PureInsight | May 27, 2002
3. Indication of failure in economic structural reform: The share-holding system that exists in form but not in substance
With the promotion of the so-called “Chinese share-holding system reform,” the stock market has received a lot of attention, and is quite heated and inflated. For a while, the Chinese share-holding system reform was considered the best remedy for revitalizing large and mid-sized government-owned companies. What is the outcome? How did the companies do after the shift to the share-holding system?
According to a July 2001 report from Mainland China, of the three main types of ownership structures (share-holding, government, and private), share-owned companies performed the worst. According to another research article on operational efficiency, private companies’ annual increase in assets averages 13.95%. The annual net asset increase rate is 8.11% for government-owned companies, and 7.79% for share-owned companies. These numbers show that the so-called “reformed” companies that went public had no competitive advantages at all. These companies were reorganized when the transformation happened, and the non-profit divisions were eliminated. Then, why are the reorganized companies even less efficient than government-owned ones? The real reason is that the share-owned companies in China were merely changed on paper, while in reality they did not operate according to the requirement of a true shareholders’ company.
When the idea of share-holding companies first emerged and when the scholars were still persuaded by the blueprint of share-holding companies’ management, the “share craze” in Shenzhen and Shanghai was already riding high. Company managers immediately recognized share-holding companies’ significant potential to raise capital and fully utilized it. By now, from experts to ordinary citizens, everyone has realized that selling shares is merely one way for the companies to make money. It does not fundamentally change the way companies operate, and does not truly separate company ownership from its operations.
Since the profit of government-owned capital is directly affected by the operation of the company, government-owned shares of these companies are at risk of loss and even bankruptcy. Thus, the government is often involved in decision-making processes, blurring the separation between politics and enterprise. The managers of these companies have no supervisor to restrict their power, and no one to monitor them. When they make a profit, they keep it in their own pocket. When they lose money, the government steps in to subsidize the operation. As a result, the management of government-owned companies is often chaotic. The managers have much power, yet they don’t have to take responsibility for losses. How are they expected to be good managers if they have no accountability? Corruption, fraud and bribery are inevitable outcomes of this situation.
If that’s the case, why are many local governments and enterprises so eager for such share-holding systems? One incentive for reorganizing government-owned companies is to avoid repaying debts. Because most of these share-holding companies were formed when non profit-making divisions were separated, old debts were naturally transferred to the government along with the non profit-making divisions. In 1999, the Chinese government established Huarong, Xinda, Dongfang, and Changcheng, four financial asset management companies, aimed at managing the 1.3 billion yuan of debt carried by the four largest government-owned independent banks (Industrial and Commercial Bank, Bank of Construction, Bank of China, and Bank of Agriculture). The asset management companies also signed agreements with over 100 large to medium-sized government-owned companies to transfer debts. However, this method didn’t solve the fundamental problem. By the end of 2000, 51%, or 32,140 of the reorganized companies had managed to avoid repaying bank loans and interest for a total 185 billion yuan. This amounts to 32% of the total loan and interest made to reorganized companies, and equals 2.07% of the 2000 GDP. The tremendous amount of bad bank loans has become a ticking bomb that could destroy the Chinese economy anytime.
Another very important factor that led to this situation is that local government officials and company managers took the share-holding system reform as an opportunity to exploit government-owned capital, a “free lunch of Socialism,” or an exchange of power and money. There are countless such examples. One of them is the so-called “first public sharing-holding company with foreign capital in China.” It claimed to have “started with 1.5 million yuan and had a 60-time increase in net assets in two years.” In actuality, two government-owned companies invested the initial 1.5 million yuan. However, 40% of the 1.5 million yuan was illegally transformed to the accounts of two individuals and a Hong Kong businessman. The shares that belong to these three people changed hands many times. When the total asset of the company was inflated to 4.2 million yuan, the Hong Kong businessman managed to obtain control of the majority of the shares. When the total asset was further artificially inflated to 27,540,000 yuan, the board members decided to transfer the “increased value” and re-allocate it among the shareholders. Individual shareholders were allocated 2.47 million of that “profit.” Meanwhile, the Hong Kong businessman who had invested almost nothing was awarded 24.67 million, of which 8.07 million was later transferred to foreign accounts through various channels. Before the company even went public, the Hong Kong businessman’s share was inflated to 98.6% of the entire company (64.6 million), while the government, which had invested the most, only held 1.4% of the company. Furthermore, the government-held shares are non-priority shares, leaving the government out of any decision-making process.
In order to attract more investment, it is not uncommon for these reformed companies to forge records and inflate returns. This is accompanied by inside-traders in the stock-exchange business who sought immediate and high profit. In the end, it is the general public who suffers the consequences. According to a special report from the Washington Post, a Chinese Finance Department survey showed that 98.7% of all companies that went public forged records to inflate profit. Large investors, company CEOs, accountants, and business reporters have formed a power group that quietly controls the Chinese share market. The biggest victims of these conspiracies are the general public who invests in small amounts. Last September, the Chinese Auditor’s Board discovered that Guangxia (Yinchuan) Limited Liability Company falsified records to show a profit of 745 million yuan in two years. Guangxia’s accounting firm contributed to the company’s malpractice by giving largely untrue evaluations and high ratings.
According to China’s State Audit Administration’s estimate on 187 large or medium-sized companies, 70% of the loss of government-owned capital occurred within the companies themselves. In other words, individuals or power groups purloined 70-80% of government-owned capital. Why did this problem happen on such a large scale? Undoubtedly, the reform of the share-holding system opened the door for “insider thieves” to move assets from the company to under their own names. Some people said that the growth of the Chinese economy largely relies on the transfers in paper of government-owned properties (and the actual losses incurred by such transfers). If that is true, does the slowing pace of growth in recent years indicate that government-owned capital that could be purloined is running out?
4. Situations investors are in:
To answer the government’s call, investors put their blood-and-sweat money and years of savings into the Chinese stock market, hoping to obtain, along with the growth of the economy, some gains above the interest rate. However, the stock market mercilessly made fools of them as they took the media’s propaganda as true and followed market analysts’ advice to invest in “good performers.” Nevertheless, some of the biggest bombs were these very stocks. For instance, “Yin-Guang-Xia”, the once Best Performer, fell from 37 yuan to 2 yuan because of false financial statements. Many investors lost all their hard earned money. This isn’t an isolated case. Falsifying records has become a common phenomenon. Almost all listed corporations in China make false statements. At the moment those “good performers” such as Lantian, and Oriental Electronics are also being investigated and their stocks have also fallen to an unbearable level.
When the momentum for “good performers” declined, the so-called “loss stocks” under the notion of asset reallocation became hot. Investors turned to the ST stocks (ST means special treatment after three years’ loss). When a ST stock continues another three years’ loss, it becomes PT (PT: further special treatment). It appeared that there was something to invest for, but this proved wrong again. Last November, China’s Security Committee suddenly announced its new Regulations for Withdrawing from the Market, namely if an ST stock cannot convert its loss within half a year, it will no longer be given PT but will directly withdraw from the market. As soon as this policy was announced, ST stocks fell one after another. Investors who bought these stocks lost completely. In this market, without a regulation for gaming, investors were hammered into a maze by the policies that come “once in the east and another time in the west.” They were lost as to which stocks to buy.
If things had stopped there, it would have been quite all right. Nevertheless, in June last year, the government staged a plan to reduce the market price of stocks of state-owned corporations and announced that the amount of the reduction was to be injected into social welfare funds. Investors could not understand why their blood-and-sweat money put into stocks could suddenly be cut to bear the historically remaining government responsibility. Why should a big gap in the social welfare funds for the whole nation be filled by 60 million investors’ hard-earned money? The Minister of Finance, government-paid economists, and analysts all argued without conscience, “The stock price reduction of state-owned corporations is good.” Thus, investors were convinced and continued to hope for the rise of their stocks. After a half year’s waiting, the index fell from 2,245 in June last year to 1,346, and recently has risen to around 1,450. Many stocks fell to half their earlier prices and many became only a few cents. Experts then started to work out some new reduction plans to bring out a multiple-gainer situation. The fooled investors have continued to wait for the government’s good policy and for the opportunity to sell their stocks.
As a matter of fact, the investors have been wrong from the beginning. China’s objective in setting up its stock market is not to optimize asset allocation and establish a modern system for enterprises. Rather, its purpose is to inject blood into failing state-owned enterprises in hopes that these enterprises will recover and survive in order to maintain an economic stability on the surface. However, because the ownership of assets is not clearly defined, management of the state-owned enterprises has been relentless in spending investors’ money and achieving very little in investment returns. Once the money is spent, new effort is initiated to trap more money from the stock market, which has been used as a cash machine, thus creating a formidable malignant cycle.
(To be continued)
Translated from:
http://www.zhengjian.org/zj/articles/2002/4/12/15363.html
