Corporate Restructuring & Governance BUSI 3101: 2016 CRRC International Talent Development Programme

Corporate Restructuring
& Governance
BUSI 3101
Lecture 10
Dr. Young Un Kim
2016 CRRC International Talent Development Programme

Announcements
• Seminar 2 starts this week
>> Attend your designated seminar time.. please
You are required to:
– Read the article of Jiangsu Glass provided on Moodle
under seminar 2.
– Prepare answers to the questions asked in the document
seminar 1 assignment on Moodle under seminar 1.
Copyright 2019 © Nottingham University Business School China. All Rights Reserved 2
Guest Lecturer – Xuan Ye
• Senior Private Equity Investor
– at Inflexion Private Equity, Shanghai, China
– Envision Capital, Shanghai, China
– MBO Partenaires, Paris, France
– …
• Academic
– Researcher in Carl von Ossietzky Universität Oldenburg
– Lecturer, EM Lyon, Shanghai Campus
– PhD Candidate at UNNC
– …
Today’s Lecture
• Key issues in corporate restructuring &
governance and relevance for China
• Antecedents & effects
• Buyouts and private equity
• Role of Boards
• Design of Compensation
• Market for corporate control & takeovers
Copyright 2019 © Nottingham University Business School China. All Rights Reserved
Key aspects
• Corporate restructuring key part & parcel of
today’s business conduct, also in China
• General picture is of some convergence of
China’s business system towards Anglo-Saxon
system, but with state as key actor
• Move from state-owned enterprises towards
privatisation (especially SMEs)
• State-owned enterprises more modelled after
western-style public corporations:
Corporatisation (listed corporations with state
as key shareholder)
Private Equity Trends in
China
7
8
Antecedents & effects of CR
- Significant part of restructuring in China initiated by
government reform of state-owned enterprises (SOEs)
- Inadequate SOE performance has triggered restructuring
in China: corporatization & privatisation (Aivazian, 2005)
- Weak corporate governance important factor for
restructuring (especially in 1990s and early 2000s), as
associated with poor firm performance and financial
manipulation
- RBV a further explanation for current restructuring
- Increasing recognition that corporate governance
mechanisms play key role in facilitating efficient and
accountable firms.
Performance of SOEs weak, leading to further SOE reform
Private Equity Trends in

China
Nature of CR in China
- Corporatization in SOEs: introducing corporate
governance mechanisms similar to developed countries
(1993 corporate law): CEO monitored by Board of
Directors; independent directors; managerial ownership.
- Aivazian et al 2005 find positive effect from corporatisation
on firm performance (sample 429 SOEs, period 1993-98;
in this period 72% of sample have been corporatized)
- Privatisation: Firms move from state-owned towards
privately owned. Overall evidence is not so positive, IPOs
have not led to improvements of performance. However
some studies indicate that privatised SOEs still
outperformed SOEs that were not privatised
- Ongoing SOE reform, national level as well as local SOEs
Modern CG in Chinese firms: 1993 company law
(revised 2005, 2013)
• The 1993 Company Law was introduced to formulate modern
governance structures and required firms to be operated under
the rules of market competition.
• It stipulates that the Board of Directors monitors managers.
Directors are elected at a general meeting of shareholders
under a one-share-one-vote system.
• The Board of Directors is usually composed of the delegates of
the large shareholders, who can nominate managers to be
members of the Board.
• When the government is the largest shareholder, a former party
secretary or a retired bureaucrat is usually assigned to be the
chairman of the board.
• 2006 new company law allows public access to basic company
registration information (identity of shareholders) – also provides
rules to allow shareholders to gain information from the
company (financial reports, minutes of meeting of BoD & BoS)
Reform in SOEs
Private equity investment in SOEs: Sinopec

•A group of private equity investors, including CICC Capital,
RRJ Capital and Hopu Investment Management, have
invested in Hong Kong-listed Sinopec as the Chinese oil
refiner agreed to sell a RMB107.1 billion ($17 billion) stake
in its retail business.
•The deal comes as China pushes to restructure its state-
owned enterprises by bringing in more private capital to
diversify ownership.
Source: Asian Venture Capital Journal 15 Sep 2014
Reform in SOEs – local SOEs
• Local SOEs have performed worse than their central
counterparts, meaning there is plenty of scope for
improvement. “It’s opening wide up. There is a ridiculous
amount of deal flow coming our way,” says a manager
with an international private-equity firm. The southern
province of Guangdong recently held a meeting at which
it offered stakes in 50 different SOEs, according to
people present. Shanghai has also been at the forefront.
In June it sold a 12% stake in a subsidiary of the Jin
Jiang hotel group to Hony Capital, a local private-equity
firm. Analysts say that this will encourage better
management practices at Jin Jiang, including stock-
option incentives for executives, and that it could serve
as a template for future such deals.
• Source: The Economist, August 30th, 2014
Private Equity in China
Interview of Caijing with Mr. Liu, chair of the board and of the
executive committee of Hony Capital
Caijing: Insiders doubt that private equity can really bring change to
companies. Unlike industrial investors, private-equity investors aren't
experts in industries, but financial investors with relatively short-term
goals to make profit.
Mr. Liu: Private-equity firms can help firms in multiple ways beyond
just providing capital. As I mentioned, private equity can aid state-
enterprise reform. Management incentives brought by state-
enterprise restructuring can then motivate the company to perform
better. Private-equity firms also provide experience for enterprises in
setting strategic goals, since private-equity firms have many industry
experts who understand corporate management. Even more, private-
equity firms can aid merger-and-acquisition strategy and
implementation.
The role of boards
China: dual tier board, with supervisory board and board of
directors (CEO monitored by board of directors; supervisory
board relatively minor role)
Corporate governance mechanisms:
- BoD needs independent directors (listed companies): Hu et
al 2010 find that average number of board member is 10,
among those on average 3 are independent directors
(sample of 304 listed Chinese firms, 2003-2005)
- Role of independent directors (CSRC 2001: guidelines for
introducing independent directors to the board of directors of
listed companies): independent directors especially need to
protect the interests of minority share holders
- Code of Corporate Governance 2002: BoD may establish a
remuneration, audit and nomination committee, which shall
be chaired by an independent director; and other special
committees
The role of boards: evidence
- Jiang et al 2009 find that independent directors help improve
performance of privatised firms relative to non-privatised
firms (period 1999 to 2002).
- Fan et al 2007 look at political connections of CEOs in
publicly listed Chinese firms.
They find that in publicly listed firms boards with politically
connected CEOs have stronger representation of current or
former government bureaucrats show weaker firm
performance than politically unconnected CEOs/boards.
- Hu et al 2010 find strong negative correlation between
ownership concentration (often state as dominant
shareholder) and firm performance (while ownership
concentration leads also to lower proportion of outside
directors and supervisors).
BoD, firm performance and CEO
replacement
• Conyon and He (2011) in their study of Chinese listed
firms find that poorly performing firms are more likely to
replace their CEOs.
• Boards with a higher fraction of independent directors on
the board are more likely to replace the CEO for poor
performance.
• Privately controlled firms are more likely to use market
based performance measures to discipline managers
(poor stock returns more likely to lead to replacement of
CEOs). SOEs more likely to replace CEOs if results are
poor based on accounting performance
Design of compensation
- Design of executive pay mainly based on base salary and
annual bonus in China whereas in UK/EU/US main incentives
expected to come from stock options (ESOs) and share awards
(LTIPs).
- Firth et al 2007 find a positive pay–performance relation in
China when performance is measured as return on assets. In
contrast, stock returns do not affect CEO compensation.
- State ownership acts to reduce compensation levels while the
presence of a foreign shareholder leads to higher pay for the
CEO. Foreign presence also increases likelihood of CEO pay
being based on the firm’s operating profitability.
- Firth et al 2007 find that boards with more NEDs are more
likely to use performance based pay design.
(Firth et al 2007: How ownership and corporate governance influence chief

executive pay in China's listed firms)
Design of compensation (2)
- Conyon & He (2011) use data on public traded Chinese
firms listed on the domestic exchanges from 2001 to
2005.
• Find positive correlation between executive pay and
shareholder returns in firms when there is a higher
fraction of independent directors on the board
• Find no correlation between pay and stock returns in firms
with a low fraction of independent directors.
• This indicates that stronger monitoring quality by the
board (due to higher fraction of independent directors) is
associated with a stronger link between pay and market
performance.
Managerial ownership
- Wang & Judge (2012) look at the effect of managerial
ownership on performance in Chinese firms. (357 SOEs for
period 1999-2006)
- Find a positive relationship between managerial ownership and
performance in Chinese firms.
- Find a positive effect of leverage (debt) on firm value, indicating
that corporate creditors enact efficient external monitoring
- Do not find a significant effect of privatisation on firm
performance
- Overall they conclude that the use of internal incentives and

corporate governance mechanisms (managerial ownership)
may be more effective to reduce inefficiency compared to
privatisation
Market for corporate control
- Threat of takeover and competition of alternative
management teams can be seen as external corporate
governance mechanism: underperformance may lead to
replacement of the management team
- Wang (2010) finds that likelihood of top executive
replacement is higher if performance is low in Chinese listed
companies
- Still limited research on market for corporate control, studies
report that compared to UK/US/Europe it is less effective due
to strong state influence (restrictions) on takeover market.
- Significant numbers of mergers and acquisitions in China
(around 2700 deals for 2009 according to PWC), with around
500 foreign buyers
- Private equity fund are growing in China, also increasing
presence of foreign investors (KKR; Blackstone etc.)
Concluding Remarks
• Recent reforms have led to restructuring
through corporatisation and privatisation with
increasing use of internal corporate
governance mechanisms
• Ongoing reforms of SOEs provides
opportunities for PE investments
• Evidence that corporate governance
mechanisms (boards, compensation,
managerial ownership) have significant
impact on performance in Chinese firms.
Next week - Revision
Lecture
• Focus on revision and exam
• Final Exam: Dec 31, 2019
• Put your questions through the Forum on Moodle
THANK YOU

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Corporate Restructuring

Dr. Young Un Kim

2016 CRRC International Talent Development Programme

Private Equity Trends in

Private equity investment in SOEs: Sinopec

Source: Asian Venture Capital Journal 15 Sep 2014

(Firth et al 2007: How ownership and corporate governance influence chief

- Overall they conclude that the use of internal incentives and

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