Political Economy of CorporateGovernance of Chinese Firms

Chenggang Xu

University of Hong Kong and SNU-WCU

11/06/2012

The Party and China’s Institution

• The Communist Party of China (CPC) is the backbone of China’s institution– The Party controls all levels of governments through

personel control– The legislator, People’s Congress (PC) at all levels of

government, is controlled by the Party– Appointments of all important posts are controlled by the

Party (e.g., CEOs of banks and large SOEs etc.)– Local governments controls economic resource– Party’s role in corporate governance of SOEs– Party’s role in corporate governance of private firms

The Party and the private sector• Private sector takes off since the late 1990s, and soon

becomes the driving force of China’s growth – The output share of private sector in national GDP has increased

from 2.5% in1998 to 47% in 2009

– Silent large scale privatization since 1997

– During 1998-2005 private sector’s output was increased by 20 fold

• However, the Party is losing control over private firms– In 1995 only 7% of private firms have party organization

– the private sector’s share of CPC member further declined between 1997 and 2002

– The growth rate of the nationwide CPC members in reserve was negative in this period! A very serious matter to the party’s future

Dramatic growth of China’s Private Sector

Year Private Industrial Enterprises Loans to Private enterprises &Individuals

　 Gross Output( mil Yuan)

% GDPLoans (mil Yuan)

% GDP

1998 2082.9 2.5% 471.7 0.57%

1999 3244.6 3.7% 579.1 0.65%

2000 5220.4 5.3% 654.6 0.67%

2001 8760.9 8.1% 918 0.85%

2002 12950.9 10.9% 1058.8 0.89%

2003 20980.2 15.5% 1461.6 1.08%

2004 35141.3 22.0% 2081.6 1.30%

2005 47778.2 25.7% 2180.8 1.17%

2006 67239.8 30.9% 2667.6 1.23%

2007 94023.3 35.1% 3507.7 1.31%

2008 136340.3 43.1% 4221.2 1.33%

2009 162026.2 47.2% 7117 2.07%

Year CPC Members CPC Members in reserve

　 Total Number (10000) GrowthTotal Number (10000)

Growth

1991 5151.7 2.38% 177.71992 5279.3 2.48% 191.7 7.87%1993 5406.5 2.41% 193.9 1.18%1994 5540.7 2.48% 203.1 4.71%1995 5703.3 2.93% 235.8 16.11%1996 5873.1 2.98% 251.2 6.54%1997 6041.7 2.87% 253.5 0.91%1998 6187.7 2.42% 243.2 -4.05%1999 6322.1 2.17% 240.1 -1.29%2000 6451.7 2.05% 232.7 -3.08%2001 6574.9 1.91% 231.2 -0.64%2002 6694.1 1.81% 232.4 0.50%2003 6823.2 1.93% 241.8 4.08%2004 6960.3 2.01% 259.0 7.10%2005 7080.0 1.72% 269.3 3.97%2006 7239.1 2.25% 286.0 6.20%2007 7415.3 2.43% 294.7 3.05%2008 7593.1 2.40% 312.1 5.88%2009 7799.5 2.72% 　　2010 8026.9 2.92% 　　

Legal/institutional changes on private sector

• As a response, the CPC constitution was amended in 2002– In year 2000, Jiang Zemin, the Chairman of the CPC, declared that

the CPC should legitimately recruit entrepreneurs at a large scale– Amendment to CPC Constitution in 2002: entrepreneurs are

recognized as advanced productive force for the first time

• Legal protection of private property rights: Amendment to the PRC Constitution, 2004

• As a result, 2003 is a turning point for the party to reverse the declining trend– Growth rate of CPC members in reserve was increased from -3%

in 2000 and 0.5 in 2002 to 4%– The private sector’s share of CPC members was increased from

1.7% in 2002 to 3.1% in 2003– In our sample, the share of party members among entrepreneurs

was increased from 20% in 2000 to 41% in 2006

Some basic questions to be addressed

• The dynamics of the importance of the Party in private sector

• Given the party is the dominant force in the national economy, – Do party-member entrepreneurs enjoy rents associated with their

party-membership capital?

– Associated with the change of the roles of the party in the private sector, what is the dynamics of rents enjoyed by party-member private owners?

• What are the implications of political elites’ rents to social welfare?– With resource obtained under favorable conditions do they

perform better than others?

A summary of some basic findings • The party was losing ground in private sector when the sector was at

a jump-start stage; but later regained control in this sector– From 1995 to 2000, the proportion of entrepreneurs who want to

join the party declined sharply– The trend was reversed after 2005

• Political rent of party members is negligible when the party is losing– Firms owned by CPC or PC members do not obtain more

resources than others before 2005 • Associated with the party’s regaining control, political rent becomes

significant– Firms owned by CPC or PC members obtain significantly more

land and bank loans than others after 2005• Political rent does not contribute to productivity

– With more scarce resources, CPC and PC member-owned firms do not perform better than the rest

Entrepreneurs’ perspectives on the Party

and party organization within private firms1995 2000 2006 2010

Is the entrepreneur a CPC member? 17% 19.90% 40.50% 41.50%

Does the entrepreneur want to join CPC if he/she is not a member yet?

23.6% 14.15% 24.48% 48.25%

Did the entrepreneur join the Party before you startup?

84.20%

Does the entrepreneur regard joining CPC be helpful to improve his/her status?

17.90% 7.80% 35.50%

Does the entrepreneur regard being a PC member be helpful for his/her status?

33.40% 27.10% 48%

Does the firm have a party organization? 7.05% 17.18% 34.66% 34.55%

No. of observation 2869 3073 3837 4624

1995 2000 2006 2010

En_CPC

0.14 -0.0146 0.00560 -0.304***

(0.150) (0.103) (0.0823) (0.0681)

Gender_F

0.46*** 0.335** -0.124 0.293***

(0.154) (0.136) (0.115) (0.0947)

En_Edu

0.0753 0.144 -0.194* -0.245**

(0.114) (0.102) (0.112) (0.111)

En_age

0.00440 0.0138** -0.00220 -0.00707*

(0.00605) (0.00551) (0.00511) (0.00408)

Firm_age

-0.0402*** -0.0223** -0.0573*** -0.0665***

(0.0149) (0.0108) (0.00905) (0.00736)

Firm_size

-3.42e-08*** -0.0001*** -0.00004*** -0.00002***

(4.32e-09) (0.00001) (0.000004) (0.000002)

En_share

-0.00419 -0.261* -0.0022 -0.004***

(0.00257) (0.154) (0.00142) (0.00115)

En_exp

-0.150 0.00580 0.0420 -0.110

(0.186) (0.0895) (0.0826) (0.0947)

N 1160 1908 2323 3082

Entrepreneurs’ Perceptions on the importance of being a Party member to their economic status: significant only in 2010

From political capital to economic capital: Monetary rents enjoyed by CPC/PC members

• The changes in entrepreneurs’ perceptions on being a party member raise a question on the dynamics of benefits that party members may receive

• No observable extra rents for party members in 1995 and 2000

– Firms owned by CPC or PC members were indifferent in borrowing bank loans from and others in 1995 and 2000.

• Substantial rents enjoyed by CPC/PC members in 2006 and 2010

– Firms owned by CPC and PC members borrowed significantly more bank loans than those owned by non-CPC or non-PC members

– Firms owned by CPC or PC members enjoyed significantly higher chances in obtaining bank loans than other firms

From political capital to economic capital: Pary-member owners and access to land

• No observable extra rents at earlier periods– Firms owned by party members and by others were indifferent in

obtaining land in 1995 and 2000

• Both CPC and PC members enjoyed substantial rents in 2006 – For firms owned by CPC and PC members, the land value over total equity ratio

is significantly higher than those of other firms in 2006.

• PC-owned firms are associated with higher ratio of lands in 2010 though statistically not significant (with P-value at 0.12)

• Plausible reason: land prices in 2010 were much too high that only very top elites would have chances to enjoy the rents

Institutional impediments to entrepreneurship

• The private sector is the major engine of China’s growth and entrepreneurship is the future of China– The share of private firms’ contribution to the Chinese GDP grow

fast from zero in 1980 to more than half in 2011

– The picture in employment is even more striking, counted for 90%

• But private property rights are still insecure, the government still controls critical aspects of production– Although entrepreneurs have obtain constitutional protections of

their private property rights since 2004, arbitrary fees were still imposed to them; courts are not independent

– The government controls the land, credits, and energy etc.

• We discover that these institutional impediments affect entrepreneurs’ allocation of their time (efforts) substantially

Contracting Institution & Work Time• China’s courts are not independent from the government• Evidence: Formal contracting institution in China

discourages productive work– Ceteris paribus, entrepreneurs who had business disputes settled

by the court chose to work less in total hours

• They work less in management;

• Their PR time is indifferent; but they spend more time in “study”

– “Study” include political studies and the “party schools”

• Evidence: Private settlement is less damaging– Ceteris paribus, entrepreneurs who had business disputes settled

privately did not affect their total work time and management time

• They spent more time in PR; but less time in study

Political motive and political elites • In addition to weak property rights and contracting

institution, there are other sever institutional constraints– e.g. government intervene allocation of capital, land, energy– Politically connected entrepreneurs are treated much better

• Many entrepreneurs in our sample reported political motives – 45% entrepreneurs want to become a Congress member– 48% of them want to cultivate an intimate relationship with the

government

• Ceteris paribus, politically motivated entrepreneurs spend more time in PR; but indifferent in other working times

• Ceteris paribus, PC-member entrepreneurs spent more time in PR– They have longer working hours; indifferent in other aspects – They counted for 19% of entrepreneurs in our sample

Concluding remarks

• When the private sector was unimportant, party-member entrepreneurs did not have rent-seeking opportunities

• The impacts of the CPC declined in the late 1990s

• Party-members’ political rents grow along with the growth of the private sector and the reform of the Party– The CPC reformed the Party by recruiting entrepreneurs: ‘Three

Representatives’

– More rent-seeking opportunities become available

• The political rents enjoyed by party-member entrepreneurs do not contribute to productivity/social welfare

Concluding remarks (2)

• Chinese entrepreneurs reduce their working hours substantially when the government violate property rights (e.g. impose fees arbitrarily)

• A substantial percentage of entrepreneurial working time is allocated to non-productive tasks (PR time) to remedy the institutional obstacles

Concluding remarks (3)• They waste more time in dealing with bureaucrats

– When their contract enforcement involves the government

– When they make losses

– When they expand business;

– When they involve M&A; or change corporate governance

– When their R&D involves patents

• Given the general insecurity of property rights, nearly half of the entrepreneurs in our sample have political motives– These entrepreneurs divert more time in PR than other

entrepreneurs