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We are the (national) champions: understanding the mechanisms of state capitalism in China.


     A. Introduction
     B. Chinese Industrial Organization as a Networked Hierarchy
        1. A simple analytical construct
        2. A stylized model
     C. Origins of Chinese Corporate Groupism

     A. Components
        1. Core (parent) company
        2. Listed company
        3. Finance company
        4. Research institutes
     B. Membership and Internal Governance
     C. Networks
        1. Intergroup networks
        2. Central-local intergroup networks
        3. Business group-party-state networks
     D. Examples
        1. China National Nonferrous Metals Industry Group
        2. China Datang Group

     A. SASAC as Controller
        1. Control rights in management
        2. Control rights in state enterprise assets
        3. Cash flow rights
     B. Consequences

     A. Implications for Comparative Corporate Governance Scholarship
        1. Law and finance
        2. Convergence
     B. Questions for the Future
        1. Legal reform?
        2. Temasek-ization of SASAC?
        3. Great reversal?
        4. Dis-integration of the national-champion groups?
     C. Implications for the U.S. Legal System



China's emergence as a global economic power poses enormous explanatory challenges for scholars of comparative corporate governance. While China appears to present a new variety of capitalism, frequently labeled state capitalism, the features and implications of this system are still poorly understood. (1) Particularly since China's economic system may be in its early stages of development, understanding the mechanisms by which state capitalism currently operates and how they may change as Chinese enterprises globalize is a pressing task for researchers.

One highly distinctive characteristic of state capitalism in China is the central role of about 100 large, state-owned enterprises (SOEs) (guoyou qiye) controlled by organs of the national government in critical industries such as steel, telecom, and transportation. Although only a handful of these firms, such as Sinopec and China Mobile, have become widely known in the West, the state sector dominates major industries in China and is increasingly active in global markets. As the Economist recently noted, "[A]s the economy grows at double-digit rates year after year, vast state-owned enterprises are climbing the world's league tables in every industry from oil to banking." (2) China now has the world's second-largest number of companies (seventy-three) on the Fortune Global 500 list of the world's largest corporations, (3) and the number of Chinese companies on the list has increased at an average annual rate of approximately twenty-five percent since 2005. (4) These globally significant SOEs are China's national champions.

More than half of the Chinese companies in the 2012 Fortune Global 500 are SOEs supervised by an organ of the central government. (5) Excluding major banks (6) and insurance companies, controlling stakes in the largest and most important of the firms are owned, ostensibly on behalf of the Chinese people, by a central holding company known as the State-Owned Assets Supervision and Administration Commission of the State Council (SASAC), which has been described as "the world's largest controlling shareholder." (7) Though the elite firms that serve as the outward face of Chinese SOEs (again, think of Sinopec or China Mobile) are listed on stock exchanges in Shanghai, Hong Kong, or other world financial capitals, they are nested within vertically integrated groups. Each company's majority shareholder is the core (parent) company of the group--which is itself 100% owned by SASAC. The core company coordinates the group's activities and transmits business policy to group members, who are contractually bound to promote the policies of the state. Individual corporate groups are often linked through equity ownership and contractual alliances to groups in the same or complementary industries, to provincial-level business groups, and even to noneconomic state-controlled institutions, such as universities. (8) Top managers of national champions simultaneously hold important positions in the government and in the Communist Party.

Although the basic outlines of this system are now widely known, in many respects the concept of state capitalism in China--particularly the organizational structure and broad governance regime surrounding these national champions-remains a black box. (9) Scholars have explored numerous facets of investment, monitoring, and organization in Western firms, but for Chinese firms, research is only beginning to unpack questions raised by state ownership: How were failing state enterprises transformed into global players, and what foreign models did Chinese economic strategists look to for inspiration? How are nationally important firms related to one another and to their sources of financing, and what links the national champions to government and Party institutions? What incentive structures operate within this system? How does the Chinese party-state behave in its role as controlling shareholder? What are the implications of this system for our understanding of Chinese corporate governance and for the potential future transformation of corporate capitalism in China?

Scholarship to date has provided only fragmentary answers to such questions. In part, this stems from the scarcity of reliable data, but it also results from the way scholars have approached the subject. (10) Most corporate governance scholars working on China, for example, have taken the individual firm--the publicly listed company--as the unit of analysis, even though corporate groups are pervasive in China's state-owned sector and the listed firm is just one part of a complex web of corporate entities and relationships that characterize Chinese state capitalism. (11) Moreover, scholars often begin and end their analyses by benchmarking the governance attributes of Chinese listed companies against global (which typically means U.S.) corporate governance standards and institutions. This approach produces insights, to be sure, but it invariably focuses the analyst's attention on what the Chinese system lacks, not on how it is constructed and actually functions. We believe that, as was the case with scholarship on Japanese corporate governance in the 1990s, (12) real headway in understanding China's variety of capitalism will come by analyzing the system on its own terms rather than principally by reference to something it is not.

In this Article, we explore the mechanisms of state capitalism in China by analyzing the distinctive system of industrial organization in which the country's largest state-owned enterprises were assembled and operate. To aid in the analysis, we expand our focus beyond the usual corporate governance concern with agency relationships and try to understand the relational ecology that fosters production in a system where all roads eventually lead to the party-state. We introduce two simple analytical constructs for this purpose: Networked hierarchy is our term for the way top-down governance features within individual state-controlled corporate groups are coupled with extensive linkages to other state-controlled institutions. Institutional bridging is our term for the pervasive use of personnel-rotation systems, linked equity-ownership structures, and strategic forms of cooperation, such as joint ventures, which serves to unite separate components of the state sector. These mechanisms create networks among businesses and other organs of the party-state, promote information flow, and provide high-powered incentives to actors in the system by linking corporate performance and political advancement. Together, these features can be thought of as means to assemble what Mancur Olson called an "encompassing organization"--a coalition whose members "own so much of the society that they have an important incentive to be actively concerned about how productive it is." (13)

While there is much more to the Chinese economy than the national champions, (14) there are many good reasons to examine the institutional ecology in which these SOEs function. By several measurements, the state sector is a significant part of the national economy. (15) Perhaps more importantly for our purposes, as a scholar recently noted, "SOEs [everywhere] remain surprisingly understudied." (16) China's nationally important SOEs have joined the ranks of the largest firms in the world and are plainly worthy of deep exploration in their own right. The national champions are the fullest expression of state capitalism in China--the global face of China Inc. It is impossible to fully understand the institutional features of the Chinese economy without examining its largest, most central actors. Bigness, as signified by the Fortune Global 500 list, does not necessarily indicate efficiency or innovative capacity, traits that will be key to the long-term success of the national champions in the global economy. But the emergence of large Chinese SOEs as major domestic and global actors may have enormous implications across a range of dimensions. (17) Finally, given the relatively early stage of development of Chinese capitalism, a robust exploration of China's largest and most politically connected firms may provide insights into how the state-directed system may evolve over time--or at least suggest which features of the current system are susceptible to change and the possible directions in which change may occur. (18)

Having defined our task as unpacking the conceptual black box of Chinese state capitalism, we focus on the major SOEs with the tightest connections to the Chinese party-state in its various institutional manifestations--that is, the approximately 100 SOL groups with a core company controlled by SASAC at the national level. (19) Our analytical focus is not an attempt to demonstrate the comparative advantages of state ownership of enterprise; to hold the national champions aloft as paradigms of efficiency, innovativeness, or good governance; or to show that the state-owned sector is more important to the development of the Chinese economy than is the private sector. Moreover, as with any stylized account, ours at times sacrifices granular detail in the hopes of achieving conceptual insight. In operation, Chinese state capitalism is likely more conflict laden and heterogeneous, and less internally cohesive, than our account may imply.

The Article proceeds in four Parts. We begin in Part I by providing some conceptual background for the study of Chinese SOEs and briefly trace the development of the corporate groups to their present state. In Part II, we illuminate the key components and main organizational characteristics of the national business groups and contrast certain features of the groups with those in Japan and Korea, which served as models for Chinese economic strategists in the 1990s. In Part III, we analyze SASAC's behavior as a controlling shareholder within the larger institutions of the party-state. In Part IV, we explore the implications of our analysis both for comparative scholarship on the Chinese corporate system and for the future evolution of China's variety of capitalism, particularly in light of increasing global activity by its national champions. We also briefly examine the implications of Chinese national champion capitalism for the U.S. legal system.


A. Introduction

Two decades of comparative corporate governance scholarship have shown that successful forms of corporate capitalism do not have identical features around the world. To the contrary, firms differ systematically in their ownership structures, sources of financing, and the surrounding set of national legal and market institutions in which they develop. (20) The spark for this insight, now so thoroughly explored as to seem prosaic in hindsight, was the striking economic ascendance of another East Asian country--Japan--in the 1980s. Two decades ago, observers recognized that while Japanese firms were globally competitive, their ownership structures, financing patterns, and governance norms bore little outward resemblance to those of U.S. public firms, whose features had long been taken for granted as the natural end point of an evolutionary process in the formation of the "modem" corporation. (21)

Today, the world once again faces a distinctive and globally important economic system in East Asia whose features appear opaque, and even menacing, to outsiders. (22) Although China's economic system has received a label, much work remains to understand how state capitalism is organized. As in the case of Japan in the 1980s, most of the corporate governance literature on China is preoccupied with agency costs and monitoring in publicly listed firms. Indeed, Ronald Gilson and Mark Roe's twenty-year-old observation on the intellectual obstacle to understanding Japanese industrial organization remains apt in relation to China: "Viewing the Japanese system through Berle-Means blinders, in the belief that it reflects only an effort to bridge the separation of ownership and control, will cause us to misunderstand it and, as a result, to miss the lessons that comparative analysis can offer." (23)

Similar to the way in which the early literature on Japan sought to locate the "missing" monitor in the main bank system, (24) many analysts of Chinese corporate capitalism have focused exclusively on agency problems in listed companies. (25) The search for solutions has taken most commentators clown a path with grooves cut by U.S. corporate governance logic, with a focus on independent directors, the market for corporate control, and robust securities regulation. This approach generates a lengthy list of (predominantly U.S.-style) formal institutions whose development is deemed crucial to the future transformation and improvement of Chinese corporate governance. (26) But this leaves largely unexplored a puzzle at the core of contemporary Chinese capitalism: how is a system missing many of the formal institutions deemed important to Western firms producing a rapidly expanding list of Fortune Global 500 companies and supporting sustained levels of economic development in China?

Some commentators claim that "relationships" are the key to success of the Chinese economy. (27) This is almost certainly an accurate observation, and scholars have made some headway in exposing these relationships. (28) But much work remains in examining the precise nature and function of the relationships supporting Chinese corporate governance and economic development, particularly in the absence of robust legal institutions. As one of us argued with Ronald Gilson, "governmentally encouraged performance of commercial obligations" under a growth-oriented authoritarian political regime may be doing the work of formal legal institutions in the Chinese economy, allowing small-scale, reputation-based trading to be scaled up to the point where entry into the global economy is possible. (29) And as that article suggested, business groups fostered by the political regime and deeply entwined with Chinese Communist Party leadership may be central to the developmental success of the regime. (30)

This Article is an attempt to dig more deeply into the structure and organizational ecology of the business groups at the center of China's system of state capitalism. Our account attempts to unearth the mechanisms underlying the uniquely encompassing nature of Chinese industrial organization and its concern not only with corporate governance but also with production, the transmission and implementation of industrial policy, and the maximization of state welfare, at least as interpreted by elite actors within the system. (31)

B. Chinese Industrial Organization as a Networked Hierarchy

Chinese state capitalism has a remarkably complex architecture. It will be helpful to get a view of the entire edifice before examining the plumbing. In this Subpart, we develop a simple, stylized model of Chinese industrial organization as it relates to nationally important firms and the corporate groups in which they are nested. We identify the principal components of the groups and illustrate their linkages graphically. After we sketch the outlines of the system, we take a step back to briefly trace its origins.

1. A simple analytical construct

As just noted, we believe that an agency-cost perspective on listed firms fails to capture key aspects of Chinese corporate governance and industrial organization. To expand our analytical lens, we introduce two simple, novel concepts. We call the organizational structure of Chinese state capitalism a networked hierarchy. This term captures a chief characteristic of the Chinese scheme of industrial organization: vertically integrated corporate groups organized under SASAC, strategically linked to other business groups--as well as to governmental organs and state institutions, such as universities--enmeshed in a helical personnel-appointment process of rotations managed jointly by the Communist Party and SASAC.

The hierarchical aspects of Chinese industrial organization are readily apparent: they range from the vertical integration of firms along the production chain to the top-down character of industrial-policy formulation and transmission in an authoritarian political regime. (32) But the Chinese system is not simply one in which vertically integrated groups transmit commands from state economic planners to SASAC and down through a chain of vertically integrated firms. These hierarchical structures are embedded in dense networks--not only of other firms, but also of party and government organs. These networks appear to facilitate information flow from the bottom up as well as from the top down. They foster relational exchange and collaboration on many levels of the production and policy-implementation processes. And they provide high-powered incentives to leaders within the system, because success in business leads to promotion and accompanying rewards in the political realm, and vice versa. This combination of authoritarian hierarchy and collaboration within high-powered incentive structures is reminiscent of another mechanism of economic transitions--private equity investments. (33)

As we discuss below in detail, these dense networks are the result of numerous pathways that link individual components of the system. Some pathways are engineered through formal legal means, such as by contract or through shareholding relationships. Others are the result of personnel practices followed by the Communist Party and SASAC. Still others are incorporated into the distinctive notion of representation in Chinese governmental organs, which assigns seats to select business leaders. We call this feature of the system institutional bridging.

One helpful way to view these constructed networks at the center of Chinese state capitalism is through the lens of Mancur Olson's concept of an "encompassing organization." (34) For Olson, this is a group representing a large enough segment of the population that it has incentives to grow the pie, as opposed to a "distributional coalition" representing a narrow segment of society, which tries to get a bigger slice for its members. (35) Olson focused on group size as the key distinguishing characteristic between encompassing and distributional coalitions, but it seems important that an encompassing coalition include all potential members whose participation can have a major impact on development--a broad cross section of political and business elites in society. The networked hierarchy, encompassing both business group managers and senior party and government officials, is a means of creating precisely this type of large, managerial coalition with control over the formulation and implementation of development policy.

Our aim in introducing these concepts is descriptive, not normative. We do not claim that these features of Chinese industrial organization necessarily lead to production efficiency. Olson noted that encompassing organizations will not necessarily lead to efficiency under all circumstances. (36) The networks we describe most likely produce countervailing effects: They enhance efficiency by fostering information sharing, reducing opportunism through repeat play, providing high-powered incentives, and reducing frictions in policy implementation. But they also reduce competition and transparency, multiply agency relationships, and soften budget constraints. (37) The interesting question for us is not whether the state sector is more efficient than the private sector but how the state sector has produced globally important firms and supported economic growth in the absence of formal infrastructure deemed essential in the standard theories on the relationship between institutions and development.

2. A stylized model

Next, we make use of the networked hierarchy and institutional bridging concepts to bring into focus the main organizational features of, and linkages among, the corporate group structures in which the national champions are nested. Figure 1 is a stylized picture of a national champion group.

Four features of this structure are highlighted here, as they will be the focus of our attention in the succeeding Parts of the Article. First, in contrast to the main postwar Japanese keiretsu and Korean chaebol corporate groups, (38) Chinese business groups are vertically integrated firms focused on a particular industry or sector, not diversified groups involved in a wide range of industries. In complementary fashion, and again in contrast to keiretsu and chaebol structures, shareholding is hierarchical: firms higher in the structure own downstream subsidiaries, but there is very little upstream or cross-ownership among group firms. Second, most of the national business groups in China contain four main components: (1) the core (parent) holding company, whose shares are wholly owned by SASAC; (2) one or more publicly traded subsidiaries--the global face of the national champion--a majority of whose shares are held by the core company; (3) a finance company that serves many important financing needs of the group and has certain parallels with Japanese main banks; (39) and (4) a research institute that coordinates the group's innovation processes. Third, two parallel structures provide for monitoring: one based on the corporate law, with SASAC as controlling shareholder, and a second, party-based structure that shadows the corporate hierarchy, especially with respect to high-level managerial appointments.

Crucially, however, these group components, as well as their top individual managers, are extensively networked to the larger system of industrial organization. Although the various corporate groups are both legally and functionally distinct from each other, complementary groups are linked in important ways. Intergroup joint ventures, strategic alliances, and equity holdings are the corporate mechanisms providing such linkages. The party-state, acting through SASAC and the Organization Department of the Party, provides another, probably more crucial, means of uniting the groups into a complementary whole. (40) Finally, the economic aspects of this structure are linked, through institutionalized personnel channels and political practices, to governmental organs, such as the National People's Congress; to important party organs; and to noneconomic state institutions, such as universities. (41) These are the institutional bridges that unite separate components of the system.

C. Origins of Chinese Corporate Groupism

We have seen that the predominant organizational characteristic of Chinese SOEs is groupism. While, as explained below, the present contours of the system are a product of two decades of experimentation, the decision to organize firms into groups was part of the initial economic reform strategy, based on observations of economic development elsewhere. As one scholar has noted,

   The formation of business groups has been one of the most profound
   components of China's efforts to engineer industrial growth. The
   deliberate disengagement of formerly state-owned enterprises from
   the command of administrative bureaus is, in part, a result of the
   perception that business groups with specific structural
   characteristics protected firms in other countries from the shocks
   and challenges of development. (42)

Indeed, governmental encouragement of business group formation to foster the growth of national champions is a common strategy. In the twentieth century, business groups served as engines of development in many countries around the world pursuing radically different economic strategies, including South Korea under Park Chung-Hee, Chile under Augusto Pinochet, and Japan under the Meiji oligarchs. (43) In many respects, China's use of business groups reflects the same motivations for group formation at work elsewhere, including filling institutional voids in weak rule-of-law environments, internalizing capital markets, marshaling scarce resources, and reducing the transaction costs of administering economic policy. (44)

Business groups around the world have typically originated with family-founded enterprises. Family ties, reputational networks, and repeated dealings create an environment conducive to commercial activity in the absence of formal institutions. Successful entrepreneurs may be handpicked by political leaders to work with the state and may also receive a variety of state-provided benefits to promote business group growth and diversification. Thus, in the typical pattern, business groups form as an outgrowth of the family firm in response to both institutional weaknesses (e.g., the lack of functional courts to enforce contracts among trade partners) and government policy (e.g., loans at preferential interest rates to make large-scale investments in heavy industry). (45)

In post-reform China, the path was quite different. When China moved away from central planning, the economy was bereft of private entrepreneurs, littered with redundancies in productive capacity resulting from autarkic economic policies, and highly fragmented along bureaucratic lines. Chinese economic strategists were intrigued by Japanese and Korean business groups as models for promoting economic development, (46) but there was no blueprint for their replication in China. The business groups in existence today did not spring fully formed from the minds of Chinese economic planners; rather, they resulted from a long process of experimentation with collaborative forms of production.

Early on, the most pressing task was integrating disjointed economic structures and improving resource allocation. In the early 1980s, the Chinese government launched a series of regional and enterprise-level initiatives to promote these reforms. One such initiative was the introduction of business alliances (jingji lianying) as a mechanism of enterprise-level integration. These alliances, typically formed by contract, were designed to encourage interjurisdictional and cross-industry collaboration among SOEs and between SOEs and other organizations, such as research institutes and universities. Collaboration within a business alliance took various forms, such as stabilization of supply-demand relationships and sharing of marketing and production facilities. (47) Used primarily from 1980 to 1986, approximately 32,000 business alliances were formed among over 63,000 SOEs. (48)

The business alliance concept, however, proved ineffective in promoting economic reform. The alliances suffered from a lack of unified leadership and created regulatory gridlock by multiplying the number of government agencies with jurisdiction over economic ventures. (49) Over time, economic strategists in the government became dissatisfied with purely contract-based collaboration and shifted their strategy in the second half of the 1980s. Although business alliances fell out of favor, these early forms of collaboration created nascent firm networks and governance mechanisms that became the building blocks for the formation of business groups in the years to follow.

In the next phase, policymakers relied on more durable and encompassing forms of collaboration among enterprises. In place of contracts, they used organizational structures based on shareholding to link finns. SOEs were organized into groups to deepen specialization, promote economies of scale, build competitiveness in domestic and international markets, and separate the commercial activities of SOEs from the regulatory role of the government. In 1987, the central government unveiled a legal definition of "business group" (qiye jituan) and specified the organizational requirements for registering as such. (50) The introduction of a formal business group concept by central government authorities sparked a fever of group formation at the local level. But often these groups were little more than hastily transformed administrative units of local governments, lacking in economic coherence and functional governance mechanisms.

In response to these problems, the Chinese central government took more control over the creation of business groups in the 1990s. The State Council constructed fifty-seven experimental business groups in 1991 and added sixty-three additional groups in 1997. These 120 experimental groups were concentrated in critical industries, such as automobiles, machinery, electronics, steel, and transportation. The groups benefited from a range of preferential policies in areas ranging from taxation to government contracts and eligibility for stock exchange listing. The government's stated purpose in forming these groups was to achieve economies of scale, facilitate interfirm collaboration, and enhance international competitiveness. The formation of vertically integrated groups also had the administrative advantage of streamlining control over the economy: a small number of major firms would serve as conduits through which policy could be transmitted to vast numbers of enterprises organized under the core firms. By the mid-1990s, creation of national champions was explicitly recognized as a goal of the central government. (51)

After years of experimentation with organizational structure, a relatively clear concept of the business group emerged in 1998 with the promulgation of the Provisional Rules on Business Group Registration. (52) Though "provisional," these rules are still in effect. Subject to various threshold qualifications, (53) a business group is defined as a group of entities comprised of four layers: (1) a parent company and (2) its controlled subsidiaries (the two required layers), along with two optional layers--(3) noncontrolled subsidiaries and (4) other firms that collaborate with the core company or its subsidiaries. Figure 2 illustrates the basic structure of a business group under the regulatory framework. In order to be registered, group members must enter into an agreement (in the form of articles of grouping) specifying the group's boundaries and internal governance rules. (54) Only registered business groups qualify for important benefits, such as eligibility to establish a finance company. (55)

This group formation process, together with the more basic step of "corporatization" of state enterprises--that is, the transformation of state agencies involved in economic activity into joint stock corporations--raised a vexing agency problem: when a corporate asset is theoretically owned by "the people," who is the principal? In recognition of this problem, several attempts were made to create a controlling shareholder, leading to the establishment of SASAC in 2003. (56) In theory, SASAC represents the state as "owner" and exercises shareholders' rights on the state's behalf. SASAC's distinctive role as controlling shareholder within the context of the party-state will be examined in Part III, below.


We now use the networked hierarchy and institutional bridging concepts to examine in some detail the key members, networked structure, and internal governance mechanisms of the groups (in Part II.A-C) and provide two examples to illustrate the variants of corporate groupism in China (in Part II.D).

A. Components

1. Core (parent) company

As noted, Chinese corporate groups have a multitiered hierarchical structure.

At the top of the group is the core company. Core companies were typically formed by "corporatizing" a government ministry with jurisdiction over a particular industry. For example, each of the core companies in the national petroleum groups was separated from the former oil ministry and transformed into a corporate entity. The core company acts as a holding company, serving as an intermediary between SASAC and group firms that engage in actual production. The core company coordinates information flow and resource allocation within the group. It transmits policy downward from the state to group members, and provides information and advice upward from the group to state economic strategists and planners. As Chinese commentators explain,

   The key sectors and backbone industries are still controlled by the
   state through wholly state-owned or state-invested enterprises....
   In reality, the state can control the nationally important
   industries and key areas to lead the economy simply by grasping a
   few hundred large state-owned holding companies or business
   groups. (57)

2. Listed company

The external face of the national champion is not a group of companies but a single firm with shares publicly traded on Chinese or Hong Kong stock exchanges and, often, also on other major exchanges. For example, PetroChina, one of the largest oil companies in the world, whose shares are listed on the Shanghai and New York Stock Exchanges, is the external face of the CNPC Group, whose core company is the China National Petroleum Corporation. SASAC's strategy in managing groups under its supervision has been to consolidate high-quality assets in specific companies and to seek public listing for those firms. These listed firms are the focus of most existing scholarship on Chinese corporate governance.

3. Finance company

One of the key benefits of registration as a group is eligibility to establish a finance company--a nonbank financial institution that provides services to group members. (58) Finance companies are exempt from the general prohibition on intercompany lending. (59) Under the current legal framework, a finance company provides services on behalf of group members similar to those provided by commercial and investment banks. Subject to approval by banking regulators, the finance companies may engage in a wide range of activities, including accepting deposits from and making loans to member companies; providing payment, insurance, and foreign exchange services to members; and underwriting the securities of member firms. They also engage in consumer finance related to the products of group members and invest in securities issued by financial institutions. (60) Deposits from group member companies are the finance companies' main source of funds. Almost all finance companies are members of state-owned groups, either at the national or provincial level, (61) and many are formidable in size. Table 1 compares the asset values of the largest finance companies as of 2009 with the asset values of Chinese banks. As the Table indicates, by assets, the largest finance company in China is comparable in size to the country's twentieth-largest bank.

In its role as the hub of group financial transactions, the Chinese finance company is a partial analogue to the Japanese main bank, at least as it operated in the heyday of postwar Japanese corporate finance and governance. However, there are several key differences. In contrast to widespread, if low-level, cross-shareholding ties between Japanese main banks and their most important borrowers, (63) the Chinese finance company holds virtually no equity in other group member firms, and few or no firms, other than the core company, own shares in the finance company. While the finance company can be utilized by the core company to help monitor group members, there is no evidence that finance companies perform an independent monitoring function, particularly with respect to the core company or listed companies in the group. (64)

The Japanese banking system was attractive to Chinese observers during the formative period of China's process of economic transition in the early 1990s, particularly for its perceived corporate governance benefits. (65) In this period, legal scholars and economists widely argued that equity ownership by the main bank in its borrowers had important governance benefits (66) and that the main bank served as a "delegated" or "contingent" monitor on behalf of other lenders to group firms. (67) It was even argued that the main bank substituted for the market for corporate control in Japan by displacing managers of financially troubled firms. (68) Yet China's finance companies bear only a weak resemblance to the main bank system and serve primarily as instruments of the core companies to effect internal group capital allocation. Unlike the situation in Japan, moreover, the Chinese corporate sector has not traditionally held significant equity stakes in the banking sector.

Given China's attraction to the Japanese model during a formative period in the emergence of its business groups, why didn't China's economic strategists structure the finances and governance of the business groups to resemble the Japanese system circa the late 1980s? Two complementary explanations, closely linked to China's overall system of economic governance, are plausible. The first is that dispersion of governance rights in member firms to nonbank financial institutions might dilute and complicate the hierarchical structure of economic management made possible by group formation under centralized state supervision. Second, the creation of nonbank finance companies within business groups--what one commentator has called "outside-the-plan financial intermediaries" (69)--poses an obvious competitive threat to the (largely state-owned) commercial bank sector. As such, Chinese regulators have been vigilant about not expanding the scope of finance company activities to the point that these institutions might constitute complete substitutes for Chinese commercial banks.

4. Research institutes

Chinese policymakers have encouraged business groups to include research institutes as members to promote high technology development and to increase international competitiveness. (70) Most of the national business groups contain one or more research institutes. The research institutes conduct R&D, with particular emphasis on applied research in areas related to the group's products and production processes. Often, the research institutes collaborate with universities on particular projects to derive complementarities between the applied focus of business R&D programs and the theoretical approach of academic researchers.

Typically established as nonprofit institutions, the research institutes receive funding from the core company in the group. Research institutes in groups with a diverse range of products may be multilayered, with a chief institute affiliated with the core company and second-tier institutes established under particular operating subsidiaries. Intellectual property arising out of the research activities is typically owned by the core company or allocated by contract in joint projects with outside institutes.

B. Membership and Internal Governance

Membership in most business groups is based on equity ownership of member firms by the core company. Although membership based on purely contractual relations among firms is permitted under the regulations on business groups, it is not common. (71) The predominance of equity ties is a reflection of governance concerns held by both the core company and the state. For the core company, equity ownership provides a more direct and flexible form of control than contract. For the state, the objectives of group formation are more effectively advanced through corporate ownership than through loose affiliations-indeed, the original business alliance concept was abandoned in favor of the business group concept for precisely this reason. (72)

In marked contrast to the ownership of business groups in Japan and Korea, equity ownership in Chinese business groups typically runs in only one direction: from the core company to downstream subsidiaries. Very little share cross-ownership is found in Chinese business groups. As with the predominance of equity ties over purely contractual relations, governance concerns--both corporate and political--appear to be the primary reason for top-down ownership patterns. The core company--as the group's dominant player, with ultimate group-wide decisionmaking authority over personnel and strategic issues--has little use for upstream share ownership; top-down stock holdings reflect and reinforce the hierarchical structure of the group. For the government, the core company's role as delegated manager and monitor of group firms would not be enhanced--indeed, it might be complicated--by cross-shareholding linkages among group firms. Moreover, to the extent that cross-shareholding is used to promote enhanced monitoring of, or risk sharing among, group members in countries such as Japan, this function may not be complementary to Chinese corporate group structures, given pervasive party involvement in group firms and other forms of party-state monitoring outside the confines of corporate law norms. (73)

Internal group governance structures are specified in legally binding agreements called articles of grouping, which are adopted by all group members. The articles of grouping are state-supplied, standard form contracts required of all registered business groups, and their specific provisions are largely composed of default rules. In reality, the core company dictates the terms of the articles, and the internal governance rules grant the core company veto rights and other enhanced governance rights with respect to the group. Many articles of grouping provide for plenary or management bodies to facilitate group or delegated decisionmaking, respectively, but these organs typically either have only advisory power or are structured so that the core company effectively controls their decisionmaking processes. In short, governance in a Chinese business group is a largely top-down process, but it is open to information and participation from below.

C. Networks

The foregoing are the main components of Chinese corporate groups and the mechanisms by which member firms are linked. But the mechanisms of Chinese state capitalism operate by joining the corporate groups into much larger networks of organizations affiliated with the party-state. These state-affiliated networks generate Chinese state capitalism's most distinctive features and raise the thorniest questions for foreign competitors and regulators. We now explore the larger networks in which individual corporate groups are embedded.

1. Intergroup networks

While groups in the same industry do sometimes compete domestically, SASAC has encouraged the national groups to collaborate in overseas projects to increase their global competitiveness. These linkages, often among groups in complementary industries, are designed to facilitate technological development and a host of other objectives, such as information sharing, marketing, and pooling of capital for capital-intensive projects. As shown below, these linkages typically take two forms: equity joint ventures and contractual alliances.

In most economies, these forms of collaboration would raise obvious antitrust concerns. China enacted an Antitrust Law in 2008 that, as a formal matter, would appear to subject these alliances (along with mergers and other combinations between SOEs) to antitrust scrutiny. (74) In practice, however, the national enterprises under SASAC supervision have thus far been virtually exempt from antitrust enforcement. (75)

We illustrate a few of the intergroup networks in the national steel groups by way of example in Figures 3A and 3B. The number of relationships involving companies in these groups is actually much greater than is pictured here. (76) These Figures illustrate the use of both ownership and contract to construct intergroup networks. They also show how networks are constructed among both complementary groups and groups comprised of erstwhile direct competitors.

2. Central-local intergroup networks

National groups under SASAC control are sometimes linked to business groups under the control of local governments. Figures 3A and 3B, above, provide an example from the steel industry: provincial group Hebei Iron and Steel has an indirect equity ownership interest in the same joint venture as national champion Baosteel. These linkages are the result of an evolving dynamic between the central and local governments. Initially, local governments sought investment from the national groups to rescue moribund local SOEs. As the national groups expanded, local governments began to view them as competitive threats to local businesses. Local protectionism increased, and a push was made to create "provincial champions." The relationship between national and local groups appears to be in flux again because of the global financial crisis, which prompted renewed central-local cooperation. The local governments now view the national champions as sources of support for small and midsize enterprises, which suffered when they lost the backing of foreign and private companies. (77) For the national groups, which are under pressure from their governmental supervisors to grow, tie-ups with local groups are an avenue of expansion.

3. Business group-party-state networks

Of course, as SOEs supervised by SASAC, all national champions are connected to the central government. But this simple syllogism masks the density of the networks that tie the leading business groups to institutions of the central government and the Communist Party. Multiple institutional bridges facilitate the network. The first is the China Group Companies Association (the Association), which is formally designed as an intermediary between the national business groups and the central government. (78) SASAC and the Ministry of Commerce oversee the Association, which has a board of directors composed of senior government officials from these and other economic ministries, as well as top managers of the most important national business groups. The Association functions as a vehicle for airing issues of concern to the central SOEs and reporting to the State Council. Recent issues discussed by the Association include streamlining the government approval process for foreign investments and improving internal risk controls in connection with foreign investments. The Association also lobbied, against strong resistance from banking regulators, for the establishment of the finance companies within corporate groups discussed above in Part II.A. (79)

A second bridge is the practice, which has roots dating to the era before SASAC's establishment, of granting substantive management rights in a nationally important SOE to the ministry with supervisory authority over the industry in which that SOE operates. For example, the Ministry of Industry and Information Technology retains important management rights over China Mobile, including the power to nominate its top managers, even though China Mobile is part of a national business group whose core company is 100% owned by SASAC. (80) In some industries, high-level, two-way personnel exchanges between ministries and national groups reinforce this link. (81)

A third institutional bridge is the routine exchange of personnel between SASAC and the central SOEs it supervises. In a policy designed to promote "mutual adaptation in political and professional qualities," (82) fifty to sixty SOE managers are seconded to SASAC annually for one-year periods and vice versa. Available data on this practice suggest that the corporate managers seconded to SASAC are fairly senior and come from leading enterprises, while the SASAC officials are relatively junior. This suggests that the exchanges are not primarily designed to facilitate SASAC's monitoring of the SOEs, but rather to build SASAC capacity and promote cooperation between the SOE sector and the government.

A fourth institutional bridge between the national champions and the government is the practice of reserving a number of positions in several elite (if functionally obscure) government and party bodies for leaders of the national SOEs. Chief among these bodies are the National People's Congress, the central government's symbolic legislative body; the National People's Political Consultative Conference, an advisory body composed of representatives of different social and political groups; and the National Congress of the Chinese Communist Party, the Party's general assembly. For example, based on a pool of candidates recommended by the party committees of the 120 central enterprises extant at the time, SASAC nominated 22 managers as representatives to the current (Eleventh) National People's Congress, and 99 managers to the Eleventh National People's Political Consultative Conference, both of which run from 2008 to 2013. (83) In 2007, the Party Committee of SASAC and the party committees of the 120 central enterprises selected 47 members to the 17th National Congress of the Chinese Communist Party. (84) The composition of the selected members was based on instructions from the Central Organization Department of the Party, which specified that no more than 70% of the positions should go to top managers of the core companies and that no less than 30% should go to middle managers of core companies and top managers of their subsidiaries. (85)

As explained in detail below, the Party also plays a major role in personnel appointments in the national business groups. One-third of the employees in the national SOEs are members of the Party, (86) and Party organizations exist within each level of the business group hierarchy. At one time, there may have been ideological reasons for the Party's pervasive role in SOEs. But a compelling political economy explanation for the practice is also apparent: the Party constitutes a massive interest group that maintained extensive ties to economic enterprises in the central-planning era. Indeed, in that era, there was often little separation between governmental, economic, and social organizations, and the Party was involved pervasively across all three spheres of activity. Corporatization and other economic reforms could have posed a major threat to important dimensions of party rule. Institutionalized party involvement in the post-reform state-owned sector can be seen as a way of buying the support of the Party for reforms that it might have otherwise blocked. From a functional perspective, the Party is also well situated to monitor personnel in the SOEs. As one commentator notes:

      The Party's control over personnel was at the heart of its
   ability to overhaul state companies, without losing leverage over
   them at the same time....

      The party body with ultimate power over personnel, the Central
   Organization Department, is without a doubt the largest and most
   powerful human resources body in the world. (87)

D. Examples

For illustrative purposes, we describe below the corporate structure and governance characteristics of two national champions: Chinalco, one of the world's largest aluminum producers, and giant power producer China Datang. As the structure of national champions go, Chinalco is unusual; Datang is typical. We include Chinalco both by way of contrast and because its structure is a legacy of a form of business alliance prevalent in an earlier stage of China's reform process. The contrast between Chinalco and Datang helps illustrate how organizational forms in the state sector have evolved over time.

1. China National Nonferrous Metals Industry Group

The Aluminum Corporation of China (Chinalco) is a Fortune Global 500 company. (88) Its origins can be traced to the Bureau of Nonferrous Metals, established in 1979 under the Ministry of Metallurgical Industry. The company was reincarnated several times before it came into its present form as the crown jewel of the Aluminum Group Corporation of China in 1999. The Chinalco group has retained some features of the business alliance concept prevalent in the 1980s, the firm's formative period. Thus, Chinalco is not only a group in its own right; it is also the centerpiece of a larger alliance of firms, the China National Nonferrous Metals Industry Group (CNNG, by its English abbreviation). (89) CNNG has four levels of firms organized to collaborate along the nonferrous metals production chain. The first three levels resemble the structure of the other national SOE groups. They consist of the core company, Chinalco; its wholly owned subsidiaries; and its noncontrolled, downstream subsidiaries. What makes this group unusual is the huge fourth level consisting of over 100 companies in which Chinalco holds no shares but with which it or other Chinalco group members have long-term trading relationships. (90) Some members of the fourth level are also members of local corporate groups and act as bridges to other business networks. (91) Because SASAC's supervisory authority is based on share ownership, the many contractual members of CNNG are not within the SASAC governance system and do not count toward the rankings of business groups by size. In essence, CNNG is an industry association with a vertically integrated, national-champion business group embedded in its core. Now consisting of 197 members,92 CNNG is a hybrid between the contractual alliances of the 1980s and contemporary business groups, in which hierarchical equity relations prevail. Figure 4 illustrates CNNG's group structure. The dotted line delineates the group boundary. The triangle shows the boundary of SASAC's jurisdiction.

The formal governance documents of CNNG serve as a capsule summary of state capitalism and reflect both political and business concerns. According to the Articles of Grouping, a major purpose of CNNG is to undertake important functions requested by the state, including implementing national economic development policies and advising the government in enacting industrial policies and in implementing corporate, industrial, and national standards. (93) This is a formal recognition of the state's goal of establishing corporate groups as a mechanism for exerting control and implementing development policies through the networks organized around the core companies. The Articles also state a straightforward business rationale for the formation of CNNG: to coordinate resources among member companies. According to the Articles, CNNG was created to provide a platform for technological exchange, capital reorganization, and sales and marketing collaboration; to improve resource allocation among member companies; to support the internationalization of research, production, and sales by member firms; to disseminate data within the Group; and to coordinate relationships among member companies. (94)

Policy and resource collaboration among a large number of firms requires coordination mechanisms within the group. Yet the lack of ownership ties among many firms in CNNG leaves the group without corporate law mechanisms to facilitate coordination. In place of organizational structures, CNNG uses contractual governance mechanisms featuring ostensibly democratic principles. CNNG's internal affairs are governed by a management council com posed of one representative of each member company and chaired by an appointee of the core company. (95) The management council has a large executive committee, comprised of three subcommittees, to implement its decisions. The executive committee is composed not only of representatives of the core company and its controlled subsidiaries, but also of representatives of firms that only have contractual relationships with these companies. In both the management council and the executive committee, decisions are made by majority vote, with one vote per member.

This group governance structure is reminiscent of the Presidents' Councils in Japanese keiretsu. (96) While some commentators placed considerable weight on the Presidents' Councils as corporate governance institutions, it is more likely that they were used mainly as information-sharing devices and to make decisions on noncore business issues in areas such as public relations. We do not have enough information about CNNG's intragroup governance mechanisms, which have parallels in many other Chinese groups, to know how important a role they play in practice.

2. China Datang Group

China Datang Group is a Fortune Global 500 company (97) and one of the five largest power-generation companies in China. Figure 5 shows the ownership structure of the Group, which is comprised of 143 companies. We have chosen this group because it is typical of national-champion groups and nicely illustrates the networked hierarchy common in major Chinese SOEs today. Note the layered structure, which features a core holding company at the top and layers of subsidiaries directly or indirectly controlled by the holding company below. Also note the top-down nature of the ownership structure and a nearly complete absence of cross-shareholding among group member companies. The Group includes three publicly listed companies controlled by the holding company. These include Datang International Power Generation Corporation (Publicly Traded Company #1 in the Figure), the shares of which are listed on the Hong Kong Stock Exchange and the London Stock Exchange. Another key member is the finance company, also controlled by the core company but with some shares held by the publicly listed companies.

But China Datang Group is not an island unto itself. As Figure 5 shows, the Group has extensive linkages to companies outside the Group: 84 nonmember companies have equity relations with group members. These networks appear to be strategic, comprised of firms operating in related or complementary industries. For example, the Group has equity joint ventures with China's other major power-generation companies, including Guodian Group, Huadian Group, and Huaneng Group. (98) China Datang Group also has a joint venture with Three Gorges Group, which is also active in power generation. Thus, the largest power-generation companies not only share a common controlling shareholder, SASAC, but also have joint ownership of a number of companies.

Although the parallel is far from perfect, in some ways, the Chinese national-group structure as a whole resembles the structure of a Korean chaebol. (99) That is, while individual corporate groups in China are vertically integrated along the production line and lack cross-shareholding among member firms, the groups under SASAC supervision, taken as a whole, resemble a giant diversified conglomerate under a single controlling shareholder with extensive cross-ownership and other forms of collaboration among members.

Top 10 Finance Companies in China, by Assets, 2009 (62)

Rank       Company           Year
            Name            Est'd

1           China            1995
         Finance Co.

2        China Power         2000
         Finance Co.

3          Sinopec           1988
         Finance Co.
4           China            2001
         Finance Co.
5           SAIC             1994
         Finance Co.

6        China Aero-         2001
        space Science
           & Tech.
         Finance Co.
7           CNOOC            2002
         Finance Co.
8        Haier Group         2002
         Finance Co.

9        China Power         2005
        Financial Co.
10          WISCO            1993
         Finance Co.

Rank       Assets         Affiliated
            (USD           Group's
          billion)         Industry

1           40.87            Oil

2           16.46        Electricity

3           8.31             Oil

4           6.85         Shipbuilding

5           6.43          Automobile

6           4.56          Aerospace

7           4.44             Oil

8           3.64             Home

9           3.55         Electricity

10          3.27            Steel

Rank      Bank with      Controlling
         Comparable         Owner
        Total Assets       (State /
       (national rank)    Nonstate)

1       Beijing Rural       State
2         Shengjing         State
3       Bank of Hebei       State
4          Bank of          State

5          Bank of          State
6          Bank of          State

7       Qishang Bank        State
8       Kushan Rural       Nonstate
9         Chang'An          State
10         Bank of          State
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Title Annotation:Introduction through II. National Business Groups, p. 697-734
Author:Lin, Li-Wen; Milhaupt, Curtis J.
Publication:Stanford Law Review
Date:Apr 1, 2013
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