In Search of an Effective Monitoring Board Model: Board Reforms and the Political Economy of Corporate Law in China

Abstract

Increasing economic globalization has fueled lively debates on the similarities of and differences between national corporate governance systems. Central to the debates are the key questions of whether different corporate governance systems will converge towards a single and standard model, and if yes, what are the barriers to the convergence of different national systems. The board governance system, for example, is a major corporate governance difference between countries. Broadly speaking, two models of board systems have developed in advanced economies. They are the dual board system (predominant in some continental jurisdictions, such as Germany and Netherlands) and the unitary board system (predominant in many other jurisdictions, in particular, the UK and the US). Board reforms have been seen in the EU, the US, and elsewhere in the aftermath of, among others, the Enron, WorldCom, and Parmalat scandals. Functional convergence and hybrid convergence of national board systems now seem prevalent. China's board reforms, however, present a unique pattern of change in formal board governance rules. The Chinese 1993 Company Law adopted a mandatory dual board structure that, in many respects, resembles the German two-tier board. In 2001, the China Securities Regulatory Commission (CSRC), China's securities market watchdog, required all companies listed on Chinese stock exchanges to have independent directors, marking a formal convergence toward AngloAmerican practices. Then in 2005, the National People's Congress (NPC), China's supreme legislature, made major amendments to the 1993 Company Law, amid a fierce debate over the design of an effective monitoring board. The reform strategy was remarkable: on the one hand, the new institution of independent directors was "codified" and made mandatory for all Chinese listed companies, regardless of their size or ownership structures. On the other hand, the traditional management-supervisory dual structure was preserved and the supervisory board as a monitoring organ strengthened. The current literature on the board reforms in China focuses primarily on whether or not the institution of independent directors may fit into the existing institutional settings in China.2 It does not address a deeper puzzle: what forces have shaped the evolution of Chinese legal rules on board governance? The 1993 Company Law was largely the product of a small coterie of officials and legal scholars. Recent economic reforms, however, have radically changed the political economy of corporate law making in China. Board governance issues, which affect all listed companies, have become ones on which relevant interest groups within the listed companies compete to exert their influence. These interest groups include the majority shareholders, the minority shareholders, the incumbent managers, the supervisors, and the employees. Thus, the trajectory of board governance reforms has been shaped not only by the official ideology and the policy agendas of the CSRC and other central government agencies, but also by interest groups politics. Within this analytical framework, I try to provide an understanding of why the mandatory independent director rule was adopted in 2001 and then, amid stiff opposition, codified in the 2005 Company Law, and why the institution of the supervisory board has persisted, despite its ineffectiveness and inefficiency in monitoring. I show that the powerful forces of globalization have an important bearing on the Chinese government's perception and choice of efficient board governance rules. The mandatory independent director requirement, which signals a formal legal change in the direction of AngloAmerican corporate governance practices, was an exemplary outcome. The dynamics of interest group politics and the forces of the predominant ideology, however, have created barriers to a wholesale convergence, and path dependence of the mandatory two-tier board structure contributed to its persistence. The article is structured as follows. Part II examines the legal rules that govern the board-level monitoring organs under the 1993 Company Law and discusses why in practice these organs have generally failed to discharge their oversight functions. Part III discusses the two approaches to board reforms, namely, strengthening the effectiveness of the supervisory board and introducing the institution of independent directors. It further assesses the extent to which the CSRC's regulatory initiative of installing independent directors on corporate boards has achieved its goals. Part IV then outlines and comments on the three aspects of the 2005 corporate law reforms that have a bearing on board-level monitoring of Chinese listed companies. Part V presents a political economy analysis of the board reforms elaborated in the preceding parts. It identifies the interest groups affected by the board reforms, and then discusses the intricate dynamics among globalization, local interest group politics, and ideology, and its influence on the making of Chinese corporate law. Part VI offers some conclusions.

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