controlled by A (i.e., at the 10% but not at the 20% level) Example of expropriation: C buys asset from A overpriced by $10,000 Gain by A = $ 10,000 * (1-Ownership of C) =$9,500 A 50%O&C B 10%O&C C
Conclusions • Higher dividends are paid by tightly-affiliated corporations • For corporations tightly affiliated to a group, dividends are negatively related to the O/C ratio to offset investor anticipation of expropriation. • For corporations loosely affiliated to a group, dividends are positively related to the O/C ratio; investors less alert to expropriation. • Most loosely-affiliated corporations belong to a few large Asian groups. • Dividends are higher in Europe than in Asia; • Multiple large owners imply higher dividends in Europe (monitoring) but lower dividends in Asia (collusion). Why? • In Europe, other large owners help contain expropriation of minority shareholders by monitoring the controlling shareholder. • In Asia, other large owners collude with the controlling shareholder to expropriate minority shareholders.
In the smaller East Asian economies, private ownership of assets and stock markets have been long established: the structure of ownership and control permits the controlling family to exploit minority shareholders who have already contributed capital. By contrast, the structure of company groups in China appears designed to exploit opportunities to expropriate the state during the transition to private ownership. Since China’s companies have high state ownership, the controlling family does not need a pyramid to control a substantial portion of the shares available to the public.
Family company F buys D’s shares at a low price. D then invests in Companies A, B and C which are about to receive valuable state assets. When these investments are announced, D’s stock market price increases, benefiting the controlling family via its holdings through F. • Expropriation takes place, not through related-party transactions, but by exploiting insider information and manipulating the news reaching the market.
Lessons from China • Cannot transplant policies requiring authoritarian regime based on homogenous population • Precipitate privatization can result in massive theft of state assets via manipulation of stock market • Attract NRI investment to zones cleared of bureaucracy. • Offer bureaucrats high rewards for measurable improvements in efficiency and productivity • Convert state agencies into profit centres, gradually spin off as companies • Keep capital account closed but make foreign investment attractive and simple.
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