Chinese Ownership: It can be a bit of a mixed bag…

From Marco Polo’s reports of Chinese grandeur to naval dominance under Zheng He, tales of the vaunted Middle Kingdom have fascinated and tantalized merchants from far-flung nations. While today’s China differs from its past iterations in many regards, its prowess in trade and commerce persists. What’s more, economists predict that China’s torrid growth should continue, with annual economic growth of 7 to 8 percent through 2030.1  China’s progress, both past and present, contributes to a tenor of prosperity. However, many speculate that outsiders’ rose-colored view of China is more attributable to carefully managed expectations than reality.

Introduction

Amidst the deluge of information surrounding China, foreign businesspersons find their ability to evaluate conditions in the People’s Republic of China (PRC) becoming more and more inadequate. One particularly hazy concept is business ownership: i.e. who owns what? For countries like China, business ownership is difficult to determine for various reasons. First, few outsiders understand the current nature of state and private ownership in the PRC. Second, many Westerners question private firms’ ability to operate without hindrance from the Chinese government. While the PRC might not technically own a firm, the ability to exercise control over a firm is de facto ownership. Thus, any analysis of business ownership must consider whether the PRC controls business operations of privately owned firms or maintains a more laissez faire approach. Finally, few in the Western world have heard of (let alone understand) China’s complex form of indirect, group ownership, qiyejituan. Accurately determining the true nature of business ownership in the PRC requires understanding the difference between state and private ownership, the degree to which the state controls private enterprise, and the difference between direct and indirect ownership.

State-owned versus Privately-owned Companies

In the years after Mao Zedong and the Communist Party of China’s victory over the Nationalists, the government nationalized businesses. As China has become increasingly market-oriented, the PRC has relaxed its grip on private enterprises, and many privately owned firms have flourished. Evaluating state versus privately owned firms requires understanding the relative quantity of each firm type, as well as employment.

  1. Firm Type. Merely comparing the number of state-owned enterprises (SOEs)2 to private firms reveals that privately owned firms, numbered at over 77 million,3  dwarf the 150,000 SOEs. With 12,000 new businesses added daily, the expected the shift from state-owned behemoths to privately owned business will continue.
  2. Employment. Today, SOEs employ 1 in 5 Chinese workers.4As shown in Figure 1, the proportion of urban Chinese employed by SOEs has fallen from almost 58 percent in 2006 to just under 33 percent in 2016.5 While the proportion of urban Chinese employed by SOEs has decreased relative to the whole, the decrease is more indicative of the staggering increase in employment from private firms.

Figure 1 – Employing China’s Urban Population, Source National Bureau of Statistics China

In terms of overall quantity of businesses and employment, privately owned firms dominate China’s SOEs. While privately owned firms dominate the business landscape in China, state-owned firms formidably contribute 30 percent of China’s GDP6 and hold assets valued at $14.69 trillion.7 At this point, China is operating with an economy of state-owned behemoths and relatively smaller, privately owned businesses.

State Control of Privately-owned Firms

In spite of China’s many market-oriented reforms, foreigners associate China with communism – continuing to believe that the Chinese government controls all businesses. Given that perception, outsiders may incorrectly presume that private ownership does not exist in the PRC due to primary party organizations and the government’s ability exert influence.

Primary Party Organizations. Outsiders warily view primary party branches, or internal committee organizations, as tools for the PRC to monitor private firms and exert influence.8  Under Chapter V Article 29 in the Constitution of the Communist Party of China, any enterprise with three or more party members may establish a “Primary Party Organization.” The objective of primary party branches is to “ensure that the party’s theories and guidelines and policies are implemented.”9 While the purpose of the primary party branches is to reinforce party principles, the majority of private firms cite economic benefits10 as the chief motive for forming primary party branches.11 Thus, the nature of the relationship between private businesses and CPC party organizations appears to be based on convenience, as illustrated in this comment from Li Zhangzhu of Yuanfang Group:

What the boss of a private enterprise cares about most is business results. The boss will only pay attention to and support [Chinese Communist Party] building if it helps to promote the growth of the business and increases profits.12

Influence from the Government. In addition to the influence from internal party branches, many firms receive “recommendations” from the PRC. Thus, it is important to consider the degree to which private firms must comply. In one instance, Tencent received harsh criticism from the PRC and the military over its popular mobile game, Honour of Kings. In response to the backlash, Tencent imposed limits on adolescent game usage.13  In another instance of governmental influencing, Chinese tech giants invested $12 billion in state-owned China Unicom.14  The Chinese government solicited the investment in order to help bolster a struggling SOE. The negotiations lasted one year, and the investing companies touted the strategic investment as a ”win-win. “In spite of investor enthusiasm, one expert voiced everyone’s quandary: “You cannot say ‘no,’ but can you limit how many times you have to say ‘yes’?”15

While influence from internal party branches appears minimal, external influence is compelling. At the present, the relationship between the government and private enterprise consists of the PRC being able to exert high levels of influence on privately enterprises, albeit in limited situations. This begs the question, is influence tantamount to ownership, or is it merely on the spectrum?

Direct Versus Indirect Ownership

For Americans, the indirect form of ownership demonstrated in qiyejituan16  appears to be antithetical to the direct form of ownership embodied in Western ownership structures. In its most basic form, qiyejituan has three distinct levels: a core firm, directly owned subsidiaries, and lower-tier subsidiaries. The core firm will directly own several of the group members and rely on complex contracts and informal agreements17 to control the remainder.

The relative flexibility and alignment with Chinese cultural norms offered by qiyejituan makes it an ideal business structure for Chinese enterprises. Thus, both state (China Unicom, China Petrochemical) and privately owned (Legend Holdings, Haier Group) firms employ the structure in their operations. Today, there are nearly 3,000-registered qiyejituan, responsible for almost 60 percent18  of China’s industrial output.19

 

Overall Analysis

Figure 2 depicts, China’s positioning on a two-by-two matrix consisting of two spectrums: direct versus indirect, and private versus state ownership.20

Figure 2 – Chinese Business Ownership

Direct Versus Indirect Ownership. The overall size of and output from China’s qiyejituan is incredible. Considering output alone, registered qiyejituan dominate their non-affiliated counterparts, producing 60 percent of Chinese GDP.21  Given the past and continued success of qiyejituan, it is likely that more groups will form in the future. For now, China’s position on the scale in Figure 2 shows that ownership in Chinese businesses consists more of informal ownership than direct business ownership.

Private  Versus State Ownership. While private firms dominate China’s SOEs in terms of output and firm type in absolute numbers, the CPC’s ability to exercise control over private businesses skews the private-versus-state dimensional scale.

Figure 3 illustrates the positioning of China’s largest businesses on the same matrix. In Figure 3, there are three highlighted groupings: Private Qiyejituan, Chinese Conglomerates, and Listed SOEs. The non-highlighted firms include one private firm that operates with little indirect ownership, and state-owned firms at the bottom. The state-owned firms are the non-listed SOEs. Those in the direct, state owned quadrant are similar to Western SOEs, where those in the indirect quadrant are more representative of Chinese SOEs.

Figure 3 – Chinese Firms on the Business Ownership Matrix

Conclusion

From SOEs to VIEs22,  Chinese business ownership differs significantly from Western constructs. Nevertheless, American and Chinese business dealings are converging at an ever-increasing rate. Those who want to invest successfully in the world’s most dynamic economy must achieve cultural literacy in understanding the nuance of Chinese business. Understanding business ownership represents a viable start.

  1. Cheremukhin, A., Golosov, M., Guriev, S., & Tsyvinski, A. (2015). The economy of people’s republic of China from 1953(No. w21397). National Bureau of Economic Research
  2. For a more thorough discussion of SOEs see the InternationalHub paper: Demystifying China’s Stodgily Owned Entities
  3. State Administration for Industry and Commerce, 2016
  4. Export. China – 7-State Owned Enterprises China – State Owned Enterprises. (2017, July 7). Retrieved January 09, 2018, from https://www.export.gov/article?id=China-State-Owned-Enterprises
  5. National Bureau of Statistics of China. (n.d.). Number of employees at state-owned, collective-owned, and private enterprises in urban China from 2006 to 2016 (in millions). In Statista – The Statistics Portal. Retrieved January 12, 2018, from https://www.statista.com/statistics/252924/employees-at-state-owned-collective-owned-and-private-enterprises-in-china/
  6. Export. China – 7-State Owned Enterprises China – State Owned Enterprises. (2017, July 7). Retrieved January 09, 2018, from https://www.export.gov/article?id=China-State-Owned-Enterprises
  7. Shanghai to shake up state enterprises ownership. (2017, February 17). Retrieved January 13, 2018, from http://usa.chinadaily.com.cn/business/2017-02/17/content_28242488.htm
  8. In reality, party organizations exist in order to reinforce the party’s message.
  9. Beijing Youth Daily. (2015, July 6). Why private enterprises should establish party committees? Retrieved January 12, 2018, from http://epaper.ynet.com/html/2015-07/06/content_141902.htm?div=-1
  10. These normally consist of subsidies ranging from tax breaks to favorable deals.
  11. Bachman, D., & Dickson, B. J. (2010). Wealth into Power: The Communist Party’s Embrace of China’s Private Sector. Perspectives on Politics, 8(2), 633.
  12. Beijing Youth Daily. (2015, July 6). Why private enterprises should establish party committees? Retrieved January 12, 2018, from http://epaper.ynet.com/html/2015-07/06/content_141902.htm?div=-1
  13. Lucas, L. (2017, Sep 22). Beijing’s battle with big tech. Financial Times Retrieved from https://search.proquest.com/docview/1953766430?accountid=4488
  14. Jim, C., Kwok, D., Roantree, A. M., Zhu, J., & Chatterjee;, S. (2017, August 16). State-owned China Unicom to raise $12 billion from Alibaba, Tencent, o. Retrieved January 13, 2018, from https://www.reuters.com/article/us-china-unicom-results/state-owned-china-unicom-to-raise-12-billion-from-alibaba-tencent-others-idUSKCN1AW0JP
  15. Lucas, L. (2017, Sep 22). Beijing’s battle with big tech. Financial Times Retrieved from https://search.proquest.com/docview/1953766430?accountid=4488
  16. Qiyejituan are business groups relying on both equity-type and informal arrangements to exercise control over the group members. For a more broad discussion of qiyejituan see the InternationalHub paper Qiyejituan: Two is Better Than One
  17. Often, these informal agreements constitute little more than a handshake.
  18. Because qiyejituan are required to meet certain requirements, this figure does not fully encapsulate the full scope of their operations.
  19. He, J., Mao, X., Rui, O. M., & Zha, X. (2013). Business groups in China. Journal of Corporate Finance, 22, 166-192
  20. The United States is included for the sake of comparison
  21. He, J., Mao, X., Rui, O. M., & Zha, X. (2013). Business groups in China. Journal of Corporate Finance, 22, 166-192
  22. For a discussion of VIEs see the InternationalHub paper series VIE: The Chinese Tech Tangram