VOLUME 26 | NUMBER 3 | SUMMER 2014 Journal of APPLIED CORPORATE FINANCE In This Issue: China’s Capital Markets and Corporate Governance Was Deng Xiaoping Right? An Overview of China’s Equity Markets 8 Carl E. Walter Corporate Governance in China 20 Randall Morck, University of Alberta, and Bernard Yeung, National University of Singapore Presentations at the CARE Conference, Hong Kong Polytechnic University Challenges for China—Beyond Minority Listing of SOEs 43 David Webb, Webb-site.com Asian Corporate Governance—and the Case of Dual-Class Shares 50 K.C. Chan, Secretary for Financial Services and the Treasury, Hong Kong Financial Reporting Practices of China’s Listed Firms 53 Joseph D. Piotroski, Stanford University Graduate School of Business Son of Enron: Investors Weigh the Risks of Chinese Variable Interest Entities 61 Paul Gillis, Peking University, and Michelle René Lowry, University of Hong Kong The State of Asian Corporate Governance 67 Jamie Allen, Secretary General, Asia Corporate Governance Association Equity Financing for Early-Stage Companies in China 71 Ning Jia, Tsinghua University The State of Sustainability in China 76 Peijun Duan, China Central Party School, and Robert G. Eccles, Harvard Business School Politically Connected CEOs, Corporate Governance, and the 85 Joseph P. H. Fan, T.J. Wong, and Tianyu Zhang, Post-IPO Performance of China’s Partially Privatized Firms The Chinese University of Hong Kong The Composition and Effectiveness of Audit Committees in the 96 Re-Jin Guo, University of Illinois at Chicago and Presence of Large Controlling Shareholders Yin-Hua Yeh, National Chiao Tung University VOLUME 26 | NUMBER 3 | SUMMER 2014 In This Issue: China’s Capital Markets and Corporate Governance A Message from the Editor 2 Executive Summaries 4 Was Deng Xiaoping Right? An Overview of China’s Equity Markets 8 Carl E. Walter Corporate Governance in China 20 Randall Morck, University of Alberta, and Bernard Yeung, National University of Singapore Presentations at the CARE Conference, Hong Kong Polytechnic University June 9-10, 2014 Challenges for China—Beyond Minority Listing of SOEs 43 David Webb, Webb-site.com Asian Corporate Governance—and the Case of Dual-Class Shares 50 K.C. Chan, Secretary for Financial Services and the Treasury, Hong Kong Financial Reporting Practices of China’s Listed Firms 53 Joseph D. Piotroski, Stanford University Graduate School of Business Son of Enron: Investors Weigh the Risks of Chinese Variable Interest Entities 61 Paul Gillis, Peking University, and Michelle René Lowry, University of Hong Kong The State of Asian Corporate Governance 67 Jamie Allen, Secretary General, Asia Corporate Governance Association Equity Financing for Early-Stage Companies in China 71 Ning Jia, Tsinghua University The State of Sustainability in China 76 Peijun Duan, China Central Party School, and Robert G. Eccles, Harvard Business School Politically Connected CEOs, Corporate Governance, and the 85 Post-IPO Performance of China’s Partially Privatized Firms Joseph P. H. Fan, T.J. Wong, and Tianyu Zhang, The Chinese University of Hong Kong The Composition and Effectiveness of Audit Committees in the 96 Presence of Large Controlling Shareholders Re-Jin Guo, University of Illinois at Chicago and Yin-Hua Yeh, National Chiao Tung University A Message from the Editor Since the death of Mao and the return to and Taipei, he moved in 1992 to Beijing, largely an illusion created and maintained power of Deng Xiaoping in the late 1970s, where he lived and worked for the next by (1) government-granted monopolies the Chinese government has succeeded 20 years. During that time, he played a and protection against foreign competi- in engineering what two contributors to leading role in China’s first IPO, Brilliance tors and (2) a seemingly endless supply this issue—Randall Morck and Bernard China Automotive, which was launched of cheap capital provided in large part by Yeung—describe as “the greatest economic in October 1992. Then, after establishing China’s state-owned banks (whose main feat in the history of the world—the lifting Credit Suisse First Boston’s China office, mandate is to promote domestic growth, of hundreds of millions of people out of he helped lead-manage in August 1994 full employment, and the financial stability the abject poverty of a pre-industrial soci- the first listing of a state-owned enterprise, of the SOEs). And so, as Walter sums up ety.” “No other government,” Morck and Shandong Huaneng Power, on the New the current state of affairs, Yeung go on to say, “has achieved anything York Stock Exchange. And after joining remotely comparable.” Morgan Stanley in 1999, Walter became For the most part China’s National How was this feat accomplished? Was a member of the Management Committee Champions remain state-controlled enter- it the willingness of Deng and the Chi- of China International Capital Corpo- prises and act like them. Beijing plays every nese Communist Party to adopt Western ration (CICC), China’s first and most role from issuer, to underwriter, to regulator, market capitalism? The answer offered by successful joint venture investment bank. to controlling investor and manager of the the collection of articles and CARE con- In that role, he not only supported debt exchanges. The state in its many guises still ference presentations in this issue is yes and stock offerings by Chinese companies, owns nearly two-thirds of domestically listed and no. (CARE, for those unfamiliar with but participated in numerous financial company shares. it, is Notre Dame’s Center for Account- reforms over the years. ing Research and Education; and the In 2010 Walter drew on these experi- Thus it’s not surprising that the Chinese presentations in this issue took place at a ences to publish (with co-author Fraser government’s conception of the role and conference hosted in June by Hong Kong Howie) a book called Red Capitalism: The rights of shareholders has turned out to be Polytechnic University and organized by Fragile Financial Foundation of China’s very different from that in most Western CARE’s director Peter Easton of Notre Extraordinary Rise. The main argument of economies. Whereas the shareholders of Dame together with Joe Piotroski of Stan- the book—which was recognized by The companies in the West—and even some ford and Gary Biddle of the University of Economist and Bloomberg as “A Best Book parts of Asia—play an important role in Hong Kong.) of the Year”—is that despite the inten- disciplining the managements of underper- Let’s begin with a look at our lead tions of its reformers, China has ended up forming firms, the minority shareholders article. Its author, Carl Walter, is a Stan- adopting the forms, but not the substance, of Chinese SOEs are viewed in Beijing as ford Ph.D. in Political Science who was of Western capital markets. With consider- a powerless and voiceless source of inex- among the first American graduate stu- able help from U.S. investment banks like pensive capital. Most Chinese managers, dents to study in China after the collapse Goldman Sachs and Morgan Stanley, the as Walter reports, view equity as a form of Maoist revolution at the end of the Chinese government succeeded in repli- of bank loan with “optional” payments of 1970s. Fluent in Mandarin, Walter was cating the entire panoply of institutions interest called dividends. able gather enough material during his that support public capital markets, from That said, it’s also not hard to see why first stay in Beijing—which ended with his stock exchanges to regulators and audi- the interest of most Western institutional acquiring a certificate in “advanced study” tors to listed companies large enough to investors in Chinese companies—the from Peking University—to complete his justify the costs of raising public equity recent case of Alibaba notwithstanding— Ph.D. dissertation on China’s central bank capital. But, as Walter makes clear, the has been falling steadily since the flurry of back at Stanford in 1981. But instead of profitability and values of most of China’s successful banking IPOs in the mid-2000s becoming an academic, Walter became a publicly traded companies—virtually all and the series of governance scandals in banker; and after several years in Tokyo of them state-owned enterprises—are recent years. For as Walter points out, 2 Journal of Applied Corporate Finance • Volume 26 Number 3 Summer 2014 with the state still holding a clear majority After noting the aptness of the Com- Second, and more important, although of domestically listed shares, “Outsiders munist Party’s official name for its the “Big Push” has raised China to the cannot help suspecting that state entities approach—“market socialism with Chi- middle ranks of the world’s economies, largely control the share price movements nese characteristics”—Morck and Yeung the odds are against its success in taking of even Hong Kong-listed Chinese com- go on to show its affinity with the writings China to the next level. China’s per capita panies.” And this means that for overseas of Paul Rosenstein-Rodan, a mid-20th GDP, at about $6,000, is now about the investors looking at Chinese companies, century development economist cred- same as Peru’s—as compared to $50,000 there are two main sources of uncertainty ited with designing the World Bank. In or more for the U.S., U.K., and other that are likely to prevent their stock prices this economist’s view, the main challenge “high-income” countries. Recent economic from reflecting fundamental values: (1) for most of today’s developing economies history is full of rapid ascents by develop- uncertainty about who’s buying the stock: is finding a way to overcome “coordina- ing countries (like Brazil and Argentina) are there large inflows of government tion failure”—that is, to create networks that, with almost predictable regularity, capital ready to prop up the values when of suppliers and manufacturers necessary become mired in what economists now call useful or expedient? and (2) uncertainty for large-scale production where there “the middle income trap.” After discuss- about the fundamentals themselves: will are none or few.