Doing Business in China

By Amy Best

Stephen Green’s book, entitled “China’s Stockmarket – A Guide to its Progress, Players and Prospects,” is an excellent soup-to-nuts overview of the past, present and future of China’s stockmarkets. Whether you are looking for a holistic understanding of how China’s markets evolved and where they are heading in the 21st Century, or if you simply desire a better understanding of certain aspects of one of the world’s most watched markets, this book is a staple and a credible resource for students and those simply interested in the global markets alike. In addition, the class is meeting with Mr. Green on Friday, May 26, so the book is particularly topical this week.

As my classmate, David Rowland, already posted a great review and summary of the book as a whole, I will attempt to drill down a bit on some of the most topical aspects on the book, specifically the regulatory framework and the effect (or lack thereof) on corruption. It is worth noting that while the book is a comprehensive overview of China’s stock markets, each chapter of the book breaks down the analysis into different subject matters (i.e. the history of the market, foreign investment and Chinese equity, the investors, listed companies, the regulatory framework, the future of the market, and the prospects for foreign investors), that can be read independently by those looking to gain insight into specific aspects of the markets in China. For more on this subject, please click below.

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Previous reviewers have provided a great overview of the book and for fear of being repetitive, the only topics covered below will be the process by which state-owned enterprises (SOEs) list on a Chinese exchange and the regulatory environment as described by the authors.
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by Carl E. Walter & Fraser J.T. Howie

Privatizing China, provides excellent insight into the history, struggles and on-going development of the stock market in China. Written in 2003 by Carl E. Walter and Fraser J.T. Howie, it is a follow-on to the 1999 book by the same authors, To Get Rich is Glorious! The authors provide historical information with a sense of hope and incredible opportunity for both Chinese national and foreign investors, all-the-while keeping the reader aware of a critical need for reform and further regulation of the system.

Following is a review of two very important themes of the book: (1) an analysis of the separate kinds of shares available on the Chinese stock markets; and, (2) the preparation necessary for a Chinese State Owned Entity (SOE) to go public.
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Privatizing China: The Stock Markets and Their Role in Corporate Reform.
Carl E. Walter & Frasser J.T. Howie

The book provided a historic view of the establishment of equity markets in China. Since the history of equity markets in China begins around 1984 (the first listing of a company is debated, but the main point is the event was low key), it is one of the few areas of Chinese history that is not mind boggling to comprehend in its entirety.

The authors choose to address most of the subjects chronologically and it flows fairly well since the market structure is constantly evolving. At the front of the book, they give a full chronology of major events in the markets and a list of abbreviations. If the topic is brand new to you, it would be helpful to bookmark the abbreviations and skip the timeline until the events are described in detail. Unfortunately, the best summary of the whole market is Chapter 10, the last. I would recommend Chapter 1 followed by 10 then through the specific areas in 2 through 9. Appendices include good references to relevant laws, listing procedures for companies and market data on individual companies up to 2002.

The opening chapter centers on the birth of the shareholder system in China out of a need to raise capital. It is interesting how a system for shareholders evolves from state owned enterprises (SOEs) in an environment without property rights. Centralized planning was not part of the establishment of markets in China; instead local governments faced with liquidity problems (no state money) sold “shares” to raise much needed capital. Receiving cash for ownership with little obligation seemed like a better deal than a loan. These initial shares more resembled municipal bonds in their structure and payout but the idea had been born. The authors describe the opening and closing of local markets around the country describe in detail how there became two major markets Shenzhen and Shanghai.

In the next section on regulation the authors describe the evolution of the CSRC and their increasing role in the markets. Through trial and error, booms and scandals, we see the People’s Bank of China (PBOC) take a decreasing role in the management of the markets. Their position created conflicts of interests which are explained in detail. After the June, 1989 unrest there was discussion over what was perceived to be capitalist and it set back the process until Deng’s southern trip in 1992 where he laid out the government’s notion of experimentation with markets. Many details concerning which companies can list and the requirements were laid out by the CSRC to replace a quota system which relied on state planning.

The next section covers the types of shares issued over different periods of the experiment. Some have fallen out of favor (B-shares) while others are difficult to interpret (State owned shares). There is good description of the purpose and intent of the different share issues as well as the difficulty in reform. The domestic equity market is still relatively small therefore small changes can cause large market swings. One example, the attempt to sell state owned shares which previously were designated non-tradable shares caused a major sell off.

The decision of how to package a company for listing is unique from the western investment banker point of view. SOEs consisted of not only the plant and factory but also the surrounding infrastructure including schools, hospitals and pensions. They determined that the entire SOE would not be attractive to investors so the money making assets were stripped out leaving the cash generating facilities as part of the listed companies. In some ways it parallels the major car manufacturer or airline entering bankruptcy, handing off pensions and debt to the government and issuing equity during reorganization. Time will tell if the Chinese Government sold the crown jewels too cheap.

The breakdown of market players is a great section full of scandal and manipulation. The rules governing trading and brokerage houses evolved over the years in response to high visibility scandals. Once again, scandal is bad politically because it usually results in riots and social discontent. The author’s data illustrate that most of the Chinese domestic market is run by the big shots through a number of schemes with little small investor retail activity. These are important points because the market becomes more susceptible to manipulation and loses it’s ability to effectively set prices. Lack of public confidence in the market removes a critical source of investment for the public and leads them to save or fuel the real estate bubble. Promoting domestic investment remains difficult while raising capital in international markets has been easier through small improvements in transparency.

Ownership, company structure and valuation all tie in to the discussion of market performance. When placed side by side, A, B and H shares of a company trade at different discounts or premiums. The issue of state owned shares seems like the elephant in the room, the long term solution for state owned shares has not been found. What is to become of the state owned equity going forward and what is their value. Experiments in the past to float state owned shares crashed the market and will probably not be attempted again in the same manner. Through secondary offerings and valuation investors place on the resulting dilution, state shares are not figured in. Over time, the state portion of equity has decreased in almost all cases due to the continue issue of new equity. So far, the state as maintained a controlling interest and maybe that is their only goal.

When discussing ownership and privatization with Chinese characteristics it brings up issues that may hinder growth of markets in China. Corporate governance with a state majority does not lend itself to shareholder advocacy. The non free floating currency or trans border transfer of cash removes arbitrage in the market. While this fact has insulated the Chinese markets during the Asian currency crisis and results in market that does not even correlate with the Hong Kong market, it limits the overall goal of capital inflow.

Overall the book was helpful to understand the mechanics of the Chinese equity markets but the authors did little to provide insight into the decisions made by the Chinese government. What is the end goal of privatization with Chinese characteristics? As certain regulations are handed down by the CSRC, the motivations are left to the reader to interpret. The question is often posed throughout the book whether changes favor Comrade Socialist or Mr. Capitalist. Only in the last chapter do the authors venture an opinion how reform should look in the future for China to prosper.

Charlie Pucciariello

In general, “One Billion Customers” is a great read. The book contains a helpful brief overview of the context provided in the book. It provides the necessary history and culture backgrounds for people to better understand the stories/cases in the book. Its narrative style and stories made it an easy read and entertaining sometimes. Majority of the cases covers the fastest growing period in recent Chinese history (from late 1990s to early 2000s).

The book also contains eight independent chapters, each telling a story of a specific business case in a particular business sector (except for chapter one, covering the history and culture backgrounds, and chapter eight, the conclusion chapter). All chapters follow a consistent structure: an overview; an often-exciting story divided into short sub-sections; a summary section titled with “what this means for you”; and a closing section titled with “Little Red Book of Business”. The closing section, “Little Red Book of Business”, summarizes the most important strategies and lessons from the story and key take away points, presented in a handy bulleted list format.

Most importantly, it is the carefully chosen stories that made this book so invaluable. Most of the stories were very popular and have become legends of China’s business history. The author fills in on the details tailored to provide lessons for a foreign company operating in China. For instance, Chapter 3 discusses the rise and fall of a Chinese billionaire smuggler Lai Changxing who used to be a peasant. His case triggered huge discussions among the Chinese people. Through this case, the author demonstrates how corruption greases the wheels of the commerce. Lai Changxing’s journey is very insightful with great details in the book. Lai created a phenomenally successful operation in the southern city of Xiamen, Fujian through his excellent ability to form personal relationships with government officials at all levels. However, the personal relationship network was not enough to prevent his fall when the top Chinese government leaders needed a case to demonstrate their determination to crack down on smuggling and get the military out of business. Thus, one of the lessons drawn from this case is that “China’s modernization is aiming at ‘rule by law’ not the ‘rule of law’, so relationships and personal power reign supreme” in China. However, the author also says firmly in the book, “Don’t Bribe. Nobody stays bought and the Chinese know it is against American law. Instead, invest in long-term, mutually beneficial relationships with customers including training, travel, and recreation opportunities.”

Another merit of this book is that most of the lessons come out of the face-to-face interactions between Chinese bureaucrats and Chinese/foreign managers as well as interactions between Chinese and foreign managers. For example, Chapter 2 tells the story of creating of a joint-venture Chinese investment bank between Morgan Stanley and China Construction Bank. This case describes the different styles and perceptions of the two leaders –Wang Qishan, the head of China Construction Bank (Wang is now the mayor of Beijing) and Jack Wadsworth from Morgan Stanley. The author shows that two major factors contributed to the main problems between the two leaders. First, there are distinctive cultural differences. And second, the two leaders used interpreters from their own organizations. These internal interpreters had their own agendas, according to which they filtered the communications. One of the lessons learned for this Chapter is to hire independent translators.

In Chapter 4, the author also uses his personal experiences as Dow Jones’ chief China representative to provide suggestions in dealing with government officials. The government Agency, the Xinhua news, tried to act as competitor as well as regulator by pulling a classic Chinese government power grab. The recommendation for this is to build good government relations roles to deal with these current issues.

In the conclusion chapter 8, the author also eases the fears of some of the foreign companies about the “New China Threat” notion. He points out that the long tradition, the problematic educational system, and the lack of corporation will hinder the growth of Chinese corporations. He suggests that “Long term mentoring is the single most effective technique for foreign companies to build an effective Chinese executive corps. Mentoring should involve real projects where people make decisions and can learn how to make them in the future.”

One caveat of the book is that it doesn’t provide much information about the success or challenges faced by small and medium sized international companies in China. However, the book does provide some cultural experiences that will be helpful for smaller corporations.

One Billion Customers – Lessons From the Front Lines of Doing Business in China by James McGregor serves as a cautionary tale for foreign businesses who are entering the China market in search of market access and profits. As a Wall Street Journal correspondent, McGregor has not only followed the Chinese economic development for the past two decades but has also gained insights from numerous high profile joint ventures and partnerships by talking with the executives who were involved with the deals. Not only he was able to shed some lights as to the details of the deals, but also the intriguing human interactions and culture clash that were central to many deals’ success or failure. Read the rest of this entry »

Privatizing China – Book Review
(By Chao Chen)

To understand the stock market in china is a challenge task. There are two independent operated stock exchanges. There are tradable shares and non tradable shares. Various types of shares are under the tradable share category such as: A share, B share, LP share, H share, N share, G share, and etc. The stock market performance is disappointing while Chinese economy is growing rapidly. Carl E. Walter and Fraser J.T. Howie provide reader with in-depth quantitative and qualitative analysis in their book Privatizing China. This book is a great tool for reader to understand this complicate and unique stock market.
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China is a country that has a very rich and long history, captured excellently by John Bryan Starr in his book Understanding China. The focus of the book is to give the reader an overall look at the country’s history, economy, politics, people and culture. The book begins by describing its recent political history. For many years, China was not a part of the world economy because its leaders chose to close its borders to the world. The death of its famous leader Mao Zedong in 1976 began the changing of the political guard in China, along with the gradual opening of its economy to the world.

The book starts by discussing the leadership change that China has experienced in the last 30 years. Initially, Deng Xiaoping (a product of the Chinese Communist revolution and one of the founders of the contemporary Chinese political system) tried to install leaders in positions to succeed him upon his eventual retirement from duties of the State. However, he was unsuccessful in his first two attempts. Finally, he was able to bring in a leader Jiang Zemin, who was not like the old guard (born in the Chinese hinterlands, ill-educated and extremely conservative), but rather a hybrid of the old Chinese mentality and the more modern global outlook. The rapid change that has occurred in China over the last half century 30 has produced leaders with very different lives, careers, and experiences than their predecessors. The people who make up this new generation of leaders differ in training, perceptions, connections, and aspirations.

The book looks to explore three main questions, namely – What are the principal problems confronting China today? What is the capacity of the Chinese political system to deal with these problems successfully? And, given the answers to these two questions, how might the political situation play itself out in the near term. The book discusses the critical problems facing China’s leaders today. These critical problems are those the author believes will threaten the nation’s ability to continue on its current trajectory of economic development. The first is the issue of government state-owned enterprises loosing money. The majority of these industrial enterprises are kept afloat by the Chinese government with loans and subsidies. This is done mainly to keep people employed and keep up the face of being a socialist country. The next problem is that of the Chinese banking system. Estimates suggest according to the book that the four largest state-owned banks in China have made circa $200 billion USD in bad debt, by providing the funds that float the state-owned enterprises mentioned above. (However, recently in the news, it was mentioned that some of China’s big banks are currently in the process of launching IPO’s, so this might prove to be a means of shoring up their cash base.)

Another critical problem facing China is the issue of urban unemployment. As a result of the financial problems the state-owned enterprises are facing, a majority of the workforce is put on reduced hours or temporary furlough. The state employs a large workforce and as such their productivity is very low as there are too many people trying to do too few jobs. Further, the inflow of workers from the countryside into China’s big cities in search of lucrative work is a big issue facing the government. It is estimated that about 100 million workers can be categorized in this manner. The disparity between the have’s and have-not’s is another issue facing the Chinese government according to the author. The gap in the standard of living between those in the urban centers and those in the country side is large and growing. The issue of taxation by the local government upon that taken by the state is a major source of dissatisfaction in the countryside. They believe that they are taxed excessively to the detriment of their way of life. If left uncontrolled, this could spiral into a major problem as recent demonstrations have shown.

Food is the next critical problem that the Chinese government will face in the coming years. The amount of arable land in China is shrinking, while the population continues to grow. China feeds 20 percent of the world’s population on less than 7 percent of the world’s arable land. Further, economic development has meant that a lot of this land is being used for housing and commercial purposes in lieu of farming. They face a balancing act of controlling the population in the country and also increasing the amount of food harvested from year to year. This control of the population is proving to be quite worrisome for the Chinese government. They have instituted a one-child policy in China, which for the most part has controlled the population. However, the Chinese population is expected to reach 1.5 billion by 2015.

The problem of environmental pollution is another issue facing the Chinese government. A large proportion of the power plants that are used in China are made up of coal-fired power plants. The bituminous coal found in large quantities in China is exclusively used in these power plants, and is in fact a very large source of the pollution attributed to China. According to the author, 80 percent of China’s bodies of freshwater are polluted, and 90 percent of the water flowing through the city is non-drinkable. Lastly, the interactions between China and its territories – Hong Kong, Taiwan, and Macau is a source of continuous friction between the Chinese government and the peoples who live in these countries.

The book details some of the geographic similarities between the United States and China. China covers about 3.7 million square miles, almost the same as the USA at 3.6 million square miles. Also, the two countries sit on roughly the same latitude; as are Beijing and New York and also Shanghai and New Orleans. However, as much as they share some similarities, they have some major differences. Firstly, only about a third of the United States is taken up with mountains and desert, while in China the reverse is true. Forty percent of the United States has land available for cultivation, while China only has about 10 percent available. Also, the rivers in the United States run from north to south, while those in China run from west to east. The population of the United States is spread around the entire country (mostly along the coasts), while most of the population of China live on the eastern coast of China.

Due to the numerous peoples that make up China, one finds that the Chinese army is the only denominator that keeps everyone together. This fact has made the Chinese army very influential and strong. The author suggests that sometimes it seems like the army controls the Chinese government rather than it being the other way around. This apparent fact has led China’s neighbors to increasing their military capacities in anticipation of China’s eventual emergence as the next super power of the world.

- Jide Onakoya

Wild Swans by Jung Chang (Reviewed by Jenny Rieck)

Jung Chang’s Wild Swans is an autobiographical/biographical account of three generations of Chinese women. The events and political storms that have rocked China in the lifetime of these three women reveal a period of history that is anything but stable. Swans tells the story of a daughter, her mother, and her mother’s mother, none of whom lived childhoods remotely resembling one another’s. In fact, it was as if the three women grew up in different civilizations all together. The author does a great job of both story telling, weaving in details of history and geography throughout to place the stories in their proper context. I highly recommend this book to anyone interested in a personal view of the historical events of the past century in China.
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