B ENCHMARKING
C O R P O R AT E
G OVERNANCE
I N C HINA
In Strategic Partnership With
W E LC O M E L E T T E R
– H E I D R I C K & S T RU G G L E S
Call it a tale of two companies: Last year, China National Offshore Oil Corp. (CNOOC)
was forced to drop an $18.5 billion bid for the U.S.-based Unocal Group. A few months
earlier, Lenovo Group Ltd. purchased IBM’s personal computer business for $1.25 billion,
instantly transforming the Chinese company into the third-largest computer manufacturer
in the world.
These examples demonstrate the evolution of China as an economic superpower and
the thorny problems of that ascent. Companies like Lenovo show how corporate China
is rising from its traditional manufacturing base to produce companies with global brand
names and to play an active role in company mergers and acquisitions worldwide.
In the nearly two decades I’ve lived and worked in China, there has been a sea change
in the mindset of corporations scrambling to the country and an explosion of privately
owned domestic companies. Gone is the “frontier mentality” of tapping into China simply
as a huge source of cheap labor – although that still remains a draw to many foreign
investors, looking to shave costs to stay competitive in developed markets. The skyrocketing
growth of Chinese buying power has transformed the country into one of the most
important markets in the world for many multinational companies: For many corporations,
the China market is crucial for long-term survival.
But the defeat of the CNOOC deal – which caused concern among members of the U.S.
Congress because the majority shareholder is the state – illustrates China’s difficult
transition from Communism to a social capitalistic model, as the state unravels full
ownership in many key industries while remaining influential in company affairs. It’s
becoming important to understand how corporate governance works among state-owned,
private and foreign-invested companies in China – and corporate boards are increasingly
PAGE 1
coming under the microscope. It is our hope that this unique study will shed more light
on how Chinese companies operate at the highest levels.
For Heidrick & Struggles, this report is in line with our mission to provide companies
in China and around the world with expert advice on executive and board member
selection, as well as appraisal of corporate leadership needs. Our partnership with
Fudan University is another step in our long commitment to China and to providing
guidance for domestic and foreign companies working in the most exciting economy
in the world.
STEVE MULLINJER
Managing Partner, China
Heidrick & Struggles
PAGE 2
W E LC O M E L E T T E R
– FUDAN UNIVERSITY’S
S C H O O L O F M A N AG E M E N T
Corporate governance is a hot topic in China. As the nation opens to foreign investment
and privatizes industries that used to be solely under state control, investors around the
world are placing large bets on the country’s future. As the influx of capital grows,
so does the pressure on Chinese corporate boards to make sure those investments pay off.
And like other markets worldwide, China has had its fair share of corporate scandal in
recent years.
Despite the growing importance of corporate governance, so far there has been little
investigation into how Chinese corporate boards are formed and operated. A review of
existing studies on Chinese corporate governance revealed little about the actual makeup
of company boards among state-owned, private and foreign-invested companies.
So we decided to find out for ourselves.
Top executives and board chairmen from nearly 100 companies took part in our 15-month
study, responding to detailed questionnaires and in-depth interviews. We asked about
how board members are selected and evaluated, their duties and responsibilities, and their
working relationship with company executives. Working closely with Heidrick & Struggles,
we surveyed across a broad range of industries to examine how many boards in China
have independent directors, supervisory committees, and a split in duties between CEOs
and board chairmen.
We are proud to release the results of our study in this report. The goal of this research was
not only to paint an accurate portrait of board makeup, roles and responsibilities in 2006,
but also to provide a benchmark to chart future changes in Chinese corporate governance.
PAGE 3
This research is important to Fudan University because we have been an intimate
part of the China story for nearly a century. Since our business education was relaunched
three decades ago with the opening of China, we have educated future business leaders
and led research into the dynamic changes of the past 30 years, a duty we are proud to
continue into the 21st century.
LU XIONGWEN
Dean, School of Management
Fudan University, Shanghai
PAG E 4
I N T RO D U C T I O N A N D E X E C U T I V E S U M M A RY
6
T H E C H I N A S TO RY
8
M E T H O D O LO G Y
11
P RO F I L I N G B OA R D S I N C H I N A
13
B OA R D PE R F O R M A N C E I N C H I N A
17
B OA R D D I V E R S I T Y I N C H I N A
20
K EY F I N D I N G S A N D R E C O M M E N D AT I O N S
26
PAGE 5
INTRODUCTION AND
EXECUTIVE SUMMARY
China is the future: The fate of the world economy is inexorably linked to this
emerging superpower.
With an annual growth rate for the past quarter century of nearly 10 percent, China is the
white-hot cauldron fueling global business growth. Companies from all corners of the world
have entered the market, and the nation is rising from its slumber to the attention of nearly
every enterprise that does work across borders. China also is shedding its status as a cheap
source of export labor as it becomes a strong consumer market on its own. Native corporations
are no longer just a cost-effective manufacturing alternative to Western factories, but are
emerging as global brand names in their own right.
Yet despite the worldwide attention to the People’s Republic of China, a glaring blind-spot
remains: How do Chinese corporate boards operate? How do they differ from their Western
counterparts? Are there differences in how boards operate in state-owned enterprises versus
private or foreign firms? There were no answers to these questions – until now.
For more than a year, Heidrick & Struggles and Fudan University have investigated how
corporate boards in China are composed, how they make decisions, and how they are expected
to change in this dynamic environment. The results paint a picture of a country in flux – deeply
committed to characteristics of its cultural heritage while also quickly embracing facets of
Western corporate governance.
SOM E K E Y F IN D I NGS I N CLU DE:
Chinese boards vary significantly depending on whether they are State-Owned Enterprises
(SOEs), Private Enterprises (PEs) or Foreign-Invested Enterprises (FIEs).
While Western corporations are increasingly interested in placing Chinese nationals on
corporate boards, native Chinese companies are still resistant to electing foreigners to their
PAGE 6
boards of directors. Many of the companies we surveyed hope to place more foreign nationals
on their boards within the next three years. And while, historically, board members from
North Asian countries such as Japan, Korea and Taiwan have been preferred, American board
members will likely be in greater demand in the future.
Like Chinese society, patriarchy – especially in private enterprises – prevails: The tendency
of a “weak board and strong chairman” is common, and boards tend to be tight-knit groups
built on business or personal networks.
Independent directors are mostly brought in to fulfill legal requirement and are limited to
advisory roles.
Only 50 percent of boards are evaluated, and their power to influence stakeholder interests
is limited.
Boards in China have limited influence on CEO selection, particularly since a high proportion
of chairmen are also the CEO of the company. Except in Private Enterprises, they have little
influence on daily operational matters.
The study shows that 71 percent of boards in China have at least one supervisory committee.
Of these, few have committees overseeing risk management, budgeting and accounting.
These differences in board composition and power among SOEs, PEs and FIEs indicate that
there is still a long way to go before boards in China reach maturity. However, based on our
research, we believe leading companies are showing others the way toward a more Western
style of corporate governance, albeit with Chinese characteristics. We hold that in the
foreseeable future, the environment of corporate governance will increase in effectiveness and
power. Although China is playing catch-up with the rest of the world in this arena, recent
government initiatives and the desire of Chinese industry leaders to play on the global business
level suggest that role of corporate boards will rise with the same meteoric intensity as the
Chinese economy itself.
PAGE 7
THE CHINA STORY
Deng Xiaoping famously said of his nation’s turn away from Maoist Communism
to raise the wealth of his people, “I don’t care whether the cat is black or white,
as long as it catches mice.” China is catching plenty of mice these days.
Turn the pages of any history book, and you won’t find any comparison to what is happening
now in China. By nearly every metric used to gauge growth, China is setting the precedent.
Unlike the sudden convulsion toward capitalism in the former Soviet Union and its satellite
states, the evolution from planned to market economy in China has been revolutionary in
its systematic, methodical nature. Step by step, the most populous nation on the planet –
with one of the longest histories of government and cultural development – has entered the
world market to the betterment of its citizens and the global economy. Despite its controversial
retention of state control over media and other vestiges of its Maoist past, China is clearly
doing something very right.
T H E S TAT IS TI CS SPEAK F O R T H E MSE LVE S:
Last year China eclipsed the United Kingdom as the world’s fourth-largest economy with a
gross domestic product of US$2.22 trillion, and is expected to overtake the United States
within the next three decades.
In 1978, more than half of the Chinese population lived below the poverty line – today, less
than 10 percent of the nation is considered poor.
Nearly 99 percent of the nation’s youth are literate today, compared to 70 percent in 1986.
Twenty-five years ago, the city of Shenzhen across the border from Hong Kong was a sleepy
fishing village – now it’s home to nearly 10 million people and thousands of factories as a result
of more than $30 billion in foreign investment. The city was one of the first Special Economic
Zones established by former paramount leader Deng Xiaoping in the eastern provinces in the
late 1970s to gradually introduce market forces to the former Soviet-style state economy while
PAGE 8
the Communist Party retained government control. Today Shenzhen’s hybrid economy displays
characteristics of both capitalism and its communist past.
As China grows, and as a result of an increased focus on corporate governance, it has steadily
relinquished many industries from state control and opened state-owned enterprises up to
foreign investment. While the government will maintain control in sectors such as civil aviation,
telecommunications and railways, most industries are now wide open for private investment
from Chinese citizens and joint ventures with foreign national companies.
TH E C OR P O R ATE GOVER N AN CE “RE VOLUTION”
China’s commitment toward improved corporate governance has increased dramatically since
it became a part of the World Trade Organization in 2001. The nation’s new Company Law,
which came into effect earlier this year, gave new rights to shareholders and raised standards
of conduct and competence for corporate directors. And as of January 2007, all listed companies
in China will adopt one basic accounting standard. The new accounting laws, known as the
Accounting Standards for Business Enterprises, expand reporting from 16 to 38 specific standards
and 48 auditing benchmarks to bring accounting practices into accordance with the International
Financial Reporting Standards. They will bring greater transparency – and increased pressure
for accountability – to management of Chinese companies.
The China Securities and Regulatory Commission also has relaxed rules to allow for the
conversion of non-tradable shares into tradable shares and has banned non-tradable shares in
new IPOs – all of which promises to increase the power of shareholders. Finally, the government
issued new rules on the definition of independent directors and has moved to strengthen
quarterly and annual disclosure requirements.
As China emerges on the world stage in the wake of Western corporate scandals, Chinese
companies have been influenced by international forces such as the Sarbanes-Oxley legislation,
which considerably increased oversight responsibilities for companies listing on the New York
Stock Exchange. As a record number of Chinese companies become publicly listed on bourses
around the world, local companies have become keen observers of corporate governance changes
promulgated by corporate scandals abroad.
“More than the Asian financial crisis in 1997, the meltdowns of Enron and Worldcom have
changed how corporate governance is viewed in China and the rest of Asia,” says Jamie Allen,
secretary general of the Asian Corporate Governance Association. “Before, there was a sense
that [Western corporate governance standards] were an attempt to impose Western standards
and values on people. Now they see it as sound financial sense.”
PAGE 9
The pressure to improve corporate governance is not only coming from international forces,
but from Chinese stockholders themselves. Since the Chinese stock markets opened in 1990,
they have grown to the eighth largest in the world, according to research by Qiao Liu of the
University of Hong Kong. About 70 million investor accounts have opened, according to the
China Securities and Regulatory Commission. Yet despite the enthusiastic entry of the Chinese
into stock markets, the markets are underperforming: From 2000 to 2004, as China’s GDP
grew by 53 percent, indexes in Shenzhen and Shanghai fell by more than a third each.
An online survey of nearly 26,000 investors by sina.com last year found that 67 percent of
respondents had lost more than half their investments in local stock markets. Yet Professor Liu’s
research shows that the greater emphasis a Chinese company places on corporate governance,
the greater the return.
Indeed, Chinese stock players are looking for stronger standards. A survey this year of 320 fund
managers in 18 countries by the Institutional Shareholders Services Inc. found the greatest
commitment to improved corporate governance were Chinese fund managers – 90 percent of
managers surveyed here said governance was “extremely” important in their investment decisions
compared to the global average of 70 percent. Moreover, the report found that 93 percent of
Chinese fund managers expected its importance to increase in the next three years, compared
to the global average of 63 percent. A chief complaint of the 30 Chinese fund managers surveyed:
corporate boards that are dominated by “insiders.”
If the transition of the country’s four top banks from being exclusively state-owned to operating
under shareholder control is any indication, the wave toward privatization will inevitably court
controversy. Bank of China and China Construction Bank investigated thefts of more than 1
billion Yuan from branch officials as the banks moved toward their initial public offerings. The
government found that nearly 10,500 officials misappropriated or stole state assets during
restructuring programs in 2004. Despite these controversies, the move toward privatization has
found great success with investors: The Bank of China raised $9.7 billion when it listed this
year – at the time, it was the largest IPO worldwide in six years. Not to be outdone, the
Industrial & Commercial Bank of China’s IPO generated a record $21.9 billion (by comparison,
Internet search giant Google raised $1.2 billion during its IPO).
Those companies that hope to succeed in the global economy are changing their ways, and that
is reflected in the composition and duties of board members. As more companies list on bourses
at home and abroad, corporate governance will increasingly be benchmarked against companies
in New York, London or Zurich. Now more than ever, it is important for companies and
investors to understand the true nature of how boards are created and how their duties are
performed to understand the current state of corporate governance in China today, and where
it is headed in the future.
PAG E 1 0
METHODOLOGY
PRELIMINAR Y RESEARCH
Fudan University EMBA students reviewed existing academic literature and research on corporate
governance and conducted reliability and validity tests. Business experts and entrepreneurs were
also consulted on the development of the interview outline and questionnaire.
QUALITATIVE FIELD RESEARCH
Between late 2005 and 2006, Heidrick & Struggles and Fudan University conducted in-depth
interviews with senior management including chairmen, CEOs and CFOs at 35 diversified enterprises
in Shanghai, Beijing, Guangdong, Zhejiang, Shandong and Anhui. These enterprises included
multinationals such as Citigroup, GE, Bell-Alcatel and Ford; state-owned enterprises such as
Shanghai Pudong Development Bank, Konka and China Eastern Airlines; and private
enterprises such as Royalstar Group and Jiaxing City Commercial Bank.
QUANTITATIVE FIELD RESEARCH
Over 1,000 questionnaires were distributed by hand or by mail, and a total of 86 completed
questionnaires received. Of the 82 enterprises that were sampled, 40 are state-owned enterprises,
21 are private enterprises and 21 are foreign-invested enterprises.
DE F IN IT IO NS
STATE-OWNED ENTERPRISE (SOE): An enterprise that is solely state-invested or controlled.
PRIVATE ENTERPRISE (PE): An enterprise invested mainly by private capital and administered
by managers assigned by the shareholder committee.
FO RE I G N - IN VE S T E D EN T E R P RI S E ( F I E ) : An enterprise invested by foreign capital and
founded according to legal procedures in China. In this study, foreign-invested enterprises are
mainly under the management control of foreign investors.
EXE C U T I VE DI RE C T O R : A director who holds a managerial position within the company.
SHAREHOLDER DIRECTOR: A director who represents the interests of shareholders but does
not hold a managerial position.
EMPLOYEE DIRECTOR: A director who represents the interests of an enterprise’s employees.
I N D E P E N D E N T D I RE C T O R : A director who is neither a shareholder nor an employee,
and who does not receive shares or a salary.
PAGE 11
Recommend people according to their abilities
and talents, not because of personal sentiments,
not because of fearing others’ gossip.
L U B UWEI
PROFILING BOARDS
IN CHINA
Board Structure by Ownership
State-Owned
Enterprises
Private
Enterprises
Foreign invested
Enterprises
31%
40%
24%
29%
23%
51%
45%
26%
Shareholder Directors
Independent Directors
Executive Directors
Employee Directors
5%
3%
23%
As our findings show, the ratio of different types of directors – representing shareholder,
executive, employee or independent interests – varies widely among the three principal types
of enterprises found in China. The executive power on PE boards commonly consists of a
“powerful president and a weak board.” For example, all the directors of a private automobile
enterprise are also internal managers of the group – but the president has the overwhelming
power in decision making. Similarly, another president in the machinery industry is also
responsible for all human resources, compensation and strategies of the company.
But in FIEs, there is a high proportion of Shareholder Directors, especially in joint-invested
enterprises, where it is important for the interests of local and international parties to have
direct board representation. Where shareholders enjoy equal power however, efficient corporate
development may be hindered – particularly if the directors have no hands-on experience, such
as one leading glass manufacturer we interviewed, whose board has only one Executive Director
and many Shareholder Directors not familiar with day-to-day operations. We also found that
Employee Directors, who often play a role in State-Owned Enterprises, are often opposed to
corporate reform, resulting in long periods of negotiation on the board. (A common practice
for such companies is to select “cooperative” employees to sit on the board.)
PAGE 13
Size of Boards in China
70
60
50
State-Owned
40
Private
30
Foreign
20
10
0
3
4
5
6
7
8
9
10 11 12 13 14 15 16 17 18 19
The size of the boards we surveyed range from three to 19 members, depending on varying
Chinese legal regulations. An odd number of board members is preferred, and nine is the
most popular number across different ownership companies. This compares to an average of
12 members on European boards, according to the 2005 Heidrick & Struggles Corporate
Governance in Europe Report.
Average Board Size
Centralized
8.8
Equal
8.9
Decentralized
12.8
KEY PO IN T S O N BO ARD SI ZE
CENT R A L IZAT I O N
In companies with de-centralized share structures, shareholders are less willing to oversee
managers – the cost of supervision is seen as higher than the benefits. Independent or other
directors are employed to help with supervision.
SI ZE
Companies with higher sales revenue or more staff also tend to have larger boards. For example,
Bank of China has 14 directors and Lenovo has 12 directors.
PAG E 1 4
PU B L IC L IS T I N G
The size of the boards of directors of listed companies is considerably larger than that of the
boards of non-listed companies, which may be attributed to the legal regulation of the number
of independent directors in listed companies. In addition, the board of directors may undertake
more external responsibilities after the company goes public, which can lead to board expansion.
For example, six of 13 Bank of China directors are independent – double the number from
three years ago.
MOS T B O ARD MEM BER S SELECTE D BY RE FE RRAL
Board Member Recommendations
Open search
3.9%
Govt referral
4.4%
Third-party
referral
1.7%
Others
9.4%
Designated
by investing
partner
14.9%
Majority
shareholder
referral
45.9%
chairman’s
referral
19.9%
This illustrates how close ties with majority shareholders and chairmen are key for board of
director selection – together, they control 66 percent of selections, according to the companies
we surveyed. Investing partner designees come in a distant third, comprising just 15 percent
of the selections.
DIF F E RE N T ST AKEHO LDER S HAVE DIFFE RE NT ROLE S
I N CRE A T ING BO ARDS
The government plays a major role in board composition and corporate governance in
large State-Owned Enterprises. The government selects board members as the representative
of state-owned shares. To provide another level of oversight, China created the State-Owned
Asset Supervision and Administration Commission of the State Council (SASAC), a powerful
agency to oversee state enterprises.
PAGE 15
Most Private Enterprises adopt patriarch-based management. Often private companies are
family-owned and run, and these families are the major shareholders of the company. Keeping
family members in key positions helps build a level of trust among the executives and the board,
but also limits the number of opinions heard in steering the average company.
Many Private Enterprises still hold close relationships with the government. For example,
one leading machine company mentioned that the assets of 66 million Yuan and the right of
land use were bought at the cost of only 10 million Yuan from the government. Other companies
such as UFIDA Software and New Hope also have relied on their relationships with the
government to get the admission to enter the capital market.
Parent companies determine the corporate governance structure of Foreign-Invested
Enterprises. According to interviews conducted, about 70 percent of these firms do not have
decision-making powers – most decisions are made by the company headquarters. These local
boards are typically established to satisfy legal requirements or to oversee a large number of
diversified businesses. Here, the board has two basic functions: to coordinate different business
units in China and to liaise with the Chinese government on behalf of the company
headquarters.
Source of all charts: Corporate governance study by Fudan University, sponsored
by Heidrick & Struggles, 2005/06. Based on quantitative data from field research.
PAG E 1 6
BOARD PERFORMANCE
IN CHINA
Companies in China don’t place a high importance on evaluating the performance
of their company boards: only half the companies we surveyed do some sort
of review.
Evaluations are most common in Private Enterprises only because many of the directors are alsos
company managers – often evaluations here are self assessments. Foreign-Invested Enterprises are
often reviewed by shareholder committees.
Overall, only 35 percent of Chinese companies evaluate individual directors. The larger the
number of employees, however, the more likely it is a company will evaluate its board of directors,
with listed companies especially likely to rate board performance. Share structure also seems to
play a role: the more decentralized the share structure, the higher the proportion of performance
evaluation.
However, State-Owned Enterprises we interviewed largely do not evaluate their boards, and when
they do, implementation is not serious. Giant state-owned companies are still controlled by
government departments like the SASAC, which are responsible for evaluation. The proportion
of performance evaluations by government department is higher in companies with between
1,000 and 5,000 employees.
Once employed, directors on these boards are rarely fired. This opens the possibility of shareholder
meetings being “rigged” by the board of directors. It is difficult for minority shareholders to have
the right of vote according to the Chinese principle of “one share one vote.” Nor can the law
punish the board of directors for not holding shareholder meetings. Corporate law does not
include items concerning the prosecution of shareholder representatives.
PAGE 17
FI N A N C IA L PER FO RM ANCE I S KE Y EVALUATION FAC TOR
Criteria Used for Board Evaluation
Others
Public comments
Return on
assets/equity
Return on
investment
Industry ranking
(rev & profit)
Stock price
Market penetration &
sales increase
Annual profit
State-owned
Enterprise
Private
Enterprise
14%
6%
Foreign-owned
Enterprise
8%
50%
29%
23%
61%
91%
54%
61%
33%
62%
50%
38%
38%
6%
14%
8%
48%
67%
62%
76%
92%
94%
Most striking in the criteria of evaluation among these three principle groups is the difference
in the importance of return on equity for State-Owned Enterprises – 91 percent of companies
surveyed said that was a key element of their criteria. For Private and Foreign-Invested Enterprises,
profit is king – 94 percent and 92 percent, respectively, ranked that as a top evaluation factor
followed by market penetration (67 percent and 62 percent, respectively). For SOEs, market
penetration only rated 48 percent, and annual profit was ranked 76 percent.
SOE S ’ FA VOR CEO -CHAI RM AN SPLIT
But State-Owned Enterprises are much more likely to decentralize control – 74 percent of
SOEs divide the CEO and chairman roles. This is likely due to the retention of control the
Party likes to place on companies. Foreign-Invested Enterprises are less likely to split the roles,
because the impact of local board decisions is minimal and largely directed by corporate
headquarters.
Split Chairman and CEO roles
Average
65%
State-owned
74%
Private
62%
Foreign-owned
57%
Split
PAG E 1 8
35%
Not split
26%
38%
43%
Boards have a greater influence in selecting CEOs in Private Enterprises and Foreign-Invested
Enterprises. But none of the listed companies we surveyed select CEOs through board member
referral – which suggests a greater importance is placed on hiring executives based on merit
rather than personal connections.
CEO Selection Channel by Enterprise
State-owned
Enterprise
Govt referral/choice
Private
Enterprise
5%
23%
Parent co/ majority shareholder choice
65%
62%
36%
Internal promotion (excl. HQ)
50%
15%
57%
31%
Executive search 0%
Open recruitment
0%
24%
64%
Board member referral
Foreign-owned
Enterprise
10%
0%
5%
24%
13%
CEO Selection Channel by Listing
Listed
Not Listed
46%
Govt referral/choice
25%
52%
Parent co/ majority shareholder choice
57%
Board member referral 0%
46%
Internal promotion (excl. HQ)
Executive search
Open recruitment
37%
2%
29%
4%
12%
18%
One dramatic change in Chinese corporate governance is the introduction of supervisory committees.
Over 70 percent of Chinese boards have at least one supervisory committee, most often for Auditing
and Compensation or Employee Appraisal. Nearly 60 percent of the companies we surveyed have
auditing committees, followed by compensation (55 percent) and nominating (33 percent) committees.
This staircase of importance matches European board structure, but implementation is much higher
in Europe, according to the Heidrick & Struggles 2005 Corporate Governance in Europe Report –
94 percent of boards there have auditing committees and compensation committees, and 71 percent
have nominating committees.
Type of Committees
Auditing
57%
Compensation/
Appraisal
55%
33%
Nomination
Others
20%
Budget & Accounting
19%
Executive/ Standing
Board of Directors
17%
Risk Management
Public Policy
8%
3%
PAGE 19
BOARD DIVERSITY
IN CHINA
Independent directors are making inroads in China: More than 30 percent of Chinese boards
now include independent directors, often from universities and research institutions. Most are
brought on to meet legal obligations and have limited decision-making power.
Sources of Independent Directors
Others
3%
Government
16%
Universities & research
institutions
35%
Relevant industries
21%
Professional intermediaries
25%
Motives for Employing Independent Directors
(by Enterprise)
State-owned
Private
Foreign-owned
PAG E 2 0
64%
4%
58%
54%
32%
37%
8%
28%
5%
2% 8%
Comply with law
Represent minority
shareholders
Gain professional
experience
Strengthen strategic
partnerships
Enhance transparency
to the public
Follow industry
practices
Role of Independent Directors (by Enterprise)
State-owned
49%
51%
Private
63%
Foreign-owned
70%
Consulting
37%
30%
Decision making
Independent directors are sought for their expertise – usually in finance, accounting or auditing
– especially on non-listed boards. But their power is still limited.
Professional Background of Independent Directors
Others
6%
Engineering
16%
Finance,
Accounting
or Auditing
36%
Law
18%
Economics
or Business
24%
Motives for Employing Independent Directors
(by Listing)
Not Listed
30%
Listed
2% 8%
60%
65%
6%
27%
2%
Comply with law
Represent minority
shareholders
Gain professional
experience
Strengthen strategic
partnerships
Enhance transparency
to the public
Follow industry
practices
Role of Independent Directors (by Listing)
Not Listed
65%
Listed
57%
Consulting
35%
43%
Decision making
PAGE 21
Unlike other board members, who are usually compensated based on financial performance,
independent directors are paid fixed fees.
Independent Director Remuneration
Based on form of
performance evaluation
3%
Based on contribution
to business goals
5%
Others
9%
Fixed payment
83%
One of the most striking results of our study is the wide gulf between Chinese firms and foreign
firms on their desire to have foreign nationals sit on their board: Chinese boards trail far behind
their counterparts abroad in the inclusion of foreign directors. More than half of all domestic
companies surveyed currently have no foreign directors, whereas half of all Foreign-Invested
Enterprises have Chinese nationals sitting on the board. State-Owned Enterprises are especially
reluctant to consider foreign directors: just over 17 percent said they would consider it, compared
to a third of private companies.
Hiring preferences
Domestic enterprises:
Hire foreign director now?
Foreign invested enterprises:
Hire local director now?
26%
50%
51%
NO
YES
23%
17%
No preference
PAG E 2 2
33%
Willing
Not willing
Domestic enterprises favor local directors because company management often lacks international
business experience or ambitions – as well as the English skills required to communication with
non-Chinese speakers. Local companies are also concerned that foreign directors would not be
familiar enough with Chinese market dynamics.
Conversely, foreign firms want the reliability and cost-effectiveness of local directors, and there
is a greater pool of Chinese senior directors with international experience to choose from.
Origin of Foreign Directors
Origin of Board
27%
State-owned Enterprises
19%
44%
Private Enterprises
18%
Foreign-invested
Enterprises
17%
15%
22%
45%
4%
22%
10% 8% 2%
11% 6% 6% 11%
9%
13%
19%
9%
13% 4%
Hong Kong
America
Japan
Taiwan
Britain
Singapore
18%
26%
Others
Preferred Foreign Directors (domestic enterprises)
Other Others
European
4%
4%
France 4%
Britain 4%
American
28%
Taiwan 5%
Singapore
9%
Hong Kong
19%
Germany
12%
Japan 11%
PAGE 23
Companies that do have foreign directors overwhelmingly prefer directors from
Hong Kong and Taiwan, but this could soon change. Asked what nationality they would
prefer to source their directors, 28 percent said they would like to place American directors
on their boards. Interestingly, we appear to be heading into a period of peaking interest
in hiring foreign directors: Nearly 47 percent of domestic companies and 69 percent of
foreign-owned companies said they were willing to hire a foreign director in the next
one to three years.
Comparison Between Domestic and Foreign-Invested Enterprises
Domestic enterprises
in 5 years
or more
21.4%
within 1 year
25.2%
Foreign-invested enterprises
in 3 – 5 years
13%
in 5 years
or more
0%
within 1 year
18%
in 3 – 5 years
6.8%
in 1 – 3 years
46.6%
in 1 – 3 years
69%
The next one to three years will be the peak period of “foreign directors hiring” for most domestic enterprises that are willing to
hire foreign directors, as well as most foreign-invested enterprises that are willing to hire Chinese directors.
Source of all charts: Corporate governance study by Fudan University, sponsored
by Heidrick & Struggles, 2005/06. Based on quantitative data from field research.
PAG E 2 4
The superior man does not promote a man
simply on account of his words,
nor does he put aside good words
because of the man.
C ONFUCIUS
KEY FINDINGS AND
RECOMMENDATIONS
Overall, our study shows there remain significant differences among State-Owned
Enterprises, Private Enterprises and Foreign-Invested Enterprises in terms of function and
role of company boards:
Executive directors are most prevalent in Private Enterprises. But since many CEOs or
presidents are also the main shareholders, they dominate the decision-making of company
boards. Shareholder Directors, however, are more common in State-Owned and ForeignInvested Enterprises and exercise greater control of board makeup and operations.
SOEs are most likely to decentralize control by separating the roles of board chairman
and chief executive officer – 74 percent of these companies we surveyed do so, compared to
57 percent of foreign-owned companies. Such power splits are rare in Private Enterprises
in China.
For CEO selection, major shareholders are the key decision makers. The government still
dominates the selection for SOEs, while Private and Foreign-Invested enterprises are more
open to board member referral. Our survey also found that the Party Committee plays a role
not only in selection of CEOs for State-Owned Enterprises, but also for hiring of senior and
mid-level managers.
An evolution is occurring with independent directors on Chinese boards: Most leading stateowned and private companies hire independent directors, which has become a symbol for
carrying out corporate reforms the government is aggressively pushing. Yet their roles are
still limited to consultation and have little direct power.
Evaluation of board performance has not become a common practice in China, especially
with state-run companies. Even when conducted, evaluations carry little weight.
PAG E 2 6
There is a wide divide in attitudes among different companies regarding inclusion of foreign
directors. Only 17.5 percent of State-Owned Enterprises will consider placing a foreigner
on their board, compared to a third of private companies. Meanwhile, Foreign-Invested
Enterprises almost universally try to get Chinese nationals on their company boards.
While most leading government-run and Private Enterprises have adopted boards of directors,
supervisory boards have little power compared to their Western counterparts.
RE C O M ME NDAT I O N S
State-Owned and Private Enterprises must build unambiguous boards that match balance and
power among all shareholders, top management and Party Committees. They must be profitdriven and market-oriented to build open corporate cultures, rather than coddled by close
relationships and cronyism.
Chinese companies must recruit and value the opinions of independent directors in order to
maintain the right balance of thought leadership for the best stewardship of their organizations.
As independent directors rise in importance, their compensation packages should be open and
flexible to match their contributions to the company.
As companies grow and expand, external and internal auditing systems must be rigorously
adopted and carried out. Government supervisory committees, which are often staffed with
individuals who have no industry expertise, should be eliminated when possible.
For Foreign-Invested Enterprises, we encourage continued efforts to localize boards and top
management with Chinese employees, who can best navigate this dynamic market. At the same
time, it is important that companies begin to integrate their businesses not just in major cities
such as Shanghai and Beijing, but across the country.
China has a long road ahead before board management and oversight achieves parity with
international standards, but corporate China is well on the path. The government is starting
to require wholly owned state enterprises to build up boards in order to improve corporate
governance. Key committees – mainly auditing, compensation and nomination committees –
have been set up to support the decision-making of the boards. But our results show that
PAGE 27
personal networks and connections are largely what bind these boards together: Although
this is very much in keeping with the Chinese cultural tradition of guanxi – an interpersonal
connection built on service toward each other – it also opens the door for cozy relationships
that can breed corporate corruption. This will be one of the greatest challenges for Chinese
companies and regulators in the future.
The corporate governance environment here is changing as rapidly as the nation itself.
Jamie Allen, the head of the Asian Corporate Governance Association, notes: “There have been
a lot of changes occurring in the past few years, but the next five years is going to be the most
fascinating time for these issues in China.”
The government has aggressively pushed for reforms as Chinese companies are remaking
themselves to be competitive on a global level. These twin forces virtually assure that corporate
governance and the responsibilities of company boards will move toward greater openness and
accountability in the future. Domestic companies are looking to the success of market leaders
like Lenovo, and are eager to follow in their footsteps. Chinese business and government leaders
know that greater transparency will improve the investing power of domestic companies on the
global stage. Opaque company leadership propped up by soft government loans is not a formula
for success in the modern business world.
But as China works to improve its corporate governance, it will continue to be influenced –
but not controlled – by international standards. History shows that no matter which steps
China takes to improve corporate governance, whatever emerges will be a distinctly Chinese
solution.
PAG E 2 8
About Heidrick & Struggles Interna tional, Inc.
Heidrick & Struggles International, Inc. is the world’s premier provider of senior-level executive
search and leadership consulting services, including talent management, board building,
executive on-boarding and M&A effectiveness. For more than 50 years, we have focused
on quality service and built strong leadership teams through our relationships with clients
and individuals worldwide. Today, Heidrick & Struggles leadership experts operate from
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For more information about Heidrick & Struggles, please visit www.heidrick.com.
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