The Politicization of Corporate Governance—A Viable Alternative?

It is accepted almost as a truism that without robust and efficiency-driven legal institutions, markets are limited in their ability to sustain capital market growth. Beyond early stages of market development, local alternatives are expected to give way to certain traits of corporate capitalism if further growth is to be achieved. This prevailing expectation is shared among development theorists, law and finance researchers, and comparative corporate governance scholars and has been the basis of rich academic writing and international policy.

Four decades of economic development in China challenge these conventions. In my paper The Politicization of Corporate Governance—A Viable Alternative?, forthcoming in the American Journal of Comparative Law, I contrast the prevailing approach above with the role played by political institutions in the governance of Chinese firms. Despite their apparent similarities, Chinese public firms, and the domestic capital markets within which they operate, sustain strong idiosyncrasies that go against many fundamentals in economics and legal thought. China’s public firms continue to rely on political influence as a substitute for conventional notions of sound corporate governance. With modern firms with global prominence and a capital market that is the second largest in the world, corporate governance in China seems to have passed the point of an “adjust or perish” prognostic.

Perhaps most strikingly, as the market continues to develop, the use of political substitutes not only has not receded, but has expanded and become more overt over time (with respect to firms with and without state ownership, and notwithstanding the locations of their listings). At its current inflection point, when the domestic demand for growth and the regime’s ability to sustain growth encounter great challenges, the Chinese government and specifically the Chinese Communist Party (CCP) have moved to exercise an even more direct and transparent role in market activity. Public firms in present-day China are increasingly governed by a politicized corporate governance in which political institutions with corporate governance capacities are deployed both inside and outside firms. In my paper, I shed light on this process, which I term the “politicization of corporate governance”; evaluate the viability of political governance for the Chinese capital market; and consider its practical and theoretical implications to the global corporate governance discourse.

The active role of the Chinese government in the market is relatively recognized (Liebman & Milhaupt eds., 2016) and has become a cause for growing concern for policymakers worldwide. As I discuss elsewhere, the recent troubling escalation of U.S.-China relations and the calls for an economic de-coupling from China have brought efforts in Congress, the SEC, and NASDAQ to enhance scrutiny over foreign issuers, and particularly those owned or controlled by the Chinese government (see here, here, here, and here, respectively).

The influence exerted by the Communist Party itself is even harder to grapple, and until recently was largely exercised in the shadows of formal state capacities (Howson, 2009; Wang, 2014). The recent politicization of corporate governance presented in my paper, however, has brought this once opaque, shadowy political influence into the light by institutionalizing, legalizing, and enhancing the Party’s own capacities in firms and the market. These developments make clear that the oversight functions of conventional internal-governance mechanisms, such as boards of directors, audit committees, and independent directors, are being supplanted by political incentive mechanisms and by party committees that are deployed within firms. At the same time, the disciplinary and enforcement functions of legal institutions and external markets are bolstered by political discipline and accountability mechanisms.

More specifically, in the politicization process: 1) a political institution, the corporate Party committee, is established as an internal corporate stakeholder that is separate from the state’s capacities in the firm. In its corporate stakeholder capacity the CCP has obtained a formalized and disclosed role in corporate oversight, in corporate decision making, and in the nomination and assessment of senior managers (with assessment criteria being increasingly attentive to firm value mainly through an added emphasis on production efficiency); 2) a newly-legalized form of external political discipline and accountability institutions (colloquially known as the Party’s anti-corruption apparatus) are operating specifically through the corporate organization. The vast authority of these external political institutions has blurred the lines between political enforcement against corruption and legal enforcement against corporate wrongdoing.

While elements in this corporate governance system impede some efficiency functions in the market and increase managerial risk aversion, at the same time they seem to produce other efficiency gains. China’s corporate groups and their public firms have been notorious for facilitating corruption and for enabling abuse by corporate insiders. Early evidence suggests that a politicized corporate governance system in China counters some of the forces that persistently jeopardized economic outcomes and that “conventional” corporate governance institutions failed to cure, such as abuse by corporate insiders, mounting corruption, local protectionism, and state capture. The evolving nature of these institutions makes a full judgment of their effects impossible. Notwithstanding, they seem to substitute for many of the oversight, accountability, and incentive-based functions of more conventional governance institutions, and thus fulfill the two primary functions of corporate governance systems elsewhere—controlling opportunistic behavior and discouraging mismanagement.

In illuminating the operation of a politicized corporate governance in China, my paper reexamines some of the most profound theories of corporate governance and economic development. First, the paper provides support for the view that the efficacy of corporate governance reform is context-dependent and that its limits are determined by political-economic contours. Second, the paper suggests that given the relevant environment, political governance in firms is not necessarily detrimental and could benefit capital market growth. Third, the paper provides an in-depth analysis of one of the world’s most influential markets; showing a case in which path-dependent substitutes for conventional institutions continue to govern modern firms and markets beyond predicted thresholds and developmental milestones, while at the same time evolving within their institutional confines. In doing so, the paper sheds new light on both sides of the convergence debate: On the one hand, it shows that convergence is not inevitable even while development continues (or, at the minimum, it suggests that substitutes can sustain economic growth further than previously assumed), thus suggesting that corporate capitalism is not a sole panacea for capital market development. On the other hand, it shows that path-dependent attributes are not stagnant, indicating that there is elasticity even within fixed institutional and political boundaries. Finally, the politicization of corporate governance in China also offers an unexplored possibility in the menu of comparative corporate governance that should revitalize the discourse in the field; systems can openly and even formally reverse from outwardly-converging frameworks toward greater divergence (and here, even to a loose form of a planned economy).

The complete paper is available here.