On 14 August, an announcement released by SINOTRUK (000951) aroused the concerns of the Chinese public. The firm stated that Shi Xiushi, Han Yuqun and Cui Junhui, all of whom had just recently been appointed as independent directors of Sinotruk, had resigned from their positions. The company accepted their request and said it would begin searching for new candidates. In fact, the three directors had previously served as governor of Guizhou province, governor of Shandong province, and deputy administrator of the State Administration of Taxation respectively. They were appointed non-executive independent directors of SINOTRUK on 26 July with an annual salary of RMB 180,000 (USD 29,412). Although it only took the group a mere 12 days from the date of their appointment to resign, the quick change has attracted the attention of the public, which has become increasingly concerned with the now common practice of hiring retired Chinese government officials as independent directors for public companies.
Statistics show that up until September 2013, of the 5760 independent directors in companies listed on either the Shanghai or Shenzhen Stock Exchange, 2590 had previously been government officials, accounting for 45% of all appointments. Furthermore, more than 30 had served as minister-level officials, over 100 as mayors, and no less than 720 as division-level officials. This phenomenon is reflective of a common problem within China’s independent director system; public companies wish to leverage the social resources and networks of retired politicians and attach too much importance to their relationship with government rather than their professional qualifications and supervisory abilities. This, to some extent, is also seen in the backwards development of companies’ corporate governance culture.
The independent director system stems from the United States during the 1930s, and has played an increasingly important role in the corporate governance practices of companies in western countries over the past several decades. In China, most corporations adopt a one-tier governance system. In this model, the management team is responsible for supervising itself, as it lacks a supervisory board. However, self-supervision tends to be a weak form of oversight. Thus, the role of the independent director was developed to resolve supervisory holes and balance power within a one-tier board, and has since formed the basis of what is now referred to as the independent director system. Independent directors are also crucial in ensuring that the influence of the largest shareholders in a company are kept in check while protecting the interests of smaller investors and other stakeholders.
In 1997, the Guidelines for Articles of Association of Chinese Listed Companies Issued by the China Securities Regulatory Commission formally introduced the independent director system to China. In 2001, the Guiding Opinions on the Establishment of Systems of Independent Outside Directors (Independent Directors) by Listed Companies (Guiding Opinions in short) defined independent directors as “a director whom does not hold any position in the company other than director and who has no relationship with the listed company engaging him or its principal shareholders that could hinder his making independent and objective judgments”. Later, in 2005, the Chinese Corporate Law (2006 Edition) formally clarified the legal status of the independent director system.
Despite all the legislative and administrative backup, judging from recent developments within China’s independent director system, the majority of independent directors lack independent and objective viewpoints, which has made the system both ineffective and inefficient. The principal reasons for this are as follows:
First, the manner of selecting and recruiting independent directors is not a completely impartial process. As it currently stands for listed companies in China, nominations are either put forward by major shareholders or the board of directors to select and recruit independent directors. Within the Guiding Opinions law, independent directors are elected at shareholders meetings. However, due to the dominance of major shareholders within Chinese firms, their representatives on company boards are able to direct the selection process, making it exceedingly difficult to ensure the nominations are independently and impartiality made.
Second, independent directors lack strong institutional guarantees of their roles within corporate boards. While the Guiding Opinions law outlines the rights and responsibilities of independent directors, the law is typically not implemented as an administrative provision or industry standard. In practice, independent directors are involved in group conferences and decisions as members of the board, but do not have the legal basis to perform other roles or exercise veto-power over controversial issues.
Third, independent directors are subject to the influence of major shareholders. When a shareholder becomes dominant, even if independent directors raise serious objections to particularly divisive issues, they are ultimately subject to compromise and can be overruled by large investors. Once more, if independent directors, whom are often appointed by major shareholders, constantly offend the interests of their sponsors while serving on the board, they are likely to become isolated from the company or even eventually dismissed. Therefore, at present, independent directors are largely unable to represent the rights and interests of middle and small shareholders as well as stakeholders.
Fourth, the marginal role that independent directors play in China reflects the deep deficiencies that are current present within companies’ core business practices. In the West, the majority of the independent directors that are recruited by listed companies are industry experts, whom are able to contribute their expertise in finance, law, strategy, operation, etc. Listed companies in China, however, are more inclined to recruit retired politicians, celebrities, and college professors as independent directors. While they may be sufficiently equipped to provide expertise from their own separate fields of work, many are unable to offer companies with an impartial and critical outside perspective. Some listed companies even expect to strengthen their connections with government and attract additional business by hiring retired senior officials.
The current defects of the independent director system reveal the relatively weak-state of corporate governance in China. The lack of qualified and autonomous independent directors significantly reduces the level of overall board oversight, and thus intensifies the imbalance caused by single shareholder dominance. Not only will this lead to stakeholder negligence during strategic decision making processes, but can also lead to corruption problems within a board when key independent voices are missing.
When evaluating the short-term profitability of a company, investors need to take into consideration the importance of long-term sustainable development , which is derived from the strength of existing corporate governance practices and sustainable development strategies. Whether there is an appropriate independent director system, active independent directors, a second-tier supervisory board, or other external constraints placed on the board of directors by stakeholders, corporate governance has a material impact on long-term sustainable development and profitability. Therefore, throughout the investment decision-making process, investors need to give adequate consideration to a company’s independent director system and the expertise and autonomy of independent directors. In recent years, the forum for corporate governance hosted by the Shanghai Stock Exchange has presented awards to outstanding independent directors, which serves as a channel for investors to select the companies that properly implement and take advantage of the independent director system.
Written by Wu Yaqiao, graduate student at the Department of Land Economy, University of Cambridge and SynTao ESG Intern