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Asset Stripping and Insider Control

A concurrent contributing force to the decline of public ownership in the post-Mao era is the outright self-seeking behavior of party-state officials and public enterprise managers. In a previous study (Lin 2001), I have discussed how and why the central planning system of the Mao era faded away during the i98os-i99os partly as a result of the growth of private exchange relations in the political process and with outsiders. By diverting resources from designated users and purposes, bending regulations, and directly undertaking for-profit activities, party-state officials weakened the abilities and tendencies of public enterprises to stay within the old system and at the same time expanded the economic space outside central planning. Since government officials were the main stewards of public ownership in China’s market transition, a collateral consequence of the growing collusion between political and economic actors for private gains is that it undermined the governance of public enterprises, where deteriorating organizational health partly resulting from insiders’ manipulation for private gains set the stage for the massive privatization in the late 1990s and beyond.

The corrosive effect of insiders’ self-seeking behavior on public enterprises has attracted considerable attention from both policymakers and observers. A focal issue is asset stripping—the conversion of corporate assets into private assets, primarily by insiders in the public sector. It is often discussed with reference toguoyou zichan liushi (the erosion and loss of state-owned assets), though the scope of the problem extends beyond SOEs and encompasses collective enterprises (especially TVEs) as well. Two related questions figure most prominently in connection with this. The first one has to do with the role of asset stripping in exacerbating the plight faced by public enterprises during the years leading up to the Fifteenth Party Congress in 1997. Premier Zhu Rongji, for example, regarded it as a major cause for the sagging performance of SOEs (Zhu Rongji 2011, 2:56-61, 139, 242-247). There are also numerous reports and case studies to the same effect, including some undertaken by the government’s own regulatory authorities (e.g., Chen Jian 1998; Chen Zhengyun, Yang Shuwen, and Sun Ming 1998; ZYQYGW 2003). In the 2004 CASS-HKUST private enterprise owner survey mentioned above, 66.5% of the respondents (n = 510) agreed or strongly agreed that asset stripping was a major contributing factor to the deteriorating organizational health that brought down many SOEs and collective enterprises before massive privatization.

The second question concerns the deepening effects on privatization as a result of the strategic moves by some public enterprise managers for selfenrichment during the process of ownership restructuring after 1997, such as exaggerating losses and/or liabilities, undervaluing assets, manipulating or distorting relevant information, and hiding or stealing enterprise funds. There has been a heated debate about the ramifications of these maneuverings in China. The debate was popularized by Larry Hsien-ping Lang in 2004, who was then a finance professor at the Chinese University of Hong Kong and has since become a prominent public intellectual in mainland China. In a series of investigative reports widely publicized through the Chinese mass media, he outlined the methods used by insiders to strip away corporate assets in the ownership restructuring of three well-known public enterprises—Haier, TCL, and Kelong, and he chastised the social injustice that such behavior rendered on society. Peking University economist Zhou Qiren (Zhou Qiren 2004) dissented by questioning some of the facts in Lang’s reports and suggested that the gains (if any) accruing to insiders during the downsizing and restructuring of the public sector could be seen as a necessary price that China had to pay for speeding up the process of ownership reform.[1]

While case materials and anecdotal evidence abound (e.g., Chen 2005; Chen Jian 1998; Chen Zhengyun et al. 1998), asset stripping is in large measure a clandestine phenomenon that evades systematic investigation using observational data. The inconsistencies and opacity of China’s evolving regulatory system pose further challenges to such investigation.[2] It is particularly difficult to obtain the necessary longitudinal information that would help assess the causal links pertaining to the first question stated above. What I attempt to do here is to focus on the period spanned by the second question and to search for provisional clues by examining available data on industrial SOEs before and after ownership restructuring. The issues that I seek to shed some light on include whether insider takeover of control was a significant phenomenon immediately after privatization and whether there is any suggestive evidence of extraordinary space for insiders to maneuver for self-enrichment during ownership restructuring.[3]

To explore the first issue, I make use of the information on chief enterprise leaders in the 1995 industrial census, the annual industrial enterprise surveys conducted by the National Bureau of Statistics in 1996-2003 and 20052007, and the 2004 economic census. I compare the data for industrial SOEs in the years immediately before and after their disappearance from the data sets. I count as insider-controlled enterprises the cases where the chief leaders, known asfaren daibiao or legal person representatives, of the industrial SOEs that dropped out in a given year and their names reappeared as chief leaders of nonpublic enterprises in the following year during 1998-2006.[4] The results are tabulated in table 7.6.

What the figures in the table show is that insiders did account for a sizable portion of the industrial SOEs undergoing privatization. The last two columns of the table also reveal that the debt-equity ratio of industrial SOEs in the year immediately before privatization tended to be higher among those that were subsequently controlled by insiders than those controlled by outsiders.[5] This descriptive statistic is intriguing, as it suggests that insider- controlled enterprises had taken seemingly greater financial risk than (later) outsider-controlled enterprises at the outset of privatization.[6] It is possible,

Table 7.6 Insider control of former industrial SOEs after privatization


Remaining number of industrial SOEs

Number of insiders as firm leaders the year after privatization

% of insider- controlled firms after privatization

Median debt-equity ratio in the year immediately before privatization
































































Sources: Data of 1995 industrial census, 2004 economic census, 1998-2003 and 2005-2007 NBS industrial surveys.

though, that the distribution patterns of the two groups of enterprises were subject to the influence of selection bias in the timing of privatization and a variety of other factors, such as sector, firm age, and recent performance and history. With these possibilities controlled for,[7] [8] however, a regression analysis of the data finds that debt-equity ratio still shows a significantly positive correlation with the likelihood of insider control in privatization. Why, then, did insiders demonstrate a stronger tendency to take over SOEs with greater financial liabilities than outsiders? Assuming insiders and outsiders did not have sharply different risk tolerance profiles, one would not expect this to have occurred to any significant extent unless the observed difference is due to some unobserved factor(s).

The relatively higher debt-equity ratio of insider-controlled enterprises could be associated with two possibilities that may have combined to shape the summary statistic. One is that the correlation reflected in varying degrees the real financial situations of the enterprises concerned prior to privatization. The other is that the higher ratio was inflated for some undisclosed agenda(s), such as facilitating strategic bargaining and/or illicit conversion of corporate assets into private assets during and after privatization. In the former case a major factor that could have driven insiders to take on greater financial liability is their firm-specific knowledge and experience, which outsiders did not have but insiders could draw upon to help contain any potential or real threat posed by the extra level of liability. In order for this mechanism to play out during the process of ownership restructuring, however, insiders had to be given sufficiently strong incentives that would more fully reward their unique human capital. In other words, the price of selling the enterprise (and thereby unloading the financial burden) to insiders had to be attractive enough (e.g., with a huge discount). In the case of a strategically inflated debt-equity ratio (which could result from undervaluation or hiding of equity, exaggeration of liabilities, or both), two conditions would be conducive to its occurrence: information asymmetry between enterprise managers and supervising officials, and collusion between them for mutual benefits, both of which have been discussed in chapter 4. Like the incentive effect just mentioned, these conditions would enlarge the space for insiders to benefit from the process of privatization. The stronger the inducing and facilitating conditions, the stronger the tendency of insiders to embrace and speed up privatization.

Closely related to these causal channels were the corresponding roles played by government officials as duly diligent “principals" negligent overseers, and active colluders, as I have pointed out in chapter 4.[9] To account for what shaped the observed link between prior debt-equity ratio and subsequent insider control, it would be useful to clearly distinguish and compare such roles, as well as those played by enterprise managers. Unfortunately, this undertaking is not feasible because the pertinent information is lacking. There are no published statistics on the transfer prices of privatized SOEs, nor can the manipulation by managers and their collusion with supervising officials be discerned from existing observational data.

There is nevertheless one piece of indirect evidence, revealed by a two- stage regression analysis (posted at the book site), concerning a link between sales growth in earlier years of reform and the likelihood of insider control during privatization. What it shows is that earlier overexpansion of sales had an enhancing effect on the correlation between debt-equity ratio and insider control at the time of privatization. If the relatively higher debt-equity ratio of insider-controlled enterprises indeed provides a rough proxy for the extra benefits accruing to insiders (via the channels just discussed) during privatization, then the enhancing effect is of relevance for understanding the mechanisms of deepening privatization. As I have shown in chapter 4, faster expansion of sales delinked from profitability entailed greater liability; with growing organizational scale and complexity it also tended to increase information asymmetry between management and supervising authorities. These in turn could increase the space for managerial bargaining and manipulation in the process of ownership restructuring. Although it is not possible to separate and directly identify these relevant effects from the data, the finding does point to a path-dependent link to the deepening of privatization after 1997 and suggests a need to broaden the time frame in the examination of the driving forces at work.

  • [1] For a collection of Lang’s reports and a sample of different views, see the edited volume by LiuYiqing and Zhang Qinde 2005.
  • [2] For example, before 1994 the value of land was not counted as part of the equity capital of public enterprises. That began to change after the government introduced a scheme called qingchan hezi(stocktaking of enterprise assets) among SOEs during 1994-1995. It was extended to urban collectiveenterprises in 1997 and to TVEs (by the Ministry of Agriculture) in 1998. Although there were general guidelines on how to assess and account for land values, in practice it was up to local authorities to decide on how to proceed and what criteria to use (Liu Weidong 2008; Xu Mu and ZhangXiaohua 1995).
  • [3] Such behavior does not necessarily fully overlap with the notion “asset stripping,” though, whichtypically denotes illicit diversion of corporate assets. See the discussion below.
  • [4] It should be noted that this method of estimation may be prone to measurement errors. One potential source of inaccuracy is the fact that the nonpublic enterprises headed by some of those identifiedas “insiders” might not be the same SOEs where they had been the chief leaders, though a check ofthe data based on four-digit classification sector code, postal code, regulatory authority, and in somecases firm ID code and starting year (which should have been changed to reflect the new identities andvintage of the privatized enterprises but somehow had yet to be modified in the data reported, thusexposing the common identities of the same enterprises with changed ownership) reveals a close matchfor more than 90% of the cases. Another potential source of problem is that some of the privatizedSOEs might be headed by surrogates or people with close ties to their former chief leaders (e.g., theirrelatives) or by insiders who had not been listed as the chief leaders in the preprivatization year. Suchcases are unobservable from the data. The overestimation and underestimation resulting from these twodifferent sources may be mutually offsetting in summary statistics, but the extent is unknown and thedistortions may introduce biases in further data analysis.
  • [5] I report the median instead of the mean because it is much less sensitive than the latter to the impactof a small number of extreme values.
  • [6] Another pattern it reveals is that the debt-equity ratio of industrial SOEs prior to privatizationtrended down after the turn of the century. This holds for both enterprises subsequently controlled
  • [7] by insiders and those by outsiders. A possible contributing factor is the efforts of the government toaddress the problem of nonperforming loans during the same period, which resulted in a transfer ofliabilities to asset management companies and massive write-offs by state-owned banks, as noted above.
  • [8] Details of the analysis are posted at the book site.
  • [9] These roles figure prominently in the literature on corporate governance and management buyoutin the West (e.g., Cumming, Siegelb, and Wright 2007; Shleifer and Vishny 1997). A major difference,though, is that the “principals” in China’s ownership restructuring were fictitious, as they were invariably government officials who had no intrinsic interest in publicly owned assets. They merely actedas agents of the public and were subject to the influence of private incentives. Moreover, ownershiprestructuring took place at a time when the basic structure of corporate governance was being fundamentally revamped and there existed many loopholes for insider manipulation and collusion at andbetween the corporate and the regulatory levels.
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