What Really Goes on Behind China’s Corporate Rows

Disputes between Shanghai Jahwa and its controlling shareholder Ping An Trust and other similar cases highlight the governance dilemma that is unique to China

By Louisa Wah Hansen

The Financial Times recently reported a public row in the 115-year-old cosmetics manufacturer Shanghai Jahwa, one of China’s oldest businesses. The controlling shareholder, Ping An Trust, publicly announced that Ge Wenyao had been removed from his position as the chairman and general manager of Jahwa Group, the holding company of Shanghai Jahwa.

This dispute has been brewing for a long time and cumulated in a high-profile conflict. However, disputes like that are not uncommon in China and they highlight the dilemma faced by many state-owned enterprises (SOEs), according to Prof. Joseph Fan, Co-Director of the Institute of Economics and Finance and professor at the School of Accountancy and Department of Finance at The Chinese University of Hong Kong (CUHK) Business School.

“SOEs face a peculiar dilemma: If the government has total control over the management, the efficiency would be very low as the government is not an expert in business management and it has so many other matters to handle,” says Prof. Fan. “If management control is delegated to a professional manager, the result would be a more efficient operation. However, because the manager does not own the business, his decisions and goals may not coincide with the controlling shareholders and conflicts would occur as a result.”

In the case of Shanghai Jahwa, he says, the company is a very important asset of Ping An Trust, whereas Ge Wenyao is the most important asset of Jahwa. Prof. Fan says: “The reason why Jahwa is the most profitable subsidiary of the Group is because of Ge’s managerial ability and guanxi. The problem occurred when he refused to listen to the direction of the new owner – Ping An Trust. But at the end of the day, this row amounted to only a ‘war of words’ （口水戰）. In practice, kicking Ge out of the subsidiary would greatly affect the stock price of the holding company, so eventually he is left alone and remains in charge of the subsidiary even though he can no longer make decisions on the group level.”

Whatever “little treasuries” and corruption are involved, Prof. Fan believes they are all just a side show. “Fundamentally, it is a conflict of interest between the parent company and the subsidiary. Originally, there was a balance of power. The Shanghai government gave all the decision-making power to the subsidiary. But now Ping An Trust, which is an SOE itself, wants to take back some of that power, thus causing the conflicts,” he says.

Prof. Fan cites a similar case that occurred several years ago that concerned Zhuhai Gree Group Corp., the biggest home appliances manufacturer in China. The majority shareholder is the Zhuhai Government. The subsidiary, Gree Electric Appliances Inc. of Zhuhai, had conflicts with the group chairman as the latter wanted to leverage on the original brand to expand the business by manufacturing small appliances. This diluted the brand and was harmful to the subsidiary.

“If management control is centralized, the business operation would be inefficient and the subsidiary may lose money. This isn’t just due to brand dilution but also the loss of motivation. The subsidiary might think: ‘If the fruits of our labor are shared with the parent company, why should we put in any extra effort?’”

For the sake of operational efficiency on the group level, Prof. Fan suggests the majority shareholders should not grab all the power. “From a cost-and-benefit point of view, the actual power should reside within the subsidiary,” he says. “Even though management control belongs to the majority shareholders, the control over business operation should belong to those who are most capable. After delegating the power, it’s a question of how to use modern corporate governance to diffuse parent-subsidiary conflicts.”

Prof. Fan explains that in the West, the board of directors has built-in monitoring and incentive compensation mechanisms, such that the CEO’s salary is tied to the performance at both divisional and group levels. If the subsidiary makes any decisions that would hurt the group, its CEO would be penalized. “But in SOEs, such dual monitoring mechanisms do not exist,” he continues. “As there are no platforms to diffuse conflicts and no incentives to avoid the problems, we witness the so-called ‘war of words’ as a result.”

“Of course I would suggest this system to be changed, but it is impossible to change it,” he says. Prof. Fan concedes that this is easier said than done. This is due to the many entrenched practices in SOEs: There are pay caps on the compensation packages and the choice of the CEO itself is determined and approved by a board of directors made up of Communist party officials. This model is in effect an SOE one.

To resolve such conflicts, the ultimate owner—in this case, Ping An Trust—could sell its shares to private shareholders so that governmental control would disappear. Privatization has been ongoing since the Split Share Reform, which began in 2006. However, the speed is extremely slow because it is a heavily regulated process and all transfers or sales of shares must go through a painstakingly slow approval process. Although an environment that allows a free transfer of shares would be the ideal way to prevent unnecessarily internal conflicts between parent companies and subsidiaries, the incentive to push for such a reform remains weak. The reason lies in the inherent advantages that SOEs have.

“Being an SOE has many advantages. You get support from the government. It’s easier to borrow money. And if you are state-owned, you are protected from legal liabilities. The risks are reduced. All of these are benefits that cannot otherwise be enjoyed by private enterprises,” he says. “In the West, we talk about corporate social responsibility. In China, the SOE sector is huge and there are a lot of inefficiencies and distortion. You can say the government is responsible for everything, but actually the government is not responsible for anything. Nobody is responsible for anything.”