STEP BY STEP

Corporate Governance
Models in China
The experience of the International Finance Corporation

35
STEP BY STEP
Corporate Governance
Models in China
The experience of the International Finance Corporation

1
Copyright © 2005
International Finance Corporation
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Manufactured in the Hong Kong SAR, China
April 2005

The International Finance Corporation, the private sector arm of the World Bank Group, promotes sustainable investment in developing countries,
helping to reduce poverty and improve people’s lives. IFC finances private sector investments in the developing world, mobilizes capital in the
international financial markets, helps clients improve social and environmental sustainability, and provides technical assistance and advice to
governments and businesses.

This volume is the product of the staff of the International Finance Corporation. The conclusions and judgements contained herein should not be
attributed to, and do not necessarily represent the views of, IFC or its Board of Directors or the World Bank or its Directors, or the countries they
represent. IFC and the World Bank do not guarantee the accuracy of the data included in this publication and accept no responsibility whatsoever
for any consequence of their use.

For additional copies of this publication in English or Chinese please contact IFC in Hong Kong +852 2509 8100 or Beijing +8610 6505 8686.

ON THE COVER: Photos at and around IFC industrial and financial sector projects in China. Photos by Greg Girard.
 C o n t ent s
Contents
4 Preface

6 The IFC Framework

12 Corporate Governance at IFC Projects

28 Support for Market Regulation

32 Appendix

3
 By Javed Hamid

Preface
Across the globe corporate governance has risen to the top of the agenda for
corporate executives and investors. From recent scandals in Europe and
America, to long-standing concerns about closely held or state-dominated
firms in Asia, the topic continues to attract much media attention.

In China, there is a popular notion that private entrepreneurs have a deep

rooted bias against transparency and are unwilling to accept global best
practices. Often when Chinese companies are exposed to initial scrutiny
from new partners or financiers, they are found woefully unprepared. And
reports about misuse of shareholder funds and
Chinese managers have a disputes among business partners further
willingness to improve corporate reinforces the image of poor governance among

governance. But too often they Chinese companies.

don’t know where to start. But weak corporate governance practices are at
odds with the fact that Chinese businessmen are
setting their sights high. They seek not just domestic leadership for their
businesses for a few years, but to establish global giants for the next
generation. In the process, entrepreneurs and managers want to learn more
about international norms and standards. While they may not have the
experience or in-house resources to adopt them alone, they have enormous
appetite for absorbing the lessons of success in international markets. IFC
experience in China indicates that a growing number of Chinese managers
and entrepreneurs have a willingness and desire to improve corporate
governance. But too often they don’t know where to start.
IFC has been positioning itself to respond to the growing We see the biggest investment opportunities in China with
needs among Chinese entrepreneurs to adopt better domestic private companies. These businesses are driving
practices of corporate governance. Today, establishing the rapid growth of the economy as they strive to expand
better practices at our client companies is an integral part and become more sophisticated. As they do so, their
of our strategy for working with Chinese companies. It is a governance structures need to meet higher standards.
strategy that is borne out of both business necessity as well
Today we are more confident about our own ability to work
as our desire to contribute to sustainable private sector
with local companies and contribute to private sector
development in China.
development because of our ability to encourage better
The International Finance Corporation—the private sector corporate governance. Our approach works best with
arm of the World Bank Group—has contributed to change Chinese companies seeking a partner who can help them
in China over the past two decades by providing loans, strive for a higher standard. We also recognize that some
equity, risk management, and technical advice to private of our partnerships will stumble or fail to deliver on their
companies and regulators. We invest in projects across the promise. Yet we have confidence that the rewards and
full spectrum of the economy, from banks and infrastructure competition of the global marketplace will drive Chinese
projects to hospitals and schools. We have a special companies to seek higher standards.
technical assistance facility based in Chengdu that serves
This study provides the background and some details of
entrepreneurs and smaller businesses.
how IFC approaches corporate governance today, and how
Our cumulative investments in China since 1985 are IFC has worked with companies to ensure that we are
approaching $2 billion in over 80 companies. IFC’s adding value to their businesses by doing so. I hope that
outstanding Chinese portfolio as of June 2004 was $779 our existing and prospective clients, other businesses,
million, after making about $400 million in new investment opinion leaders, journalists, and IFC’s staff can learn from
during the preceding 12 months. this experience. And I hope that this report contributes to
the further development of good practices in corporate
governance in China.

5
 The IFC Framework

Toward Better Practices in China

In the 1990’s, the International Finance Corporation sought opportunities to expand
development through the private sector in China. Sichuan-based Plantation Timber
Products aimed to be a leader in the local wood products market. PTP’s business model
was based on competitive pricing, international quality, local production, and excellent
customer service. IFC provided technical assistance and support that helped the company
achieve its goal of being a leader in sustainable business practices. IFC also encouraged
PTP to establish strong corporate governance as its business expanded, including the
adoption of financial accounting systems that allowed directors and shareholders to
properly evaluate the company’s performance.

Compliance was not always easy and the value of the higher standards was not always
clear to the company’s local management when new practices were being adopted. Yet,
years later when the company’s founders were ready to seek
“Transparency made us new shareholders, their efforts were rewarded. The company
far more atractive” to was viewed differently by the international investment
investors. community from most other Chinese greenfield companies, or
startups. A track record with International Accounting Standards-
based audited financial statements and a management with clear accountability to its
board of directors impressed both the bankers preparing the company for sale and
ultimately its new buyers.

“Certainly the transparency we’ve established in the company made us far more
attractive. Investors knew we were prudent and responsible and had ethical business
practices,” said a senior company executive after PTP’s sale to a multinational company.

IFC’s experience working with Plantation Timber Products and other companies and
financial institutions in China has helped us foster better corporate governance practices
in promoting a stronger private sector. While good practices are important, in China
they have also provided a means for improving investor confidence, enhancing corporate
performance, and increasing access to capital. This publication highlights some of our
experiences and what we have learned in the process.
Why Corporate Governance? Business Case for Better Practices
Corporate governance refers to structures and processes Promoting good corporate governance in China is a good
for directing and controlling companies. Collectively, these business approach for IFC. Our partnerships with Chinese
constitute a set of rules that govern the relationships among companies involve risks that must be carefully managed.
management, company shareholders, and other stakeholders IFC faces investment risk, or the possibility that borrowers
including consumers, creditors, employees, the general will default on loans or manage their company in a way
public, neighboring people and suppliers. The rules of that undermines the value of IFC’s equity. As a commercial
corporate governance aim to ensure that managers act in investor and one that aims to encourage other investors to
the best interests of their shareholders rather than simply follow our lead, a default would undermine our mission.
acting in their own interests or those of a majority
Increasingly investors and lenders face reputational risk,
shareholder.
or the possibility that companies they support might engage
Good corporate governance can provide companies in in practices that tarnish a sponsor’s or international bank’s
emerging markets better access to outside capital by making reputation. Such risk is especially pronounced in situations
them more attractive targets for portfolio investment. Some where many stakeholders are exposed to poor performance
companies attempt to improve their governance practices or lax controls, such as at deposit-taking institutions. At
for that reason alone. For example, CalPERS, the California banks, abuses in governance could cost public depositors
state employee pension fund that is the largest in the United their life savings. IFC has a role to play in encouraging
States, has kept its money out of China in part because practices that protect all stakeholders.
poor transparency hinders its ability to monitor investments.
IFC also focuses on governance because we put a
Good corporate governance also increases capital inflows
priority on developing capital markets. Poor governance
from domestic investors. For growing companies seeking
undermines the integrity of publicly traded securities and
to diversify their investor base, governance can become a
discourages the use of public markets to allocate savings
point of competitive differentiation that enhances their
efficiently. Without efficient markets, savings will not flow
capacity to tap a wide array of financing sources.
to areas where they can be used to build profitable
companies that provide needed goods and services.

Finally, IFC promotes sustainable business—that is,

helping clients balance profits with a broader concern for
people and the environment. IFC has led the way in
integrating corporate governance into all phases of the
investment process simply because well-run, transparent
companies are much more likely to be profitable in the
long term.

7
 Creating Value for Clients
IFC is the private sector arm of the World Bank Group that invests in private companies in developing
countries. But IFC’s work in corporate governance in China is one example of the additional value
IFC provides for private sector clients beyond capital.

IFC has advised industry regulators on how private companies are typically governed in more developed
economies, and when appropriate offers models on which evolving regulatory systems can be based.
IFC has an ongoing dialogue with regulators to communicate to them our experience on the company
level and suggest how that might be helpful in developing policies. In some instances IFC experts
comment on proposed regulations and have held workshops on international best regulatory practices.

IFC works with individual companies to improve transparency, disclosure, and treatment of minority
shareholders, usually in the context of our investment activity. When we take an equity stake in a
company, we often recommend experienced directors who can function
Many client companies don’t set as advocates for improved governance. While this may seem like a
up a proper corporate governance small step, an internationally trained director can become a lightning
system until they’re about to go rod for change on a Chinese board of directors that previously has
public. We now try to encourage been made up of management and state shareholders representatives.
them to do it earlier. They offer specific, constructive suggestions on board operations. We
work with companies to develop a plan for restructuring or expanding
their boards to include audit and compensation committees that improve accountability and ensure
that executive and staff pay is linked to performance. In other cases, IFC has recommended changes to
a company’s articles of association to enhance the rights of minority shareholders or other stakeholders.

To be sustainable, IFC’s contribution to the process must be a portion of a broader partnership. IFC can
contribute international consultants or staff expertise that can help localize well established international
practices to align them with prevailing business practices. The partnership also involves helping companies
conduct more effective shareholder meetings. IFC always requires investee companies to adopt
international accounting standards, and to disclose financial information at regular, frequent intervals.

“Many client companies don’t set up a proper corporate governance system until they’re about to go
public,” observes Mike Lubrano, head of IFC’s Corporate Governance Unit. “We now try to encourage
them to do it earlier by convincing them they’ll create more value. Investors are willing to pay more
for shares at an initial public offering or in the aftermarket for companies that can show they’ve had
two years or more experience with an audit committee.”

Often, however, companies that approach IFC are seeking to enhance their standing by associating
with an internationally recognized financial institution. Credibility, rather than credit, is the first item
on their agenda. To fulfill our role in this type of partnership, IFC must be demanding. Because partnering
with IFC sends a positive signal to the market, we must require best accounting procedures, as well as
international environmental and social business practices. Our experience indicates companies that
are receptive to good corporate governance practices and improved accountability are also likely to be
good corporate citizens across the board (see box on page 13).
 The IFC Framework

Challenges and Opportunities in China a desire to avoid conflict. These two traits lead to an
Corporate governance is a new concept in China and most emphasis on informality and being discreet that can often
managers and boards remain unaware of basic governance be perceived by outside investors as insufficiently
procedures, often confusing governance with general transparent. Yet trying to impose formal structures on an
management. As a consequence, bridging the gap between organization that has traditionally done business in a certain
rhetoric and reality is required. way can lead to a insurmountable culture clash. When IFC
first suggests changes in governance practices, companies
The private sector has clearly become the engine of growth,
sometimes interpret the suggestion as indicating a lack of
seemingly offering enormous investment opportunities. But
trust in the company’s management. Handled insensitively,
the structures in place at private companies are often
such a development could adversely affect the relationship
immature, reflecting the newness of the private sector.
with that client company.
“Most small and mid-sized enterprises in China are run
informally,” commented one IFC staff member who advises A more hospitable environment for corporate governance
smaller businesses. “They’re family-owned, they don’t will not be created overnight. Yet the enormous transfer of
have checks and balances, and their financial reporting is assets from the state to the private sector, for example, is
not transparent.” creating a new breed of private
enterprises. With grand ambitions
The state-owned enterprises that are Most small and mid-sized for growth, many entrepreneurs
diversifying ownership on their way enterprises in China are realize they can no longer rely
to becoming private enterprises suffer
run informally. simply on friends, family, and
from a different set of governance
internal cash flow to finance their
problems. When these companies take
visions. This development offers opportunities for creating
on private ownership, they carry the legacy of the state-
more transparent corporate structures in local companies,
dominated decision making regime. They often have
thereby setting a powerful precedent for others to emulate.
complex and opaque corporate ownership structures,
By creating real-world examples of transparency and
overlapping new and traditional bodies of corporate control,
world-class governance at local companies, IFC brings about
and reporting practices that are focused on satisfying the
a powerful demonstration effect showing a new model of
information requirements of the authorities rather than the
transparent, equitable, and communicative Chinese
needs of investors.
enterprises that prosper and thrive.
Today most Chinese companies tend to be compliance-
For enterprises that support this broader vision of what
oriented: They want to know what they must do to meet the
business in China can be, IFC’s work offers a blueprint for
letter of the law, but are not inclined to go beyond those
making that vision real. In so doing, it also contributes to
basic requirements. This situation offers IFC an opportunity
the country’s smooth transition to a market economy. The
to demonstrate the value of corporate governance when it
following chapters examine ways in which IFC works with
invests in its partner companies.
regulators and private companies in the industrial and
Another challenge at this stage of the game is that China’s financial sectors to make good corporate governance a
business culture is largely relationship-driven and built on reality.

9
IFC’s Approach to Corporate Governance
Adding Value The aim of IFC’s activities in corporate governance is to add value
to client companies. This is achieved by developing a collaborative relationship with
investee companies and working with them to improve their governance.

Prioritizing Corporate Governance The first task for IFC investment staff
when examining the corporate governance of a potential investee company is to
identify whether governance will be a priority for IFC’s engagement with the client.
Priority is given to improving an investee company’s governance when the client’s
practices present a special risk for IFC’s investment or an exceptional opportunity
to improve the client’s governance.

Risk One type of risk is investment risk, where the returns on IFC’s investment
are jeopardized by poor performance (in the extreme case, corporate failure) or
mistreatment of IFC and other investors. Another type is reputational risk, where
although IFC’s own investment is protected, corporate governance abuses threaten
other shareholders and stakeholders in the company, or even undermine the integrity
of local capital markets.

Opportunity First, the client company’s commitment to achieving good corporate

governance is fundamental, which is why this is the first of the four key areas in
which IFC evaluates the governance of companies. If governance improvements are
imposed by IFC on an unwilling client, then any corporate governance improvement
program is likely to be little more than an artificial compliance exercise.The second
aspect of opportunity is that some countries and markets have moved further than
others in carrying out legal and regulatory reforms that encourage good corporate
governance. In these countries and markets, IFC’s crucial contribution is to give
meaning to these reforms by implementing improved governance practices at the
company-level.

Six Steps IFC’s corporate governance methodology uses a step-by-step process.

This introduces the client to IFC’s approach to corporate governance, the investment
staff then reviews the client’s governance practices and, where necessary, IFC
develops a corporate governance improvement program with the client.

Step 1: First Impressions

Step 2: Client Self-Assessment
Step 3: Corporate Governance Review
Step 4: Corporate Governance Improvement Program
Step 5: Documentation and Implementation
Step 6: Supervision
 The IFC Framework

Assessing Chinese Companies

In seeking to evaluate corporate governance practices at Chinese companies, IFC seeks information in four broad areas.

Commitment to Good Corporate Governance Transparency and Disclosure

• Ownership structure • Information dissemination
• Governance structure • Internal audit and internal controls
• Major transactions and material events • External audit and external auditors
• Organic documents • Fair disclosure
• Policies relating to corporate governance • Financial statements
• Corporate events calendar • Shareholders agreements
• Company corporate governance code • Disclosure of major transactions and material events
• Country corporate governance code • Regulatory and self-regulatory review
• Compliance responsibility • Responses to information requests
• Shareholders agreements • Meetings with securities analysts
• Succession
• Foreign listings of shares

Structure and Functioning of the Board of Directors Treatment of Minority Shareholders

• Establishment of a board of directors • Ultimate beneficial ownership
• Board policies • Shareholders meetings
• Agenda and minutes • Attendance and results of shareholders meetings
• Current board membership • Related party transactions
• Composition of the board • Changes of control
• Independent board members • Minority shareholder nomination of board members
• Skill mix • Other minority shareholder rights
• Functioning of the board • History of shareholder relations
• The board and management team • Differentiated classes of shares
• Audit and other standing committees
• Conflicts of interest and related party transactions
• Board evaluation
• Corporate secretary (secretary of the board)
• Supervisory board (inspection committee)

11
Corporate Governance at IFC Projects

IFC’s activities span China. Among its more than 80 projects financed over two decades, IFC has
provided investment and technical assistance for large and small businesses in Sichuan, supported
financial institutions and heavy manufacturing in Fujian, financed toll roads in Zhejiang, and encouraged
pork farming in Jilin. It has provided equity and loans to formerly state-owned companies as well as
newly emerging private sector companies. Even so, Chinese enterprises across sectors and regions
lack a tradition of private control and diverse shareholdings, and the emergence of a rapidly growing
private sector has only recently created the demand for establishing these corporate customs.

Even companies that strive to develop professional practices and respect minority shareholders often
fall short of international best practices. Without traditions deeply embedded in the marketplace, there
are few places for managers to turn for guidance on improving practices. IFC has been able to fill that
gap with some companies it works with in China.

Improving Governance at Industrial Corporations

Plantation Timber Products

China’s rapidly growing economy and the recent liberalization of government housing policies offer
opportunities for Chinese to own homes for the first time. This trend has fueled a residential construction
boom and created strong demand for housing materials such as wood flooring. Until recently, China met
that demand by importing medium-density wood-based floor paneling or using local products of low
quality.

Sichuan-based Plantation Timber Products entered the market in the mid-1990s, aiming to be a leader
in the local market. PTP’s business model was based on competitive pricing, international quality,
local production, and excellent customer service. It delivered through a new operations site in Leshan,
a small city about one hour outside of the provincial capital of Chendgu. IFC initially provided a loan
financing package of $38 million to help PTP to set up a state-of-the-art timber processing plant with
equipment imported from the United States and Europe. The company’s plantation base lay within a
100-kilometer radius of the factory, making it easy for local farmers to transport raw lumber to the site.
Based on the success of the Leshan factory, PTP established a second one in Hubei Province, for
which IFC also provided financing. IFC made equity investments in the businesses.

IFC encouraged PTP to establish strong corporate governance and other good practices (see page 13)
as its business expanded. The first step was to bring in a major accounting company to ensure PTP’s
financial accounting systems were consistent with international standards. This allowed directors and
shareholders to properly evaluate the company’s performance and provided an independent assessment
of the accuracy of its financial records. “Having someone
come in and to help design and double-check our systems A Proxy for Good Management
was very useful,” said former CEO Daniel Spitzer. “It
Often companies willing to strive for high standards in
helped us to anticipate a number of issues.”
corporate governance are also open to adopting best

IFC encouraged transparent management accountability. practices and modern management techniques in other
areas of their businesses. Plantation Timber Products is a
“We carefully evaluated all our business activities against
good example. IFC was able to support such efforts in
criteria IFC had given us, to ensure they were above
several areas, helping improve the developmental impact of
reproach,” Spitzer said. “We also used those criteria as basis
the company while increasing the value of the business.
for in-house training on business ethics and internal
reporting.” Information technology. Because PTP had diverse
base of Chinese and overseas customers, IFC encouraged
The additional work required to meet the new standards the company to buy and install enterprise resource
was worth the effort: When the company’s founders were planning, or ERP, software. Linking information about
ready to seek new shareholders, they were gratified that ordering, purchasing, finance, and production, the
their operations were viewed differently by the international ERP system formed a data network that connected the

investment community from most other Chinese-based Leshan and Hubei operations plus six branch offices and
numerous outlets and warehouses. It also allowed managers
companies. After establishing good accounting practices,
to effectively oversee inventory levels and enabled the
a track record in audited financial statements, and a
company to respond more quickly to changes in customer
governance regime that included independent directors, the
demand.
company found international investment banks eager to
represent it. Environmental health and safety. IFC worked with
PTP to establish guidelines for evaluating EHS performance
In July 2004, PTP was sold to Carter Holt Harvey, the —days lost to injury and other data that helped the company
fourth-largest paper products company in Australasia and conform to international standards. These issues were
which was seeking to establish a presence in the Chinese addressed at the corporate level and integrated into the
market. “They looked at us in terms ofContinued on page 14
our management company’s overall business functions. Partly as a result, PTP

capabilities and disciplines. At the core was corporate became the first Chinese company in the timber industry to
achieve ISO 14000 certification for management excellence.

Environmental protection. Working in an environmentally

sensitive industry that makes use of natural resources, PTP
recognized its responsibility to minimize waste and protect
its timber plantations—operating in an environmentally
friendly and sustainable manner. Efforts included
minimizing risks stemming from fiber dust emissions,
wastewater discharge, formaldehyde emissions, and noise
levels.

13
 governance and good reporting,” said Spitzer. “Certainly the transparency
we’ve established in the company made us far more attractive. In the due
diligence phase before we were acquired, we had 30 people on the buyer’s
team reviewing our different financial and operational issues. All those areas
had already been covered in IFC reports.” After the due diligence, Carter
Holt Harvey determined PTP complied with their requirements and the deal
went forward.

“I’m sure our reputation as an IFC client and

“Our reputation as an IFC client
partner helped us in the eyes of the buyer,”
and partner helped us in the eyes
Spitzer concluded. “Investors knew we were
of the buyer. They knew we were
prudent and responsible and had ethical business
prudent and responsible and had
practices. They also knew we’d be able to work
ethical business practices.”
effectively with international management
systems. IFC was undoubtedly a very important reference for us.”

The city of Leshan and its outlying areas also benefitted from PTP’s success.
Among the plantation workers were local Sichuanese who had been laid off
from state-owned enterprises. Farmers who had sown low-margin crops
began to plant fast-growing varieties of wood on hillsides requiring less
intensive cultivation, such as eucalyptus and pine. Transport of timber
products indirectly provided employment in trucking, loading, logistics, rail,
and even shipping. Local furniture companies were able to expand product
lines and upgrade the quality of their goods, attracting new business that
elevated overall production levels and created new jobs. The company’s
collaboration with IFC has been so successful that it has led other local
companies to approach IFC for guidance, creating new client relationships
for the organization.

PTP Manager Cheng Zheng notes that companies often are eager to work
with IFC because they want to secure financing. But he cautions that they
should not only have a short-term focus. “Management skills, expertise,
and creating a culture of transparency are more critical,” he says, “because
they confer a greater strategic advantage over time.”
 Corporate Governance at IFC Projects

Chengdu Huarong Chemical Company new guidelines for financial management, corporate
governance, and environmental practices. Although New
Huarong Chemical demonstrates how a privately managed
Hope was an experienced local manager of successful
company can transform an ailing state enterprise into
businesses, it lacked experience in presenting its plans to a
a profitable business that contributes to the local
board of directors or using the board effectively to help the
economy. It also offers a model for how corporate
company make sound, long-term business decisions.
governance improvements can contribute to that process.
Huarong was founded in 2000 by one of China’s largest “IFC set broad rules and suggested big picture issues that
private holding companies, the New Hope Group. It needed to be addressed. The rules and details were all
acquired the facilities of the Chengdu Chemical Company, worked out by New Hope. This was a partnership,”
an insolvent state-owned enterprise 40 kilometers west of commented a senior manager. “The principal assistance
Chengdu. The factory’s main product, high-purity that IFC provided was in helping management operate the
potassium (KOH) flakes, is used across a range of industrial business from the board level down. IFC encouraged
applications, including alkaline batteries, cosmetics, food management to provide board meetings with a clear agenda
additives, and pharmaceutical products. Its secondary and to conduct the meetings in accordance with the agendas.
product, PVC, is a plastic raw material used in construction,
By building an understanding of what directors need to
home appliances, autos, and furniture.
contribute to the success of the business, management
To this venture New Hope brought management expertise, gained a better appreciation for establishing controls and
working capital, and local market knowledge; IFC provided good accounting procedures. To meet the needs of the board
$3.2 million in equity and $16 million in loans from its Huarong established strict internal systems for reporting
own account and with participants. IFC also set forth and verified its reporting through audits. Unlike some

15
foreign companies that meet international standards by investing heavily at
the outset in outside consultants, Huarong was determined to meet the new
requirements as much as possible through internal resources and staff.

The upside to Huarong’s reliance on internal staff, who faced a steep learning
curve, was that the management built in-house capacity and skills that helped
maintain better reporting even after the systems were implemented. New
Hope, the parent company, also benefited by having access to management
resources that could contribute to establishing similar practices in subsequent
acquisitions of state owned enterprises.

Board-led changes at the company encouraged the development of a

compensation system that tied pay to performance. Management abolished
the policy that guaranteed lifetime employment and doled out automatic
promotions on the basis of seniority. Employee salaries were reformed to
link to business unit performance. Employee pay began to fluctuate with
production.

Huarong’s board took control of hiring both the general manager and the
financial manager. The board gained greater confidence in management’s
reporting and created an additional check within the management structure
to ensure professional and honest practices at the company.

Board-led reforms combined with investment and improved management

helped New Hope transform a failing chemical plant into a highly productive
company. Changes went beyond corporate governance, demonstrating the
company’s commitment to best practices across the board. The company
improved its environmental practices through a new water treatment facility,
and focused on better worker safety, helping employee morale and productivity.

After three years in operation, Huarong’s sales tripled to $30 million. By

2003, when the revamped factory lines operated close to capacity, Huarong
was manufacturing international-grade KOH and PVC and exporting to or
exploring markets such as the United States, Japan, and South Korea.

The company also has contributed greatly to the local economy of Sichuan
province, an area hit hard by the ongoing restructuring of China’s state-
owned enterprises. It reemployed about one-sixth of the Chengdu Chemical
staff when it acquired the plant and continues to serve as a source of
employment for laid-off state enterprise workers. Over its brief history,
 Corporate Governance at IFC Projects

Huarong has absorbed more laid- “By working with IFC, we learned to says New Hope Chairman Liu
off workers than any other Yonghao. We felt we needed
form more detailed business plans,
company in the area, and has been help with management and
and to comply with international
recognized by the city govern- guidance on attaining
standards.”
ment for its contribution to international standards.
supporting the local economy. The company also hires We also felt that IFC could help introduce New Hope to
farmers for part-time transport and cleaning work, enabling more international players.” Today, he says, IFC is
many to double their farm income. instrumental in helping New Hope enter new industries
such as natural gas, in markets such as Shenzhen where
Chengdu Huarong has performed well and the owners and
the group has never operated before. “By working with
management feel that the increased accountability from
IFC,” says Liu, “we have learned what to consider when
good practices has contributed to its performance. New
working with an international partner. We need to form
Hope has expanded its use of international practices in other
more detailed business plans, and to comply with
new investments in state owned enterprises and to some of
international standards.”
its other investments.

“In the past, we’d had some experience restructuring

For more examples of IFC industrial projects,
state-owned enterprises but Huarong was a bigger project,” see Appendix, page 32.

The legacy of a state dominated economy has provided few

rules or guidelines to support businesses that are accountable
and transparent to private shareholders. Therefore IFC can
best fulfill its role of promoting private sector development
by encouraging good practices and creating demonstration
companies. To do this effectively, IFC needs to make the
case for undertaking often difficult changes to the corporate
culture among our clients. IFC tries hard to test investees

for commitment at the start of each engagement. “We have

to agree with companies at the outset that there’s a value to
what we’re doing,” says IFC’s East Asia and the Pacific
Associate Director, Karin Finkelston. “Everyone seems to
think our name can be helpful. But there’s a lot of work
involved in getting our name attached to the company.”

Each investment poses risks that must be managed and

minimized to ensure the value of IFC’s participation in a

17
 particular project and to the project sponsors involved. As a result, IFC
requires potential clients to demonstrate a willingness to move toward
internationally recognized practices that support
IFC has to agree with companies better governance. “Changes don’t happen
at the outset that there is a value overnight,” observes Ms. Finkelston. “You have
to what we’re doing. to identify the place where changes are needed,
prioritize those changes, and then make the
transition gradually. You’re really looking for a cultural change within the
organization. It takes time.”

While IFC has had some notable successes in encouraging better governance
practices, not all projects turn out as expected. Experience indicates that
this occurs because a client has underestimated the degree of commitment
required to overhaul its corporate governance regime. Local managers may
resist better practices even after they weigh the advantages because of factors
that undermine the traditional business case. The company may like the
concept of better governance, but improving governance requires enormous
commitment. A few companies have found, either before or after IFC has
committed to investing, that they are unwilling or unable to do what it takes
to make the necessary changes. IFC builds in exit levers that enforce
standards.

In China today, legal reform and consistent application of regulation create

dilemmas for businesses. Managers may resist internationally accepted
practices simply because the local policy or regulatory enforcement
environment drives them out of the market if they try to pioneer greater
transparency and accountability.

IFC experienced such a case with a company located in a remote interior

city of China—an area where private entrepreneurship was lacking and
joblessness was on the rise. IFC began working with an industrial company
that had a wide range of sustainable business
Changes don’t happen overnight. issues to address. When IFC began speaking
You have to prioritize and make with the company, it was dumping thousands
the transition gradually. of tons of largely untreated waste into local
rivers each day and had only a frail grasp of
worker safety issues. Management needed to take control of the issues and
given the potential risk it faced on pollution and safety issues the company
was an excellent candidate for corporate governance reform.
 Corporate Governance at IFC Projects

Governance for Small Businesses

China Project Development Facility is an IFC-managed
multi-donor facility that supports small- and medium-sized
enterprises in Sichuan province, in the west of China. It has
developed a corporate governance program, funded by the
Canadian and Italian governments, to support good
practices at smaller companies. In China many enterprises,
especially domestically listed companies, don’t yet recognize
the benefits of good governance practices. By working with
companies to bring about specific improvements in
shareholders meetings, board of directors and management
team, the program aims to increase investor confidence in
An auditor brought in early as part of the company’s small enterprises.
developing relationship with IFC discovered irregularities, “While investors are relying on the central government to
which IFC discussed with company management. Manage- issue new laws to regulate listed firms, we can also do a lot
ment was open about shortcomings in its past accounting of things to help those small and medium enterprises that
do not know where to go to in order to improve their
practices, and agreed all future financial statements would
corporate governance,”
be reviewed according to international accounting said CPDF General We can help those small and
standards. Manager Mario Fischel. medium enterprises that do not
T h e p ro g r a m o f fe r s
know where to go to improve
Despite this encouraging start, company management advisory services to these
companies to help them corporate governance.
later resisted full financial disclosure, a condition of
set up the board of
IFC’s financial support. The company concluded that directors and teach them how to organize shareholder
implementing IFC’s recommendations would create a meetings. It provides templates that assist in preparing
company documents. It also delivers training courses to local
significantly higher tax burden than it had previously borne.
accounting firms to help them work with the SMEs to prepare
In a market where competitors were not adhering to such audit reports in accordance with international and domestic
practices, management concluded that operating according standards.
to IAS would have put the company at a competitive The program’s first agreements to provide support were
disadvantage. In the end, IFC was forced to sell its stake— made with Jinjiang Foaming Materials, Guanglin Electrical
a disappointing but necessary step. Appliance, and Mainland Hope Group. Firms received
tailored technical assistance and support for step-by-step
improvement of their corporate governance structure
and practices. Support included provision of specific training
and orientation session for the board of directors and
management; review of corporate documents and internal
decision making processes; organization restructuring;
preparation and implementation of shareholders’ meeting;
and advice on addressing specific corporate governance
concerns. IFC hopes to use the relationships to facilitate
access to finance through close cooperation with financial
institutions, demonstrating to other small firms the benefits
of adopting good practices.

19
 Providing Intellectual Capital

Corporate governance has been identified by the Chinese government as the core element
of the modern enterprise system. Such policy focus reflects the significant progress that
China has made in building market institutions and the importance it attaches to changing
corporate behavior. To support this policy, IFC’s East Asia and Pacific Department joined
with the Private Sector Development Unit, East Asia and Pacific Region of the World
Bank to publish Corporate Governance and Enterprise Reform in China: Building the Institutions
of Modern Markets. The Development Research Center at the State Council supported
and facilitated the study. A draft of the study was presented and discussed at a workshop
organized by the World Bank Group and DRC in May 2001 in Beijing.

The study was released the following year at an international conference on corporate
governance reform in post-WTO China cosponsored by the World Bank Group, the
Development Research Center of the State Council, and the National Accounting Institute.
Ningxia University joined the program through the Global Development Learning
Network facilities. The conference was attended by more than 400 Chinese and
international experts and policy makers in Beijing and more than 70 people in the campus
of Ningxia University in Yinchuan, the capital of Ningxia Hui Autonomous Region,
connected through the World Bank Global Development Learning Network facilities.
Delivering the keynote address at the conference, the World Bank President Mr.
Wolfensohn noted that as China begins to implement its commitments to the WTO, the
policy focus on corporate governance in China is sending a strong signal that the
government is committed to further market reforms.

The study was described the “most comprehensive account of Chinese corporate
governance practices available today,” by the China Business
Review. “The work clearly delineates the governance problems
An IFC-World Bank study provided
that China is facing while it builds modern financial institutions
the “most comprehensive account
and efficient capital markets and explains why the current
of Chinese corporate governance efforts to clarify the ownership rights of Chinese firms are
practices available.” crucial to the nation’s overall economic reform program.” It
makes a large number of recommendations concerning the
policy and legal frameworks, procedures, and institutional capacity for improving corporate
governance practices in China.

The study was intended to provide those with an interest in the corporate governance
practices of Chinese companies with new insights into their status and new ideas for
ways to support and participate in their future improvement.

The study reflects the increasing emphasis that IFC and the World Bank place on improving
corporate governance practices as part of the overall effort to support the development
of the market institutions needed for sustained growth and poverty reduction. In China,
the World Bank’s work over the years in support of government reforms in the financial
sector, corporate restructuring, accounting, and legal and judicial practices has contributed
directly to the development of the institutions of corporate governance.
 Corporate Governance at IFC Projects

Sharing Local and International Perspectives

The Global Corporate Governance Forum, co-founded by the World Bank Group and
the Organization for Economic Cooperation and Development is an advocate, supporter,
and disseminator of high standards and practices of corporate governance in developing
and transition economies. It provides a convening venue for the leading players in
governance worldwide. Its theme of partnership between the public and private sector
is established through a Private Sector Advisory Group, which comprises internationally
recognized business leaders serving in an individual capacity, drawn from developing,
developed and transition economies. The Private Sector Advisory Group of the Global
Corporate Governance Forum, headed by American corporate governance pioneer Ira
Millstein, has been a catalyst for improved practices around the world.

In January 2003, PSAG cohosted a conference and held meetings in Shanghai. The group,
including representatives of the PSAG Investor Responsibility Task Force, chaired by
Peter Clapman of TIAA-CREF, participated in a conference co-hosted by the Forum, the
Chinese Securities Commission and the Shanghai Stock Exchange followed by private
meetings with Chinese business executives. Javed Hamid, IFC’s director for East Asia &
the Pacific, provided an address that offered practical areas for further reform on
corporate governance. PSAG offered Chinese businesses a range of industry perspectives
from the United States, Europe, and other parts of Asia.

The conference was attended by over two hundred Chinese business leaders. It provided
an opportunity to discuss global issues in corporate governance and the remarkable
progress made in China in recent years, mostly due to the leadership of the CSRC.
CSRC emphasized its determination to promote a strong corporate governance agenda
in China. CSRC has provided basic training for the independent directors required to
serve on Chinese boards.As a result of the meeting the Forum and IFC began encouraging
the formation of a Chinese Institute or Association of Corporate Directors. The global
support of such institutions is a key part of the Forum’s global mission. The time is right
for such an organization in China.

After the conference, the PSAG’s Investor Responsibility Task Force held private meetings
with chief executives from some of China’s leading listed companies “These CEOs clearly
understand what it will take to attract the kind of private, long-
Some Chinese CEO’s understand term capital that our investor group represents,” said Peter
what it will take to attract the kind Clapman. While investors such as Capital Group are already
of private, long-term capital active in China, a few others were there to investigate the
institutional investors provide. recent opening of local company shares to qualified institutional
investors. The group concluded, at least in part, that China still
faces some serious structural problems that have to be resolved before the broader
market will be attractive to more conservative investors. But they gained an appreciation
of the real pioneers in adopting good practices.

21
 Financial Institutions
Financial institutions play a critical role in economic development. Effective institutions allocate
capital to enterprises that can make the most productive use of the funds. A broad and deep financial
sector is fundamental to building local businesses, large and small. Strong, competitive, and broad-
based domestic capital sources are needed for companies to start up and grow.

In China, some of IFC’s largest equity investments have been made in the banking sector. As a
significant equity investor in China’s banks and nonbank financial institutions, IFC has an interest in
raising governance standards and our significant equity investments provide a platform to influence
in this area more effectively.

Governance safeguards not only protect investors in financial institutions. At deposit-taking institutions,
where people’s life savings may be at stake, good governance is important for safeguarding other
stakeholders. IFC’s governance work with financial institutions complements the support we provide
at the operational level—introducing best practices in credit analysis, risk management and portfolio
monitoring, and internal controls.

While Chinese banks have a reputation for lax internal processes and governance, IFC’s experience
indicates that most want opportunities to improve practices. Management of an increasing number of
financial institutions are realizing that they are better served by
Looming competition has helped voluntarily implementing improved practices before competition forces
financial institutions focus on change upon them. Looming market liberalization due to World Trade
differentiating themselves. Organization membership has helped focus institutions on
differentiating themselves from competitors. For institutions eager to
adopt best practices, working with IFC starts them on the road toward setting themselves apart in the
market, and improving their brand and ability to raise capital for expansion.

Building a Modern Bank of Shanghai

One bank that made this connection early on was the Bank of Shanghai, a full-service commercial
bank whose primary mandate is to support local privately owned small and medium enterprises.
Established in 1995 with a legacy as a cooperative financial institution, it watched banks proliferate
along the shores of Shanghai’s Pudong New Area, a district the city government had marked to become
country’s new financial center. Suddenly the skyline bristled with potential foreign and local competitors.

IFC began working with Bank of Shanghai by implementing a program of technical assistance aimed
at improving operational practices and funded by the European Union and Japanese governments.
Given management’s willingness to receive this assistance, Bank of Shanghai was targeted as a good
candidate for governance reform. Introducing better governance standards in a prominent financial
institution was a priority for IFC because of its potential demonstration impact on other banks in
Shanghai and China. The idea was to create a lending institution that could serve as a models.
 Corporate Governance at IFC Projects

IFC needed a stronger relationship in order to deliver the Environmental Protection. Because banks face
sort of support required for Bank of Shanghai to achieve increasing scrutiny, Bank of Shanghai also took steps to
improved practices in corporate governance. In 2000, IFC manage potential liability stemming from environmental
invested nearly $25 million to take a small equity stake in issues related to project financing. The bank established
Bank of Shanghai. IFC was now able to influence corporate an environmental management system to ensure its lending
governance practices as a shareholder rather than a outside activities comply with Chinese laws and appointed two
consultant. As a shareholder, IFC was also able to require senior officers responsible for conducting environmental
project environmental and social reviews and an annual appraisals on all projects.
environmental performance report, enhancing the overall
Auditing. A board-level audit committee was created to
sustainability of the bank’s operations.
ensure the completeness and objectivity of work conducted
The biggest changes were taken at the board of directors. by external auditors and assess whether the bank’s internal
IFC encouraged Bank of Shanghai to increase the controls were effective and complete. Because management
frequency of board meetings and improve the quality of was no longer the auditor’s client, auditors became less
information provided to directors. Many Chinese directors vulnerable to pressure from management and more
asked few questions at first, and bank management often likely to safeguard the interests of the bank’s minority
supplied only information of limited value. But eventually shareholders.
the local directors began coming up with their own
Executive Remuneration. A compensation committee was
questions, many of them quite challenging, regarding the
created to review executive pay and create performance-
rate of change in the bank’s loans, its deposits, its capital
based promotion criteria for senior managers. Criteria
adequacy, profitability, and other key data on performance.
involved profitability metrics such as return on equity,
As the process of change unfolded, Bank of Shanghai capital adequacy, and non-performing loan ratios. Bonuses
expanded the board’s supervisory powers by setting up were tied to managers’ ability to meet those performance
independent board-level committees on risk management, targets, making the promotion process more transparent
auditing, and compensation. This resulted in ongoing and clarifying the board’s expectations of senior manage-
changes in the following areas: ment. Moreover, the existence of an audit committee
challenged the assumption common among Chinese
Risk Management. To consolidate the management of
enterprises that promotions were doled out automatically
bank-wide risks, Bank of Shanghai broadened the remit
by virtue of seniority. IFC worked with the bank to establish
of its Credit Management Department, converting it into
a basis for recognizing performance, a controversial and
a revamped Risk Management Department and setting up
difficult change for many in Bank of Shanghai to accept,
a credit review center to scrutinize big loans prior to
but one that was vital to the bank’s transformation into a
approval. Procedures were established for identifying,
profit-oriented institution.
quantifying, and managing risks, and for adopting a
standardized rating system for internal use. The bank also Information Disclosure. Working with IFC, the Bank of
set up a collateral recovery department to centralize Shanghai modernized its reporting practices in a number
management of large nonperforming assets. of ways. Until 2003, for example, the financial information

23
released in the bank’s annual report was calculated according to Chinese rather than international
accounting standards. In fact, Bank of Shanghai had compiled international-standard data but chose
not to release it for fear of confusing stakeholders with what might have looked like two conflicting
sets of financial data. Working with management, IFC persuaded the bank to begin releasing IAS
figures in its annual report.

Bank of Shanghai’s improved corporate governance regime attracted attention. It was a key factor in
the decision by HSBC to take an 8.0 percent equity stake in the bank in 2003. It was the first such
investment by a foreign commercial bank in a Chinese bank. Total foreign equity participation has
reached 18 percent, allowing Bank of Shanghai to decrease the level of state ownership and diversify
its shareholder base.

Commercial Banks

In addition to Bank of Shanghai, IFC has committed to take equity investments in five other commercial
banks in China, including three other city commercial banks—small, geographically limited lenders
that provide critical support to China’s chronically under-funded smaller enterprises. It has also
provided technical assistance programs to many banks by replicating the Bank of Shanghai training.
Among the banks was the city commercial bank in Chengdu offered assistance through the China
Project Development Facility. As part of its support IFC is providing ongoing technical assistance
that includes operational practices and strengthens banks’ corporate governance procedures.

While IFC-invested banks have demonstrated a willingness to adopt better practices, much work still
needs to be done. As IFC’s relationships with smaller commercial banks mature, it expects to provide
additional technical assistance to strengthen the corporate governance and institutional capacity of
selected financial institutions. Assistance will include corporate governance assessments and
identification and nomination of independent directors. It will also include training in the concepts of
corporate governance and the role of the board in the oversight of accounting, auditing, compliance,
strategic planning, human resources, and executive compensation.

IFC Support for Chinese Commercial Banks

Bank IFC Investment FY
Bank of Beijing 2005
Bank of Shanghai 2000-2002
Chengdu City Commercial Bank Non-investment
China Minsheng Banking Corporation 2003
Industrial Bank 2004
Nanjing City Commerical Bank 2002
Xi’an City Commerical Bank 2003
 Corporate Governance at IFC Projects

Nonbank Financial Institutions: Following a change in Chinese insurance regulations

IFC’s Work in the Insurance Sector allowing 25 percent foreign ownership of New China Life,
the company has attracted the interest of several foreign
Despite their limitations, commercial banks remain the
investors including a leading international life insurer. IFC
main source of formal financing for businesses in China.
took an equity stake in the company. Using the capital
The rapidly growing economy will benefit from the
from foreign investors, New China Life became a leader
development of a broader and deeper market for financial
in a market that was formerly a state monopoly and is a
services, yet many basic financial institutions have either
serious competitor to the foreign insurers now jockeying
been state monopolies or have yet to develop in China.
for position as China’s insurance market opens up due to
With entry into the World Trade Organization, the financial membership in the World Trade Organization.
sector will be gradually opened to foreign competitors. If
IFC’s equity investment in New China Life encouraged
Chinese companies are to compete, they must develop
better practices.
quickly and grow rapidly. Good corporate governance will
provide safeguards for these nonbank financial institutions Meeting procedures. Board meetings and shareholder
to develop. meetings are designed to air different perspectives.
IFC’s primary contribution to improved corporate Shareholders are normally consulted only on major issues,
governance in nonbank financial institutions has been while directors are charged with overseeing the entire
primarily in the insurance sector. New China Life company. Directors typically decide which resolutions will
Insurance Company is a Beijing-based company selling go to shareholders for approval. New China Life separated
policies in major Chinese cities. Established in 1996, it is the meeting to add clarity to the purpose of each meeting.
one of only five companies nationally licensed to operate Additionally, the company can now offer shareholders
in the life, health, and pension insurance sectors. sufficient advance notice of their meeting.

25
 Meeting agendas. As part of its commitment to improved practices, New
China Life management has begun providing documentation related to
important agenda items prior to meetings. In the past, shareholders or board
members were often asked to approve an item after only a brief review
during the meetings. By circulating documents well in advance, the company
now ensures parties have time to review important issues and board members
have adequate opportunity to discuss important issues in advance.

Financial disclosure. IFC encouraged transparency and good financial

disclosure at New China Life. IFC worked with the company to help it
follow its own detailed disclosure procedures more closely, ensuring that
shareholders and board members had access to
Better practices provide a means more complete financial information for
for improving investor confidence, informed decisions.
enhancing corporate performance Independent directors. Chinese securities
and increasing access to capital. regulations prescribed that a third of board
members for listed companies must be
independent as of mid-2003. Yet, New China Life had no history of
independent directors. With IFC’s encouragement and motivated by its own
desire to have a public listing, New China Life nevertheless appointed the
required percentage of independent directors, even before becoming a listed
company.

Board meeting dialogue. Challenging senior management is not a widely

accepted cultural practice among shareholders in China. If handled
insensitively, questions are dismissed rather than viewed as an effort to
improve company performance. Over time at New China Life, better
practices have helped foster an environment where questioning management
became permissible. Many Chinese shareholders have become less reluctant
to ask questions. Today, the chairman is receptive to questions from
shareholders and board members, seeing this as an opportunity to clarify a
position or receive feedback that can contribute to further changes.

Special board committees. IFC assisted New China Life in setting up

committees designed to improve governance by the board. An audit
committee now meets regularly and discusses budgets in detail, and an
investment committee is under discussion. A nomination committee and a
remuneration committee are also functioning well.
 Financial Institutions

Chengdu Small Enterprise Credit Guarantee

Corporation

Many banks remain unwilling to lend to China’s capital-

starved small and medium enterprises until credit risks can
be reduced further. Credit guarantees institutions are one
channel for reducing those risks.

Chengdu Small Enterprise Credit Guarantee Corporation

was the first Chinese credit guarantee company set up by
local and foreign government partners (the city of Chengdu
While these steps might seem like basic and standard
city government and the Swiss government). Although the
corporate practices, they represented big steps for a entity itself was government-funded, IFC decided to support
Chinese company at the time. the enterprise and encourage best practices in its
governance and operations because of its potential impact
IFC’s experience in working with companies and financial on private sector development.
institutions in China has helped us use better corporate
To bring CGC’s governance into line with international
governance practices as a key tool in promoting a stronger
norms, China Project Development Facility provided
private sector. Good practices in our client companies in
extensive support:
China have provided a means for improving investor
confidence, enhancing corporate performance, and Drafting legal documentation. CPDF helped draft legal
increasing access to capital. documents including a detailed shareholders agreement
spelling out the rights and obligations of shareholders. The
agreement laid out working procedures for the company’s
board and delineated lines of authority among shareholders,
board members, and management. CPDF also helped
strengthen the company’s articles of association and for
management to come up with a code of conduct articulating
the company’s values and strategic vision.

Creating an Audit Committee. CPDF helped CGC select

board members with an auditing and finance background to
commission outside audits and appoint external auditors.

Increasing management board efficiency. Duties of

managers and board members were clearly separated to
ensure that board members formulated strategy while
management implemented it. A proper incentive system
was also put into place to align top managers’ compensation
with market rates, helping the company attract and retain
higher quality executives.

27
Support for Market Regulation

Although China’s regulatory apparatus is adapting quickly to meet the challenges of a market economy,
it is still a work in progress. IFC is supporting China’s effort to build a framework for effective regulation
by identifying gaps in the current system, commenting on existing and proposed laws and rules, and
responding to the regulators’ demands for strengthening regulatory capacity in key areas—especially
those related to financial markets.

On the Right Track

In recent years Chinese regulatory officials have shown impressive zeal in implementing reforms,
especially for adopting legislative and regulatory changes aimed at improving corporate governance.
In some instances IFC commented on regulations. In others, IFC experiences at the company level,
especially in pilot projects, were communicated back to regulators through an ongoing dialogue to
help provide perspective that encouraged more thorough and meaningful regulations.

The China Securities Regulatory Commission issued a host of regulations early 2001 that constituted
a significant leap toward bringing its regulatory regime into line with international standards. They
included a directive mandating quarterly reporting; guidelines on qualifying and appointing independent
directors; rules aimed at enhancing disclosure, improving the workings of the stock market, and codifying
inspections of listed companies; a national corporate governance code; and an amended directive on
the form and content of quarterly reports. More recently, regulations have strengthened the position of
minority shareholders.

IFC provided comments on various drafts of the Code of Corporate Governance for listed companies
that was prepared by CSRC and was completed in 2002. IFC also provided extensive comments to the
drafting of the Code of Corporate Governance for Shareholding Banks drafted by the People’s Bank of
China.

In addition to the establishment of a regulatory framework for better corporate governance, significant
progress has been made in implementation. For instance, CSRC began delisting firms with poor profit
records and has even moved to shut down companies with especially poor governance practices.

In industries that are relatively new to private participation and regulatory oversight in China, such as
insurance, regulators may seek guidance to assist formulating effective policies. IFC often works with
regulators to determine international practices against which Chinese regulations can be benchmarked.
IFC helped create a $250,000 technical assistance program for the China Insurance Regulatory
Commission at its outset. The program commissioned a comparative study of regulatory regimes in
several developed economies including the European Community, the United States, Canada, Australia,
Singapore, and Hong Kong. The program was designed by CIRC, which organized a local team to
carry out the research; IFC the job, and lack rudimentary
IFC is supporting a framework
arranged funding from the knowledge of the decision-
for effective regulation.
government of Australia. making mechanisms used by
Information derived from the program helped Chinese corporate boards.
officials create a regulatory environment in line with
As a result, many Chinese company boards fail to function
international best practices.
effectively. This situation won’t change until there is better
Despite these encouraging first steps, regulators still knowledge of directors’ roles and strong incentive for
operate under significant constraints. Regulatory bodies individual directors to better educate themselves. In many
may not have the power or the political will to investigate market economies, there are real legal consequences if
improprieties. “All regulators will tell you they don’t have directors fails to perform their fiduciary duties. While some
enough power,” says one of China’s top securities officials. problems have been fixed, Chinese law has not yet fully
“Often it takes a scandal to really focus people’s will— evolved to the stage where the consequences of a breach
both legislators and regulators—so as to become stringent of duty are clear.
in applying the rules.”
With the emergence of independent directors in China, the
process is beginning to change. CSRC has begun to require
Cultivating Independent Directors
that every listed Chinese company make at least one-third
The boardroom is the battleground for good governance
of its directors independent. The rule begins the process of
around the world.
increasing the autonomy of boards from management.
Yet boards of directors are new to China’s emerging private
Implementation will take time. There are few qualified
sector companies. Traditionally in state owned firms
candidates—experienced people who understand and can
managers, together with their party and government
carry out the role of an independent director. CSRC has
supervisors, play the main role in running companies.
recognized the need for capacity building to support
Boards of directors are slowly replacing those governance
regulations requiring more independent directors. It
mechanisms in China. Today, cultivating a base of capable
established training programs to educate and train corporate
directors, especially independent ones, may become the
directors of listed companies.
critical factor in determining the success of China’s
transition from the old to the new ways of governing Such training offers its own challenges. China’s unique
companies. cultural and business environment limits the usefulness of
training materials developed elsewhere in the world.
To be effective, directors must know their rights and
Western experience is needed, but can only be effective
responsibilities. But because China has no tradition of
when combined with local knowledge to develop materials
active, independent boards, many do not. Boards ultimately
that respond to the specific requirements of Chinese listed
function as a check on the power of management or
companies. To overcome those challenges, IFC offered
majority stakeholders—a new concept to most directors.
assistance to CSRC.
Often, they do not fully understand the responsibilities of

29
IFC partnered with the Australian Institute of Company Directors, an
organization that provides training to company directors in Asia Pacific.
The Institute has emerged as a regional player in disseminating best practices
in corporate governance, and has helped set up Institutes of Company
Directors in other countries across Asia Pacific. Working with IFC and CSRC,
the Institute designed a training program for directors of listed companies
aimed at accomplishing the following objectives:

• Familiarizing participants with basic principles of business law,

accounting, strategic direction, and governance

• Creating a code of conduct for directors

• Training and supporting local tutors who could continue the program

• Establishing an Institute of Directors in China

Such a program is improving participants’ capacity to perform as independent

directors by enhancing their professionalism, skill, and knowledge. By
qualifying Chinese tutors, the program also creates a local capacity to train
listed companies’ directors and independent directors.

IFC also wanted to ensure the program remained effective even after external
support was withdrawn. This objective was achieved by developing course
content and a curriculum that remained the intellectual property of CSRC
after the project ended, and by training tutors who could continue teaching
company directors in the future.

“We found to our surprise that many more people enrolled than we thought,”
said one senior Chinese official. “As a result, we’ve created quite a number of
these courses. We have trained 10,000 people over the past few years, including
professionals such as lawyers and accountants, institutional investors, and
academics. We now have a well-developed roster of teachers, mainly from
Qinghua and Fudan Universities. Classes are held in Shenzhen, Shanghai,
and Beijing. We normally get between 200 and 400 students per class.”
 Support for Market Regulation

Training is just the beginning. Ultimately, China must Looking Ahead

develop a business culture where directors know what is China presents exciting opportunities for regulatory reform
expected of them and are motivated to do the job in a and improved corporate governance. Learning from both
manner that benefits of the overall system. For that to the successes and the increasingly well documented failures
happen, a director’s liabilities must be made credible: Those in other markets, China can build on global experience to
who do wrong, or fail to do right, must pay a price. And if build its own regulatory institutions with solid foundations.
there is a price, there must be insurance. Many Chinese But these opportunities come freighted with risk—mainly
candidates for directorship are not wealthy by international the risk that China’s pioneering private sector companies
standards. If found liable for substantial fines, they may be will fail to set good examples. In a transition economy,
unable to pay. Insurance companies must offer directors power of precedent is crucial, so practices developed in
and officers insurance, a common practice internationally. today’s economy are likely to have long-term consequences
It benefits the markets by exposing insurance companies for China’s institutions.
to greater liability and encourages them to scrutinize the
Rules prescribing a fixed number of independent directors
individuals they insure.
effectively begin the process. Going forward, the challenge
will be to ingrain principles of fairness, accountability,
transparency, and fiduciary duty in management and
governance practices. The long term benefit to the economy
will be sufficient investor protection that ensures China
will remain attractive to capital in the long term.

31
 Appendix

Selected IFC Support Across Industrial Sectors

PROJECT FISCAL YEAR SECTOR CORPORATE GOVERNANCE SUPPORT

ASIMCO 2004 Automotive IFC is helping improve practices and policies that resulted in new audit and
compensation committees of the board of directors.

CSMC 2004 Electronics IFC provided materials developed by Corporate Governance Unit to help
Technologies select board members and establish board committees. IFC placed an
Corp observer on the board to work with it on developing better board meeting
procedures and practices.

Chengdu Huarong 1999-2002 Chemicals IFC encouraged better practices, supported by seat on board, and assisted
Chemical Company selection of outside directors. IFC encouraged improved financial reporting
and auditing of financial statements.

China Green 2004 Utilities IFC providing corporate governance assessment; improvement program
tailored to the specific needs in the areas of: shareholder rights and equitable
treatment; the board of directors; transparency and disclosure; and
commitment to corporate governance. Provided training to the relevant staff
and board members.

Great Infotech 2003 Technology IFC is helping the company transform from a family-owned business to an
institutional investor-sponsored professional business. IFC helped the company
to identify two independent nonexecutive directors who will contribute to the
development of board practices that are in line with best international
practices. The company is preparing for an IPO on the Hong Kong Stock
Exchange. IFC intends to work with company management on corporate
governance related issues to ensure compliance with the higher standards
expected of listed companies.

Fenglin Group 2004 Forestry IFC has encouraged several improvements, including the appointment of a
credible auditor and preparation of financial statements according to
international standards. The company has separated its fibreboard business
from other businesses to increase transparency. The board will be expanded
and IFC will continue to advise the company on improving practices to help
the company prepare for listing on a public exchange.

Jilin Zhengye 2003-2004 Agribusiness IFC provided technical assistance to develop an enterprise resource planning
Agricultural system. This effort will contribute to better accounting practices and
Development transparency for managing and directing the company.

Nanjing Kumho 1996-2004 Automotive IFC has an observer on the board who provides advice to help the company
Tire improve practices.

Planation Timber 1996-2001 Forestry IFC encouraged PTP to establish strong corporate governance as its business
Products expanded, including adoption of international accounting standards and audits
by an international firm.

Shanxi Antai 2004 Mining Antai sought a partnership to tap into IFC’s knowledge of best practices in
Group environmental management and corporate governance. In adopting better
practices it hopes to build stronger credibility for a possible listing of its shares
internationally.

Southern Aluminum 2004 Aluminum IFC is jointly developing a corporate governance action plan with the company
Industry Co. to improve its practices.

Wumart Stores 2004 Retail Wumart sought IFC’s participation in its initial public offering to signal a
commitment to meeting high standards in order to improve access to capital.
As an equity investor, IFC will advise through its Corporate Governance Unit
on corporate governance practices to help it adopt practices.
 PUBLICATION TEAM

Regional Director
Javed Hamid

Associate Director
Karin Finkelston

Lead Economist
Stoyan Tenev

Project Manager
Desmond Dodd

Lead Writer
Winter Wright

Other Contributors
Shannon Atkeson, Li Ren, Wenqin Zhu

Photography
Greg Girard

Design and Production

Polly Yu Production Limited
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