6th Global Conference on Business & Economics
ISBN : 0-9742114-6-X
Minority M&A in Chinese Banks - Perspectives on Integration
and Competitive Challenges
Peter R. Haiss, University of Economics and Business Administration, Vienna, Austria
Johannes Bolzano, University of Economics and Business Administration, Vienna, Austria
ABSTRACT
The strong foreign investment growth in the Chinese financial sector has raised a lot of doubt recently.
This paper analyzes the difficult situation of western investors that are currently only offered minority stakes in
mostly desolate Chinese banks. We discuss the theories of early market entry via minority acquisitions and
contrast them with the downsides of hasty investment decisions. We then apply the resource based view and
theories of cooperation to offer a framework for pragmatic solutions and increased profitability. Finally we
show that the short-term financial focus of western banks can result in a considerable destruction of value and
that patient participants in the bidding race could indeed profit from the mistakes of their competitors.
INTRODUCTION
Almost every major financial institution is currently trying to grab a hold in the Chinese market
(Gallego et al., 2004). In the last months more than 23 billion dollars were invested into the country’s financial
sector (HVB, 2005) which is currently growing twice as fast as the American market (Bloomberg, 2005). Figure
1 shows the real GDP growth in China compared to the USA and the EU-25.
2001
2002
2003
2004
2005
China
8:3 %
9.1 %
10.0 %
10.1 %
9.9 %
USA
0.8 %
1.6 %
2.7 %
4.2 %
3.5 %
EU-25
1.9 %
1.2 %
1.2 %
2.4 %
1.6 %
Figure 1: Real GDP growth per region (Euromonitor International, 2006)
The entire boom has made China already the number one recipient of foreign direct investment, with
over $60 billion in 2004 (Financial Times, 2005). Right now the biggest banks of the world are fighting a
strategic battle about who will get the most interesting acquisition objects. As seen in Figure 2, FDI inflows to
USA and Western Europe have overall been strongly decreasing while investments in China show a constant
upward trend.
2000
$41,073m
2001
2002
2003
China
$47,282m
$53,197m
$53,966m
+/15.12%
12.51%
1.45%
USA
$314,007m $159,461m
$71,331m
$56,834m
+/-49.22%
-55.27%
-20.32%
Western Europe
$657,575m $324,080m $289,156m $239,734m
+/-50.72%
-10.78%
-17.09%
Figure 2: FDI inflows per region (Euromonitor International, 2006)
2004
$61,151m
13.31%
$95,859m
68.66%
$101,638m
-57.60%
Nonetheless, the huge amounts of money involved should not blur the picture about the limited
influence this may have on governance and performance of the target banks. Due to legal restrictions, a signle
foreign investor can only buy minority stakes in the range of two to 20 percent in China currently. While
investors are required to inject their technology and knowledge, their ownership and thus governance are limited.
The goal of the paper is to discuss how this limited foreign ownership can improve governance and
performance, which obstacles need to be removed and which strategic capabilities are necessary. Is it possible to
extend strategies and operations across national markets with minority interests? Applying the resource based
view and cooperation theory, we argue that while the single investment is small, the sheer number of deals and
the high international attention paid to the fate of the investors will provide major signals to the market. The
challenge for the minority investors will be to bundle their interests while competing with one another.
The remainder of the paper is organized as follows. The next section summarizes the most important
developments in the Chinese banking sector, mainly the investment in the big four Chinese banks that account
for 60% of total banking sector assets. That’s also where we discuss the bad loan crisis that poses a serious
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threat to the entire sector. Thereafter we give an overview of the theories that might have lead to the rush into
the financial sector especially the early mover advantages and the pros and cons of different entry strategies
applied to China. What’s more we show the major downsides of current investment practices that mostly derive
from the lack of control in a minority stake. Finally we offer solutions that can help to overcome the difficulties
discussed beforehand. We emphasize the importance of the resource based view that can in this context be
applied to generate far greater profits in the global pooling of resources. At last we highlight the need for
regulatory change and show that cooperative strategies of foreigners can offset many of the disadvantages
encountered.
CHINESE BANKS AS ACQUISITION TARGETS
Out of China’s 128 commercial banks the so called big four are being examined as they currently are
subject to major initial public offers (IPO) or partial takeovers and account for almost 60 % of total Chinese
bank assets that can be seen in figure 3 (Podpiera, 2006). China Construction Bank, Bank of China, Industrial
and Commercial Bank of China and Agricultural Bank of China all have similar advantages and disadvantages
to offer for their western investors (Tsang, 2006).
Industrial &
China
Agricultural
Commercial
Bank of China
Construction
Bank of China
Bank of China
Bank (CCB)
(ABC)
(ICBC)
Tier one capital
$22,809m
$22,507m
$20,600m
$16,670m
Assets
$464,213m $429,432m
$637,829m
$422,151m
Capital assets ratio
4.91%
5.24%
3.23%
3.95%
Pre-tax profit
$1,215m
$54m
$321m
$820m
Real profits growth
-27.90 %
-89.70 %
-61.90 %
129.80 %
Return on assets
0.26 %
0.01 %
0.05 %
0.19 %
NPL to total loans
16.29 %
9.12 %
21.24 %
na
Figure 3: Key facts of the big four in 2003 (Shimizu, 2005)
As emphasized by Chinese regulatory officials, the banks and the government have shown a lot of
effort to carry out major reforms, the Bank of China appearing to be the healthiest (McGregor and Guerrera,
2005). The changes include the reduction of bad debt or the orientation towards a more risk oriented regulatory
framework. Some banks have even started to hire foreign managers to improve their performance despite
Chinese ownership. Furthermore the enormous market capacity means a lot of potential customers for foreign
participants that are granted an operating license.
However, most of the banks are greatly overvalued with a price earnings ratio of around 30 for Ashares. The point becomes more apparent the near insolvency a few years ago of several major banks and an
expected credit default rate of between 30% and 50% that was only recently reduced to an acceptable level
(Schiffmacher, 2004), (Busse, 2005), (Hirn, 2004). What’s more it must be noted that new likely to turn out bad
loans are still being handed out to locals. The NPL deterioration trend with will become even more prevalent
when government injections will be left out in the future (The Economist, 2005).
2002
2003
2004
3Q 2005
BOC
22.5 %
16.3 %
5.1 %
na
CCB
15.2 %
9.1 %
3.9 %
na
ICBC
24.4%
21.2%
19.0%
na
ABC
36.6%
30.8%
26.8%
na
SCB total
25.6%
20.1%
15.6%
10.1%
Figure 4: Official amounts of non-performing loans of state owned commercial banks (Podpiera, 2006)
Even though the official numbers shown in figure 4 make the banks seem healthier, a recent study of
Ernst & Young warns that the real amounts of bad debt are probably much higher than their estimates (Ernst &
Young, 2006). The official level of non-performing loans (NPLs) as of December 31, 2005 was reported to be
$133 billion for the big four banks. As seen in figure 5, the bad loans of the big four could in the end turn out to
be 2.7 times higher than stated.
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Financial Entity
NPLs
Big Four Banks
$358 bn
AMCs
$230 bn
Other System-Wide NPLs
$323 bn
Total NPLs in China
$911 bn
Figure 5: Estimated real amount of non-performing loans (Ernst & Young, 2006)
This threat makes the price paid for the minority stakes appear even higher and less reasonable. Instead
of being reduced to an acceptable level, further loans are probably being issued to questionable lenders even if
they are involved in projects with no foreseeable return on investment. Banks will have to learn to resist the
pressure of local governments that used to dictate the issuance of loans (Ernst & Young, 2006).
Foreign Investments
Despite the weak financial condition of the big four, minority stakes in three of them have already been
purchased by foreign investors as shown in Figure 6 (Ernst & Young, 2006). Considering that the banks are
currently not at all transparent due to lacking government support the buyers have entered into relatively risky
deals with no real prior due diligence carried out. That’s why we will examine the different theories that might
have lead to these decisions in the next chapter, followed by potential downsides of current market entry
practices and remedies for further losses after that.
Chinese banks
Investor
% Ownership
ICBC
Goldman Sachs, American
Express, Allianz Group
10.0%
Bank of America Corp.
CCB
Temasek Holdings
8.67% (can be increased to
19.9% in the next 5 years)
5.98%
Royal Bank of Scotland,
Merrill Lynch, Li Ka-shing
10.0%
Temasek Holdings
10.0%
UBS
1.6%
BOC
Asian Development Bank
0.24%
Figure 6: Strategic investors in the big Chinese banks (Ernst & Young, 2006)
EARLY MARKET ENTRY VIA MINORITY M&AS AND JOINT VENTURES
In this chapter we discuss both the potential first mover advantages of early entrants and their preferred
method of market entry via minority mergers. We show that early mover advantages are often overestimated by
western managers compared to their Asian counterparts and point to joint ventures (JV) and subsidiaries as
attractive alternatives to mergers and acquisitions.
Early Mover Advantages
Previous research has found it very important to be among the early entrants into a new market (Song
et al., 1999). In theory the first or early mover advantage is a result of special resources that become available to
firms that enter new markets prior to others. In accordance with Barney’s resource based view these resources
have to be valuable, rare, imperfectly imitable and non substitutable (Barney et al., 2001). These requirements
met, the resources attained through early entry are supposed to provide the pioneers with a sustainable
competitive advantage compared to late entrants that will prevail for a long time.
One of the most commonly acknowledged advantages is the better customer access of pioneers that
leads to a significantly higher market share both in the short and in the long run (Carow et al., 2004, Liebermann
and Montgomery, 1988, Luo and Peng, 1998, Makadok, 1998). As a main reason for the sustainability of the
larger market share the cost of change for customers is emphasized (Makadok, 1998). Once customers have
picked a certain company they will be less willing to go through the process of finding another firm even if it
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offers higher quality or more competitive prices. It is however yet to be seen whether this will hold true in the
Chinese cultural environment and the financial services industry. In general, Chinese customers were found to
stick less to certain brands in case they find better offers (Forum China, 2005). This would greatly reduce the
potential of creating an early mover advantage in China.
Furthermore, early movers appeared to outperform their competitors in terms of profitability (Luo and
Peng, 1998, Song et al., 1999). This was explained by cost advantages on the one hand and higher sales growth
on the other. Cost growth was again decomposed into the ability to acquire superior locations at better prices
and to benefit from higher qualified staff and better equipment that could be harder to get for late entrants.
Figure 7 shows how this applies to the four major Chinese banks with 113,500 subsidiaries and more than
1,389,000 employees. Being able to benefit from the huge retail nets could help the foreign banks to quickly
spread their services to a very wide customer base.
Industrial &
Agricultural
Commercial
Bank of China
Bank of
Bank of China
China (ABC)
(ICBC)
Employees
189,000
310,000
390,000
500,000
Subsidiaries
12,000
21,500
20,000
60,000
Balance sheet total
$464bn
$429bn
$577bn
$360bn
Figure 7: Employees and subsidiaries in the big four Chinese banks (Hirn, 2004)
China
Construction
Bank (CCB)
Another important point supporting early mover advantages is tacit knowledge in the area of human
resource management (Barney et al., 2001). Especially in the context of cultural differences between east and
west this complex resource will take a long time to be built. Pioneers are the first to gather experience from
handling both Chinese employees and customers. This managerial knowledge can be the main determinant of
later success when competition increases and consolidation begins. Those who can best attract customers and
manage their companies efficiently are those likely to survive in economic downswings when market shares and
cost reduction become more and more important (Song et al., 1999). This knowledge type resource will also be
relatively hard to transfer to other competitors thus constituting a base for long term sustainability.
Finally, the current situation in China is also seen as a window of opportunity that could disappear over
time (Luo and Peng, 1998). In a rapidly changing legal framework the future possibilities of market entry into
the financial sector are rather unclear. This point is however weakened by the WTO agreements signed by China
forcing it to liberalize its financial sector even more in the future.
However, research has also found several downsides of early entry that can be partly applied to the
Chinese financial sector. Pioneers are also exposed to a far higher risk due to general uncertainty in the market
(Luo and Peng, 1998). This holds especially true for the Chinese banks and their nontransparent financial and
management structures. In general, however, the risk was observed to be higher in the manufacturing industry
compared to the services sector (Song et al., 1999). Furthermore, the degree of risk turned out to decline after a
longer market presence.
Another important limitation of the early mover assumptions is the potential loss of the competitive
advantage over time (Liebermann and Montgomery, 1988). Late entrants could for example buy one of the
banks that were before acquired by pioneers thus profiting from free-rider effects in combination with lower risk.
This concern appears to be even more justified considering the current limitations to foreign stakes in banks to
20% for a single institution. A change in the regulatory framework could convert the prior early mover
advantage into a disadvantage if competitors should manage to go ahead and buy the former targets (Carow et
al., 2004). The second reason for a loss of the competitive advantage are the technological and market
uncertainties. It is currently not clear if the boom in China will be sustainable over the next decades or if a crash
might occur. Also the issue of non performing loans remains yet to be completely solved and could greatly harm
those that have already invested in corrupted and badly managed banks. What’s more changing customer needs
could also open the door new competitors thus reducing the degree of sustainability of the early mover
advantage (Liebermann and Montgomery, 1988).
Other research doubts the long term market share and cost advantage, stating that it could even be
turned into a disadvantage by competitors (Boulding and Christen, 2003, Mathews, 2002). In China customers
could be lured to change their financial institutions through better offers and extensive promotional efforts. The
likelihood of this issue depends, however, on the degree of consumer learning. It might occur that Chinese
clients turn out to be resilient to competitors’ offers and try to avoid the cost of change. We found that this
crucial issue is yet to be validated by future developments and therefore remains a point uncertainty.
Furthermore western managers were found to overemphasize the importance of early market entry
compared to their Chinese counterparts (Song et al., 1999). Especially differentiation advantages were not
supported in the empirical studies conducted. On the other hand the services offered by banks can be seen as
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rather easy to substitute in comparison with manufacturing or technical products that require extensive research
and development efforts.
Despite the initially mentioned advantages of early movers, we showed the downsides of early entry
that are backed by several empirical studies. This makes it necessary for the pioneering banks to focus on the
resources and resulting advantages that are likely to prevail in the long run. Especially process learning and
managerial knowledge seem to be of vital importance to long term success. This skill could also help to
maintain a larger market share through better customer relationship management techniques. Therefore the early
birds could keep dominating the future financial markets despite the risky bank loan situation and the potentially
volatile customer base. However, we doubt, whether the sustainable competitive advantages that remain are
significant enough to offset the cost of non performing loans, corruption issues and regulatory impediments that
currently exist. Due to the importance of resource based view in this context we will discuss the most vital
resources below when examining the possible ways out of the currently difficult situation.
Minority Mergers and Acquisitions
Foreign bank interests in Chinese banks are currently limited to a maximum of 25%. Furthermore a
single foreign institution is only allowed to hold a 20% stake (Pollitt et al., 2005). The third limitation is that
foreigners can currently engage in merely two participations at once (Thompson, 2005). This currently practiced
method of entry can mean a quick access to the Chinese market. On the other hand it imposes significant
financial risks as it is very costly. Furthermore it is to be doubted whether the minority stakes will ever become
controlling participations (Pollitt et al., 2005). Banks might expect the government to hand over control to them
as in the case of Eastern European or Latin American countries. There is however currently no significant proof
that this will happen in the near future.
Chinese
Banks
Majority Stake
Chinese
Partners
Foreign
Partners
Minority Stake
Max 25%
Partner A
Partner B
Partner C
Max 20%
Max 20%
Max 20%
Government
Partner D
Figure 8: Current Limits to Ownership of Chinese Banks
The fact that most banks chose acquisitions as their market entry strategies made the contrast between
Merger & Acquisition (M&A) and Joint Venture (JV) market entry strategies interesting for our research.
Traditional literature offers several reasons for the choice of acquisitions (Berger et al., 2004, Lin, 2005,
Trautwein, 1990).
The most common theory is the efficiency theory stating that mergers can create synergies. Financial
synergies can reduce capital costs by reducing risk and increasing company size. This increased size can also
lead to the creation of an internal capital market (Trautwein, 1990) where capital might be attained more
effectively. Operational synergies on the other hand are a result of knowledge transfers that lead to an improved
production process. However the cost for transferring the information must be taken into account when
calculating synergies. Especially in the case of Chinese banks the cultural barriers can greatly reduce the
positive effects of knowledge transfer mainly to the disadvantage of the foreigners. Finally firms can realize
managerial synergies that improve the output of the target firm by applying superior management knowledge
(Berger et al., 2004). This also holds true for the case of the Chinese financial sector where the local banks are
likely to profit from foreign risk management and organizational knowledge. Most of these synergies were
strongly criticized in other literature for often being an aim but hardly ever being realized (Hennart and Reddy,
1997).
Another interesting approach for justifying mergers is the potential to create a monopoly or to
significantly increase the market share (Trautwein, 1990). Applied to China the idea seems logical as the big
four local banks operate huge networks with thousands of subsidiaries all across China and its many provinces.
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It is however not clear yet, how much foreign banks will be able to exploit this network considering their
minority participation mentioned above.
The third important theory for market entry via an acquisition states that the buying managers have
superior information concerning the target price of the financial institution thus benefiting from information
asymmetries. This leads to the question whether markets value companies efficiently, an assumption that has
already been falsified numerous times (Chien-Hsun, 2003, Cunningham, 1997, Fridson and Alvarez, 2002,
Graham and Zweig, 2005, Gyntelberg et al., 2005, Schilit, 2002, Wang, 2003). However, for the big four in
China with their high degree of non performing loans it seems that the asymmetrical information will turn out to
be in favor of the Chinese managers rather than the foreigners (Flierl, 2004).
Finally the liability of foreigness is mentioned as an important obstacle that can be overcome more
easily via the participation in a local institution (Lopez Duarte and Esteban, 2004, Miller and Parkhe, 2002). In
this view western firms suffer disadvantages in terms of their image or the treatment by governments. Merging
with locals they can benefit from the same advantages and operate more efficiently. This is a very important
way for global investors to grab the growth opportunities in liberalizing markets when entering a market via
acquisitions. The same was seen in the Central and Eastern European (CEE) countries when they opened their
doors to FDI and western banks came rushing in (Domanski, 2005). As some banks missed the opportunity back
then to acquire interesting targets quickly enough, the urge for rapid acquisitions has become even stronger in
China’s opening.
Most of the theories mentioned appear reasonable when considering a complete or majority acquisition.
The current limitations to foreign ownership might on the other hand neutralize most of the benefits and leave
the buyers with bad loans and no control at all. This issue will be discussed below in the chapter about potential
downsides of the current market entry strategies.
Minority Joint Ventures
While minority-stake acquisitions are currently booming in China, the market entry via joint ventures
(JV) is comparatively seldom used in the financial sector (Hennart and Reddy, 1997, JPMorgan, 2004, Lopez
Duarte and Esteban, 2004). It appears that banks learned from other industries that failed to cooperate in China
by means of a joint venture (Trautwein, 1990). In the following, some analogies will be drawn from the
closeness of minority-acquisition and minority-joint ventures. Nevertheless management theory does mention
some differences (Hennart and Reddy, 1997, Zeira and Newburry, 1999).
The seemingly most striking argument for Joint Ventures are the so called indivisibilities, meaning that
in an acquisition the buyer participates in every asset of the target firm. This is exactly what happens to western
banks now that do not only pay for market access and subsidiaries but also invest in giant portfolios of non
performing loans and unskilled management that they have to handle in order to achieve synergies. Cooperation
via a joint venture on the other hand would mean that the bad loans leave the strategic partners rather unaffected
while at the same time market access and cooperation in core business can be realized (Lopez Duarte and
Esteban, 2004).
The next critical issue applying to China are management costs when acquiring parts of a firm. In order
to increase the efficiency of the target a lot of managerial resources will be necessary probably mainly helping
the Asian part. The strong cultural differences further increase the gap between the different corporations thus
creating a more severe problem.
What’s more the next commonly acknowledged problem in the current bank merger wave has also
been discussed in literature (Luo and Peng, 1998). It is extremely difficult for western banks to carry out a
reliable due diligence. The high degree of opacity within the purchased banks makes it almost impossible to
determine an approximately accurate value for the firm. This is yet another area where joint venture can be an
efficient way to reduce costs of entry by giving the buyer a further insight on the real value through the course
of time while not forcing him to pay for something that he doesn’t know.
Finally the governmental restrictions of only holding a minority share are also discussed. The fact that
a minority ownership in a bank leaves the buyer without any real control in fact puts the alternative of a joint
venture in a much more favorable light. Even though minority JVs also offer a low degree of control, at least
they do not cost as much as their acquisition counterparts, making the deal seem more reasonable. Nonetheless it
must not be forgotten that mergers can offer a higher degree of safety as the joint venture can be called off quite
easily, especially in China. On the other hand, banks could also suffer similar problems in a participatory
situation if the government decides to get rid of them (Hennart and Reddy, 1997).
Finding the right way for entering the Chinese market
At last, it appears that most banks have hardly considered their entry via the establishment of an
independent network of subsidiaries. Especially considering the WTO deadline in 2006 that is supposed to make
China treat foreign banks like locals puts a further emphasis on the question, why wholly foreign owned
enterprises were not chosen (Chandrasekhar, 2005) and why banks did not defer their entry. One of the reasons
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were probably the regulations of the Peoples’ Bank of China that significantly reduced the possibilities for
foreigners to conduct proper business in China (Howson and Ross, 2003). Mostly the central bank has fixed
some requirements that are hard to meet for foreigners like branch-level capital reserves, deposit requirements
and other obstacles that act as strong entry barriers. With these strict rules it appears that China is trying to
bypass WTO regulations, being a member but keeping competitors behind the great wall. The most important
pros and cons of the different entry forms are summarized in figure 9.
WFOE or EJV
Minority Acquisition
100% for WFOE, majority
Amount of control
Rights of a minority shareholder.
ownership for EJV is possible.
Purchasing price
Usually par value
Negotiable
There has been no PBOC approval
so far. The preparation of an IPO
IPO
Chinese or foreign IPO possible
would
require
considerable
restructuring.
Strong red tape barriers and
Market entry requirements
Comparatively low requirements
seasoning requirements.
Due to WTO rules, restrictions
should fall by end 2006. However,
each branch requires a certain Can be easily implemented with no
Geographic access
amount of working capital that acts restrictions.
as a barrier for establishing new
branches.
Execution speed
Up to 14 months
Depends on each case
Figure 9: Comparison between minority acquisitions and their alternatives (Howson and Ross, 2003)
Note: WFOE = wholly foreign owned enterprise; EJV = equity joint ventures; PBOC = People’s Bank of China;
IPO = initial public offering; WTO = World Trade Organization
As we have pointed out, the different entry modes offer distinctive advantages. On the other hand it
currently appears to be too difficult to compete with local banks that can own more than 10.000 branch offices
in each province, while foreigners can only operate in a certain set of locations. Notwithstanding these
disadvantages will be reduced more and more in the coming future, neutralizing many of the key advantages of
mergers or joint ventures. That’s why we will discuss the major downsides of the current entry strategies in the
following chapter.
POTENTIAL DOWNSIDES OF CURRENT MARKET ENTRY PRACTICES
The low degree of control means that companies will have to cope with the common difficulties
associated with minority participations (Wei, 2003). It will make it quite hard to reduce the prevailing credit risk
by introducing new credit rating methods. As it seems the banks will have to go through a lengthy process of
compromises in order to reach their goals. Previous research also has suggested that state ownership leads to
lower bank efficiency and profitability (Berger et al., 2005). Furthermore, in China’s case there is very little
evidence on efficiency determinants in the financial sector.
To make most of their current investments foreign banks should look to carry out a careful due
diligence before acquisition (Pollitt et al., 2005). In the case of China this means not only looking at numbers
but also at the distribution nets that the partner has to offer. Should the second factor be unsatisfactory the
foreign bank could as well have waited and entered the market a few years later on its own.
Furthermore banks must strive not only to cut existing bad loans but to avoid giving out new ones in
the future. It is still a common practice that local governments force banks to give out loans to friends of the
party even if the get involved in businesses that obviously won’t break even (Thompson, 2005). So far there
seems to be no possible way for foreigners to influence the credit issuance behavior of the Chinese managers
other than waiting and hoping.
From a political perspective it is currently not at all clear, where the government’s lures for foreign
stakeholders will finally lead. While China is likely to stick to the WTO regulations leading it to open up its
financial markets more and more in 2006, it is doubted whether the government will ever grant a high degree of
control in its most important banks in the next decades (Chandrasekhar, 2005). That would mean that the
negative effects of a minority stake would last for a very long time rendering the foreigners paralyzed and
leaving them with a lot of assets out of control. So far, each equity investment has been approved individually
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by the state council with advice from the Chinese central bank and was not based on a strict set of rules that
were foreseeable (Howson and Ross, 2003).
Late entrants on the other hand could benefit from the predecessors’ mistakes by waiting for the
regulations to loosen and then entering on their own without any of the problems mentioned. This was already
emphasized above in the chapter on early mover advantages and their drawbacks. However it should not be
forgotten that the long term value of a company is strongly influenced by its current corporate governance
(Sanders and Boivie, 2004). In this respect most banks still need major improvements of corporate leadership
(Hamid, 2005). The process of making Chinese banks fit for global competition could under the current
regulatory situation last for a very long time thus costing western investors vast amounts of time and money.
The fact that only two different participations by a single foreigner are currently allowed by law increases this
risk of an erroneous investment. Should new and better acquisition targets become available, the banks will be
bound to their current commitments leaving a lot of space for competitors to enter the market and grab a
strategically important position.
The pressure of shareholders is most probably one of the main reasons for this hasty entry of global
banks into the Chinese market (Hamid, 2005). This could yet prove to be another example of investment myopia,
granting banks a quick access to the market on the one side but costing them a fortune in the long run.
Host country point of view
We also doubt the positive effects of minority FDI on the Chinese economy as a whole that has been
emphasized by both governments and foreign investors. Within the FDI literature, the notion whether and to
what extent FDI is conducive to general economic growth in the host country is heavily debated (see Mencinger,
2003, Misun and Tomsik, 2002, and Mody, 2004 for a review). From a macroeconomic point of view, valuable
lesson can be drawn with regard to the sequencing of reforms in the transition from planned to market
economies in the Central and Eastern European transition countries. As long as most CEE governments tried to
restrict bank market entry to minority acquisitions, foreign bank entry neither improved corporate governance
nor proved conducive to economic growth (Hagmayr and Haiss, 2006).
There is recent empirical evidence and discussion if and under what circumstances FDI into banks may
play a pivotal role for host country growth (Detragiache et al., 2006, Domanski, 2005, Eller et al., 2005).
According to the experience of the transition countries in Central and Eastern Europe, Papi and Revoltella (2003)
conclude that minority foreign acquisitions (i.e. minority FDI) are not conducive to GDP growth in the host
country. They argue that majority stakes of about 70 per cent are necessary to achieve cost efficiency. This is yet
another very important point that emphasizes the need for less state control. As mentioned above, a reduction of
state ownership in banks leads to better performance in most cases (Berger et al., 2005, Papi and Revoltella,
2000). Under the impact of severe systemic banking crises foreign banks were invited to acquire majority stakes
in bank privatization and thus could positively influence economic development (Eller, Haiss and Steiner, 2005).
Both China and Turkey currently still rely on minority foreign involvement, as other transition economies did
during their earlier stages of economic restructuring (Hagmayr and Haiss, 2006).
To sum up, the major drawbacks of the current entry practices of western banks into China draw an
obscure picture of the future. The vast limitations in ownership are not likely to change for the big four banks in
the next time. That leaves westerners prey to bad management practices, issuance of further non repayable loans
and a lot of friction arising through cultural differences and other managerial obstacles. That’s why we will
discuss in the next chapter what the banks might have thought about when entering into these partnerships and
how they could offset their weak positions even under the current circumstances. We will show that a few key
measures can improve the situation a lot even if it will be hard in any case to totally offset the enormous
investments that have already been made and break even.
OVERCOMING THE LIMITATIONS OF MINORITY STAKES AND FINANCIAL WEAKNESS
This chapter aims to analyze a few strategies that could help western banks to make the best out of their
current situation by focusing on their strengths and combining them with their counterparts. We apply the
resource based view to the banking sector and show why it fits well into the culturally heterogeneous
environment. We then highlight the importance of integration within the organizations and cooperation between
them so that market entrants can pool their resources thus achieving higher profits in this dynamic environment.
Barney’s resource based view can be applied to wide variety of management challenges (Barney et al.,
2001). According to the theory, resources can be the base of a sustainable competitive advantage taken that they
are valuable, rare, hard to imitate and substitutable. These resources don’t necessarily have to be of a material
kind. In the culturally dynamic environment of west-east cooperation in the financial sector, process and
managerial knowledge can become an important asset as well (Barringer and Harison, 2000). The following
paragraphs describe in short, which processes and characteristics could turn out to be the key to long term
success for entrants into the Chinese financial sector.
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Reputation has turned out to be one of the common key resources of the global banks. That’s why it
seems to be an important factor in offsetting the disadvantages of a minority stake (Shamsie, 2003). Even if a
minor participation means a low degree of corporate control, foreign banks can use their image to improve the
Chinese partner’s competitive position. This could meanwhile reduce the harmful effects of inefficient corporate
governance that has been seen as the prevailing problem in the Chinese big four (Thompson, 2005).
Another important resource offered by Western banks is their size. Looking at American banks,
Citigroup with a market value of $245 billion has become a key player in the global banking industry (Ewing,
2005). The bank has achieved this by a skyrocketing performance in the last decade, as it had still been in a
severe crisis in 1990.
Concerning the competitive advantage, Citigroup can achieve a cost advantage because of the
enormous size of Citigroup. The second rather obvious advantage of Citigroup is its gigantic capitalization that
makes it extremely resilient to economic crises of any nature (Citigroup, 2004). No matter what happens to the
bad loans, they will always account only for a fraction of global bank assets and never drive them bankrupt.
However it should not be overseen that buying a Chinese bank for two times its book value without great
earnings expectations will not necessarily be a good business (Chan, 2005). To make up these overvaluations,
western banks will have to try getting management control in this bank and carry out careful strategic planning
combined with thorough risk management practices in order to stay competitive.
Smaller banks should furthermore focus on building a sustainable advantage through differentiation
(Miller, 2003). By providing services of high quality that seem hard to imitate or substitute they can gain an
important market share among their far larger rivals. This is however a very challenging task as it involves a
great deal of flexibility and innovativeness towards new customer solutions. It must also be noted that due to the
strong competition these advantages will be much harder to maintain in the future leaving little space for minor
participants and making consolidation throughout the entire sector very likely (Wiggins and Ruefli, 2005).
The next interesting resource of foreign banks is their global orientation and presence. Banks like
HSBC and Citigroup have been present all around the world for a long time and can offer not only a lot of
expertise to their partners but maybe even access to customers. That way, Chinese banks could grow well
beyond their borders and expand their market share onto a global scale. Nonetheless, before this can happen, the
credit default and efficiency issues must be seriously dealt with.
On the other hand banks should transfer their risk management knowledge to their Chinese partners in
order to improve the overall debt situation (Uzzi and Gillespie, 2002). Especially smaller European banks
should engage in this high degree of knowledge sharing in order to compete with big competitors. No matter
what size the partner, the rising debt issue must be dealt with immediately. Better risk management would
finally also increase the value of their own stake (Miller and Parkhe, 2002). This will be especially true, once
the Chinese government stops its constant capital injections to make up for insufficient corporate governance
(Pollitt et al., 2005).
A further immaterial resource that banks could offer would be listing of Chinese banks at foreign stock
exchanges. Mostly, the strong regulatory frameworks of these trading places will put the managers under strong
pressure to meet the necessary requirements. This measure could improve transparency, reduce corruption and
get the entire management into a more market oriented track.
Finally, western minority shareholders could pool their interest by forming trade associations or similar
institutions thus constituting yet another resource. That way they could ask for concessions like more influence
than before. If foreigners form interest groups, the government is much more likely to give in to their pleas than
if they were on their own. Furthermore these trade associations could keep a close relationship to international
organizations like IMF, IFC or ADB. The bigger the associations could get, the more could be changed for the
sake of a better financial outcome in the long run. The next step would be for the foreign organizations like IFC
and ADB to get involved in the banks themselves. Over time these efforts could prove to be remedies for a
catastrophe (Institute of International Finance Inc., 2006).
Improving corporate governance
After the resource based view, several sources see corporate governance as the most important
instruments for realizing profits in Western-Chinese financial sector cooperation (Bai et al., 2004, Barney et al.,
2001, Barringer and Harison, 2000, Bekier et al., 2005, Braendle et al., 2005, Guofen, 2003, OECD, 2005,
Thompson, 2005).
Notwithstanding, changes in corporate governance can only occur if the government sets a few key
measures that create an adequate framework for improvements (Institute of International Finance Inc., 2006).
Firstly, state interference in companies should be reduced to a minimum while foreign minority shareholders’
rights should be increased as noted above. Another measure would be specific training programs for Chinese
directors to make them work in a more market oriented way. This seems particularly necessary for listed
companies that have to meet stock market requirements. Next, more institutional investors could be brought
aboard for banks to increase ownership distribution and improve the quality of decisions. Other important
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recommendations include the introduction of post-IPO monitoring systems for corporate governance, stronger
law enforcement for protecting minority shareholders and the promotion of investor education. Within this
changed framework it would be much easier to apply western managerial practices, improve risk management
and avoid the future issuance of bad loans.
Finally, the application of corporate governance can also be seen under a resource based view (Barney
et al., 2001), even if only in a negative way. Companies that do not manage to properly apply suitable corporate
governance can thereby lose all the benefits of their other unique resources. This fact alone means potential
trouble for future cooperation. As it will be quite hard to impose western corporate governance practices upon
Chinese banks when only in a minority stakeholder position, it also seems unlikely that the banks will be able to
make us of all the combined resources thus achieving synergies. Furthermore the cost of restructuring and
recapitalization is estimated to be huge for governments, thus likely to be postponed as long as possible (Yan et
al., 2005). That’s why all the measures described in this chapter should be combined in order to improve the
stakeholder position at first and to then introduce western governance techniques that can help to generate
higher profits and efficiency in the end (Berger et al., 2005).
CONCLUSION
In this work we provide data on conditions for and development of foreign bank entry in China.
Drawing on the literature on early mover advantages, resource dependence, M&A and JV, we identify “weak
spots” in minority foreign bank acquisitions. Our core contribution lies in discussing remedies of how to
overcome these from both the foreign investors and host country view. We offer semi-collaborative strategies closely bundle interests vs. host country authorities while maintaining competition in the market – as solution
and argue that this dichotomy provides a rich ground for further research.
While the results generally confirm the vital importance of an early mover advantage (Song et al.,
1999), the potential downsides of a quick entry were found to partly outweigh the positive aspects. Shareholder
protection regarding corporate fraud definitely needs further improvement in order to make Chinese banks an
attractive investment (Wang, 2005). It seems however likely that the changing ownership situation will
contribute to solve this issue (Thompson, 2005). In the meantime the involvement of external executives is
highly advised in order to improve corporate governance as soon as possible (Peng, 2004). This would also
make corruption among top executives more difficult thus significantly increasing the venture’s value
(Schnatterly, 2003). Only through these measures and an appropriate control of credit default risk will
investments prove to create value (Pollitt et al., 2005).
Should the banks fail at this task, they will find it hard to resell their participations to other investors in
order to make way for new projects. Despite these issues it has to be acknowledged that the investments, as bad
as they may seem, only constitute a relatively small commitment for the big western banks (Pollitt et al., 2005).
Nonetheless this paper shows that the short-sighted investment decisions caused by shareholder pressure and
instant result orientation might prove to destroy plenty of value in the long run. The patient participants will then
be those likely to profit from the mistakes of their competitors. Global banks need to make sure that they have
sufficient management capacity to manage the new complex environments when entering markets at such rapid
pace. Being holders of minority interests, foreigners will face the challenge to cooperate in order to gain
influence, while competing amongst each other. Therefore a focus on early success alone can turn out to be
dangerous, diverting attention from the gloomy long term prospects of the cooperation. As McKinsey
consultants emphasize in their guide on corporate value management, managers of public companies should
always thrive to create the highest possible long term value for their shareholders in terms of total shareholder
returns (Koller et al., 2005). We wonder whether the global banks will accomplish this target considering their
current market entry strategies in China.
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