Back in September 1999, the 4th Plenum of the Communist Party's Central Committee declared that corporate governance lies at the core of the modern company system. The China Securities Regulatory Commission (CSRC) and the State Economic and Trade Commission (SETC) collaborated to develop the Code of Corporate Governance, released in 2002 and currently applicable to all listed companies in China on a "comply or explain basis." The Institute of International Finance (IIF) in a 2006 follow up report to a 2003 report, observed that positive changes in the corporate governance framework have been made through revisions to the Company Law and Securities Law. These changes, which came into effect on January 1, 2006, strengthen minority shareholder rights. However, more needs to be done by way of implementation and enforcement of revised rules and regulations. While the recent steps might lead to a de jure compliance with applicable international principles, ultimately, according to the IIF, the government's recent steps to improve corporate governance, important as they are, do not provide a long-term solution for the major corporate governance problems in China. To bring about real effective change, it is necessary that the government reduce its role and influence in Chinese companies.

General Overview

The basis for this assessment is an updated March 2006 Task Force Report by the Institute of International Finance (IIF) on Corporate Governance in China, assessing it against the IIF's "Code of Corporate Governance for Emerging Markets". The IIF's guidelines differ from the broader Organization for Economic Cooperation and Development (OECD) Core principles in that they are more detailed and aimed at implementation, but do not diverge from them in their substance. (IIF 2002, p. i)

Since the IIF's first China Task Force visit in late 2003, improvements have been observed in the overall corporate governance structure of the country. In its follow-up visit in February this year, the Task Force recognized that positive changes in the corporate governance framework have been made through revisions to the Company Law and Securities Law. These changes, which came into effect on January 1, 2006, strengthen minority shareholder rights by: (1) Allowing companies to use cumulative voting, if desired, thereby empowering minority shareholders to appoint directors and/or supervisors; (2) Imposing a stricter duty of care on directors, supervisors, and senior management; (3) Granting shareholders the right to bring a derivative suit or direct suit against directors, supervisors, and senior management; (4) Introducing the concept of 'piercing the corporate veil,' enabling courts to look beyond the principle of limited liability and; (5) Increasing minority shareholder protection by granting shareholders the right to check and copy the company's account books and meeting minutes, allowing share buybacks, and granting shareholders the right to petition for liquidation of a company. (IIF 2006, p. 2)

Despite this progress, China continues to lag behind many other emerging market countries in the area of corporate governance. The IIF report confirms that, while China's overall corporate governance framework now complies with roughly two thirds of guidelines prescribed in the IIF's Code, up from about one-half two years ago, corporate governance as practiced in most Chinese firms has considerable room for improvement. (IIF 2006, p. 2)

The IIF Task Force recommended that more needs to be done by way of implementation and enforcement of revised rules and regulations. Specifically, the Task Force proposed the following actions to further improve corporate governance in China: (1) Reduce state interference in operations of SCCs; in particular, reduce the state's influence in appointing senior management and in setting business strategy; (2) Introduce corporate governance best practices designed specifically to improve corporate governance in SCCs; (3) Move from "comply or explain" to a strictly enforced Code of Corporate Governance; (4) Align management interests with the interests of minority shareholders; in particular, better align executive remuneration with overall company performance; (5) Rationalize the board governance structure by eliminating redundancies caused by the quasi two-tier structure; (6) Establish specialized courts to deal with enforcement of securities laws; this will expedite the delivery of justice for securities and finance-related offenses and reduce the cost of litigation; (7) Allow new listing of A shares on the Shanghai and Shenzhen stock exchanges. (IIF 2006, p. 9)

The 2005 Financial Stability Report, published by the People's Bank of China (PBC), acknowledges that despite great progress, there is still a gap between corporate governance of China's financial institutions and requirements of the OECD principles. Particular attention should be given to the following two aspects. First, ownership ambiguity and the problem of insider control of financial institutions. Second, market-driven incentives and checks and balances. Over the past years, state-owned and state-controlled financial institutions have linked personnel appointment and performance evaluation with administrative levels. (PBC 2005, pp. 138, 139)

According to the IFF report, the government has been encouraging Chinese companies to improve their corporate governance culture. One mechanism to improve corporate governance has been to encourage Chinese companies to list on the Hong Kong Stock Exchange (HKEx), which has a more effective post-IPO corporate governance monitoring system than the Shanghai or Shenzhen stock exchanges and higher standards of corporate governance for listed companies. Several Chinese companies that have recently listed shares on the HKEx improved their corporate governance and increased financial transparency prior to their IPO listings. However, this strategy could result in a natural selection problem, where companies listed on the local Chinese exchanges may be considered second-tier companies with weaker corporate governance compared to the better-governed companies listed on the HKEx. (IIF 2006, p. 3)

The government's recent steps to improve corporate governance, important as they are, do not provide a long-term solution for the major corporate governance problems in China. To bring about real effective change, it is necessary that the government reduce its role and influence in Chinese companies. The government's controversial decision to reshuffle the CEOs of China's four leading mobile phone companies is an example of the degree of state interference that continues to hinder substantive governance improvements in China. Given the large number of state controlled companies (SCCs) listed on the domestic exchanges, improvements in China's corporate governance culture is possible only if corporate governance in SCCs is improved. (IIF 2006, pp. 3, 4)

According to the PBC's 2005 Financial Stability Report, relevant departments have formulated and promulgated a series of regulatory decrees to provide implementation bases for the improvement of corporate governance of financial institutions. According to the stipulations of the "Guidelines for Corporate Governance of Joint-Stock Commercial Banks (JSCBs)" and the "Guidelines for Independent Director and External Supervisor System of JSCBs" issued by the PBC in 2002, commercial banks should build up an organizational structure with shareholders' meeting, board of directors, board of supervisors and senior management at the core, establish an institutional arrangement that ensures independent operation and effective checks and balances of all bodies, and foster scientific and efficient mechanisms for making decisions, providing incentives and providing checks and balances. The "Code of Conduct for the Governance of Listed Companies" issued by CSRC in 2002 set forth clear requirements with regard to shareholders and shareholders' meetings, directors and boards of directors, supervisors and boards of supervisors, controlling shareholders and listed companies, performance evaluation and incentives, checks and balances, as well as information disclosure and transparency. This document also provided a set of evaluation standards for governance quality of listed companies, including listed financial institutions. (PBC 2005, p. 135)

In a speech by Governor Zhou Xiaochuan of the PBC, quoted in the 2005 Financial Stability Report, Governor Zhou notes that since the concept of corporate governance was introduced to China, great progress has been made in corporate governance of financial institutions. The Third Plenary Session of the 14th National Congress of the Communist Party of China (CPC) in 1993 attempted to introduce the concept of corporate governance to its documents. In 1999 the fourth Plenary Session of the 15th National Congress of the CPC officially drafted this concept in major party documents. (...) Based on international experiences, the state has taken a clear attitude towards the Principles of Corporate Governance issued by the OECD that is to play out its role in promoting the formulation of corporate governance. (PBC 2005, p. 136)

Liu, in a 2005 paper on current practices, economic effects and institutional determinants of corporate governance in China comes to the following conclusions. First of all, the corporate governance model adopted in China can be best described as a control-based model, in which the controlling shareholders (in most cases, the state) employ all kinds of governance mechanism to tightly control the listed firms. It has been found that concentrated ownership structure, management-friendly boards, inadequate financial disclosure, and inactive take-over markets have been the governance norms in China. Second, the control-based governance model, while promoting the fast-growth of China's stock market, does have many built-in weaknesses, which make it less effective in disciplining management/controlling shareholder, and foster firms' long-term performance. More important, such a model provides the controlling shareholders a large room to expropriate minority shareholders, and eventually undermine the public's confidence in the stock market. The paper finds evidence that firms with their governance practices deviated from the control-based model, but followed the market-oriented governance model, tend to have better performance and make corporate policies that are in the interest of the minority shareholders. (Liu 2005, p. 2)

Liu also cites research that has found that these suboptimal governance practices in China root in China's specific institutional setting. Because the initial intention of developing the Chinese stock market is to experiment and find an alternative venue for the state owned enterprises (SOEs) to gain additional capital and improve their efficiency, and the legal environment in China is weak, the stock market regulations in China have been evolved to address the tradeoff between growth and control. The so-called 'administrative governance' approach, although fostering fast-growth of the Chinese stock market, also seriously thwarts the emergence of more effective governance models. Under the administrative governance, almost every sector, including the stock market, is heavily regulated. As a consequence, it becomes difficult to separate business and politics. The quality of public governance thus is of the first order importance in shaping corporate governance, because politicians or politician-connected businessmen can easily hijack any governance systems and seek rents for themselves. As a matter of fact, almost every corporate governance practice in China can trace its origin to a certain deficiency in public governance and is more or less related to politician's or politician related businessmen's rent-seeking incentives. (Liu 2005, p. 3)

In 1990 and 1991, China's two stock exchanges -- the Shanghai and Shenzhen Stock Exchanges were opened with great fanfare. In slightly over fourteen years, China's stock market has grown to become one of the largest in Asia (second only to the Japanese market) with market capitalization of close to US$500 billion. About 1,400 firms have gone public and raised close to 800 billion RMB (around US$100 billion). Corporate China, especially the state owned enterprises (SOEs) has benefited greatly from rapid equity issuance growth and public enthusiasm for the equity market due to a lack of other attractive investment vehicles. China now boasts 1,400 listed companies, more than 130 securities firms, over 100,000 practitioners, and over 70 million investor accounts. (Liu 2005, p. 4)

The International Monetary Fund (IMF) team reports in the 2006 Article IV consultations that the authorities have made progress in reviving the equity markets. A critical step in this direction has been the reforms to convert the non-traded shares of state-owned companies listed on the stock market to tradable shares, which is expected to be largely completed by end-year. As a result, stock prices have significantly rebounded and interest in new IPOs and secondary placement offers has soared. Nevertheless, more needs to be done to ease access to the market and allow stocks to be publicly issued based on firms' disclosure of financial data and prospects. (IMF 2006, p. 23)

The non-tradable share reform program was a key initiative taken by the authorities to boost the development of China's equity market. China's equity market languished over the last several years reflecting uncertainty over how the government might choose to sell off its large holdings of non-tradable shares, representing some two-thirds of total stock market capitalization. To deal with this situation, the government initiated in April 2005 a reform program to convert state-owned shares to tradable shares in listed companies. This reform program has moved rapidly--out of some 1,350 listed companies, nearly 900 companies, which account for 70 percent of the stock market capitalization, had completed the reform program by April 2006. (IMF 2006, p. 25)

The Principles

Principle I: Ensuring the Basis for an Effective Corporate Governance Framework

II

The 2006 report by the Institute of International Finance (IIF) notes that oversight and regulatory responsibilities rest primarily with the China Securities Regulatory Commission (CSRC). The CSRC, as a centralized supervisory agency of securities markets, is responsible for promulgating regulations/ rules concerning regulation of the securities market and monitoring companies' compliance with relevant regulations. The Ministry of Finance (MOF) is responsible for promulgating the relevant financial and accounting regulations/ rules. As corporate governance reform in China is closely linked to the reorganization of the state controlled companies (SCCs), the State-owned Assets Supervision and Administration Commission (SASAC) established in 2003 also has a key role to play. In this connection, it should be noted that a robust and unified insolvency regime has yet to be established in China and the authorities appear to be working hard toward this goal so that creditors are protected appropriately and consistently in the SCC-related bankruptcy process. (IIF 2006, p. 18) However, the available information does not sufficiently address China's compliance with this principle.

The CSRC was created in October 1992 as the executive branch of the State Council Securities Commission (SCSC) to conduct supervision and regulation of the securities markets. The scope of its authority was subsequently expanded. In 1998, in accordance with the State Council Reform Plan, the SCSC and the CSRC were consolidated to form a unified supervisory agency under the direct control of the State Council. Currently, major function s and responsibilities of the CSRC include: supervising securities and futures markets; overseeing the issuance, trading, custodial services, and settlement of securities; monitoring the behavior of listed companies; governing the stock exchanges; regulating securities and futures companies, investment fund managers, and investment consulting firms; and penalizing activities that violate relevant laws and regulations. Unlike in some other countries, China does not appear to suffer from potential regulatory inconsistencies. The MOF, CSRC, China Banking Regulatory Commission (CBRC), and China Insurance Regulatory Commission (CIRC) are closely consulted and coordinate regulation to avoid conflicting guidelines for banks and insurance companies following their IPOs. (IIF 2006, p. 18)

China has two stock exchanges in Shanghai and Shenzhen. The Shanghai Stock Exchange is playing a more prominent role in terms of the number of listed companies/shares and total market capitalization. The stock exchange is a nonprofit membership organization directly governed by the CSRC. The stock exchange is performing a variety of functions such as providing facilities and a marketplace for securities trading, approving and arranging listing/delisting, monitoring securities transactions, overseeing listed companies, and disseminating market information. The stock exchange's listing requirements set out several criteria on the company's total share capital, profit history, and the number of shareholders. Although the stock exchange is given some degree of discretion, the enforcement and punitive authorities fall primarily within the purview of the CSRC. For instance, the stock exchange is engaged in market surveillance activities to detect manipulative transactions, but it is the CSRC that has the administrative power to penalize a company involved in such malpractices. The recent revision to the Securities Law has granted more powers to the stock exchange which allow it to directly approve the listing of shares and corporate bonds and make decisions on suspension and termination of listing. (IIF 2006, p. 18)

Liu, in a 2005 paper on current practices, economic effects and institutional determinants of corporate governance in China comes to the following conclusions. First of all, the corporate governance model adopted in China can be best described as a control-based model, in which the controlling shareholders (in most cases, the state) employ all kinds of governance mechanism to tightly control the listed firms. It has been found that concentrated ownership structure, management-friendly boards, inadequate financial disclosure, and inactive take-over markets have been the governance norms in China. Second, the control-based governance model, while promoting the fast-growth of China's stock market, does have many built-in weaknesses, which make it less effective in disciplining management/controlling shareholder, and foster firms' long-term performance. More important, such a model provides the controlling shareholders a large room to expropriate minority shareholders, and eventually undermine the public's confidence in the stock market. The paper finds evidence that firms with their governance practices deviated from the control-based model, but followed the market-oriented governance model, tend to have better performance and make corporate policies that are in the interest of the minority shareholders. (Liu 2005, p. 2)

Principle II: The Rights of Shareholders and Key Ownership Function

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The 2006 Institute of International Finance (IIF) report notes that proxy voting is permitted in both the Code of Corporate Governance in Listed Companies issued by the China Securities Regulatory Commission (CSRC) and Company Law. For instance, the CSRC Code mentions, "shareholders can either be present at the shareholder meetings in person or they may appoint a proxy to vote on their behalf, and both means of voting possess the same legal effect." The CSRC Code states that listed companies should make every effort, including utilizing modern information technology, to increase the number of shareholders attending shareholder meetings. Company law endorses the one-share-one-vote principle by clearly stipulating "when a shareholder attends the shareholders meeting, each share he holds is entitled to one vote." (IIF 2006, p. 11) However, the available information does not sufficiently address China's compliance with this principle

Cumulative voting is also encouraged in the CSRC Code as a means of fully reflecting the opinions of minority shareholders. The Code articulates that "a cumulative voting system should be earnestly advanced in shareholder meetings for the election of directors and that "listed companies that are more than 30 percent owned by controlling shareholders should adopt a cumulative voting system." Provisions for cumulative voting, which were previously in the CSRC Code, have now been codified in the Company Law through recent revisions, giving it the legal backing required for better enforcement. (IIF 2006, p. 11)

According to Company Law, a general shareholder meeting should be held annually and interim shareholder meetings should be held within two months of the occurrence of several pre-specified circumstances. Such circumstances include requests by shareholders holding at least 10 percent of the outstanding stock. (IIF 2006, p. 12)

A meeting notice and agenda should be provided to shareholders 30 days in advance. The guidelines of the IIF Code call for notices and agendas to be sent within a reasonable amount of time in advance of meetings. The best practice suggested by the IIF Code is that meeting notices and agendas should be sent at least one month prior. Under the Company Law, adoption of a resolution at the shareholder meeting requires the majority of votes held by shareholders attending the meeting. As noted above, a resolution regarding merger/division/dissolution of the company requires affirmative votes by at least two-thirds of the votes. If the procedure for convening or the method of voting at a shareholders' meeting, shareholders' general meeting, or meeting of the board of directors violates laws, administrative regulations, or the company's articles of association, or if the substance of a resolution breaches the company's articles of association, the Company Law allows shareholders to protect their interests through civil litigation by stipulating that "a shareholder may file a petition with the People's Court to revoke the resolution within 60 days of it being adopted." (IIF 2006, p. 12)

As for takeover and merger procedures, Company Law says, "if a company is to undergo merger or division, its shareholders should adopt a resolution," and this resolution "requires affirmative votes by at least two-thirds of the votes held by shareholders attending the meeting." It also requires that the merger/division proposal be subject to the approval of the relevant authorities. In recognition of an increasing trend in M&A, the Chinese government seems to be willing to create an environment that is more hospitable to corporate takeovers and mergers. The CSRC issued the Administration of Takeover of Listed Companies Procedures (the "Takeover Procedures") in December 2002, which regulates M&A activities in listed companies in China. Non-state companies, including private and foreign companies, are now allowed to acquire Chinese listed companies. However, the market for corporate takeover is still not well-developed. In particular, hostile takeovers are still considered to be nearly impossible in China. (IIF 2006, p. 12)

Standard & Poor's, in a 2003 country governance study on China notes that under the existing share registration system, all listed shares are secured and fully transferable. Shareholders do not have equal rights in terms of profit sharing, participation in shareholder meetings in person or via proxy, voting, and monitoring/ questioning/making recommendations to the management. However, given that the most common shareholding structures have one major shareholder, it is difficult for the minority shareholders to form a large enough pool to reach the minimum thresholds needed to enjoy some of their rights, such as nominating directors, calling special meetings, and raising a resolution to the board and/or at the shareholder meetings. From a legal standpoint, a company's Articles of Association have binding force on all shareholders, directors, supervisors and managers. The Articles should be approved at shareholder meetings. The Law also allows shareholders to amend the content of the Articles. Chinese laws give shareholders pre-emptive rights. Such rights can effectively prevent the issuance of shares to new shareholders and thus mitigate the potential for dilution of existing shareholder's ownership stakes and voting rights. (S&P 2003, p. 11)

Principle III: The Equitable Treatment of Shareholders

EN

The Institute of International Finance (IIF) in a 2006 report noted that positive changes in the corporate governance framework have been made through revisions to the Company Law and Securities Law. These changes, which came into effect on January 1, 2006, strengthen minority shareholder rights by: (1) Allowing companies to use cumulative voting, if desired, thereby empowering minority shareholders to appoint directors and/or supervisors (2) Imposing a stricter duty of care on directors, supervisors, and senior management (3)Granting shareholders the right to bring a derivative suit or direct suit against directors, supervisors, and senior management (4) Introducing the concept of 'piercing the corporate veil,' enabling courts to look beyond the principle of limited liability and (5) Increasing minority shareholder protection by granting shareholders the right to check and copy the company's account books and meeting minutes, allowing share buybacks, and granting shareholders the right to petition for liquidation of a company. (IIF 2006, p. 2)

Overall, the IIF concludes, the Chinese corporate governance framework addresses roughly three-fourths of the minority shareholder protection guidelines contained in the IIF Code, up from about one-half two years ago. Scope for further improvement exists in strengthening rules regarding changes to the capital structure. The IIF's "Code of Corporate Governance for Emerging Markets" differs from the broader Organization for Economic Cooperation and Development (OECD) Core principles in that they are more detailed and aimed at implementation, but do not diverge from them in their substance. (IIF 2006, p. 11; IIF 2002, p. i)

The China Securities Regulatory Commission (CSRC) Code addresses in detail the issues associated with majority (controlling) shareholders and the recent revision to the Company Law defines a "controlling shareholder" as "a shareholder whose capital contribution to a limited liability company accounts for at least 50% of the company's total capital or whose shareholding accounts for at least 50% of the total share capital of a joint stock company; or a shareholder whose capital contribution or shareholding, although not accounting for 50%, is nonetheless, through the voting rights attaching to his or her capital contribution or his or her shareholding, able to materially affect the resolutions of the shareholders' meeting or shareholders' general meeting." (IIF 2006, p. 17)

As for buyout offers to shareholders, the CSRC Code makes a general statement that if controlling shareholders increase/decrease their shareholdings or if the actual control of the company transfers, the company and its controlling shareholders should disclose relevant information to all shareholders on a timely basis. The numerical threshold that triggers mandatory offers to all shareholders is stipulated in the Securities Law. The State Council released administrative regulations in 1993 ("Administration of the Issuing and Trading of Shares: Tentative Regulations") which require legal persons directly or indirectly owning 30 percent or more of outstanding shares of a listed company to make an offer to purchase all outstanding shares from other investors within 45 days of reaching this threshold. The IIF Code defines 35 percent ownership of the company as the trigger point for mandatory offers. Regarding the regulations and procedures for takeovers in general, the CSRC promulgated the Takeover Procedures in 2002. These procedures also provide for the regulations of mandatory offers. (IIF 2006, p. 17)

Regarding significant shareholders , the CSRC Code calls for the timely disclosure of the interest of shareholders who own "a comparatively large percentage" of the company's outstanding shares. Unlike the IIF Code, however, no numerical threshold regarding "being comparatively large" is given in the Chinese Code. In 2002, the CSRC promulgated the "Administrative Measures of the Disclosure of Information on Changes of Shareholdings of Listed Companies" which purports to objectively set out the requirements for disclosure of interests of certain shareholders. (IIF 2006, p. 17)

The code attempts to strengthen the roles of the boards of directors and supervisors. According to Articles 29 and 31, a listed company must establish transparent procedures to select the board of directors, and a listed company in which the controlling shareholder owns a stake in excess of 30 percent should adopt a cumulative voting mechanism to ensure the voting interests of minority shareholders. Article 49 requires listed companies to introduce independent directors who do not hold any other positions within the company. Articles 60 and 61 state that members of the board of supervisors must be permitted access to information related to operational status and be allowed to hire independent intermediary agencies for professional consultation, without interference from other company employees. (Shi & Weisert 2002)

Principle IV: The Role of Stakeholders in Corporate Governance

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The available information does not sufficiently address China's compliance with this principle.

Chapter 6 of the China Securities Regulatory Commission (CSRC) Code states that a listed company shall respect the legal rights of banks and other creditors, employees, consumers, suppliers, the community and other stakeholders. A listed company shall actively cooperate with its stakeholders and jointly advance the company's sustained and healthy development. A company shall provide the necessary means to ensure the legal rights of stakeholders. Stakeholders shall have opportunities and channels for redress for infringement of rights. (CSRC Code, p. 9)

Chapter 6 further states that a company shall provide necessary information to banks and other creditors to enable them to make judgments and decisions about the company's operating and financial situation. A company shall encourage employees' feedback regarding the company's operating and financial situations and important decisions affecting employee's benefits through direct communications with the board of directors, the supervisory board and the management personnel. While maintaining the listed company's development and maximizing the benefits of shareholders, the company shall be concerned with the welfare, environmental protection and public interests of the community in which it resides, and shall pay attention to the company's social responsibilities. (CSRC Code, p. 10)

The CSRC Code also calls attention to the importance of social responsibility of the company. It clearly states that while maximizing shareholders' benefits, the company should be concerned with environmental protection and the public interest of the community in which it resides. (IIF 2006, p. 15)

Principle V: Disclosure and Transparency

II

The 2006 report by the Institute of International Finance notes that the China Securities Regulatory Commission (CSRC) Code unambiguously states that information disclosure is an ongoing responsibility of listed companies. In addition to disclosing mandatory information, companies should also voluntarily and on a timely basis disclose all other information that may have a material effect on the decisions of shareholders and stakeholders. This includes information on performance assessment and compensation of directors, independent directors' opinions on related-party transactions, controlling shareholder's interests. Disclosure among listed companies has improved, especially for more recent listings due to the CSRC's requirement that companies prepare financial statements for three years ahead of an IPO. (IIF 2006, pp. 14, 15 ) However, the available information does not sufficiently address China's compliance with this principle.

The IIF report notes that financial disclosure remains weak. Ongoing reforms to state controlled companies' (SCCs) share structure and the lack of reliable financial information makes it difficult for China's equity market to function efficiently. (IIF 2006, p. 3).

Regarding significant shareholders, the CSRC Code calls for the timely disclosure of the interest of shareholders who own "a comparatively large percentage" of the company's outstanding shares. Unlike the IIF Code, however, no numerical threshold regarding "being comparatively large" is given in the Chinese Code. In 2002, the CSRC promulgated the "Administrative Measures of the Disclosure of Information on Changes of Shareholdings of Listed Companies" which purports to objectively set out the requirements for disclosure of interests of certain shareholders. (IIF 2006, p. 17)

With respect to the annual report, the CSRC rule, "Implementation guidelines on information disclosure for companies seeking public offering of stock" requires companies to release the audited annual report within four months of the end of each fiscal year and the audited interim report within two months of the end of the sixth month in each fiscal year. Since 2002, companies have also been required to release un-audited quarterly reports as well. These reports should be available in their entirety on the Internet. (IIF 2004)

Chinese regulators have made measurable progress on raising national accounting and auditing standards and practices in the context of ongoing corporate governance reform. However, more efforts are required to bring the accounting regime and audit quality in line with internationally recognized standards. In the past, Chinese companies applied accounting rules on an industry-by industry basis. To rectify this situation, the Ministry of Finance issued "Provisional Accounting Regulations for Joint-Stock Limited Enterprises" in 1992, which became the first statutory accounting rules for listed companies in China. These rules were subsequently revised to result in the promulgation of Chinese Accounting Standards (CAS) in 1997, which subsume 16 separate accounting rules and are broadly in line with International Accounting Standards (IAS). With regard to accounting standards, the CAS still differs substantively from the IAS in some respects. Particularly notable is the fact that the CAS does not allow for the wider use of fair value measurement. For example, IAS 39 requires companies' short-term assets and long-term assets held for the trading/sale purpose to be measured at fair value, but the CAS allows them to be measured at historical cost (book values). This lack of fair value accounting is also evident in the treatment of goodwill (the difference between the cost of acquisition and the values of net assets acquired). The Ministry of Finance seems to consider the use of fair value method premature for Chinese listed companies. (IIF 2006, p. 16)

On February 15, 2006, the MOF formally issued 38 specific Basic Accounting Standards for Business Enterprises (ASBE) that will become effective on January 1, 2007 and apply to all listed Chinese companies. The new ASBE standards will bring Chinese accounting practices largely in line with International Financial Reporting Standards (IFRS), with some exceptions. Company Law calls for companies to establish internal accounting systems in accordance with these standards. Company Law also requires listed companies to prepare and publish their financial and accounting reports at the end of each fiscal year. These reports should include a company's balance sheet, income statement, cash flow statement, and statement on profit distribution. Furthermore, the CSRC has issued rules requiring companies issuing B shares to explain any departure from IFRS in the appendix of their annual reports. The accounting reports of listed companies should be available for shareholder inspection at companies' premises. Further improvements can be made by requiring Chinese firms to comply with the IIF Code's guidelines on disclosure of off-balance sheet transactions and requiring the board of directors to assess/monitor risk. (IIF 2006, p. 16)

To support implementation of corporate governance practices, all listed companies in China are called on by the CSRC Code to disclose the gap between their practices and the recommendations in the Code and the reasons for the existing gap (the so-called "comply or explain" rule). (IIF 2006, p. 15)

The code includes specific provisions on information disclosure. Articles 88 and 89 require the listed company to disclose promptly any information that may have a substantial impact on the decision making of shareholders or associated parties. Articles 13 and 14 require the listed company to fully disclose prices of related party transactions and prohibit it from providing financial collateral to related entities. Article 92 requires the listed company to promptly release detailed information on controlling shareholders. And Articles 25 and 27 require controlling shareholders to honor the independence of the listed company and to avoid interfering or directly competing with the listed entity. (Shi & Weisert 2002)

Principle VI: The Responsibilities of the Board

EN

According to the 2006 Institute of International Finance (IIF) report, the Chinese corporate governance framework encompasses over three-fourths of the guidelines pertaining to the board of directors in the IIF Code. Major aspects underpinning the functioning of the board of directors are well addressed. The IIF's "Code of Corporate Governance for Emerging Markets" differs from the broader Organization for Economic Cooperation and Development (OECD) Core principles in that they are more detailed and aimed at implementation, but do not diverge from them in their substance. (IIF 2006, p. 13; IIF 2002, p. i)

The IIF report notes that recent revisions to the Company Law (see below) have clarified and made more permanent the role of the supervisory board in Chinese companies, but a number of shortcomings remain. China has a quasi two-tier structure of board governance, designed very loosely on the German governance system, with a board of directors and a supervisory board. However, in practice, Chinese supervisory boards merely rubber stamp decisions taken by the board of directors, which is the main decision making authority. This duplication and overlap of functions creates redundancy in the corporate governance structure. Further, it dilutes the authority of the board of directors and increases administrative costs for companies. (IIF 2006, p. 8)

Furthermore, several independent directors that the IIF Task Force met during its visit indicated that, despite improvements in the governance framework of boards (such as requiring that at least one-third of board directors be independent), independent directors still have limited ability to influence the overall strategy of the company. (IIF 2006, p. 3)

Nonetheless, the revisions to China's Company Law have clarified the structure and the roles of the board of directors and the supervisory board, which are as follows: (1) The board of directors is styled after the 'board of directors' in the Anglo-Saxon model of corporate governance, where the board oversees and aids management decision making. Similar to practices followed in the UK and the US, guidelines issued by the CSRC require that at least one-third of directors be independent.(2) The supervisory board in China is much smaller than the supervisory board in Germany, and shares only a few similar responsibilities with its German counterpart. (3) In China, the board of directors is the main decision-making authority, with the supervisory board designated with legal powers to overturn decisions taken by the board of directors. In practice, the supervisory board is only symbolic and any attempt to strengthen its role is likely only to create further ambiguity in China's board structure. (4) The blending of the Anglo-Saxon model and the German model of corporate governance dilutes the effectiveness of both the board of directors and the supervisory board and duplicates administrative costs by increasing the overall number of directors in a company. (IIF 2006, pp. 8, 9)

The China Securities Regulatory Commission (CSRC) Code presents a general principle that board directors should faithfully, honestly and diligently perform their duties in the best interests of the company and its shareholders. In cases where resolutions by the board of directors violate relevant laws or regulations and result in losses to a company, directors responsible for making such resolutions are liable for damages. (IIF 2006, p. 13)

The CSRC has also issued specific guidelines about qualifications of independent directors of listed companies. It first defines independent directors as those directors "who hold no posts in the company and who maintain no relationship with the company and its major shareholders that might prevent them from making objective judgments independently." The guideline goes on to list several specific requirements for independent directors. Most notably, a person who holds more than 1 percent of the outstanding shares of a company directly or indirectly, or a person who is among the top 10 largest shareholders of a company cannot hold the position of independent director. Also a person who was an employee of the company in the past year cannot be an independent director. Independent directors have to make a public statement as to their independence. The guideline also states that independent directors can concurrently hold the post of independent directors at a maximum of five listed companies. Given the limited availability of qualified independent directors, this provision can be justified for the time being, but as corporate governance reform in China progresses, it might become necessary to lower the maximum number of concurrent independent directorship held by the same person. The IIF Code cites several requirements that should be met to qualify as an independent director. Importantly, an independent director cannot have been an employee of the firm in the past three years nor have a current business relationship with the firm. (IIF 2006, p. 13)

Concerning the composition of the board, the CSRC Code simply states that the number of directors and the structure of the board should be in compliance with laws and regulations. The Company Law specifically requires that the board of directors be composed of not fewer than 5 but not more than 19 members. With regard to the share of independent directors, CSRC guideline stipulates that as of end-June 2003, at least one-third of board members should be independent. (IIF 2006, p. 13)

According to the CSRC Code, the nomination committee should nominate directors. An independent director should chair the nomination committee and the majority of its members should be independent directors. The nomination committee is responsible for formulating standards and procedures for the election of directors, extensively seeking qualified candidates, reviewing candidates, and issuing recommendations. The CSRC guideline adds that shareholders holding more than 1 percent of outstanding shares-whether independently or jointly-may nominate independent directors for election. Prior to convening the shareholder meeting to elect independent directors, the guideline also requires that the company submit the relevant background materials about the nominees to the CSRC and the stock exchange. Within 15 working days, the CSRC should examine the qualifications of the nominated candidates. If a nominee is rejected by the CSRC, he or she can still be a candidate for director but not an independent one. Under the IIF Code, a committee, chaired by an independent non-executive director, should nominate new board members. (IIF 2006, p. 14)