GOVERNANCE

Assignment – 1

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There are three primary directions you can take on the first paper; 1) the explanation and history behind the corporate governance system in any country other than the United States, United Kingdom, Germany or Japan.  Do some research and consider how they have developed their own unique approach to corporate governance given the culture, religion, tax code, legal structure and history of how their businesses developed.  They might have modified one of the general structures of the above four countries or they may have taken off in their own direction.  You want to think about how the governance structure originated and how it is applied in the country’s unique environment. 

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Abstract

Although China’s economy has grown
rapidly in recent years and investment
in its stock markets has soared,
corporate governance institutions
remain nascent. A RAND report
analyzes the evolution of Chinese
corporate governance, describing recent
reforms that have created Western-style
oversight mechanisms. It also identifies
obstacles to reform that stem from the
continued prevalence of state
ownership, and recommends policies
that will help address those obstacles so
that China can move toward
international standards of corporate
governance.

RAND > Published Research > Research Briefs > RB-9405 >

The Evolution of Corporate Governance
in China

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China’s economic reforms have fueled rapid
economic growth in the past three decades. At the
same time, the Chinese have developed policies to
create Western-style oversight mechanisms and
corporate governance, in an effort to improve
public confidence in their markets at home and
abroad. Despite this progress, however, corporate
governance mechanisms in China remain weak. A
2003 study by the World Economic Forum ranked
China 44th out of 49 countries surveyed in terms of
quality of corporate governance.

A 2008 RAND report titled Chinese Corporate
Governance: History and Institutional Framework
describes the recent history of corporate
governance institutions in China, identifies
obstacles to the evolution of best practices in this
area, and recommends policies to promote

RESEARCH
B R I E F�

OBJECTIVE ANALYSIS.
EFFECTIVE SOLUTIONS.

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Market Capitalization of the Shanghai and
Shenzhen Stock Exchanges

SOURCE: Wind Data, one of the

largest providers of data on Chinese

financial markets. See

http://www.wind.com/en/home.html.

improvement.

Emergence of Corporate Governance

Until recently, the government controlled almost every aspect of China’s economy, and most
enterprises were state-owned. In the 1990s, China took the first steps toward modern
corporate governance by establishing the Shanghai and Shenzhen Stock Exchanges and by
creating a new government body — the China Securities Regulatory Commission (CSRC) — to
regulate its new stock market. The next 10 years saw the emergence of a modern enterprise
structure, as China passed its first Company Law, delineating the rights and responsibilities
of corporations. Notably, investments in Chinese stock markets surged during this period (see
figure). But despite these reforms, state shareholders still enjoyed overwhelming favoritism
over individual investors. In 2006, China implemented the first of several new policies
intended to address the continuing power imbalance between state and individual
shareholders.

To describe the current status of corporate governance in China, the report identifies two sets
of institutional entities: those internal to companies and those external to them. The inner
circle of governance consists of shareholders’ general meetings, boards of directors and
boards of supervisors, and management personnel. The outer circle includes regulators
(primarily the CSRC), the stock exchanges, the Chinese legal system, the auditing system, and
institutional investors. The report describes the roles of each of these entities in shaping
corporate governance in modern China.

Obstacles to Progress

1. Overwhelming concentration of state
ownership. Two-thirds of companies
listed in the Shanghai Stock Exchange are
state enterprises, a legacy of the state-
controlled economy. This problem is the
source of many of the other obstacles to
progress listed here, such as lack of
independence of boards of directors and
insider trading. It also has the effect of
diverting resources away from
companies, reducing the liquidity of the
capital markets, and discouraging

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NOTE: RMB=renminbi, the Chinese

currency

minority investors from engaging in long-
term investment. Recent reforms have
improved protection of minority
shareholders, but it remains difficult for them to disagree with state shareholders.

2. A direct result of ownership concentration is the lack of independence among boards of
directors. Members of both corporate boards of directors and boards of supervisors are
typically selected and removed by the dominant owner of the company, which is often
the Chinese government. As a result, directors are likely to be impeded in carrying out
fiduciary duties, and supervisors are less likely to be able to exert independence from
the board of directors and senior managers.

3. Rampant insider trading. Because so many Chinese enterprises are state-owned, with
nontradable shares, insiders at many of these companies have made fortunes on stock
offerings. This problem is so widespread that one well-known Chinese economist once
called the stock markets “a casino without rules” The problem is exacerbated by the
absence of a well-defined concept of “fiduciary duty” and by weak enforcement
provisions under Chinese law.

4. Weak mechanisms to control false financial disclosures. Corporate fabrication of
financial reports is a serious problem in China. Although steps are being taken to change
a business culture that has long tolerated corruption, weaknesses in the accounting
profession, the media, and the courts undermine reform. The accounting profession has
little independence from management and suffers from a severe shortage of qualified
auditors. Although the media has made progress in exposing corporate fraud, journalists
are often hired through a process that is influenced by senior corporate officials.
Securities litigation did not appear in China until 2001, when the Supreme People’s
Court of China developed a framework for investors to sue listed companies for losses
caused by false financial disclosures. But even today, the process is slow and
cumbersome. About 1,000 suits have been filed against 14 companies, but most remain in
legal limbo and none has yet been settled by the court in favor of investors.

5. Finally, China continues to suffer from immature capital markets, characterized by the
Chinese banks’ preferential treatment of state-owned enterprises, difficulties in issuing
corporate bonds, and the absence of an over-the-counter securities market and
corporate debt market.

Future Prospects and Recommendations

[1]

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Despite these problems, the report’s authors are optimistic about the evolution of corporate
governance in China. They point to the increasing globalization of listed companies, such as
those listed in Hong Kong, as a trend that has helped align those companies with
international standards of governance. They also point to the new government policy
allowing mainland Chinese citizens to invest in non-mainland stock markets, a move that will
force mainland enterprises to compete with their Hong Kong counterparts for investors. Also,
as China’s market economy matures, it will stimulate the development of more experienced
personnel who are badly needed to serve as company managers, independent directors, and
certified public accountants.

To overcome the obstacles to better corporate governance, the authors recommended a
number of policy options. These include better defining the functions of supervisory boards,
making it easier for investors to sue management, and toughening the punishment for insider
trading — all steps that have been recommended by other experts. The authors also suggest
reviving the now-banned regional over-the-counter markets, establishing an incentive
mechanism to encourage reporting of insider trading, and promulgating the concept of
fiduciary responsibility.

[1] Older CTL facilities continue to operate in South Africa, but key parts of their technology
are considered obsolete today.

Read the Full Report

This research brief describes work done for the Center for Corporate Ethics and Governance within the RAND Institute for
Civil Justice and documented in Chinese Corporate Governance: History and Institutional Framework by Yong Kang, Lu Shi,
and Elizabeth D. Brown, TR-618-RC, 2008, 60 pp., ISBN: 978-0-8330-4611-6. (Full Document).

This research brief was written by Laura Zakaras.

This product is part of the RAND Corporation research brief series. RAND research briefs present policy-oriented summaries
of individual published, peer-reviewed documents or of a body of published work.

Copyright © 2008 RAND Corporation

The RAND Corporation is a nonprofit research organization providing objective analysis and effective solutions that address
the challenges facing the public and private sectors around the world. RAND’s publications do not necessarily reflect the
opinions of its research clients and sponsors.

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OECD Home Directorate for Public Governance Governance in China 

Governance in China

Synthesis (in Chinese ) | Table of Contents (in Chinese ) | How to Order

Governance is the next issue to tackle on the development path of the People’s Republic of China. Further adapting institutions and the functioning of the state to an increasingly market-oriented economy is
crucial to maintain economic dynamism. Governance reform is also fundamental to address emerging strains related to rising inequalities and environmental deterioration. This report goes beyond the general
statement that governance matters. It shows how, in practice, governance impacts on public action by looking at different policy sectors, such as agriculture, higher education, labour market and social
protection, foreign investment, environment protection, collection of statistics, protection of intellectual property rights, banking and tax collection. The study also takes stock of the progress made in public
management and public finance and explores policy options for the future. Further redefining the role of the state, modernising public management, adjusting the relations between levels of government and
consolidating the institutional framework for market forces are four directions in which reform efforts should be pursued.

Synthesis
Governance is recognised as critical to economic development and the achievement of a society’s objectives. OECD member countries target a development path built on three pillars: good governance,
economic growth and social cohesion. Good governance is thus seen as a crucial element to address challenges and fault lines facing a nation and to ensure sustainable development. China is now undergoing
a crucial transformation in its system of governance, adapting institutions and the functioning of the state to an increasingly market-oriented economy. This transformation is also being spurred by key strains
that have emerged related to fiscal and financial imbalances, rising inequalities and environmental deterioration. In 2003, the OECD initiated a project to share with China the expertise of its member countries on
governance issues. The China Governance Project was also the opportunity to better understand the challenges faced by China and to organise policy dialogues on these issues. This project was undertaken in
the framework of the programme of co-operation between the OECD and China, initiated in 1996. It thus benefited from a relationship of mutual trust established between the OECD Secretariat and Chinese
ministries and bodies in many areas.

Table of Contents

Part I – Public Sector Management
Chapter 1. Civil Service Reform in China.
The Chinese Government has undertaken extensive reforms to its civil service system over the past 10 years. These have encompassed recruitment and selection, training, appraisal, rewards and punishments,
compensation, discipline and other areas. This chapter reviews each of these elements. The chapter argues that the capacity of the civil service has improved during the past 10 years. But the capacity
improvements may be explained by reasons other than civil service reform, such as by improvements in China’s system of education. The rapid expansion of higher education since 1980 has produced a large
population that is eligible for civil service employment.

Chapter 2. The Reform of Public Service Units: Challenges and Perspectives .
China’s large and diverse sector of “public service units” (PSUs – shiye danwei) is a galaxy of public service providers operating alongside core government and separate from other state-owned or state-
sponsored organisations such as state-owned enterprises (SOEs), state-owned financial institutions and state-sponsored “social organisations”. Following on from the reform of SOEs and core government, the
reform of PSUs represents the third major step of reforms that aim at transforming the organisational structure of the public sector into one that assists the socialist market economy.

Chapter 3. Fighting Corruption in China
Corruption has been openly recognised as an emerging challenge to China’s economic and social reform. In 2002, then President Jiang Zemin defined “anti-corruption mechanisms” as a “major political task for
the Party”. Incumbent President Hu Jintao has declared the fight against corruption a priority on the political agenda of his government, as corruption threatens both the economic development and the political
and social stability of the People’s Republic of China (PRC). This chapter tracks the development of corruption, analyses the causes for its perceived or real expansion, as well as reforms and policies that the
Chinese authorities have adopted in response.

Chapter 4. E-government in China
E-government refers to the use of information and communication technologies, and particularly the Internet, as a tool to achieve better government. In China, the state of e-government reflects the transitional
nature of contemporary Chinese society toward a “socialist market economy”. The country’s information society is inchoate with persisting digital divides, i.e. diffusion and access to information and
communication technologies (ICT) are uneven and although Internet penetration has grown rapidly in wealthy urban areas, it remains fairly low in per capita terms.

Chapter 5. Institutional Arrangements for the Production of Statistics
Chinese statistics have come a long way from a pure reporting system in a centrally planned economy to a system that increasingly relies on surveys and modern statistical techniques to service users, be they
government or the public at large. Nonetheless, many challenges remain. In recent years, the quality of Chinese economic statistics, in particular the growth rate of real GDP and other data has been repeatedly
questioned by several Chinese and western authors. Questions about data quality inevitably lead to questions about the institutional organisation of China’s statistical authority and the methods of statistical
data compilation in China.

Part II – Public Finance
Chapter 6. Governance in Taxation in China

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With its transition to a market-oriented economy, China has gone through major tax reforms in the last two decades. Significant measures to improve governance in taxation were implemented, including
unifying tax laws, equalizing tax burdens, simplifying the tax system, rationalizing the decentralized system and standardizing revenue allocation methods between the central and local governments. However,
more needs to be done to improve China’s tax system so that transparency, stability and the rule of law become the guiding principles.

Chapter 7. Public Sector Budgeting Issues in China
China has undertaken extensive reforms to its budgeting system over the past 10 years. These have encompassed the entire budgeting cycle: formulation, approval, implementation and audit. This chapter
reviews each of these elements. China has made crucial progress in this field. The early challenge was fundamentally to create the institutional infrastructure for a modern budget process where none had
previously existed. In the planned economy, all resource allocation decisions were made in the plan with the budget serving essentially as a secondary accounting device.

Chapter 8. China’s Public Expenditure Policies
China’s evolution from a centrally planned to a market-based economy has led to major transformations of its public expenditure policies. Significant progress has been made in raising spending on
infrastructure to a level more in line with China’s development needs, in improving mechanisms for expenditure budgeting and planning, notably by bringing some extra-budgetary accounts into the main
budget. Nevertheless, significant problems remain.

Part III – Institutional Framework for Market Forces
Chapter 9. Regulatory Management and Reform in China
China’s potential benefits from regulatory reform are significant, as is the potential downside if a number of serious regulatory problems are not addressed. This chapter reviews China’s recent efforts to improve
regulatory capacities and to build a regulatory environment on the basis of the rule of law.

Chapter 10. Reforming State Asset Management and Improving Corporate: Governance: The Two Challenges of Chinese
Enterprise Reform
Enterprise reform in China is facing two main but interwoven challenges: on the one hand, to establish the state as a full or part-owner of enterprises rather than as a manager, and on the other hand, to improve
corporate governance in general, and of listed companies in particular.

Chapter 11. Labour Protection: Challenges Facing Labour Offices and Social Insurance
One of the key institutional outcomes of China’s economic reforms has been to create a new role for employers that is separate from the state and allows enterprises to concentrate on their business. To protect
workers, the government has set up public institutions for many social and administrative functions that until recently pertained to work units (danwei) or did not exist. This chapter focuses on three such
functions for which the 1994 Labour Law makes the government responsible: employment services, labour inspection and social insurance.

Chapter 12. Competition Law and Policy in China
This chapter focuses on two issues, namely: i) the enactment of a general competition law that would provide a coherent basis for combating localism and other “monopolistic” conduct by enterprises and local
governments; and ii) the adoption of a “national competition policy” calling upon all parts and levels of government to incorporate competition policy into all aspects of proposed and existing laws and policies
that affect market conduct. These two issues were identified in the 2002 OECD study China in the World Economy: The Domestic Policy Challenges and will here be discussed from a governance perspective.

Chapter 13. Governance of Banks in China
The conceptual framework for governance in banking reflects the special role of banks in a market economy. In order for the bank to act as a profit-oriented corporation, it must have genuine owners and the
corporate governance regime should enable the owners to hold the management accountable for achieving a competitive return at acceptable risk. At the same time, banks have fiduciary obligations to
depositors and also perform many “public good” functions such as acting as repository of savings, supplying currency and allocating resources in the real economy. Therefore, banks operate in a regulated
environment.

Chapter 14. Intellectual Property Rights in China: Governance Challenges and Prospects
Today, top leaders in the Chinese Government have become aware of the importance for China to build a sound intellectual property rights (IPR) system. While accession to the WTO has opened new
opportunities for the Chinese economy, it has also exposed Chinese firms to greater international competition under the WTO rules, including Trade-Related Aspects of Intellectual Property Rights (TRIPS). This
means that the government and Chinese industry need to learn as quickly as possible how to play by the new “rules of the game”. Indeed, Chinese leaders are realising that the protection of intellectual rights is
crucial not only as a condition for foreign investment and technology transfer, but also for promoting Chinese innovation, which will determine China’s future competitiveness in the global knowledge economy.
China has thus, over the past two decades, quickly developed a set of IPR laws and regulations that are today basically in conformity with international practice and standards. The main challenge for the
coming years is to improve upon the governance of the legislative, administrative and enforcement systems in order to make the existing laws more effective in stimulating innovation and protecting IPR.

Chapter 15. The Governance Challenges of Foreign Investment Policy in China
Foreign investment has played a major part in economic development and economic growth in China. When economic reforms commenced in the late 1970s, there was no framework for foreign investment.
Thus, existing government structures were adapted and legislation created anew in the form of separate legislative enactments for each form of foreign-invested enterprise (FIE). China has subsequently
received large quantities of foreign direct investment (FDI) in the past quarter of a century, rising to nearly USD 55 billion in 2004.

Chapter 16. Institutional Framework for Effective Agricultural Policy: Current Issues and Future Challenges
Since reforms began in 1978, China’s agricultural sector has been transformed from a centralized system of commune-based farming into a household-based system. China’s leaders are de-emphasizing formal
planning and are increasingly accepting allocation by markets. However, agriculture remains a sensitive area and is subject to intervention. This chapter describes the main institutions dealing with agricultural
policies, with some suggestions for next steps in the reform process.

Part IV – Ensuring Sustainable Development
Chapter 17. Environment and Governance in China
China has made remarkable progress in sustaining high economic growth rates, raising incomes and lengthening life expectancy. However, the pattern of economic growth, rapid industrialization and
urbanization has not been environmentally sustainable. These processes have generated high pressures on the environment, including surface and ground waters, air in urban areas, land and natural resources.
This in turn has adversely affected human health and the productivity of natural resources. If the state of the environment continues to deteriorate, these problems will intensify and the potential for maintaining
economic growth may be undermined.

Chapter 18. Higher Education – Finance and Quality
In its quest to become a major player in the global market, China has made impressive strides in many domains, not least in the area of higher education. The Chinese Government recognizes the key role of
education in realizing its goals in other domains, and the Ninth Five-Year Plan (1996-2000) and the current Tenth Five-Year Plan (2001-06) have seen enrolment in tertiary institutions more than double from 9.4
million in 2000 to 20 million in 2004. It has also witnessed the rapid rise in the number of non-government (min ban) institutions that compete with the older, better-established state ones.

Figure 4.2 Types of information provided by China’s e-government web sites (%)

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Related Documents
Policy Brief : China’s Governance in Transition

Governance in China – Synthesis in Chinese

Governance in China – Table of Content in Chinese

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Electroniccopy available at: http://ssrn.com/abstract=1233070

1

A Review of Corporate Governance in China

Larry Li*, RMIT University

Tony Naughton, RMIT University

Martin Hovey, University of Southern Queensland

Abstract

The 2005 policy decision to change the status of non-tradable state and non-state shares

into tradable A shares ushers in a new era in the stock markets of China. Over time all of

these shares will be tradable and potentially transferred to foreign and domestic private

sector investors. These changes have the potential to significantly alter the monitoring

and control of the majority of listed firms that until now have been controlled by tightly

held blockholders of non-tradable shares. It is therefore timely to reassess the corporate

governance of Chinese listed firms. This paper reviews the theoretical and empirical

corporate governance literature in China.

*
The corresponding author. School of Economics, Finance and Marketing, RMIT University, Victoria

3000, Australia. Tel: 61-3-9925 5638, E-mail: larry.li@rmit.edu.au.

Electronic copy available at: http://ssrn.com/abstract=1233070

2

A Review of Corporate Governance in China

1. Introduction

China’s long period of programmatic reforms initiated in the late 1970s appears now to

be more focused on market reform in the post-WTO environment and the opening of the

financial sector to greater foreign competition.

In the late of 1970s, China initiated an extended period of pragmatic reform ushering in a

period of dynamic economic growth The restructuring of the economy and the resulting

efficiency gains have contributed to a more than tenfold increase in GDP since 1978, and

in China becoming the second-largest economy in the world after the US in 2006, when

measured on a purchasing power parity (PPP) basis (CIA, 2007). The Economist (2008)

reports that China’s gross domestic product (GDP) grew 11.4 percent year-on-year to

24.66 trillion Yuan (3.43 trillion U.S. dollars) in 2007. To achieve this goal, over the past

three decades China has dramatically changed many aspects of its economy. Corporate

governance, being a major aspect of the corporate reform program, is not an unfamiliar to

investors in China. The reform of the corporate governance system is now recognised as a

vital component of the success of the economic reform in China.

In defining corporate governance in China, Clarke (2006) considers it as the set of rules

and practices regulating relationships among participants in post-traditional
1
Chinese

business enterprise and that which governs decision making within that enterprise.

Corporate governance in China tends to regulate relationships among all parties with

interest in the business organization. Although post-traditional enterprises are no longer

as tightly controlled by the state as they once were, most Chinese studies pay more

attention to the two primary types of firms in China: state-owned enterprises (SOEs) and

publicly held companies (PHCs). This paper reviews Chinese corporate governance and

will focus on PHCs while recognising the bulk of listed firms remain within the control

of the state either directly or indirectly. .

1
A post-traditional enterprise is an enterprise hat is no longer tightly controlled by the state through the

traditional planning system

3

This chapter is organized as follows: Section 2 contains a review of corporate

governance. Section 3 provides the information of corporate governance research in

China. Section 4 briefly explains the two corporate governance codes in China. Section

5

describes issues with current corporate governance system in China. Finally, a summary

and the conclusions are presented in Section 6.

2. Review of Corporate Governance

Recent corporate scandals around the world have highlighted deficiencies in corporate

governance systems. The impact of these business events has forced a radical

reassessment of how companies are directed. Mallin (2004) argues that corporate

governance is a relatively new and evolving area and its development has been affected

by theories from a number of disciplines including finance, economics, accounting, law,

management, and organizational behaviour. The types of questions raised when we

consider corporate governance are: How do investors secure a return on their investment?

What is the proper level of authority for management in making business decisions?

What is the appropriate level of residual rights allocated to managers? How do investors

make sure that managers are not self-serving, nor misappropriate the assets? How do

shareholders influence strategic decisions and the business operations of the company?

How do investors influence managers’ behaviour? None of these questions are easy to

answer, because none of the existing corporate governance models can resolve all these

issues completely.

Shleifer and Vishny’s (1997) paper is regarded as the first major attempt to consolidate

the key theoretical influences on corporate governance. Their paper examines the overall

corporate governance system around the world, and investigates investors’ protection and

ownership concentration in particular. They posit that the key element of corporate

governance is to provide good returns to investors on their financial investment.

Therefore, legal protection of investor rights is considered one of the key issues of

corporate governance, and countries with good corporate governance systems usually

provide relatively better protection to investors. There is a prevailing view that strong

legal protection of investor interest has made diffuse ownership feasible under the

4

common-law system, such as in US, UK and commonwealth countries (La Porta et al.

1998). In non common-law countries, legal protection for investor interests is typically

vested with concentrated, rather than diffuse ownership (Gul and Zhao, 2000).

Generally speaking, corporate governance has been classified into two major categories:

internal and external governance (Denis and McConnell, 2003; Gillan, 2006). Internal

governance normally includes features of boards of directors, ownership and control, and

managerial incentive mechanisms. On the other hand, external governance covers issues

relate to the external market and government policies and regulations (Gillan, 2006).

Denis and McConnell (2003) provide an excellent summary of corporate governance

research. They posit that there are two major generations of corporate governance

research. The first research generation focused on the internal governance mechanism,

and tried to determine whether these internal mechanises, such as board of directors,

executive compensation and ownership and control, affect firm performance in individual

countries. The second generation is more likely to consider the influence from external

forces, such as market and legal and regulatory issues, on the structure and effectiveness

of corporate governance around the world. The research of the second generation begins

with the work of La Porta et al. (1998). Researchers now pay more attention to the

relationship between the legal system and corporate governance mechanisms.

Recently, corporate governance has received much attention in Asia, particularly after the

1997 Asia financial crisis. Johnson et al. (2000) point out that poor corporate governance

had a significant effect on the extent of currency deprecations and stock market declines

in the Asian crisis. Their findings indicate that countries with weak legal protection of

shareholder rights and poor enforcement were more susceptible to a fall in asset values

and a collapse of the exchange rate. Eiteman et al. (2001) also support the notion that a

weak corporate governance system was one of the major causes of the Asian financial

crisis. The importance of legal protection to creditors and minority shareholders is also

emphasized by La Porta et al. (1997).

Claessens and Fan (2002) provide a comprehensive corporate governance review in Asia

5

and confirm the limited protection of minority rights and highly concentrated ownership

in Asia. Firms are normally controlled by one or more shareholders, thus the separation of

management from ownership is rare and family controlled corporations are prevalent in

East Asian countries. For example, the largest ten families control half of the total value

of listed corporate assets in Indonesia, Philippines and Thailand (Claessens et al. 2000).

Traditionally, some large Korean business groups (Chaebols), such as Hyundai, Samsung

and Daewoo, were also family based (Ehrlich and Kang, 1999). In China, listed

corporations are normally controlled by State and financial institutions, and tradable A-

shares accounts for only a small part of total shares outstanding (Li and Naughton, 2007).

Another interesting phenomenon in Asian countries is a pyramid ownership structure,

which is defined as owning a controlling holding of the stock of one corporation which in

turn holds a controlling interest in another, a process that can be repeated a number of

times (Claessens et al. 2000). This raises some important questions. Why is ownership

concentration more prevalent in East Asian countries? And why is significant corporate

wealth in East Asia concentrated among a few families? Generally speaking, block

ownership is attractive to blockholders when they can attain private benefits from

controlling the firm (Shleifer and Vishny, 1997). On the other hand, investors may feel

confident that their benefits are well protected through block shareholdings, especially in

some countries without well functioning investor protection law and effective

enforcement (La Porta et al., 1999).

Corporate governance issues have come to the fore in China particularly since the late

1970s, because the development of the corporate governance system is recognized as a

vital component of the restructuring of SOEs. Before the economic reforms, Chinese

industry was dominated by state ownership, and SOEs were the major economic

contributors. Managers in SOEs were required to fulfil the production plans specified by

the government rather than maximize the investment returns for the only investor — the

state. The governance structure of SOEs was an integral part of the general government

framework. At that time, SOEs were characterized by low productivity and efficiency,

high input and low output.

6

Since the late 1970s, many trials were carried out to improve the overall financial

performance and work efficiency of SOEs: profit retention, profit contracting and tax on

profit (Liew, 1997). The opening of the Chinese capital market eventually accelerated the

development of corporate governance in China. In addition, the introduction of a set of

Laws provided a legal foundation for SOE reform, including SOE Law, Company Law,

and Securities Law. These laws required corporations to form three statutory corporate

governing bodies: the shareholders, the board of directors, and the board of supervisors.

Shareholders meet at least once per year at the annual meeting as well as special

shareholder meetings to vote on the company’s development strategy, investment plan

and other important issues. The major responsibility of the board of directors is to

minimize the costs that arise from the separation of ownership and decision control of the

modern corporation (Fama and Jensen, 1983). The major function of the board of

supervisors is to supervise directors and senior managers to make sure that they fulfil

their responsibilities. In 2001 and 2004, the authority issued the “Code of Corporate

Governance for Listed Companies in China” and the “Provisional Code of Corporate

Governance for Security Companies”. These two Codes add many features of corporate

governance that exist in some of the major economies of the world. Since China has

become one of the key members in the world economy, it is important to have a deeper

understanding of the current corporate governance system in China and the corporate

governance studies related to the Chinese market. What has been lacking in this process

is a sound theoretical framework to embrace the unique social/practical/economic

environment of China.

3. Corporate Governance Research in China

In recent years, there has been a proliferation of corporate governance literature relating

to China. There are two main streams. The first can be defined as descriptive of practice

of prescriptive tests that recommend forms and best practice, examples include Hovey

and Naughton (2007) and IFC (2005). The second represents more mainstream academic

research exploring the evolution of corporate governance, particularly focusing on the

growing number of listed firms. The literature ranges from traditional quantitative

empirical work (Hovey et al., 2003; Firth et al., 2006; Dahya et al., 2003; Xu and Wang,

7

1999) and predominating qualitative studies that involve surveys and interviews (Mar and

Young, 2001; Tobin, 2005).

3.1 Internal Governance

3.1.1 Board of Directors

Issues related to boards of directors have been well documented. The major responsibility

of board of directors is to minimize costs that arise from the separation of ownership and

decision control of the modern corporation (Fama and Jensen, 1983). The board of

directors receives its authority for internal control and other decisions from the

stockholders of corporations. The major responsibilities of the board are to hire, fire,

monitor and compensate management, and ensure that shareholders’ wealth is

maximized. Traditionally, corporate board research globally has mainly focused on the

relationship between board size (Yermack, 1996; Bhagat and Black, 2002), management

compensation (Core et al., 1999; Martin and Thomas, 2005), board composition

(Rosenstein and Wyatt, 1990; Bhagat and Black, 2002), the separation of CEO and chair

(Bhagat and Black, 2002; Dahya et al., 2002) and firm performance and other strategic

decisions, such as CEO turnover and takeover activities. Hermalin and Weisbach (2003)

provide a comprehensive review in this area.

The findings of empirical research can be summarised as follows: (1) a board with more

outside directors is not associated with superior firm valuation, but is associated with

better decision making, such as CEO appointment, executive compensation, and CEO

turnover; (2) there is no conclusive answer to the relationship between board size, the

separation of CEO and chair, and firm performance. Recently, more attention has been

paid to the evolution and determinates of board size and structure (Lehn, et al., 2003;

Linck et al., 2008), busy boards (Fich and Shivdasani, 2006), and board interlocks

(Larcker et al., 2005) in the corporate governance literature.

Turning to the Chinese studies, Liang and Li (1999) indicate that outside directors are

positively associated with higher returns on investment in China, meanwhile, duality of

titles and board size have no explanatory power on firm performance. Recently, Chen et

8

al. (2006) find that when there is a high proportion of external directors they are less

likely to engage in fraud, which is consistent with the international literature. Chen et al.

(2006) also argue that the combination of CEO and chair tends to lead to higher instances

of fraud. A plausible explanation of this finding is that managers with more power are

likely to abuse their positions and engage in fraudulent activities. However, based on

their findings, Li and Naughton (2007) argue that board size and board composition do

not impact on firm performance. One possible explanation might come from the launch

of new policies and rules in the Chinese stock market in recent years. New policies detail

the regulations covering board independence for all public firms. With the introduction of

the requirement for greater board independence, board size typically increased as a

consequence. Therefore these board variables are no longer distinguishable to investors.

Alternatively, a theoretical explanation could be that the factors are endogenous and

therefore do not have explanatory potential (Harris and Raviv, 2004; Hermalin and

Weisbach, 2003). Clarke (2006) also questions the efficiency of outside directors in

China because the unclear structure and their function is not clearly defined.

Another interesting board topic in China is the role of the supervisory board. Chinese

listed companies adopt a two-tier board structure, a Board of Directors and a Supervisory

Board. Xiao et al. (2004) and Dahya et al. (2003) question the usefulness of the

supervisory board and suggest further improvement of the supervisory board’s

independency and function enforcement. Clarke (2006) also states that the board of

supervisors has been unable to play the monitoring role in Chinese companies simply

because the supervisory board has no significant powers to monitor the daily business

operations and appoint senior management members.

3.1.2 Ownership and Control: State and Institutional Ownership

The relationship between ownership structure and firm performance has been well

documented. Recently, much of the research focuses on the behaviour of blockholders.

Holderness (2003) reports that insiders control approximately 20 percent of the

ownership of listed corporations in the U.S.. La Porta et al. (1998) also posit that

ownership is heavily concentrated in developing economies. Claessens et al. (2000) find

9

that more than two-thirds of firms are controlled by a single shareholder, that the

separation of management from ownership is rare and family controlled corporations are

very common in East Asian countries. Faccio et al. (2001) report that family ownership in

East Asia leads to severe conflicts with other stakeholders and poor firm performance.

However, Anderson and Reeb (2003) argue that family owned firms perform better than

nonfamily owned firms in the well regulated and transparent markets, because family

ownership can reduce agency problems. Denis and McConnell (2003) conclude that

concentrated ownership most often has a positive effect on firm value, in that large-block

shareholders can monitor and control the company’s daily business activities to minimize

agency costs. Holderness (2003) also confirms that block ownership can be motivated by

the benefits of control, such as the decision rights and personal privileges.

In China, the major shareholders are likely to be institutions and the state rather than

individuals, and the majority of publicly traded companies are state-controlled (Claessens

and Fan, 2002). Prior studies have investigated the relationship between state ownership

and firm performance in China, and find that firm accounting performance is negatively

related to the level of direct state ownership (Xu and Wang, 1999; Qi et al. 2000; Hovey

et al. 2003). If the state controls the company, it is not surprising that politicians and

state-controlling owners sit on most board seats. The likelihood of finding a director

representing minority shareholders is very small. The possible explanation of this

phenomenon is that local politicians can use their connections to influence both the

market and the firms under their jurisdictions, because at this stage the Chinese economy

remains relationship-based, and firms can benefit from the services provided by

politicians in creating economic rents and enforcing transactions (Claessens and Fan,

2002). Mallin and Rong (1998) also argue that guanxi (personal relationships) still plays

an important role in business practices in China.

Another unique feature of the Chinese corporate governance model is large institutional

shareholdings. As mentioned above, tradable A-shares only represent a small proportion

of the total shares outstanding. In China, institutional shares, normally referred to as legal

person shares, have two types of holdings: state legal person shares and legal person

10

shares. State legal person shares are shares held by other state owned institutions or

enterprises, and legal person shares are shares held by non-state owned institutions or

enterprises. However, most previous studies treat these two types of ownership as the

same (Xu and Wang, 1999). Private legal person shareholders have distinguishing

characters from state institutional shareholders and individual shareholders. Unlike state

institutional shareholders, they can be assumed to be better motivated and more

concerned with the financial performance of the companies. Moreover, they are elected to

the board of directors and to the supervisory board, rather than being appointed.

Typically they have more working experience in industry than that of state directors.

Besides having voting power on important issues such as the selection of the

management team and dividend policies, they can access corporate inside information

and have the right to question management at any time about operations of the firm. Most

previous studies of the Chinese market that identify legal person institutional holdings

separately from direct state ownership find that holdings by legal persons are positively

related to firm performance (Xu and Wang, 1999; Qi et al. 2000; Chen and Gong, 2000;

Hovey et al. 2003).

Besides state, legal person, and tradable A-shares, Chinese stock companies also have

employee shares, management shares and foreign shares. However, not many studies

consider the influence of these types of shares, because normally these shares only

account for a very small proportion of the total share outstanding, or only a few

companies have these types of shares. Moreover, overseas investors can become holders

of non-tradable shares through share issues by Chinese stock companies, but these shares

are even less common than shares made to foreign investors of tradable shares. One of

the major reasons might be that free market style mergers and acquisitions are not

allowed. Xu and Wang (1999) indicate that there is no active takeover market in China.

All major mergers and acquisitions are engineered by the state.

3.1.3 Managerial Incentives

Another major issue of corporate governance is that of determining the levels of the

compensation of senior management teams, and the means by which they are made.

11

Normally managers receive their compensation in four ways in developed countries:

salary, bonuses, perquisites and stock-based incentives. Tirole (2006) finds that the

sensitivity of payment to performance has increased significantly since the early 1980s,

and that stock options are becoming the most prevalent component of CEO compensation

in the U.S. The evidence from other developed economies on this issue generally

supports the U.S. evidence (Bryan et al., 2002).

Before the economic reforms began in the late 1970s, SOEs managers were paid based on

a highly structured payment scale system. The state tightly controlled the major activities

of SOEs, and all profits made by corporations were absorbed into the state budget and the

state reallocated them wherever they saw fit (Shen, 1993). Managers of SOEs acted as

government representatives and were paid based on their rank within the payment scale

system. In the other words, there was no incentive system to motivate managers to

maximise the financial performance of the firm. However, the payment system has

undergone dramatically changes since the late 1970s.

Management compensation in Chinese listed firms is now determined by the board of

directors. In the early 1990s, more incentive motivated reward systems were introduced

to SOEs. The most popular system was that the CEO’s compensation was made up of a

cash salary and a performance bonus (Firth et al., 2006). However, the bonus payment

system was not sufficiently flexible in practice. One of the major reasons was that the

method of bonus payment was not clearly defined, and the formulae used in determining

bonuses were not disclosed. Recently, listed Chinese firms have been encouraged to

adopt a more practical approach to solve this problem, which is more performance

related. It is worth noting that very few Chinese firms have executive stock option

schemes.

There is a developing body of work regarding performance based approaches. Kato and

Long (2006) find a significant relationship between the top executives’ compensation and

shareholders’ value in China. Meanwhile, the sales growth rate also has significant

relationship to executive compensation. Rui et al. (2002) find that CEO compensation is

12

significantly related to the return on assets, more so than for stock returns. In addition,

firms with foreign shareholders tend to pay more to CEOs than firms controlled by the

state. The explanation might be that foreign shareholders want to have the best available

managers in the market and so the remuneration is higher. However, Liu and Otsuka

(2004) argue that the new reward system has not brought the expected improvements in

productivity. Mengistae and Xu (2004) conclude that little evidence of performance and

compensation relationship has been found in their study. In addition, Firth et al. (2006)

find that on average the sensitivity of pay to performance is low, and this raises questions

about the effectiveness of incentive systems in China. These mixed results provide

inconclusive evidence of the role of compensation in China.

3.2 External Governance

3.2.1 External Market

The literature on the market for corporate control indicates that external markets are

important for facilitating mergers and takeovers of listed companies. In this context, well-

functioning regulations and laws protect the benefits of investors, particularly small

investors. Under this situation, it can be argued that high product market competition is

the most powerful force toward economic efficiency. In the long-term, product market

competition can force companies to minimize costs, upgrade technology and form

suitable corporate structures to fit the needs of market (Shleifer and Vishny, 1997). In a

market which facilitates the market for corporate control, the share ownership is widely

dispersed. Therefore, the shareholder influence on management is weak. Unsatisfactory

performance is often disciplined by shareholders selling and by subsequent takeovers.

However, takeover activity and an active external market are not always a component of

the governance mechanisms around the world. China is a typical example. As mentioned

before, free market style mergers and acquisitions are not allowed in China. In April

2005, the Chinese authorities announced the gradual floating of non-tradable state owned

shares for all domestically listed companies. All listed companies are required to propose

a reform plan to transfer the status of non-tradable shares and to develop a compensation

package for existing tradable shareholders comprising flexible combinations of cash,

13

warrants and bonus shares. In addition, the authorities announced plans to allow foreign

firms to acquire substantial holdings of tradable shares through the market, up to an

initial limit of 10% of the target’s stock. The central purpose of this reform is to convert

non-tradable shares to tradable shares at a price acceptable to minority investors.

Therefore, it is understandable that these sweeping ownership reforms will affect the

performance of Chinese listed companies and through them the Chinese economy. The

reforms are also having a major impact on the investing community and financial system

in China. As a result, we are expecting a more active market for corporate control to

develop with a significant impact on corporate governance practice.

3.2.2 Legal system

La Porta et al. (1998) argue that the legal system is a fundamentally important corporate

governance issue. Early corporate governance studies normally focus on board structure,

executive compensation, ownership structure or external control mechanisms. Recently,

researchers have paid more attention to the importance of legal system (Denis and

McConnell, 2003). In particular, they contend that strong legal protection for investor

interests has made diffuse ownership feasible under the common-law system. They also

argue that ownership is heavily concentrated in developing economies. In addition, La

Porta et al. (1998) find that the concentration of ownership in the largest public

companies is negatively related to investor protections, implying that small shareholders

are unlikely to play a major role in countries that fail to protect their rights. La Porta et al.

(2002b) find the evidence of higher valuation of firms in the countries with better

protection of minority shareholders. The work of La Porta et al. (1998) set in motion of

train of empirical studies that continues to this day.

Allen et al. (2005) examine China’s legal system based on the definitions of the measures

employed in La Porta et al. (1998). They find that apparently China falls in between the

English–origin countries and French-origin countries, implying China has the middle

level of investors’ protection. However, the poor record of law enforcement and severe

corruption problem put China at the bottom of the list of countries analysed, regardless of

its legal origins. Allen et al. (2005) state that China is the one of the worst countries in

14

terms of political freedom and property rights protection, consistent with the findings of

La Porta et al.’ (2004). In addition, the Chinese government still has the power to

intervene in the practice of law enforcement. In the other words, China still does not have

an independent and effective judicial system and sufficient number of qualified legal

professionals (Allen et al., 2005). Yet, China is still enjoying one of the highest economic

growth rates in the world; therefore, one could conclude that the legal system is not

necessarily one of the fundamental factors restricting economic development. In short,

Allen et al. (2005) conclude that China’s legal system is not ahead of any of the other

major emerging economies despite its remarkable economic achievements. This implies

that at this stage, without strict enforcement, corporate governance rules and regulations

lack any creditable role in the domestic market. It is the voluntary adoption of best

practice that has the potential to make a difference (Li and Naughton, 2007).

3.2.3 Financial system

The Chinese financial system has played an important role in supporting the nation’s

economy growth, and it has undergone a significant change in the last two decades. This

section provides a descriptive study of the Chinese financial system, and issues

associated with the system.

3.2.3.1 The Chinese Banking Sector

Between 1950 and 1978, the People’s Bank of China (PBOC) was the only financial

institution in China, and responsible for all government credit loans, income and

expenses. After 1978, there has been substantial progress in the Chinese banking sector,

such as monetary policy independence, banking autonomy and service diversification.

Four state-owned banks were established and took over the commercial banking business

from PBOC. Currently the Chinese banking sector is dominated by the “big four”: the

Industrial and Commercial Bank of China (ICBC), the Agricultural Bank of China

(ABC), the Bank of China (BOC) and the People’s Construction Bank of China (PCBC).

The four state owned commercial banks collectively account for over fifty percent of the

15

total asset and liabilities (CBRC, 2007
2
), and together with regional state owned banks

dominate the banking sector. The PBOC and China Banking Regulatory Commission

(CBRC) are two current regulatory bodies which are responsible for financial

supervision, and policy issuing.

The banking system plays an important role in corporate governance in China. It is far

from being a model similar to Japan or Germany where there banking sector is more

directly involved in corporate governance and monitoring. In China, the banking sector

has been closely involved with the corporate sector through relatively freely available

lending, particularly to SOEs or listed firms with strong state connections. This

relationship fosters weak corporate governance where banks are less inclined to monitor

as is evident in the non-performing loan data. The absence of a viable corporate bond

market reinforces the lack of financial market discipline on the corporate sector.

To date, the government still tightly controls the banking system in China. La Porta et al.

(2002a) find that 99.45% of the top 10 largest commercial banks in China still are owned

by the state and this ownership level is one the highest in the world. Generally speaking,

government ownership of banks is high in countries with low level of per capita income,

underdeveloped financial systems and inefficient government (Naughton and Hovey,

1999). Allen et al. (2007) also concludes that China’s financial system is dominated by a

large, inefficient banking sector. The majority of loans are still allocated to the inefficient

SOE sector, while the dynamic private sector relies more on borrowing from other

sources (Allen et al., 2007). Recently IPOs by the banks have diluted this control and

liberalization of foreign direct investment in regional banks is changing the Chinese

banking landscape.

The most important problem of the Chinese banking sector remains the nonperforming

loans (NPL hereafter) within the big four banks (Allen et al., 2005), and reducing NPL to

sustainable levels is one of the most important tasks for China’s banking system in the

2

Source: China Banking Regulatory Commission Website, http://www.cbrc.gov.cn

16

short term. According to CBRC, major banks in China carried NPLs of RMB 1.2 trillion

on their balance sheets as of the 31 December 2006. Table 1 provides the overall

information of China’s banking sector and reported distribution of NPLs across different

types of financial institutions. As observed, the state owned commercial banks account

for a substantial portion of the NPLs. As bad as the figures in Table 1 appear, they may

be still significantly underestimated. Allen et al. (2007) argue that lack of clear

classification of NPLs is a notable explanation. In addition, the official numbers of NPLs

exclude the bad loans which have been transferred to the four state owned asset

management companies (AMCs), discussed below.

Table 1: Financial Institution in China and NPLs, December 31, 2007

% of Total Assets

& Liabilities

NPLs

(RMB Billion)

NPLs of

Total Loans

State Owned Commercial Banks 53.20% 1114.95 8.05%

Joint Stock Banks 13.80% 86.04 2.15%

City Commercial Banks 6.40% 51.15 3.04%

Other Financial Institutions 26.60% 16.28 4.53%

Source: China Banking Regulatory Commission Website, http://www.cbrc.gov.cn

Generally speaking, China’s huge NPLs burden is largely a result of poor lending

decision to SOEs, and the lack of a commercial credit culture in major financial

institutions. SOEs obtained the majority of this external funding from the banks, the big

four in particular. However, the overall financial performance of SOEs is still not

satisfactory. These banks often keep lending to underperforming SOEs even though they

have little ability to repay, under perception that the ultimate losses will be covered by

the government (Naughton and Hovey, 1999). The second major cause is the lack of a

commercial credit culture in the Chinese banking sector. Senior managers of all major

banks are typically appointed by the central government, so it is hard to believe that

major banks have fully independent business activities. Major lending activities for

infrastructure projects and social welfare subsidies sometimes are under the mandate of

the government; therefore profitability is not the most important issue in the associated

17

decision making. As a result, lending processes and risk management skills are far from

meeting international standards. Therefore, Allen et al. (2005) conclude that China’s

financial system is dominated by a large but inefficient banking sector.

To address NPLs problem, the Chinese government set up four AMCs in 1999 to manage

and dispose of NPLs which were bought from the big four state-owned commercial

banks. The AMCs have adopted a variety of approaches to solve the huge NPLs problem

since 1999. The primary approaches adopted include debt for equity swaps, liquidation

methods and securitizations. For the debt for equity swaps, AMCs are entitled to

purchase NPLs from SOEs at the agreed price, and further monitor the business activities

of SOEs. Liquidation methods include sale or leases of real property, direct sales of

packaged or individual NPLs to investors, and bankruptcy settlement. Securitization is a

process of transferring non-marketable assets to a special purpose vehicle and issuing

securities to investors with a “guaranteed” stream of cash flows generated by the assets.

Legal support of securitization has been provided by the introduction of Trust Law in

2001. Recent reports (PricewaterhouseCoopers, 2007) indicate that as of the end of 2006,

the AMCs have resolved RMB 1.21 Trillion of the 1999 transfer loans. The total sales to

foreign investors from 2001-2006 is more than RMB 212 billion, roughly USD 26.4

billion. In an effort to minimize loss and maximize recovery, the AMCs will also provide

debtors with such services like management consulting, off-market mergers, spin-offs,

restructuring, and IPO recommendations. Moreover, the Chinese central government has

injected foreign currency reserves into these banks to improve the balance sheets.

However, all these methods of NPL reductions cannot prevent new NPLs from

originating in the banking system. If the NPLs keep accumulating, it might lead to a

financial crisis. This could spill over into other sectors and trigger an economic recession.

Therefore, more effective approaches might be to relinquish state majority control of

state-owned banks, and increase the levels of competition and efficiency. In terms of

corporate governance, the banking sector performance does little to improve the system.

The lax lending by banks props up weak governance and offers little by way of market

monitoring of the corporate sector.

18

3.2.3.2 The Chinese Equity Market

In 1989, the State Council decided to establish two primary national stock exchanges

markets. With the opening of the Shanghai and Shenzhen stock exchanges in 1990 and

1991 respectively, listed companies were able to raise funds from domestic and foreign

investors. The primary initial purpose of opening the two stock exchanges was to raise

funds for restructuring and fostering a more effective management system in SOEs

selected for listings. Though the market was immature, the number of listed companies,

trading volume and the total market capitalization grew quickly during the 1990s to

become one of the largest in the region. According to the latest figures issued by the two

stock exchanges as at April 2008, there are 690 companies listed on Shenzhen stock

exchange with a total of 732 stocks issued, with having a total market value of more than

RMB 4157.5 billion Yuan. As to the Shanghai stock exchange, in April 2008, 863

companies had stocks issued on it, for a total of 1,140 stocks issued with a total market

value of more than RMB 17,198.8 billion Yuan. The emergence of the stock market

characterizes a major change in the ideological framework of reforms in China, which

represents an important constituent part of the process of ownership changes.

The National Development and Reform Commission (NDRC) and China Securities

Regulatory Commission (CSRC) are the two official regulatory bodies responsible for

monitoring stock exchange activities and security policy formulation. Until recently the

NDRC and CSRC together determined how many shares in total should be issued each

year in accordance with development objectives. As we can see, this process of selecting

listing companies in China differed considerably from a mature market economy, where

the decision to list an enterprise is normally governed by the listing rules of the stock

exchange, and firms make listing decisions in collaboration with investments banking

advisors.

China’s listed firms were burdened with poor corporate governance because of state

control via majority ownership of shares. Some analysts argued that share prices had

fallen over the several years because individual investors had no effective control over

how firms were managed. As previously mentioned, the Chinese authorities announced

19

on 29 April 2005, that there would be a gradual market float of non-tradable state-owned

shares for all domestically listed companies. The reforms undertaken involve a dramatic

ownership structure change, by way of an increase in the supply of tradable company

shares in the share market as it is rapidly opening to foreign strategic foreign investment

by single share holding up to 10%. At this moment, the reform is still far from the final

stage, so this might be a future research direction of Chinese corporate governance

system. The gradual floating of all issued shares and the opening to foreign investors

creates the potential for an active market for corporate control in China.

4. Corporate Governance Codes in China

In order to establish a complete modern enterprise system and standardize the operating

process of listed companies and security companies, the CSRC has issued few regulations

on corporate governance. In January 2001, the CSRC issued a “Code for Corporate

Governance of Listed Companies” in China (hereinafter the LC Code). The Code is

applicable to all listed companies within the boundary of the People’s Republic of China,

and aims at the protection of investor’s interests and rights, the basic behaviour rules and

moral standards for directors, supervisors, managers and other senior management

members of listed companies. In January 2004, the CSRC issued a “Provisional Code of

Corporate Governance for Security Companies” in China (hereinafter the SC Code). The

Security Code is applicable to all listed companies with the boundary of the People’s

Republic of China, and pays more attention to the operations of securities companies,

ensuring the legitimate interests of shareholders, clients and other interested parties of the

securities companies are well protected. These two Codes are the major measuring

standard of evaluating whether a listed/security company has a good corporate

governance structure. If major problems exist with the corporate governance structure of

a listed/security company, the securities supervision and regulation authorities may

instruct the company to make corrections in accordance with Codes.

The LC Code contains seven main chapters dealing with shareholder and shareholders’

meetings; the listed company and its controlling shareholders; directors and the board of

directors; the supervisors and the supervisory board; performance assessments and

20

incentive and disciplinary systems; stakeholders; and information disclosure and

transparency. The SC Code has a similar structure, and also addresses the issues related

to management personnel and the basic principle of relationships between securities

companies and clients. The brief summaries of the LC and SC Codes are as follows:

(1) Shareholder and shareholders’ meeting

A listed company should ensure fair treatment toward all shareholders, and all

shareholders should enjoy the legal rights stipulated by laws, administrative regulations

and the company’s articles of association. They should have redress through legal action

if their rights are violated. The listed company should establish efficient channels of

communication with its shareholders and shareholders should be informed of major

matters that affect the company. Directors, supervisors and managers of companies

should bear the liability of compensation if they breach laws and regulations. In related

party transactions, these transitions should, in principle, be at market value.

Additional requirements related to security companies include requirements that

shareholders and actual controllers of a security company have the qualifications required

by the laws, administrative rules and CSRC regulations. Security companies and their

major shareholders are required not to provide financing or guarantees to related parties

or other shareholders directly or indirectly. Moreover, security companies are required to

notify the CSRC if the company has a major change in the management team or

ownership or having a heavy financial loss. There is also a legal requirement if a

securities company suspects major illegal activities.

(2) Controlling shareholders

The controlling shareholders must comply with laws and regulations while exercising

their rights as investors, and should be prevented from harming the listed company’s or

other shareholder’s legal interests. Meanwhile the controlling shareholders have the right

to nominate candidates for directorships and supervisory committee positions based on

their professional skills, knowledge and experience. The decision-making rights belong to

the general shareholders’ meeting or to the board of directors. Listed companies should

21

operate independently of their controlling shareholders in such aspects as personnel,

assets and financial affairs. The board of directors, the supervisory committee and other

internal offices of listed companies should operate in an independent manner.

(3) Directors and board of directors

The election of directors should be organized in a transparent, independent, open, and fair

procedure. The detailed information about the candidates for directorship should be

disclosed prior to the shareholders’ meeting. The election for directors should fully

reflect the opinions of minority shareholders. The elected directors should “faithfully,

honestly, and diligently” perform their duties for the best interests of the company and all

shareholders, and they should contribute adequate time and energy to their duties. For the

independent directors of a listed company, they should be independent from the listed

company and its major shareholders and fulfil their duties faithfully and diligently. The

board of directors should be made accountable to shareholders, should treat all

shareholders equally, and should ensure that listed company complies with the relevant

laws and regulations. The LC Code specified that by 30 June 2003, at least one-third of

the board should be independent directors.

The SC Code, on the other hand, requires that inside directors of a securities company

should not exceed half of the total directors, and appointing directors from outside

professionals is encouraged. Independent directors of a security company should have the

basic knowledge of securities markets and be familiar with relevant laws and regulations.

They should be honest and creditable, and have more than 5 years’ working experience in

related fields. The term of office of independent directors should be the same as that of

other directors, but should not be renewed twice consecutively.

(4) Supervisors and supervisory board

The supervisory board of a listed or securities company should supervise the corporate

finance, monitor directors’ performance, and protect the company’s and shareholders’

legal rights and interests. Supervisors should have professional knowledge or relevant

work experience in such areas as law and accounting. The structure and the members of

22

the supervisory board should be able to independently and efficiently fulfil their duties.

The supervisory board’s meeting should be minuted. The supervisory board may require

the directors, management personnel or other related persons to attend the supervisory

board meeting and answer the questions that the board is concerned about. Securities

companies are encouraged to appoint outside professionals as their supervisors.

(5) Performance assessments and incentive and disciplinary systems

The performance of directors, supervisors, and management of a listed or security

company should be assessed through a fair and transparent procedure, and evaluation

processes should be conducted through a combination of self-review and peer review,

and approved by the board of directors. The evaluation results and compensation of

directors and supervisors should be reported to the shareholders’ meeting. The

appointment and removal of senior staffs should comply with legal procedure in a fair,

independent and transparent manner, and should be publicly announced. The

compensation for management personnel should be related to the company’s performance

and the individual’s work performance.

(6) Stakeholders and clients relationship

A listed or security company should respect the legal rights of the various stakeholder

groups and provide the protection to the interest related parties, such as creditors,

employees, consumers, suppliers, and communities. Employees in particular are

encouraged to provide relevant feedback to improve the company’s overall performance.

Moreover, securities companies should observe the laws and regulations when providing

products or services to clients, should give full disclosure of the contents and risks of the

products or services, and should not infringe the client’s property rights, options, right to

fair deals, right to be informed and other legitimate rights and interests. In addition,

securities companies should not misappropriate the clients’ settlement funds for

transactions, properties entrusted by the clients for management and the securities

deposited by the clients in the company. Securities companies are encouraged to release

23

their audited annual financial report to the public and make sure the contents of such

disclosure are true and accurate.

(7) Information and disclosure and transparency

A listed company should disclose all information that may impact on the decisions of

shareholders and stakeholders. The importance of the provision of truthful, complete and

timely information is emphasized. The disclosed information should be accessed by the

shareholders and stakeholders in an economical, convenient and speedy manner. The

corporate governance information of the company should be available to the public, plus

the explanation if there is a gap between the company’s corporate governance and the

Code. Furthermore, detailed information of major shareholders and changes of major

shareholders should be available to the public accurately and in a timely manner.

To further strengthen the corporate governance activities in the Chinese market, the

CSRC has issued a series of regulations called “Standards Concerning the Contents and

Formats of Information Disclosure” in shares, bonds, and other types of securities issued

since August 2003. These regulations aim to standardize the information disclosure

activities for public offering of securities by the listed and securities companies and

protect the legal rights and interests of investors.

5. Issues in the Current Corporate Governance Model in China

On the surface, these codes provide similar guidelines to those found in codes issued in

many other parts of the world. This implies that Chinese listed firms and securities

companies have a corporate governance system which is similar to the characteristics of a

corporation in a mature market economy. However, Clarke (2003) argues that the

fundamental dilemma of SOE reform stems from the state policy of maintaining a full or

controlling ownership interest in enterprises in several sectors. On the one hand, the state

wants the SOEs to be efficient, while wealth maximization is not the sole objective of

SOEs, otherwise, there would be no rationale for maintaining state ownership. Claessens

and Fan (2002) also argue that the issue of the ownership of a firm’s value is more

complicated when the state is the controlling owner. First, the state is not the ultimate

24

owner, but the agent of the ultimate owners – the citizens. However, the motivation of

value maximization is not an incentive for the state because of other political priorities, as

well as the corruption that is evident in China (Che and Qian, 1998; Lin et al., 1997;

Peng, 2001). Second, there are many different types of governmental agencies that

control the equity stake of companies. For example, ownership controlled by the central

government may have different incentives from ownership controlled by local or regional

governments, or state institution ownership. Third, it is hard to distinguish the

relationship between state ownership and firm performance, especially in socialist

countries, such as China, because other institutional structures must also be taken into

account. Faccio (2006) finds that companies with stronger links to the government have

higher leverage, lower taxation, and higher market shares, but they underperform non-

connected companies on accounting measures. Furthermore, she points out that this

phenomenon is more popular in countries with higher levels of corruption, with barriers

to foreign investment, and less transparent systems.

Several key problems in the Chinese corporate governance system are well documented

(Hovey et al. 2003; Lin, 2004; Allen et al., 2005; Clarke, 2006). The first is the highly

concentrated ownership structure. Companies with a widely dispersed ownership

structure where no individual owns a controlling block of shares are virtually-non-

existent (Clarke, 2006). Albeit, in China in instances where private blockholders own

controlling blocks of shares, the findings of Hess et al. (2008) indicate that expropriation

of minority investors does exist. Market liquidity is severely impeded because the state

and legal person shares cannot be traded on the stock market because of trading

restrictions, resulting in only around 35% of total shares being freely tradable. This has

significantly reduced market liquidity and has become a major obstacle to market

efficiency. In addition, those large investors may only act in their own interests at the

expense of individual investors, suggesting individual shareholders’ interests are not well

protected, irrespective of whether blockholders are state or private sector investors.

The second key problem is insider trading, self dealings, collusion and market

manipulation, although the Chinese government has policies against these activities

25

(Tam, 2002). The major cause of these issues is the absence of effective monitoring of

companies by their directors and supervisory boards and of the market by regulatory

authorities. In addition, at no stage in the chain of monitors are there appropriate

incentives because the ultimate owner of SOEs and most listed firms is the state (Clarke,

2003). Moreover, to attract outside investors, companies were found to provide falsified

financial information to the public in order to hide their efficiencies and mismanagement,

and those companies definitely severely damaged the reputation of the Chinese stock

market (China Economics Time, 2001).

The third major problem is the dysfunction of the board of directors, board of supervisors

and other relevant committees (Tam, 2002; Schipani and Liu, 2002). By law, large

shareholders have more power on directors’ appointments due to the one share one vote

principle, and it is hard to see that directors represent minority shareholders’ interests

even though the LC Code requires recognition of minority interests in appointment

(Clarke, 2006). One of the major reasons is that politicians and state-controlling owners

sit on most boards and committees because of the highly concentrated ownership

structure. As a result, these boards and committees lack independency. Chen et al. (2002)

find that around 80 percent of directors on Chinese boards are closely connected to the

government or governmental agencies, and only a few are professionals (lawyer,

accountants or finance experts). The likelihood of finding a director being concerned with

or representing minority shareholders is very small. Moreover, Clarke (2006) claims that

supervisory boards lack the power to control directors and the management team, and

plays no important role in corporate governance in China.

The final key problem is the legal system (Tam, 2002; SSE, 2003). La Porta et al. (2003) find

that enforcement of laws is more effective than just having strong regulations, and is

particularly relevant to China. Allen et al. (2005) argue that the inefficiencies in the Chinese

market can be attributed to poor and ineffective regulation and enforcement. Lin (2004)

identifies four areas of weakness in the Chinese external governance structure: lack of

information transparency and professional managers; weak legal enforcement; the absence of

or weak monitoring by banks, professional organizations, and the media; and the

26

insignificant roles played by individual shareholders and small institutional shareholders. As

a result, the Chinese stock market is characterized by: a short history; an extremely high (but

volatile) growth rate; high government intervention; low transparency and weak investor

protection.

To solve these problems, a number of suggestions have been proposed by researchers

(Lin, 2004; Clarke, 2006; Allen et. al, 2007). Generally speaking, a well discussed

suggestion is to make the non-tradable shares tradable. The limitations of large block of

non-tradable shares have been well documented, and the Chinese authorities have

previously attempted to resolve this problem in 1999 and 2001. However, these two

attempts did not receive a positive market reaction as the proposals were not attractive to

tradable shareholders. In 2005, the Chinese authorities made the third attempt to

introduce a programme of gradual floatation of non-tradable shares for all domestically

listed companies. More than 1500 listed companies are involved and each company was

required to provide a compensation package for existing tradable shareholders

comprising flexible combinations of cash, warrants and bonus shares and approved by the

general shareholders’ meeting. While the bulk of state and legal person shares are now

technically tradable, there are restrictions in place on the quantity that can be traded for a

several more years. This ongoing reform will have an extensive impact on the investment

community and financial system in China in the long run.

Second, the functions of board of directors and supervisors have to be clearly defined,

strengthened and made more independent. To improve the quality of the board’s

operations, more professional and/or independent directors and supervisors are required

to sit on boards and minority shareholders’ interests should be explicitly considered

during the process of director appointment. There is also a need to strengthen and enforce

requirements to operate specialised committees of board of directors, such as corporate

strategy committee, nomination committee, remuneration committee, and auditing

committee. The LC Code is weak in this respect. The legal and regulatory system must

be given greater powers to enforce. All these committees should be composed entirely of

independent directors. Moreover, a more clearly defined performance related

27

compensation mechanism should be implemented for directors and supervisors.

Third, as observed above, China needs to have well functioning investor protection laws

and more efficient legal enforcement systems. The enforcement of laws and regulations

must be effective enough to deter irregularities in China. More specified explanations of

laws and regulations should be implemented to minimise the legal “grey’ area. From the

corporate governance aspect, the major concern is to monitor the expropriation of the

investors by senior managers. Therefore, managers also should be properly motivated

instead of expropriating investors by entrenching themselves by staying in their position

even though they are not qualified for the job or are no longer effective, or any other

means.

Fourth, there is a need to provide better protection for the interests of individual investors

and enforce their rights. Several approaches need to be introduced: (1) enhancing

shareholders’ voting mechanisms; (2) entitling shareholders to question the company’s

business operations; (3) lowering the minimum required number of shares for the

shareholders to raise proposals; (4) safeguarding the interests of minority shareholders;

and (5) increasing the legal obligation of controlling shareholders (Lin, 2004).

The Chinese government appears to have realized the existing flaws in the current

corporate governance system, and has implemented several policies to improve the

market efficiency and the overall quality of public companies in China. Although there

are many laws and regulations governing the corporate behaviour of companies, further

attention should be paid to the political/legal will, efficiency and transparency of legal

enforcement. Evolution in the corporate governance in China provides a framework for

corporate governance experiments. We argue that China has undergone considerable

corporate governance evolution but has yet to establish a unifying system that balances

social-economic forces with the economy. China has a unique environment and the

evolution of corporate management, supervision and governance is likely to continue to

develop into a uniquely Chinese system. China has the opportunity to capture best

international practice while controlling the excesses of the existing internal weaknesses.

28

6. Concluding Remarks

This chapter has reviewed the complex process of transition that China has experienced

in enterprise reforms and the emergence of a system of corporate governance. Legal,

institutional and regulatory reforms have accompanied this transition. The review has

focused on the problems and challenges in implementing a corporate governance system

in China. A central issue is the still powerful influence of the state in the corporate sector

of the economy. We document the problems that remain and make suggestions for

ongoing change. However, in conclusion we recognise that dramatic change in terms of

enforcement and compliance will not happen overnight. Culture and systemic barriers

remain powerful and the operation of an efficient and ethical corporate governance

system that protects the interests of all parties is still an ambitious goal. However, we

have observed the lack of what might be regarded as a best practice corporate governance

system has not to date been an impediment to economic growth. The remarkable

economic success of China in recent history has been achieved with a unique system of

economic management and corporate regulation and governance.

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CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

CORPORATE GOVERNANCE IN CHINA
Scores for Chinese companies cluster around the median relative to global peers, VIEs and SOEs have distinct governance risks

September 2017

CORPORATE GOVERNANCE SCORE

RE DISTRIBUTION

0 1 2 3 4 5 6 7 8 9 10

MSCI China Index MSCI Emerging Markets Index

MSCI ACWI Index

Laggards Leaders

This report is based on the 149 constituents of the MSCI China Index as at 11 September 2017.

Some references are made to other Chinese companies in coverage.

Top 5 Scores Bottom 5 Scores

China Shenhua Energy Co Ltd 7.2/10 Alibaba Group Holdings Limited 0.0/10

China Merchants Bank Co Ltd 7.2/10

CTRIP.COM International Ltd. 1.6/10

China Telecom Corporation Ltd 7.2/10 JD.COM Inc. 2.1/10

Sun Art Retail Group Ltd 7.1/10 Netease, Inc. 2.7/10

Lenovo Group Ltd 7.1/10 Huaneng Renewables 2.8/10

CHINA IN CONTEXT

Recognition of the importance of corporate governance principles has a long history in China. China’s first corporate governance

code was introduced by the China Securities Regulatory Commission (CSRC) in 2001, ahead of many APAC peers, and updated

further in 2011. In August 2016 a review of this code was announced by the Chairman of the CSRC, and other legislative reforms

are also under review. As more and more global investors consider investing in Chinese equities, the importance of these efforts

to adopt and adhere to global standards of good corporate governance can only continue to grow. Our report examines the

many opportunities – and risks – presented by current corporate governance practices in China, based on the expectations of

these potential investors.

The expectations of global investors regarding the governance of publicly traded companies have been guided by the adoption of

corporate governance codes and standards across virtually all global markets, beginning with publication in the UK in 1992 of

“Financial Aspects of Corporate Governance”, more widely known as the “Cadbury Report”. According to Cadbury, “The

shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate

governance structure is in place,” and “The responsibilities of the board include setting the company’s strategic aims, providing

the leadership to put them into effect, supervising the management of the business and reporting to shareholders on their

stewardship. The board’s actions are subject to laws, regulations and the shareholders in general meeting.” These core principles

have been used to inform the definition of good corporate governance ever since.

Contents
Variable Interest Entities

Founders Favored
2
2

State Involvement 4
Misalignment of Interests 5

Ownership Snapshot 6

https://www.google.com.hk/url?sa=i&rct=j&q=&esrc=s&source=imgres&cd=&cad=rja&uact=8&ved=0ahUKEwjq85bPn4zTAhXGVbwKHTAQAYwQjRwIBw&url=https://en.wikipedia.org/wiki/Flag_of_China&psig=AFQjCNE0iIbnvq0KRrz3R7_rO_hbFyvdzA&ust=1491444970978467

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CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

KEY FINDINGS

 China adopted its first corporate governance code in 2001, ahead of

many APAC peers, and with updates in 2011 and 2016. As China’s market

becomes more accessible to global investors, corporate governance

practices will likely face increased comparison to global standards. This

report examines the opportunities and risks to minority shareholders

presented by current corporate governance practices in China.

 In aggregate, constituents of the MSCI China Index cluster more around
the median score on corporate governance relative to constituents of the
MSCI ACWI Index. Key areas of concern include pay and board issues (no
independent chair, no independent board majority), controlling
shareholder and related party transaction conflicts, and limited
shareholder protection rights. Regulatory oversight differences between
A-share (Mainland China) and H-share (Hong Kong) listings, in some cases
for the same company, contribute additional layers of risk and
complexity.

 Companies employing variable interest entity (VIE) structures are large

(16 companies with constituent weights on the MSCI China Index of 12%

as of 1 August 2017) and show generally strong returns. But VIE

governance structures are often tilted to favor the founder and

ownership risk is increased due to legal uncertainties.

 In contrast to private enterprises, over the past five years shareholder
returns at Chinese state-owned enterprises (SOEs) have underperformed
the MSCI China Index. The Chinese State has undertaken a multi-pronged
reform program aimed at improving returns, but the possibility of
misalignment between the strategic interests of the state and those of
minority shareholders remains a key governance risk.

MARKET CHARACTERISTIC |VARIABLE

INTEREST ENTITIES

Despite being some of the largest, most discussed companies in China, four of

the bottom five governance assessments for constituents of the MSCI China

Index utilize a variable interest entity (‘VIE’) structure.

Under current Chinese legislation, foreign investors are not permitted to

invest directly in Chinese companies that operate in key industries, e.g.,

internet, education and telecommunications.

RISK – GOVERNANCE STRUCTURE FAVORS FOUNDERS

 Many VIEs retain founder involvement. Due to the nature of the

contractual relationships and the associated risks, the reputation and

equity commitment held by the founder is often key to an IPOs success.

 Founders typically use three primary tools to maintain a tight grip on

the control of the listed SPV – a dual share class structure granting them

superior voting power; incorporation in a management-friendly

jurisdiction; and dominating the board, often via the key role of

Chairman while retaining executive powers.

MSCI.COM | PAGE 3 OF 8 © 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

CAPITAL AND OWNERSHIP STRUCTURE

Dual Share Classes with Unequal Voting Rights

Among the 12 VIEs that are founder firms, eight utilize dual class share

structures with the share class held by the founders carrying superior voting

rights. This arrangement has allowed the founders to reduce their capital

investment while maintaining control of the company. With this dual class

share structure not permitted in Hong Kong,
1
these eight companies are listed

on U.S. stock exchanges as a foreign private issuer.

Figure 1 | Disparity between Founder Ownership and Voting Rights at VIEs

Source: MSCI ESG Research. Data as at 27 July 2017

1
This approach is not viable on Hong Kong Exchanges & Clearing (HKEX) as a result of the opposition

to dual class shares by the Securities and Futures Commission in October 2015 which aborted an

earlier consultation to allow dual class shares to be listed on HKEX. In June 2017, HKEX started a

consultation with a view to allowing dual class shares on a new board

http://www.hkex.com.hk/eng/newsconsul/hkexnews/2017/170616news.htm.

DEPRIVATION OF SHAREHOLDER PROTECTION RIGHTS

The VIEs are typically incorporated in the Cayman Islands with some utilizing

the Cayman Islands ‘Exempt Companies’ provisions. Two provisions are of

particular concern – the absence of legal requirement to hold AGMs and

setting the requisition threshold for an EGM at an excessively high level. Hong

Kong Listing rules specifically require the holding of AGMs.

 Last AGM …

Two VIEs have taken advantage of the flexibility under the ‘Exempt

Companies’ regime to avoid the holding of AGMs.

Last AGM >>

Baidu

2008

JD.com

None since 2014 IPO

In their respective Articles of Association, Alibaba, Baidu and JD.com have

taken advantage of the Cayman Islands ‘Exempt Company’ provisions to

impose unusually high thresholds to request an EGM.

 EGM Threshold versus Aggregate Voting Rights of Minority Shareholders

Baidu JD.com Alibaba

EGM Threshold >> 50% 33.3% 33.3%

Aggregate Voting Rights of

Minority Shareholders > 30.8% 20.0% 45.2%*

*Those shares not held by the executive officers (10.6%), Softbank (29.2%) or Yahoo (15.0%).

Given the size of the respective controlling interests at Baidu and JD.com, the

minorities are left unable to take remedial action through convening an EGM.

At Alibaba, some 75% of minority shareholders would need to collaborate to

request an EGM, a near impossible task.

0%

25%

50%

75%

100%

58.COM
Inc

Alibaba VIPSHOP
Holdings

JD.COM Baidu,Inc. YY Inc. MOMO
INC

TAL
Education

% of Shares Held % of Total Voting Rights Held

http://www.hkex.com.hk/eng/newsconsul/hkexnews/2017/170616news.htm

MSCI.COM | PAGE 4 OF 8 © 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

MARKET CHARACTERISTIC | STATE

OWNERSHIP

In contrast to VIEs, which dominate the MSCI China Index in terms of

capitalization but represent a small number of companies, about 90

companies in our dataset (59.7%) are State-owned.

ORGANISATION OF STATE OWNED ENTERPRISES

In China, some 102 central state-owned enterprises (SOEs) are supervised by

the State-owned Assets Supervision & Administration Commission (SASAC).

SASAC appoints and provides training to the directors of these central SOEs. It

decides on their remuneration and sets profit targets for these SOEs. There

are also local SOEs supervised by local bureaus of SASAC in the various

different provinces/municipalities.

HOW MUCH EQUITY IS HELD BY THE STATE?

The state typically holds a majority stake (MSCI ESG Research and local

regulations both utilize 30%+ of the voting rights as the threshold for a

majority stake).

Figure 2 | Percentage of State Holdings at MSCI China Index SOEs

Source: MSCI ESG Research. Data as at 27 July 2017

Figure 3| Relationship between Chinese Government, SASAC , SOEs, Huijin and MOF

Source: MSCI ESG Research

Figure 4 | Common Control in Banking Sector

Source: Company Annual Reports.

14.6%

19.1%

33.7%

30.3%

2.2%

10 – 30% 31-50% 51 – 60% 61 – 74% 75+%

State Council of
the National

Peoples’ Congress

Ministries

Ministry of
Finance

Financial
Institutions

SASAC

Central SOEs

Subsidiaries or
Departments

Local
Governments

Local SASACs

Local SOEs

Subsidiaries or
Departments

China
Investment
Corporation

Central Huijin
Investment

Financial
Institutions

Ministry of Finance / Central
Huijin Investment Ltd

Agricultural Bank
of China

Industrial &
Commercial Bank

of China
Bank of China Ltd

China Construction
Bank

64.6% 57.3% 79.2% 69.3%

MSCI.COM | PAGE 5 OF 8 © 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

RISK – MISALIGNMENT OF INTERESTS IN SOE FIRMS

 Shareholder returns at Chinese SOEs underperform relative to both other

MSCI ACWI Index SOEs and other MSCI China Index constituents, given

possible misalignment of interests within SOEs.

 The SOE reform program represents an effort to address this possible

misalignment in the long term. The previous 2013-14 reform initiatives

have shown limited progress to date. SASAC set three key goals for listed

SOE companies in 2017, a sign of continued focus on the SOE reform

process.

 One of the SOE reform tracks is to make boards more autonomous. In general

Chinese SOE boards include government representatives and sector

expertise, but most boards do not have a majority of independent directors,

while 75% of Chairman roles are executive positions.

2013-14 SOE REFORM INITIATIVES

Since the November 2013 third plenum of the Central Committee of the CCP,

SOE reform has been on the agenda for the Chinese government. However,

instead of wholesale financial reform, the SOE reform process has been one

of incremental changes, using the various approaches below.

One of the themes of SOE reform has been to change state control from

management of company to management of capital.

 Management of Capital: establishing state-owned capital investment and

operation companies, transferring the equities in SOEs from SASAC to these

companies.

 Mixed ownership reform, allowing non-state capital to share ownership of

SOEs together with SASAC-controlled state-owned parents, with a view to

sharing board control with non-state interests.

 Giving company boards more autonomy to make decisions, segregating party

control and management/board control under the legal framework.

 Mergers in strategic sectors including railways, telecommunications, energy

(e.g., coal and power companies), shipping and steel.

 Increasing dividend payouts by SOEs.

In our June 2015 report “China’s Economic Transformation: A New Era of ESG

Opportunity,” we highlighted that the new round of SOE reform would aim to

enhance corporate efficiency through mixed ownership and incentivized pay.

However, progress has been limited to date.

Increasing Dividend Payments

In 2014 MOF raised the ratio of profits to be handed over by SOEs to the

government. More than 120 SOEs administered by the central government

would pay 5 percentage points more of their profits.The plan divided the SOEs

into five categories that would be required to pay between zero and 25

percent of after-tax profits as a dividend to the government.
2

Figure 5 | Required Dividend Payments at SOEs

Required % of Post-Tax Profit
as Dividends to the State

Applicable Companies

25% China National Tobacco Corporation

20%
14 companies, including energy companies such as China

Petrochemical Corporation and telecom carriers such as

China Mobile

15%
70 companies, including railway-related companies such as

China Railway Engineering Corporation and resources

companies such as Aluminum Corporation of China

10% 30+ firms, including nuclear energy and culture companies

Source: MOF data (www.mof.gov.cn)

2
http://www.globaltimes.cn/content/858820.shtml

http://www.mof.gov.cn/

http://www.globaltimes.cn/content/858820.shtml

CORPORATE GOVERNANCE IN CHINA

MSCI.COM | PAGE 6 OF 8 © 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

OWNERSHIP SNAPSHOT
Governance risks vary widely depending on the nature of the company’s ownership, the separation of ownership and management, and the design of the capital structure

and its impact on shareholders’ voting rights.

Largest Owner Classification Key Owner Types Complex Ownership Structures Control Enhancing Structures

Concentrated ownership dominates in China,

where 81.9% of MSCI China Index constituents

include a shareholder or shareholder group,

often the State itself, who controls 30% or

more of the voting rights,

Most Chinese firms are state-owned at 59.7%,

often controlled by other state companies via

intermediate holding companies. At 26.2%,

founder firms are the next most significant

group, and many of these are VIEs (variable

interest entities, see page 3).

Few MSCI China Index constituents are

party to cross shareholdings or

positioned at levels 3 or below in a

stock pyramid, although the pyramidal

nature of many of the SOEs (state

owned entities) is noted.

Companies with unequal voting rights are

generally listed on US exchanges (variable

interest entities, see page 3). In a market where

81.9% of companies are controlled, such control

enhancing structures are not really needed, and

yet they are employed anyway.

Controlling – Largest shareholder or shareholder

group holds 30% or more of the voting

rights.

Principal – Largest shareholder or shareholder

group holds between 10% and 30% of the voting

rights.

Widely Held – No shareholder or shareholder group

holds more than 10% of the voting rights.

Founder – Founder serves as Chairman or CEO

Family – Family hold 10% or more of the voting

rights and maintain at least one board seat

State – State directly or indirectly controls 10% of

the voting rights

Corporate Parent – Issuer is a subsidiary (30% or

more) of a corporate, which itself may be listed

*Owner types may overlap or separate owners may be of

different types at a company

Cross Shareholdings – Two or more

entities hold at least 0.5% of shares in each

other, or via a circular or more complex

cross-shareholding arrangement.

Pyramids – Control is exercised through a

chain of non-controlled companies, which

ultimately results in a shareholder gaining

voting power that is misaligned with their

economic interests.

Multiple Share Classes with Unequal Voting Rights (or

no voting rights for one class) or classes which carry

different rights to vote on director appointments.

Voting Rights Mechanisms include ceilings on

ownership or voting rights, voting rights limits based

on nationality, or additional voting rights accruing

depending on ownership duration.

Golden Shares – Government veto rights for

transactions or changes to governing documents.

81.9%

14.8%

3.4%

68.3%

2

4.2%

7.5%

37.3%

28.2%

34.5%

Controlling Principal Widely Held

MSCI China Index

MSCI Emerging Markets Index

MSCI ACWI Index

26.2%

16.1%

5

9.7%

53.7%

5.4%
10.5%

8.9% 10.4%
12.1%

18.6%
11.8%

15.1%

Founder Family State Corporate
Parent

MSCI China Index
MSCI Emerging Markets Index
MSCI ACWI Index

14.1%

2.0%

7.2%
3.5%

6.3%

1.7%

Cross Shareholdings Pyramid Structure

MSCI China Index
MSCI Emerging Markets Index
MSCI ACWI Index

6.0%

0.0% 0.0% 0.0%

4.2%

9.2%

0.0% 1.2%

9.7%

16.0%

2.3% 1.8%

Multiple Share
Classes w/

Unequal Voting
Rights

Voting Rights
Limits

Extra Voting
Rights –

Ownership
Duration

Golden Shares

MSCI China Index
MSCI Emerging Markets Index
MSCI ACWI Index

CORPORATE GOVERNANCE IN CHINA

AMERICAS

+ 1 212 804 5299

EUROPE, MIDDLE EAST & AFRICA

+ 44 2 7618 2510

ASIA PACIFIC

+ 612 9033 9339

ABOUT MSCI ESG RESEARCH PRODUCTS AND SERVICES

MSCI ESG Research products and services are provided by MSCI ESG Research LLC, and are designed to provide in-depth research, ratings and analysis of

environmental, social and governance-related business practices to companies worldwide. ESG ratings, data and analysis from MSCI ESG Research LLC are

also used in the construction of the MSCI ESG Indexes. MSCI ESG Research LLC is a Registered Investment Adviser under the Investment Advisers Act of

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CORPORATE GOVERNANCE IN CHINA | SEPTEMBER 2017

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OECD-China Policy Dialogue on Corporate Governance

Corporate Governance of Listed Companies

in China

SELF-ASSESSMENT BY THE CHINA SECURITIES REGULATORY
COMMISSIO

N

This report looks at the institutional framework of corporate governance in China through the prism of the
OECD Principles of Corporate Governance and is a product of the ongoing OECD-China Policy Dialogue on
Corporate Governance. By assessing a broad range of laws, regulations and codes, it provides a valuable
reference for understanding how much has been achieved in Chinese corporate governance and the main
ambitions of future reform efforts.

The report shows that corporate governance has improved signifi cantly since the Chinese stock market
was created in 1990, with important achievements in establishing and developing the legal and regulatory
framework. The OECD-China Self-Assessment represents a thorough review of all laws, regulations and codes
that relate to every principle recommended by the OECD Principles of Corporate Governance. It documents
the advances in the Chinese Corporate Governance framework. Building on this report, bilateral co-operation
between China and the OECD will continue to enhance the understanding of China’s corporate governance
system and how it impacts on company and investor behaviour.

Contents

Preface by Shang Fulin, Chairman, China Securities Regulatory Commission

  • Preface by Richard Boucher
  • , Deputy Secretary-General, OECD

    Chapter 1.

  • The corporate governance framework in China
  • Chapter 2.

  • Shareholders’ rights
  • Chapter 3.

  • The equitable treatment of shareholders
  • Chapter 4.

  • Information disclosure
  • Chapter 5.

  • Board and supervisory board: responsibility and supervision
  • Chapter 6.

    Stakeholders

    and corporate social responsibility

    ISBN 978-92-64-11908-6
    26 2011 08 1 P -:HSTCQE=VV^U][:

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    OECD-China Policy Dialogue
    on Corporate Governance

    Corporate Governance of
    Listed Companies in China

    SELF-ASSESSMENT BY THE CHINA SECURITIES
    REGULATORY COMMISSION

    Please cite this publication as:

    OECD (2011), Corporate Governance of Listed Companies in China: Self-Assessment by the China Securities
    Regulatory Commission, OECD Publishing.
    http://dx.doi.org/10.1787/9789264119208-en

    This work is published on the OECD iLibrary, which gathers all OECD books, periodicals and statistical
    databases. Visit www.oecd-ilibrary.org, and do not hesitate to contact us for more information.

    Corporate Governance
    of Listed Companies

    in China
    SELF-ASSESSMENT BY THE CHINA SECURITIES
    REGULATORY COMMISSION

    This work is published on the responsibility of the Secretary-General of the OECD. The

    opinions expressed and arguments employed herein do not necessarily reflect the official

    views of the Organisation or of the governments of its member countries.

    ISBN 978-92-64-11908-6 (print)
    ISBN 978-92-64-11920-8 (PDF)

    Corrigenda to OECD publications may be found on line at: www.oecd.org/publishing/corrigenda.

    © OECD 2011

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    Please cite this publication as:
    OECD (2011), Corporate Governance of Listed Companies in China: Self-Assessment by the China Securities
    Regulatory Commission, OECD Publishing.
    http://dx.doi.org/10.1787/9789264119208-en

    FOREWORD

    CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011 3

  • Foreword
  • This Report looks at the institutional framework of corporate governance in China
    through the prism of the OECD Principles of Corporate Governance and is a product of
    the ongoing OECD-China Policy Dialogue on Corporate Governance. By assessing a
    broad range of laws, regulations and codes, it provides a valuable reference for
    understanding how much has been achieved in Chinese corporate governance and the
    main ambition of future reform efforts. The Report shows that corporate governance has
    improved significantly since the Chinese stock market was created in 1990, with
    important achievements in establishing and developing the legal and regulatory
    framework.

    In preparing the Report, the China Securities Regulatory Commission (CSRC) has,
    together with other relevant agencies and ministries, accomplished a major body of work
    and taken it through a process of extensive consultation and inter-agency drafting. OECD
    considers this an important achievement; a tangible sign of China’s commitment to
    excellence and testimony to its readiness to continue the modernization of the country’s
    capital markets and corporate governance practices.

    Throughout the drafting process, the OECD Secretariat, as well as national
    representatives from the OECD Corporate Governance Committee, have been engaged in
    workshops and policy discussions with their Chinese counterparts. In November 2010,
    the full Committee had an opportunity to discuss the report in-depth with a Chinese
    delegation and was impressed with the breadth and depth of the legal and regulatory
    framework that China has established in the area of corporate governance.

    The Committee noted that the corporate governance framework in China is
    developing and adapting to the country’s economic transformation. As market discipline
    is still evolving, the role played by the formal legal and regulatory framework remains
    essential for building an efficient and competitive capital market.

    Given China’s concentrated ownership structure, potential conflicts of interest
    between majority and minority shareholders remain a core corporate governance issue. It
    is therefore very useful that the Report looks at the issues of equitable treatment of
    shareholders and mechanisms to prevent abusive related party transactions. The Report is
    also helpful in identifying mechanisms for shareholder redress. On a related topic, the
    Committee pointed to the challenges of coordinating the multiple roles played by state
    entities – as shareholders, regulators and managers.

    In terms of provision of information to the market, the Report demonstrates the
    importance China attaches to improving disclosure and transparency. This includes the
    introduction of low-cost dissemination channels and ensuring that Chinese accounting
    and auditing standards are of high quality and aligned with international standards. The
    Committee took an interest in China’s dual board system, the board of directors and
    supervisory board. The Report emphasises board composition and duties. In particular,

    FOREWORD

    4 CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011

    the discussion highlighted the importance of providing information to investors about the
    board and senior management selection process.

    China – like all other countries around the world – faces the continuous challenge of
    ensuring that its corporate governance laws and regulations are translated into good
    corporate practice. Ultimately, the rules and laws on paper must be effectively
    implemented in order to make a difference. This is a long-term commitment that will
    benefit from constant attention to the quality of the legal system; the presence of self-
    regulatory organizations and cooperation with international institutions. For China,
    priority areas for attention may include: curbing abusive related party transactions,
    enhancing the quality of boards, improving shareholder protection and curbing market
    abuse. It may also be useful to devote special attention to the all-important issue of how
    to improve effective implementation and enforcement.

    To conclude, the OECD Corporate Governance Committee considered the discussion
    of China’s self-assessment an important and timely exercise. Members of the OECD
    Corporate Governance Committee were also pleased to participate when the Report was
    launched at the OECD Asian Roundtable on Corporate Governance in Shanghai, which
    was kindly hosted by the CSRC and the Shanghai and Shenzhen Stock Exchanges in
    December 2010.

    Building on this Report, bilateral cooperation between China and the OECD will
    continue to enhance the understanding of China’s corporate governance system and how
    it impacts on company and investor behaviour. As a consequence, the OECD Corporate
    Governance Committee looks forward to further strengthening of cooperation and a
    mutually beneficial dialogue with Chinese authorities in the area of corporate governance.

    Acknowledgements

    The OECD would like to extend sincere gratitude to the Government of Japan for
    their generous financial support of the OECD-China Policy Dialogue on Corporate
    Governance.

    CONTRIBUTORS

    CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011 5

    Corporate Governance of Listed Companies in China
    Editorial Committee

    Chairman SHANG Fulin

    Vice chairmen GUI Minjie, LI Xiaoxue, ZHUANG Xinyi

    YAO Gang, LIU Xinhua, JIANG Yang

    ZHU Congjiu, WU Lijun

    Members YANG Hua, TONG Daochi, QI Bin,

    ZHAO Zhengping, WANG Lin,

    ZHANG Sining, HUANG Wei,

    JIAO Jinhong, SUN Shuming, LIU Hongtao

    ZHANG Sheffeng, ZHANG Yujun,

    SONG Liping, YU Jianhua, YU Baoheng

    Consulting Committee

    MA Mingzhe, WANG Shi, WANG Wei, WANG Dongming,

    NING Xiangdong, LIU Hongru, SU Shulin, LI Yang,

    LI Zhaoxi, LI Weian, XIAO Gang, ZHANG Weiying,

    ZHANG Xinwen, CHEN Qingtai, LIN Yixiang, JIN Liyang,

    HU Ruyin, JIA Xiaoliang, XU Lejiang, GUO Guangchang,

    GUO Shuqing, LU Guangiu

    CONTRIBUTORS

    6 CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011

    Drafting Team

    Team Leander YANG Hua

    Deputy Leaders OUYANG Zehua, ZHAO Lixin,

    CAI Jianchun, AN Qingsong, YAN Bojin

    LIU Yan

    Members HUANG Ming, ZHANG Weidong,

    PAN Chunsheng, ZHU Huan, GAO Li,

    JIANG Xinghui, SUN Hongxia,

    JIANG Xueyue, CHEN Zhaohui

    HUANG Jianshan, YONG Xu,

    REN Shunying, SHE Jiangxuan,

    REN Wei, ZHOU Hongda

    OECD Experts Team

    OECD Corporate Affairs Division:

    Grant Kirkpatrick, Fianna Jesover

    OECD Corporate Governance Committee:

    Ben Cushman, Magda Bianco

    TABLE OF CONTENTS

    CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011 7

  • Table of Contents
  • Preface
    by Shang Fulin, Chairman, China Securities Regulatory Commission ……………………………. 9

    Preface
    by Richard Boucher, Deputy Secretary-General, OECD ……………………………………………….. 11

    Chapter 1. The corporate governance framework in China ………………………………………………. 13

    1.1 The history and development of corporate governance in China …………………………………….. 13
    1.2 The legal framework of corporate governance for listed companies in China …………………… 18
    1.3 Institutional framework for the corporate governance of listed companies in China………….. 24
    Notes …………………………………………………………………………………………………………………………… 28

    Chapter 2. Shareholders’ rights ………………………………………………………………………………………. 29

    2.1 Introduction to shareholders’ rights ……………………………………………………………………………. 29
    2.2 China’s practices compared with OECD principles ………………………………………………………. 29

    Chapter 3. The equitable treatment of shareholders …………………………………………………………. 41

    3.1 Introduction to the equitable treatment of shareholders …………………………………………………. 41
    3.2 China’s practices compared with OECD principles ………………………………………………………. 42

    Chapter 4. Information disclosure …………………………………………………………………………………… 51

    4.1 Introduction to information disclosure ………………………………………………………………………… 51
    4.2 China’s practices compared with OECD principles ………………………………………………………. 55

    Chapter 5. Board and supervisory board: responsibility and supervision ………………………….. 77

    5.1 Overview of the board of directors and supervisory board system in China …………………….. 77
    5.2 China’s practices compared with the OECD principles …………………………………………………. 80

    Chapter 6.

  • Stakeholders and corporate social responsibility
  • ……………………………………………… 95

    6.1 China’s legal guarantee for the protection of stakeholder interests………………………………….. 95
    6.2 China’s practices compared with the OECD principles …………………………………………………. 99

    PREFACE BY SHANG FULIN

    CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011 9

    Preface

    by
    SHANG Fulin

    Chairman, China Securities Regulatory Commission

    This year marks the 20th anniversary of the Chinese capital market. In the past two
    decades, it has started from scratch and experienced an extraordinary growth with market
    size increasing from small to big and market coverage from regional to nationwide,
    playing an important role in the national economic and social development. The
    development of the capital market has promoted the establishment of a modern enterprise
    system in China. Listed companies, outstanding representatives of Chinese enterprises,
    are the corner stone of sound capital market development. The improved governance
    system and higher governance level of listed companies have consolidated the foundation
    of the capital market, increased its attractiveness and vitality, given an effective boost to
    the capital market’s role in optimising resource allocation and promoted the healthy and
    steady development of the Chinese capital market.

    Corporate governance in China has been explored and established in the process of
    state-owned enterprises reform and private enterprises growth. Corporate governance
    experience and model with Chinese characteristics have come into being in light of the
    actual situation in China. It has developed under the joint effort of the government and
    market participants, with the former playing a leading role in the construction and
    improvement of the corporate governance legal framework. Although China has started
    the creation of a legal system for corporate governance rather lately, the system has
    developed fairly quickly and increasingly full-fledged. The China Securities Regulatory
    Commission (CSRC) has all along identified the improvement of corporate governance as
    a priority, adopted various strong measures in the areas of independent directorship,
    information disclosure, interest related party transaction, general shareholders’ meeting,
    merger and acquisition and reorganization and investor protection within the framework
    of the Company Law and the Securities Law, and issued a series of department rules and
    normative documents, including Code of Corporate Governance of Listed Companies,
    Regulations on Information Disclosure of Listed Companies, Guidelines on Articles of
    Association of Listed Companies, Rules on Shareholders’ Meetings of Listed Companies,
    Guiding Opinions on the Establishment of the System of Independent directors in Listed
    Companies, Provisions on Strengthening the Protection of the Rights and Interests of
    Public Shareholders, Regulations on the Takeover of Listed Companies, Regulations on
    Major Asset Reorganization of Listed Companies, and Regulations on Option Incentives
    of Listed Companies (Trial) etc. The formulation and implementation of these regulatory
    provisions and normative documents have greatly promoted the corporate governance
    reform process and facilitated the improvement of corporate governance level of listed
    companies. Meanwhile, pushed by the CSRC, a special campaign was launched as of
    2005 for listed companies to conduct non-tradable share reform, clear off outstanding

    PREFACE BY SHANG FULIN

    10 CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011

    debts from controlling shareholders and improve corporate governance. The campaign
    has consolidated the market foundation and is of great practical significance to build up
    market confidence and encourage steady investment growth.

    The development of corporate governance practices in China and the constant
    improvement of the relevant legal system offer useful information for other countries.
    China also needs to further draw upon mature experiences of other countries and relevant
    international organizations and objectively evaluate achievements and gaps. For this
    reason, the CSRC and the Organisation for Economic Co-operation and Development
    (OECD) reached an agreement to cooperate on a joint corporate governance assessment
    programme. As an international organization born to deal with challenges of economic
    globalization, the OECD has all along committed itself to providing a platform for
    governments to explore, develop and improve economic and social policies. The
    organization has long-term experience in the field of corporate governance. Its Principles
    of Corporate Governance provide a set of international standards for corporate
    governance and have extensive influence in member states as one of the most influential
    guidance on corporate governance in the world. The cooperation between the CSRC and
    the OECD is designed to advance dialogue and communication between Chinese
    corporate governance legal system and internationally accepted rules and therefore of
    special significance for the exploration into a mode of compatibility between Chinese and
    foreign corporate governances.

    The OECD-China corporate governance joint assessment programme was formally
    launched in 2009. Upon consulted arrangement between the two sides, the CSRC
    working group completed a self-assessment report after meticulous discussions and
    revisions, i.e., the present China Listed Company Corporate Governance Report. The
    English edition of the report was presented to the OECD, which then provided feedbacks
    and conducted a discussion about the report at its Corporate Governance Committee
    meeting. The now finalized report describes the status of corporate governance in China,
    covering shareholders’ rights, equal treatment of shareholders, information disclosure,
    responsibility and supervision of the board of directors and the supervisory board,
    stakeholders and corporate social responsibility. It features a detailed comparison
    between Chinese corporate governance system and practices and the relevant OECD
    principles.

    The creation and development of Chinese corporate governance and other legal
    systems governing companies have moved from drawing upon experiences of other
    countries to finding its own corporate governance model. For a long time, China has
    humbly learned from others on the basis of its national conditions and made active efforts
    to integrate itself into the world economic system. Looking into the future, China will
    take an active part in international rule-making. Dialogue and communication between
    China and the world including cooperation between the CSRC and international
    institutions will continue and expand comprehensively, which will be very much
    beneficial for Chinese enterprises to go global and for foreign enterprises to invest in
    China.

    SHANG Fulin
    Chairman of China Securities Regulatory Commission

    PREFACE BY RICHARD BOUCHER

    CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011 11

    Preface

    by
    Richard Boucher

    Deputy Secretary-General, OECD

    For more than twenty years, Chinese authorities have worked hard to build a stronger
    corporate governance framework as part of accelerated enterprise reform and capital
    market development. Indeed, since the stock market was established in 1990, the
    corporate governance framework has been transformed and capital markets have
    developed dynamically. New institutions have been created and many new laws and
    regulations have been adopted – and this process continues.

    In this Self-Assessment, the Chinese Securities Regulatory Commission (CSRC)
    presents China’s laws and regulations by reference to the OECD Principles of Corporate
    Governance. The assessment documents how much has been accomplished, and points
    out the direction for further development. The report was thoroughly discussed by the
    OECD Corporate Governance Committee which was impressed by the breadth and depth
    of the legal and regulatory framework that has been developed by the Chinese authorities.
    All aspects of the Principles are addressed.

    The Self-Assessment is an important and timely benchmarking exercise. The OECD
    is very pleased that it is being launched at the OECD Asian Roundtable on Corporate
    Governance in Shanghai, hosted by the CSRC and the Shanghai and Shenzhen Stock
    Exchanges. The Self-Assessment will contribute to better understanding and exchange of
    experience among all the jurisdictions in the region.

    Going forward, China – like many other countries around the world – faces the
    challenge of ensuring that its laws and regulations are translated into changed corporate
    practice. This is a key issue for many authorities who seek to sustain capital market and
    corporate development and has become central to the OECD Committee’s work.

    This report is a key output of the OECD-China Policy Dialogue on Corporate
    Governance that began in 2004 and has proven very successful in promoting mutual
    understanding and supporting China’s reform agenda. The OECD looks forward to
    continuing to deepen our partnership with China in improving corporate governance.

    Richard Boucher
    Deputy Secretary-General, OECD

    1. THE CORPORATE GOVERNANCE FRAMEWORK IN CHINA

    CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011 13

    Chapter 1

    The corporate governance framework in China

    1.1 The history and development of corporate governance in China

    Corporate governance in China has emerged and developed as China has shifted from
    a planned economy to a market economy. The establishment and growth of China’s
    capital market and the evolution of Chinese enterprises from government affiliates to
    modern companies have made it necessary to establish a new corporate governance
    framework.

    Until 1978, most Chinese enterprises were state-owned. A major characteristic of the
    state-owned enterprise management mechanism was its administration-driven, unified
    and collective governance. Enterprises were mainly managed by “administrative” means
    and ranked in accordance with the levels of government concerned and the size and
    affiliation of the company. Corporate production plans were not decided by the market,
    but by the government according to a national plan and its sub-plans. Business
    performance was measured by the number of planned targets that were met, rather than
    by the market value realised. Political entitlement was the major incentive for managers
    and employees. Managers had no independence in business activities, nor could they
    share the fruits of successful business operations, and therefore lacked the drive to
    improve enterprise management. As managers’ autonomy and corresponding
    administrative ranks were mainly decided by the size and economic resources of their
    companies, they were inclined to expand the size of the enterprise while paying little
    attention to its business performance.

    Economic reform progressed in China’s urban areas after the Third Plenary Session
    of the 11th Communist Party of China’s (CPC) National Congress in 1978. The
    centrepiece of the reform was the revitalisation of state-owned enterprises (SOEs) to
    make them more efficient by restructuring the old enterprise system. Spawned by the
    reform of SOEs, China’s attention to corporate governance grew as the SOEs strived to
    put a modern enterprise system in place. China’s corporate governance made steady
    progress as more and more companies were listed.

    China’s corporate governance development to date has been a 30-year process that
    can be divided into four phases.

    1.1.1 Phase 1: From 1978 to 1984

    The major feature of this phase was decentralisation. In 1979, the State Council
    promulgated a number of rules and regulations on reforming the enterprises’ management

    1. THE CORPORATE GOVERNANCE FRAMEWORK IN CHINA

    14 CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011

    mechanism. These new rules were geared to readjust the relationship between the state
    and its enterprises, to give SOE managers more freedom in business activities, and to
    replace the state’s direct administrative control over the SOEs with a management model
    in which direct state control is supplemented by economic incentives. Favourable
    measures in terms of fixed-asset investment, asset depreciation and working capital
    management were provided to the SOEs to expand their incentives for better business
    performance. Pilot programmes to enhance SOEs’ business independence were
    introduced and their successful experiences were summarised and formulated into the
    SOE Management Responsibility System in 1981, which was set by the state as the goal
    of SOE management mechanism reform.

    1.1.2 Phase 2: From 1984 to 1992

    The major feature of this phase was the change in SOEs’ profit distribution and the
    formation of the management responsibility system. Before the reform1, SOEs’ profits
    were all claimed by the state. After the reform, the profits of large and medium-sized
    SOEs were taxed, after-tax profits were shared by the state and enterprises, and the “SOE
    Manager Accountability Mechanism” was put in place. In 1984, the idea that the
    ownership and management of state-owned enterprises could be separated as appropriate
    was suggested for the first time. In 1986, the CPC Central Committee, together with the
    State Council, issued a number of documents, including the Terms of Reference for
    Managers of State-owned Industrial Enterprises, explicitly stipulating that the manager is
    a company’s representative of a legal personality, and a new type of corporate leadership
    system featuring “overall responsibility of the manager, a supervisory and guarantee role
    for the company’s CPC subcommittee, and democratic management by the employees”
    was also established.

    From 1987 onwards, the transformation of the SOEs’ operational mechanism became
    the priority of SOE reform. According to the principle that ownership and management of
    companies can be separated, a major reform of SOEs’ business operation models was
    initiated and a contract-based responsibility system2 was set up. In the transitional period
    from a planned to a market-based economy, the contract responsibility system played a
    positive role in guaranteeing the steady growth of government revenue, promoting the
    separation of enterprise ownership from management, and the separation of government
    from enterprises, providing SOE employees with greater autonomy and incentives, and
    making SOE development more sustainable. But experience has shown that the contract
    responsibility system had embedded weaknesses too, mainly in that it failed to avoid the
    short-term performance oriented behaviors. The basis of the contracts was often
    arbitrarily decided and was neither fair nor objective: the contractors shared the gains
    when the enterprises were profitable but were not personally liable when they incurred
    losses. The system failed to find a fully satisfactory solution to the challenge of separating
    the role of the government from enterprises.

    In July 1992, the State Council formulated and promulgated the Regulation on the
    Transformation of Operational Mechanisms of Industrial Enterprises Owned by the
    Whole People, delegating 14 independent powers of operation to SOEs, thereby
    accelerating the pace at which SOEs moved from a planned economy to a market
    economy.

    1. THE CORPORATE GOVERNANCE FRAMEWORK IN CHINA

    CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011 15

    1.1.3 Phase 3: From 1993 to 2003

    The establishment of a modern enterprise system was at the core of SOE reform
    during this phase. In 1993, it was made clear that “efforts need to be made to transform
    the SOE management mechanism and establish a modern enterprise system that suits the
    needs of a market economy, with clearly defined ownership, rights and responsibilities,
    and features the separation of government from enterprises and scientific management.
    Modern enterprises can have many organisational forms based on the composition of
    capital. Practising the corporate system in SOEs proved to be a useful way to start
    building a modern enterprise system.”

    The Company Law, which was promulgated in December 1993, provided legal
    support to the establishment of a modern enterprise system and laid the groundwork for
    China’s corporate governance framework. China made the decision to define its basic
    economic system as one in which state ownership is the main feature, with the common
    development of diverse forms of ownership. In line with this definition, efforts were
    made on two fronts. Firstly, SOE reform and structural adjustment of the national
    economy were accelerated towards the direction of building a system in which enterprises
    would become legal entities responsible for their own business operations, profitability,
    development, self-discipline, and risk portfolio as real market players. Some SOEs were
    restructured into limited liability companies or limited joint-stock companies. With
    articles of association drafted, shareholders’ meetings, boards of directors, and
    supervisory boards established, and senior management appointed, a basic framework for
    a corporate governance structure had taken shape. Secondly, as the non-state sector of the
    economy was elevated from a previously subordinate position to one of importance on a
    par with the public sector, the policy and institutional obstacles limiting its rapid
    development were removed. As a result, the number of non-state firms has continued to
    grow steadily.

    Since the early 1990s, a nationwide capital market with stock exchanges acting as the
    main agent has gradually developed and the number of listed companies has grown
    exponentially. Most of the listed companies were restructured SOEs that had gone
    through shareholding reform. As the state or state-owned companies still held controlling
    shares of those listed companies, many of the old SOE management styles and
    mechanisms were maintained. Meanwhile, as the number of listed non-state holding
    companies grew, so their governance increasingly became an issue. The improvement of
    the corporate governance of listed companies was a major item on the agenda of China’s
    capital market development at that time.

    In 2001, China joined the World Trade Organisation and undertook to adopt the
    OECD Principles of Corporate Governance and improve corporate governance of
    Chinese listed companies.

    The China Securities Regulatory Commission (CSRC) and the National Economic
    and Trade Commission jointly issued the Code of Corporate Governance of Listed
    Companies in early 2002. This document is based on the OECD Corporate Governance
    Principles and gives particular consideration to the circumstances and outstanding issues
    of listed companies in China. It expounds on the basic principles of corporate governance,
    the means to achieve investor protection, and the basic code of conduct and professional
    ethics that need to be observed by directors, supervisors, managers and other executives
    of listed companies.

    1. THE CORPORATE GOVERNANCE FRAMEWORK IN CHINA

    16 CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011

    1.1.4 Phase 4: From 2004 to present

    Historical constraints to good governance of listed companies started to be gradually
    addressed from 2004 onwards. With the help of government regulators, such as those
    represented by the CSRC, the level of corporate governance among listed companies has
    been constantly improving. The State Council issued Opinions on Promoting the Reform,
    Opening and Steady Growth of Capital Markets in January 2004, clarifying the strategic
    importance of capital markets in national economic development and charting the course
    for resolving some long-standing problems. In April 2005 the CSRC, under the guidance
    of the State Council, introduced a reform designed to address the issue of non-tradability
    of certain shares held by a company’s shareholders, a residual problem from the period
    before the companies went public. The smooth progress of this reform successfully
    solved the problem of dividing interests and prices among the state-owned shares,
    institutional shares and tradable shares in a company’s share structure, and enabled equal
    rights to the trading of and earnings on shares among all categories of shareholders. All
    categories of shares are now valued by the market mechanism, which constitutes the basis
    for common interests among all categories of shareholders.

    The Company Law and the Securities Law, both introduced in 2006, provide the
    foundation for drawing up and developing a corporate governance framework in China.
    The revised Company Law improved companies’ governance structure and mechanisms
    to protect lawful shareholders’ rights and public interests. It highlighted the legal
    obligations and responsibilities of those in actual control of the company – the directors,
    senior management and supervisors. It improved companies’ financing and financial
    accounting systems of companies and the systems governing corporate mergers, divisions
    and liquidation. While ensuring the lawful rights and interests of the creditors are well
    protected, it facilitated the reorganisation of companies.

    The revised Securities Law improved the system governing the issuance, trading,
    registration and settlement of securities and provided for the establishment of multi-tiered
    capital-market architecture. It improved the supervision of listed companies, made
    issuance examination more transparent, established the mechanism of introducing a
    system for recommending/sponsoring listing. It also increased the legal responsibilities
    and rules on integrity obligations of the controlling shareholders or those actually in
    control, namely the directors, supervisors and senior management of listed companies.
    The revised law strengthened investor protection, especially for minority investors,
    established a securities investor protection fund, and defined the system of civil
    responsibility to compensate for damages to investors. Following the revision, related
    agencies made corresponding adjustments to other relevant laws, regulations and criterion
    documents to ensure that they better reflect market rules.

    The state-owned Assets Supervision and Administration Commission of the State
    Council carried out corporatisation reforms of large central government SOEs and piloted
    the establishment of boards of directors according to the Company Law and in light of the
    OECD Guidelines on Corporate Governance of State-Owned Enterprises.

    The issue of fund misappropriation by major shareholders and other related parties
    was a problem that seriously affected the healthy development of listed companies. To
    address this issue effectively, the CSRC drafted regulations imposing a strict limitation on
    fund misappropriation in listed companies by controlling shareholders and other related
    parties. It conducted pilot programmes on “shares for debt” and co-operated with local
    governments and other relevant agencies to deal with the difficult problem of debt
    repayment arrears. At the same time, it focused on the establishment of a long-term

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    mechanism to forestall new debt repayment arrears while old arrears were being repaid.
    The Criminal Law was amended to inflict greater penalties on major shareholders and
    actual controllers involved in fund misappropriation of listed companies. This problem
    was essentially resolved by the end of 2006.

    Following the completion of the reform on non-tradable shares and collection of debt
    repayment arrears, in March 2007 the CSRC launched a three-year campaign to
    strengthen the governance of listed companies. During the campaign, listed companies
    looked into existing problems in corporate governance and conducted in-depth, effective
    rectification of misappropriation of company funds by major shareholders, incomplete
    separation of funds and personnel between a listed company and its controlling
    shareholder, irregular operations of listed companies’ boards of directors, shareholders’
    meetings and supervisory boards, and inadequate internal controls.

    During this campaign, the listed companies gained greater awareness of standard
    operations and improved their level of governance, and some listed companies gradually
    introduced effective corporate governance models adapted to their companies.

    1. Listed companies were marked by greater independence and the diversification of
    directors has started to play an important role in the constant improvement of
    corporate governance and internal controls.

    2. Operations of the board of directors, supervisory board and general shareholders’
    meeting are more standard and effective. Online voting at general shareholders’
    meetings has increased and the use of accumulative voting is more extensive. The
    rules of procedures for board meetings are more standardised and relevant
    decision-making more scientific. The functions of the board of directors’
    specialized committees have been further strengthened, with many companies
    adopting work procedures, detailed responsibilities and clarified procedures for
    the specialized committees.

    3. The system of internal control has been further improved, with many listed
    companies systematically sorting out and improving their internal controls by
    drawing up rules and improving them where necessary.

    4. The information disclosure systems of listed companies has become more fully
    fledged and detailed. Meanwhile, companies are more likely to take the initiative
    to disclose information with more in-depth and extensive coverage. They are also
    more sensitive and respond faster to substantive information.

    5. The management of investor relations has greatly improved. Most listed
    companies have improved their investor relations management system, appointed
    full-time staff responsible for investor relations, set up hotlines and designated
    website modules for investors, and interact and exchange information with
    investors on an irregular basis. They are also more active in implementing
    corporate social responsibility.

    The chart below shows the current Corporate Governance Framework of Listed
    Companies in China:

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    Concerning allocation and balance of company powers, four specific company organs
    with power and work division are set up to form the organizational structure.

    The general shareholders’ meeting is the power and decision-making organ of the
    company and has decision making power concerning major issues. The board of directors
    is the operational implementation organ of the company, being responsible to the general
    shareholders’ meeting, and has the decision making power concerning management
    issues under the authority of general shareholders’ meeting. The board of directors may,
    according to the resolution of the general shareholders’ meeting, set up special
    committees, such as strategy committee, auditing committee, nomination committee,
    remuneration and appraisal committee, etc., The management is responsible to the board
    of directors, and is in charge of the daily operation and management of the company. The
    supervisory board is the supervision organ of the company, which supervises whether
    directors and managers violate laws or articles of association of the company when
    accomplishing corporate duties, and is entitled to inspect company’s finance.

    1.2 The legal framework of corporate governance for listed companies in China

    China’s legal framework for corporate governance comprises four levels: basic laws,
    administrative regulations, regulatory provisions, and self-disciplinary rules.

    The first level comprises some fundamental laws, formulated either by the National
    People’s Congress or its Standing Committee. They include the Company Law, the

    General Shareholders’ Meeting

    Board of Directors Supervisory Board

    Special Committees

    Management

    Stakeholders

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    Securities Law, the Criminal Law Amendment Act (6), the Law on the State-Owned Assets
    of Enterprises and the Accounting Law.

    The second level includes State Council administrative regulations, notably: Opinions
    on Promoting the Reform, Opening and Steady Growth of Capital Markets, Circular of
    the State Council on its Approval of the CSRC’s Opinion on Improving the Quality of
    Listed Companies.

    The third level involves departmental provisions formulated by the Ministries,
    Commissions, the People’s Bank of China, the Auditing Administration and other
    agencies with administrative jurisdiction directly under the State Council. These include:
    the Code of Corporate Governance of Listed Companies, Regulations on Information
    Disclosure of Listed Companies, Guidelines on Articles of Association of Listed
    Companies, Rules on Shareholders’ Meetings of Listed Companies, Guiding Opinions on
    the Establishment of the System of Independent Directors in Listed Companies,
    Provisions on Strengthening the Protection of the Rights and Interests of Public
    Shareholders, Regulations on the Takeover of Listed Companies, Regulations on Major
    Asset Reorganisation of Listed Companies, Regulations on Option Incentives of Listed
    Companies (Trial), Regulations on the Registration and Settlement of Securities.

    The fourth level of self-disciplinary rules refers to the Rules on Listing Stocks and
    Trading Rules made by the stock exchanges, among others.

    When the laws, regulations and rules at various levels are drafted, the legislature or
    competent administrative departments generally carry out in-depth research and
    implement the relevant legal procedures strictly to solicit a broad scope of opinions
    through round-table discussions, argumentation, consultation and comments so that
    individual citizens and market entities are able to express their views directly or through
    their representatives, thereby safeguarding their legitimate rights and interests.

    Perpetrators of irregularities and violations in corporate governance shall be held
    accountable for the relevant administrative, civil and criminal responsibilities. The CSRC
    may deliver administrative sanctions, such as warnings, fines, disqualification and
    banning the entry into the securities market of the companies and individuals responsible
    for violations. Those suspected of a criminal offence shall be transferred to the judicial
    departments to ascertain criminal liability. The company registration department and
    other competent departments may also punish violating companies, intermediaries and
    persons responsible by ordering them to return company property, confiscating the illicit
    gains, imposing a fine, cancelling company registration and revoking a business licence,
    ordering intermediaries to stop business operations and revoking qualification certificates
    of those directly responsible. Furthermore, shareholders may also, according to law, file
    lawsuits against those persons and institutions that have undermined the legitimate rights
    and interests of the company and its shareholders and claim civil damage. Companies in
    violation shall undertake the responsibility of civil compensation and pay the fines. When
    assets are insufficient, civil damage compensation shall be paid out first. Criminal
    responsibility shall be investigated when a criminal offence is involved.

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    1.2.1 Basic laws

    1.2.1.1 Company Law (2006)

    The Company Law (2006) is formulated to standardise the organisation and behaviour
    of companies, to protect the legitimate rights and interests of companies, shareholders and
    creditors, safeguard socioeconomic order and promote the development of a socialist
    market economy. It governs the incorporation and organisational structure of limited
    liability companies, equity transfers of limited liability companies, the incorporation,
    organisational structure, issuance and transfer of shares of companies limited by shares,
    the qualifications and obligations of company directors, supervisors and senior
    executives, corporate bonds, corporate finance and accounting, company mergers, splits,
    capital increases and reductions, company dissolution and clearance, branches of foreign
    companies and legal liabilities.

    1.2.1.2 Securities Law (2006)

    The Securities Law (2006) was drawn up to standardise securities issues and
    transactions, protect the legitimate rights and interests of investors, safeguard socio-
    economic order and public interests and promote the development of a socialist market
    economy. It governs securities issues, securities transactions, general provisions, listing
    of securities, disclosure of information, prohibited transactions, acquisition of a listed
    company, stock exchanges, securities companies, securities registration and clearance
    institutions, securities service organisations, securities industry associations, securities
    regulatory institution and legal liabilities.

    1.2.1.3 Criminal Law Amendment Act (6) (2006)

    Amendment VI to the Criminal Law (2006) was designed to match the amended
    Securities Law and Company Law, to give a more complete definition of legal liabilities
    in the securities field, improve the laws governing the securities market and promote its
    healthy development. The Amendment governs the following corporate governance-
    related offences: disclosure breaches, non-disclosure of major information, breach of trust
    and damage of listed company’s interests, insider trading and leakage of insider
    information and manipulation of securities or futures market.

    1.2.1.4 Law on the State-Owned Assets of Enterprises (2009)

    The Law on the State-Owned Assets of Enterprises
    3

    (2009) was promulgated to
    safeguard the country’s basic economic system, to consolidate and develop the state-
    owned sector, strengthen the protection of state-owned assets, allow the state-owned
    sector to play a dominant role in the national economy, and promote the development of a
    socialist market economy. The Law governs the institution that performs the function of
    investor, enterprises with funds from the state, the selection managers of enterprises
    funded by the state and the assessment of their performance, significant matters bearing
    on the rights and interests of the investor of state-owned assets, operational budgets of
    state-owned assets, supervision of state-owned assets and legal liabilities.

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    1.2.1.5 Accounting Law (2000)

    The Accounting Law (2000) was introduced to standardise accounting behaviour,
    ensure the truthfulness and completeness of accounting materials, strengthen economic
    administration and financial management, improve economic performance and safeguard
    the order of the socialist market economy. This law lays out requirements regarding
    accounting practices, special provisions on companies’ accounting practices, accounting
    supervision, accounting offices, accounting personnel, and legal liability.

    1.2.2 Administrative regulations and regulatory documents

    1.2.2.1 Regulations on the Administration of Company Registration (2005)

    These regulations provide for the confirmation that a company qualifies as a legal
    personality, standardised company registration and complete and standardised provisions
    concerning the establishment, alteration and termination of companies in terms of
    registration, registered items, registration of establishments, changes and cancellations, as
    well as registration procedures.

    1.2.2.2 Opinions on Promoting the Reform, Opening-up and Steady Growth of
    Capital Markets (2004)

    These opinions focus on the need to fully appreciate the importance of capital market
    development, the guiding ideology and tasks for promoting reform, and the opening-up
    and steady growth of capital markets. Efforts need to be made to improve relevant
    policies to promote the steady growth of capital markets. The structure of capital markets
    needs to be optimised and the range of investment securities expanded. The quality of
    listed companies needs to be improved and their operation should be standardised. Efforts
    should be made to promote the standardisation of intermediaries in the capital markets
    and strengthen their professional skills. The development and integrity of the legal system
    need to be promoted to raise the level of supervision over capital markets. Emphasis
    should be put on co-ordinated efforts to fend off and monitor market risks. Past
    experiences and lessons learned should be reviewed to steadily promote implementation
    of the opening-up policy.

    1.2.2.3 Circular of the State Council on its Approval of the CSRC’s Opinion on
    Improving the Quality of Listed Companies (2005)

    This document discusses how improving the quality of listed companies must be
    viewed as a priority. Corporate governance must be improved to enhance listed
    companies’ business performance and management and raise their level of standardised
    operations. Efforts need to be made to address both the symptoms and root causes of the
    quality issues pertaining to listed companies, especially related to outstanding problems.
    Effective measures must be taken to help listed companies grow and excel. Their
    supervision and management mechanisms must be improved and regulatory co-ordination
    must be strengthened. Better leadership and guidance should be provided to create a
    favourable environment for the healthy development of listed companies.

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    1.2.3 Regulatory provisions and normative documents

    1.2.3.1 Code of Corporate Governance of Listed Companies (2002)

    The Code of Corporate Governance for Listed Companies (2002) was drawn up in
    line with the basic principles established by the original Company Law, Securities Law
    and other relevant laws and regulations, and has made a positive contribution to
    promoting listed companies in China to establish and improve a modern enterprise
    system, standardise their operations and promote the healthy development of the
    securities market. The Code governs shareholders and shareholders’ meetings, listed
    companies and controlling shareholders, directors and board of directors, supervisors and
    the supervisory board, performance assessment and incentive and disciplinary systems,
    stakeholders, and information disclosure and transparency. The Code comprises the main
    measurement criteria used to judge whether a listed company has a sound corporate
    governance structure. The securities regulatory institution has the power to order the
    listed companies that have major problems in corporate governance to remedy them
    according to the Code. The CSRC is making active preparations to amend the Code,
    along with the amendments to the Company Law, Securities Law and other relevant laws
    and regulations, in order to adapt to the changed market environment, enhance the
    effectiveness of listed-company governance, encourage them to improve quality and
    promote the healthy development of Chinese capital markets.

    1.2.3.2 Regulations on Listed Companies’ Information Disclosure (2007)

    These regulations set out the requirements and listing particulars for the issuance of
    an Initial Public Offering (IPO) prospectus, offering circular, periodic reports, ad-hoc
    reports, information disclosure management, supervision and legal liability.

    1.2.3.3 Guidance on Listed Companies’ Articles of Association (2006)

    This document provides guidance on business purposes and scope, shares,
    shareholders and shareholders’ meetings, boards of directors, managers and other
    executives, supervisory boards, financial and accounting systems, profit distribution and
    auditing, public announcements and notices, mergers, divestments, capital increases and
    reductions, dissolution and liquidation, and revision of the articles of association.

    1.2.3.4 Rules on Listed Companies’ Shareholders’ Meetings (2006)

    These rules relate to the convening of shareholders’ meetings, their resolutions and
    related notifications, and supervisory measures.

    1.2.3.5 Guiding Opinions on the Establishment of the System of Independent
    Directors in Listed Companies (2001)

    These opinions provide guidance on independent directors, who must truly be
    independent and have the necessary qualifications to perform their duties. The
    nomination, election and appointment of independent directors must be conducted

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    according to the law and relevant regulations. Listed companies must accord the
    appropriate importance to independent directors and the role they play. Independent
    directors must have independent opinions on major issues affecting the listed company,
    which shall provide its independent directors with the required conditions to fulfil their
    roles.

    1.2.3.6 Provisions on Strengthening the Protection of the Rights and Interests of
    Public Shareholders (2004)

    These provisions cover the introduction of a trial public shareholder voting system on
    major issues pertaining to a company and the enhancement of the independent directors
    system, giving more importance to the role played by independent directors. They also
    seek to improve investor relations management and raise the quality of information
    disclosure by listed companies, including those with active profit distribution plans, and
    to reinforce the supervision of listed companies and their senior management.

    1.2.3.7 Regulations on the Takeover of Listed Companies (2006)

    These regulations outline listed companies’ requirements in relation to the disclosure
    of rights and interests, tender offers, block purchases, indirect purchases, exemption
    applications, financial advisors, ongoing supervision, supervisory measures and legal
    liability.

    1.2.3.8 Regulations on Major Asset Reorganisation of Listed Companies (2008)

    These regulations outline listed companies’ requirements in relation to the principles
    and standards, procedures and information management governing major asset
    reorganisation. They also include special provisions on issuing shares for asset purchase,
    applications for issuing new shares or company bonds after a major asset reorganisation,
    supervision management and legal liability.

    1.2.3.9 Regulations on Equity Incentives of Listed Companies (Trial) (2005)

    These regulations outline listed companies’ requirements in relation to general
    provisions, restricted shares, stock options, implementation procedures and information
    disclosure, supervision and penalties for breaches of regulations.

    1.2.3.10 Regulations on the Registration and Settlement of Securities (2006)

    These regulations outline listed companies’ requirements regarding institutions in
    charge of registering and settling securities, managing security accounts, trusteeship and
    depository of securities, the clearance and delivery of securities and money, risk
    prevention and handling delivery defaults.

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    1.2.3.11 Basic Standard for Enterprise Internal Control (2008)

    The Basic Standard covers the objectives, principles and elements that enterprises
    should establish and implement regarding internal controls, internal environments, risk
    assessment, control activities, information and communication, and internal supervision.

    1.2.4 Self-disciplinary rules

    1.2.4.1 Rules Governing the Listing of Stocks on the Shanghai Stock
    Exchange (2008), Rules Governing the Listing of Stocks on the Shenzhen Stock
    Exchange (2008)

    These rules cover: the general principles and provisions on information disclosure,
    directors, supervisors and senior management, appointed advisers/investment banks,
    listing of stocks and convertible bonds, periodic reports, general provisions on ad-hoc
    reports, resolutions of boards of directors, boards of supervisors and shareholders’
    meetings, transactions requiring disclosure, related-party transactions, other material
    matters, suspension and restoration of trading, special treatment, suspension, resumption
    and termination of listing, applications for review, co-ordination between domestic and
    overseas listings, day-to-day regulation and dealing with breaches of these rules.

    1.2.4.2 Trading Rules of the Shanghai Stock Exchange (2006), Trading Rules of
    the Shenzhen Stock Exchange (2006)

    These rules cover: the trading market, securities trading, other trading-related matters,
    trading information, supervision of trading activities, handling extraordinary
    circumstances during trading, trading disputes, trading fees, disciplinary sanctions.

    1.3 Institutional framework for the corporate governance of listed companies in
    China

    The institutional framework of China’s corporate governance is composed of three
    parts: the CSRC, the agency in charge of securities and futures markets; corporate
    governance-related government agencies, such as the Ministry of Finance, the state-
    owned Assets Supervision and Administration Commission, General Administration of
    Industry and Commerce, China Banking Regulatory Commission (CBRC), and China
    Insurance Regulatory Commission (CIRC); and stock exchanges and companies
    registering and settling securities.

    1.3.1 CSRC

    The CSRC is a public institution directly under the State Council. Pursuant to relevant
    laws and regulations, and with the mandate of the State Council, it performs a unified
    regulatory function over China’s securities and futures markets to make sure that market
    order is maintained and capital market operations comply with the law. CSRC is located
    in Beijing and has 18 functional departments, one inspection division and three centres. It

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    also has a public offering review committee and a merger and acquisition reorganisation
    review committee, composed of both CSRC professionals and invited experts from
    outside. The CSRC formally became a member of IOSCO in 1995, was elected as a
    member of the Executive Committee, the IOSCO’s decision-making body, for the first
    time in 1998, and has kept that position since then.

    In February 2009, CSRC joined the IOSCO Technical Committee, the standard-
    setting agency in international securities regulation. CSRC also co-operates actively and
    extensively with securities regulators in other countries and regions.

    The CSRC performs the following regulatory functions in the securities markets:

    • devises the relevant rules, regulations and measures for the securities markets
    according to law, and exercises the right to examine, approve and review
    according to law; regulate the issuance, listing, trading, registration, custody and
    settlement of securities according to law;

    • supervises securities-related businesses of issuers of securities, listed companies,
    stock exchanges, securities companies, securities registration and settlement
    institutions, securities investment fund management companies, and securities
    services organisations;

    • formulates qualification standards and codes of conduct for securities
    professionals and oversees their implementation, oversees and inspects the
    issuance, listing and trading of securities and information disclosure, provides
    guidance and supervision over the activities of securities-industry associations
    according to law, deals with activities in violation of market supervision and
    management laws and administrative regulations, and performs other duties as
    provided for by law and administrative regulations. CSRC can enter into co-
    operation with counterparts in other countries and regions and carry out cross-
    border supervision.

    The CSRC has established 36 securities regulatory bureaus in the provinces,
    autonomous regions, municipalities directly under the Central Government and cities
    specifically designated in the state plan. It also has a Shanghai Commissioner’s Office
    and a Shenzhen Commissioner’s Office. With regard to the supervision of listed
    companies, CSRC has established a local supervision responsibility system that features
    “local supervision, clear responsibilities, individual accountability and mutual co-
    operation”. This system has further clarified the terms of reference and positioning of the
    local branches of CSRC, and their role as “on-site” supervisors, and made supervision
    more timely, targeted and effective. Thanks to this system, regulatory resources have
    been integrated and strengthened and the work of CSRC has been able to advance in
    greater depth and with greater momentum.

    In order to put the local supervision responsibility system into operation, CSRC has
    accelerated the construction and improvement of the “comprehensive regulatory
    framework for listed companies”, a framework that involves the participation of many
    departments and local governments, which will make the regulatory work more
    authoritative and effective. The main group responsible for “the comprehensive
    regulatory framework for listed companies” is “the task force for standardised operations
    of listed companies”. This inter-agency task force was established in April 2005 under the
    mandate of the State Council and with the participation of representatives from
    12 ministries including the National Development and Reform Commission, Ministry of
    Public Security, Ministry of Finance, Ministry of Commerce, People’s Bank of China,

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    state-owned Asset Supervision and Administration Commission, General Administration
    of Customs, State Administration of Taxation, State Administration for Industry and
    Commerce, China Banking Regulatory Commission, and China Insurance Regulatory
    Commission. Its goal was to conduct a joint study on the major issues concerning the
    standardisation of listed companies, co-ordinate the activities of various departments,
    form regulatory synergy, and jointly promote standard practices among the listed
    companies. The task force, since its inception, has accomplished a lot in building a
    comprehensive regulatory system for listed companies, which is now in place. It has gone
    a long way towards strengthening co-ordination among relevant supervisory authorities,
    promoting the non-tradable share reform, preventing the misappropriation of funds by
    majority shareholders of listed companies and promoting the standardisation of listed
    companies.

    The law enforcement structure of the CSRC comprises four aspects. First, the
    enforcement bureau, whose main responsibilities include: organising, co-ordinating,
    guiding and supervising the investigation of cases, case filing and review, enforcing
    administrative punishment, cross-border law enforcement co-operation and anti-money
    laundering. Second, the enforcement contingent’s major responsibilities include:
    investigating major cases of insider trading, market manipulation and false statements and
    other important, urgent or sensitive cases affecting a wide range of sectors and areas.
    Third, local enforcement bureaus and their enforcement officials, whose major
    responsibilities include investigating cases within their jurisdictions, informal
    investigations and all sorts of co-operative investigation. Fourth, the administrative
    disciplinary bureau, which takes care of the trial of all cases.

    1.3.2 Government agencies with a role in corporate governance

    1.3.2.1 The Ministry of Finance, a department of the State Council and its
    responsibilities related to corporate governance mainly include:

    1. Drafting laws and regulations pertaining to financial and accounting management,
    devising and executing regulations and rules of financial and accounting
    management.

    2. Drafting distribution policies between the state and enterprises, managing central
    government budget that is allocated to support enterprises, drafting and
    organising the implementation of the General Rules of Finance for Enterprises,
    supervising the financial affairs of enterprises reporting directly to Central
    Government, managing the returns on state-owned assets, and administration over
    the asset-appraisal industry.

    3. Drafting and supervising the implementation of accounting rules and regulations
    and the Accounting Standards for Business Enterprises, drafting and supervising
    the implementation of the general government budget and the accounting system
    governing administrative institutions and industries, guiding and supervising the
    work of certified public accountants and accounting firms, guiding and managing
    social auditing, and examining and approving the establishment of branches of
    foreign accounting firms in China.

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    1.3.2.2 The state-owned Assets Supervision and Administration Commission, a
    special agency reporting directly to the State Council. Its responsibilities related
    to corporate governance mainly include:

    1. Authorised by the State Council, it performs shareholders’ responsibilities
    according to the Company Law and other laws and administrative regulations,
    supervises and manages the state-owned assets of the enterprises under the
    supervision of the Central Government (excluding financial enterprises), and
    enhances the management of state-owned assets.

    2. It supervises the preservation and enhancement of the value of supervised
    enterprises’ state-owned assets, including through statistics and auditing,
    introducing a system that establishes targets/objectives and enhances the value of
    state-owned assets. It also devises assessment criteria, is responsible for the
    management of wages and remuneration of supervised enterprises, and drafts and
    implements policies regulating the income distribution of their senior executives.

    3. Guides and drives forward the reform and restructuring of state-owned
    enterprises, advances the establishment of a modern SOE enterprise system,
    improves corporate governance, and promotes the strategic adjustment of the
    layout and structure of the national economy.

    4. It names directors and supervisors to state-controlled companies and companies
    with state-owned assets according to the relevant regulations and the respective
    companies’ articles of association.

    5. It is responsible for seeing to it that supervised enterprises turn state-owned
    capital gains over to the state, participates in devising management systems and
    methods for the state-owned capital operational budget, which it calculates and
    implements along with the final accounts, in accordance with related regulations.

    1.3.3 Stock exchanges and security registration and settlement company

    1.3.3.1 Shanghai and Shenzhen Stock Exchanges

    The Shanghai Stock Exchange was founded on 26 November 1990 and the Shenzhen
    Stock Exchange on 1 December 1990. Both are independent legal entities directly
    governed by CSRC. They provide venues and facilities for centralised securities trading,
    organise and supervise securities trading and exercise self-regulatory management. Their
    functions include: providing a marketplace and facilities for securities trading; drawing
    up business rules; accepting and arranging listings; organising and monitoring securities
    trading; regulating members and listed companies; and managing and disseminating
    market information.

    1.3.3.2 China Securities Depository and Clearing Corporation Limited

    Founded in 2001, the China Securities Depository and Clearing Corporation Limited
    is a non-profit legal entity directly governed by the CSRC, providing centralised
    registration, depository and settlement service for securities trading. Its main functions
    include: establishing and managing securities and settlement accounts; providing a venue
    for the depository and transfer of securities; registering securities holders’ names and

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    28 CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011

    rights; managing securities and financial clearing and settlement; distributing warrants on
    behalf of issuers; providing securities registration and settlement of business-related
    queries, information, advisory and training services according to laws.

    Notes

    1. Before 1983, SOEs turned their profits over to the government. With the progress of
    the economic reform, the distributional relationship between the government and the
    SOEs gradually changed to payment of tax by the latter according to the tax category,
    item and rate specified by the relevant authorities since 1983.

    2. The contract-based responsibility system was an operational and management system
    that established the respective responsibility, rights and interests of the governments
    and the SOEs in operational contracts according to the principle of separation of
    ownership and operations, which allowed enterprises to operate independently and
    shoulder responsibility for their own profits and losses while complying with socialist
    public ownership.

    3. State-owned assets of enterprises (simplified as “state-owned assets”) refer to the
    rights and interests formed by funding in various forms from the state to the
    enterprises.

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    CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011 29

    Chapter 2

    Shareholders’ rights

    2.1 Introduction to shareholders’ rights

    A common practice of Chinese company law theorists is to divide the rights of
    shareholders into “self-benefit rights” and “co-benefit rights” according to the purposes of
    exercising the relevant right. The self-benefit right can also be called a beneficiary right,
    referring to the shareholders’ right to seek to acquire economic benefits. These are
    manifested as rights in economic benefits. Co-benefit rights can also be called
    shareholders’ rights to govern or participate in the relevant company’s governance, and
    are manifested as a number of shareholders’ rights to participate in the company’s
    decision-making, operations, management, supervision and control.

    As far as the Company Law is concerned, in China, shareholders’ self-benefit rights
    include the right to request the distribution of a dividend, the right to request the
    distribution of residual assets, the right to transfer shares and the right to request share
    purchases. Shareholders’ co-benefit rights include the right to vote, the right to
    shareholders’ representative action, the right to request or convene general meetings of
    shareholders, proposal rights, enquiry rights, the right to revoke or confirm annulment of
    decisions of the shareholders’ meeting, the right to revoke or confirm annulment of
    decisions of the board of directors, inspection rights and cumulative voting rights.

    2.2 China’s practices compared with OECD principles

    2.2.1 Principle II A. Basic shareholder rights should include the right to:
    (1) secure methods of ownership registration; (2) convey or transfer shares;
    (3) obtain relevant and material information on the corporation on a timely and
    regular basis; (4) participate and vote in general shareholders’ meetings;
    (5) elect and remove members of the board; and (6) share in the profits of the
    corporation.

    2.2.1.1 Principle II. A (1): Secure methods of ownership registration

    According to Article 157 of the Securities Law, a securities registration and clearing
    institution performs the functions of custody and transfer of ownership of securities and
    registration of the names of the security holders. The Law’s Articles 160 and 162 also
    provide that on the basis of the results of securities registration and clearing, the
    institution shall confirm the fact that particular securities are held by particular holders
    and provide registered information on the security holders. It shall ensure the truthfulness,

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    accuracy and completeness of the register of security holders and the records of
    registration of change in ownership, that it may not forge, alter or destroy such register or
    records. The securities registration and clearing institution also carefully preserves the
    original evidence relating to registration, custody and clearing and important original
    evidence shall be kept for a period of no less than 20 years. In the early 1990s China set
    up securities depository and clearing institutions in Shenzhen and Shanghai and in 2001 a
    merged institution was formed, the China Securities Depository and Clearing Corporation
    Limited (SD&C). CSRC issued the Measures for the Administration of Securities
    Registration and Clearing in April 2006, providing fairly complete regulations on the
    registration of stock ownership. According to Article 28 of the Measures for the
    Administration of Securities Registration and Clearing, after a security has been the
    subject of a public offering, the issuer should submit to the securities registration and
    clearing institution a list of securities owners and other relevant information on the
    security issued. On this basis, the securities registration and clearing institution shall carry
    out initial registration of the list of securities owners. The securities issuer shall guarantee
    that the information provided be lawful, truthful, accurate and complete.

    China realised paperless securities for listed companies at a fairly early stage. The
    SD&C provides sound back-office support for the transfer of shares and follows universal
    rules, such as the delivery versus payment principle and the principle of mutual
    counterparties to ensure safety in conveying or transferring shares.

    2.2.1.2 Principle II. A (2): Conveying or transferring shares

    2.2.1.2.1 Freedom to convey or transfer shares

    Article 138 of the Company Law provides that shareholders can transfer shares in
    accordance with the law. Article 39 of the Securities Law provides that shares that have
    been lawfully approved for trading shall be traded on Chinese stock exchanges or other
    stock exchanges approved by the State Council. Article 102 of the Securities Law
    provides that the State Council shall determine the establishment and dissolution of a
    stock exchange. The stock exchange provides a venue and facilities where securities are
    collectively traded and organises and supervises securities trading. According to Articles
    111 to 113: investors sign agreements with securities companies, entrusting them with
    buying and selling securities for them. Entrusted by investors, securities companies will
    file trading declarations based on the rules of security trading, participate in collective
    trading and undertake clearing and delivery responsibilities according to transaction
    results. The securities registration and clearing institutions conduct stock clearing and
    delivery of securities and capital funds with securities companies in accordance with the
    rules of clearing and delivery, handle the procedures of security registration and transfer
    ownership for the clients of securities companies. Stock exchanges provide guarantees for
    the organisation of fair collective trading.

    For a shareholder of a listed company, shares may be transferred directly through
    stock exchanges’ automatic bidding system within trading hours and according to stock
    exchange trading rules. The securities registration and clearing company will, on the day
    after the transaction, transfer shares to the counterparty and cash to the seller. In addition
    to the automatic bidding system, for large-volume transactions, the two sides may choose
    to use the block-trading system, a transfer procedure, which is similar to that of the

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    automatic bidding system. In addition, shareholders may also convey or transfer shares by
    agreement between them.

    Article 29 of the Measures for the Administration of Securities Registration and
    Clearing provides that for securities listed and traded on stock exchanges, the securities
    registration and clearing institution shall update the registration of the list of security
    owners according to share transfers. For securities transferred through mutual agreement,
    succession, donation, compulsory enforcement or administrative allocation, the securities
    registration and clearing company shall adjust the balances of the relevant securities
    accounts and change the registration of the list of securities owners.

    2.2.1.2.2 Restrictions to transfer by certain shareholders

    Article 142 of the Company Law restricts the transfer of shares by some shareholders.
    Shares of a company held by its founder may not be transferred for a period of one year
    starting from the date of the company’s establishment. Shares that have been issued
    before the public offerings shall not be transferred for a period of one year starting from
    the date of trading of the company’s shares on a stock exchange.

    Each year the shares transferred within the term of office of the directors, supervisors
    and executives of the company shall not exceed 25% of the total shares of the company
    held by them. Their shares of the company shall not be transferred for a period of one
    year starting from the date of trading of the company’s shares on a stock exchange. If
    these people leave the company, they shall not transfer the shares of the company held by
    them for a period of six months from the date of their departure. The articles of
    association may otherwise provide for restrictions on the transfer of the company shares
    held by its directors, supervisors and executives that are more restrictive than the
    Company Law.

    2.2.1.3 Principle II. A (3): Obtaining relevant and material information on the
    corporation on a timely and regular basis

    Article 97 of the Company Law provides that a joint-stock limited company shall
    maintain its articles of association, the record of shareholders, the corporate bond
    counterfoils, the minutes of general shareholders’, board of directors’ and board of
    supervisors meetings, and its financial and accounting reports on the company’s premises.
    Article 98 provides that a shareholder is entitled to inspect the articles of association, the
    record of shareholders, the corporate bond counterfoils, the minutes of general
    shareholders’ meetings, the minutes of board of directors’ and board of supervisors’
    meetings, and the financial and accounting reports of the company, and is entitled to
    make a proposal or enquiry concerning the company’s operations. Article 146 provides
    that a listed company shall make public its financial conditions, operating conditions and
    major legal actions in accordance with the relevant laws and administrative regulations
    and shall make public its financial and accounting reports half-yearly in each fiscal year.
    Article 166 provides that the financial and accounting reports of a joint-stock limited
    company shall be available at the company’s premises for shareholders’ inspection as
    from the twentieth day prior to the annual general shareholders’ meeting and that a joint-
    stock limited company established through a public offering shall make public its
    financial and accounting reports. In addition, the Securities Law requires listed companies

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    32 CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011

    and companies whose bonds are traded on the market to disclose more information to
    investors. The Securities Law provides three types of disclosure obligations, annual
    reports, half-yearly reports and ad-hoc reports. The Administrative Measures for the
    Information Disclosure of Listed Companies promulgated by the CSRC and the Listing
    Rules of stock exchanges also contain relevant regulation. Details in this regard are
    provided in Chapter Four – Information Disclosure.

    2.2.1.4 Principle II. A (4): Participating and voting in general shareholders’
    meetings

    The Company Law has no restriction on shareholders’ participation in general
    shareholders’ meetings. According to the Company Law, when a shareholder attends a
    general shareholders’ meeting, each share he or she holds is entitled to one vote. Shares
    held by the company itself do not have voting rights. At present, joint-stock limited
    companies in China only issue common shares.

    Chinese companies that are listed both on the Chinese mainland and overseas may
    issue both domestic currency denominated shares on the mainland and foreign currency
    denominated shares overseas. According to Article 85 of the Articles of Association of
    Companies Seeking a Listing outside the PRC Prerequisite Clauses, if required by the
    rules of the stock exchange where the company is listed, the Articles of Association of the
    company shall contain clauses, such as “shareholders of domestic investment shares and
    those of foreign investment shares listed outside of the PRC are regarded as shareholders
    of different categories”. These shareholders will participate in the voting of general
    shareholders’ meetings according to their categories.

    Article 8 of the Code of Corporate Governance of Listed Companies in China
    promulgated by the CSRC in 2002 provides that “besides ensuring that general
    shareholders’ meetings proceed legally and effectively, a listed company shall make
    every effort, including making full use of modern information technology, to increase the
    number of shareholders attending the shareholders’ meetings. The time and location of
    the shareholders’ meetings shall facilitate shareholder participation”.

    The CSRC started to promote the network voting system in 2004. Now the network
    voting system is actively implemented at general shareholders’ meetings on matters
    related to material rights and shareholders’ interests.

    2.2.1.5 Principle II. A (5): Electing and removing members of the board

    According to Article 100 of the Company Law, the general shareholders’ meeting
    shall exercise the authority to elect and replace members of the board of directors.
    Shareholders may exercise their right to elect or remove members of the board through
    participation in general shareholders’ meetings.

    Furthermore, according to the relevant provisions of the Company Law, shareholders
    holding over 3% of shares (individually or collectively) have the right to propose
    candidates for the board of directors.

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    CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011 33

    2.2.1.6 Principle II. A (6): Sharing in the profits of the corporation

    Article 4 of the Company Law provides that the shareholders of a company are
    entitled to assets’ benefits. Accordingly, shareholders may participate in the distribution
    of profits of the company in proportion to their respective shares. The Company Law
    establishes the “same rights for same shares” principle, according to which each
    shareholder is entitled to dividends on the basis of his or her proportion of ownership.
    Shareholders who believe that their rights to share in the profits of the company have
    been infringed upon by a director or company executive may file a lawsuit according to
    Article 153 of the Company Law.

    The CSRC’s Provisions on Strengthening the Protection of the Rights and Interests of
    the General Public Shareholders (2004) make it clear that listed companies should
    implement proactive profit distribution. Guidance for the Articles of Association of
    Listed Companies (2006) provides that shareholders of listed companies obtain dividends
    and other forms of interest distribution according to the proportion of shares they hold. In
    order to guide and standardise dividend distribution by listed companies, CSRC published
    Decisions on Amending Certain Provisions on Cash Dividends by Listed Companies,
    requiring that listed companies state their cash dividends policy explicitly in the articles
    of association and that the profit distribution policy should maintain continuity and
    stability.

    2.2.2 Principle II. B: Shareholders should have the right to participate in, and
    to be sufficiently informed of, decisions concerning fundamental corporate
    changes.

    According to the Company Law, shareholders shall exercise the right to vote on the
    following matters:

    2.2.2.1 Principle II. B (1): Amendments to the articles of association

    By law, only the general shareholders’ meeting has the authorisation to amend a
    company’s articles of association. According to Article 104 of the Company Law, a
    resolution containing changes to the articles of association has to be adopted by the
    general shareholders’ meeting with a two-thirds majority.

    2.2.2.2 Principle II. B (2): Authorisation of changes in capital

    By law, only the general shareholders’ meeting has the authorisation to increase or
    reduce registered capital. Such a resolution has to be adopted by an absolute majority of
    voting rights in favour, accounting for two-thirds or more of the voting rights represented
    by the shareholders attending the General Shareholders’ Meeting. In practice, the board
    of directors usually proposes a change and provides the information to shareholders in
    advance before the meeting is convened. Article 41 of the Measures for the
    Administration of the Issuance of Securities by Listed Companies gives detailed
    provisions on the scope of approval by the general shareholders’ meeting regarding the
    issuance of shares by listed companies.

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    34 CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011

    2.2.2.3 Principle II. B (3): Major transactions

    According to Article 122 of the Company Law, any purchase or sale of major assets
    within one year or provision of a security in excess of 30% of the total assets by a listed
    company shall be deliberated and determined at a general shareholders’ meeting and the
    resolution should be adopted by an absolute majority of voting rights in favour,
    accounting for two-thirds or more of the voting rights represented by shareholders’
    attending the meeting. In practice, the board of directors announces the relevant
    information to the shareholders in advance before a general shareholder’ meeting is
    convened.

    2.2.2.4 Principle II. B (4): Mergers, divisions, dissolution and changes to
    corporate form

    The adoption of resolutions on these matters also requires affirmative votes by
    shareholders representing two-thirds of the voting rights at the general shareholders’
    meeting.

    2.2.3 Principle II. C: Shareholders should have the opportunity to participate
    effectively and vote in general shareholders’ meetings and should be informed
    of the rules, including voting procedures, which govern these meetings.

    2.2.3.1 Principle II. C (1): Shareholders’ right to receive information concerning
    the date, location and agenda of general meetings.

    Article 103 of the Company Law provides that in order to hold a general meeting of
    shareholders, notice concerning the time, venue and matters to be considered at the
    meeting shall be given to each shareholder 20 days in advance. In the event of an interim
    meeting of shareholders, the notice may be given 15 days in advance.

    The Guidance for the Articles of Association of Listed Companies amended by the
    CSRC in 2006 further improves the procedures for convening general shareholders’
    meetings in that companies may, according to their actual circumstances, decide whether
    to include in their articles of association a procedure for a public summons. Article 55 of
    the Guidance provides that the notice shall include the date, location and length of the
    general shareholders’ meeting as well as matters and proposals submitted to the meeting
    for deliberation. Furthermore, the annotation of Article 55 specially requires that the
    notice and supplementary notice about a general shareholders’ meeting shall give full and
    complete information about all detailed contents of all proposals and items. Article 56
    provides that if the election of directors or supervisors is to be discussed at the general
    shareholders’ meeting, full and detailed information about the candidates shall be
    disclosed in the notice, at minimum including personal information such as educational
    background, work experience and concurrent jobs, whether the candidate has any related-
    party relations with the company, its controlling shareholder or actual controller, the
    person’s holding of company’s shares and whether the person has been penalized by the
    CSRC or other competent departments or disciplined by a stock exchange. Article 57
    provides that after the announcement is issued a general shareholders’ meeting should not
    be delayed or cancelled without legitimate reason and items listed in the notice shall not
    be cancelled. If the meeting has to be delayed or called off, the convener shall make the

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    relevant public announcement and explain the reasons at least two working days before
    the original date of the meeting.

    The Listing Rules of Shenzhen and Shanghai Stock Exchanges also require listed
    companies to make available on designated websites other information necessary for
    shareholders to make reasonable judgement on matters to be discussed.

    In practice, listed companies in China usually announce specific information such as
    the date, location and issues to be reviewed of the general shareholder meeting in the
    media, including on the internet.

    2.2.3.2 Principle II. C (2): Shareholders’ right to propose resolutions and ask
    questions

    2.2.3.2.1 Right to propose resolutions. According to Article 103 of the Company
    Law, shareholders holding 3% of the shares of the company individually or jointly
    may, ten days prior to the general meeting of shareholders, submit an
    extraordinary written proposal to the board of directors. The board of directors
    shall, within two days of receipt of the proposal, inform other shareholders and
    submit the proposal to the general meeting of shareholders for deliberation.
    According to Article 22 of the Company Law if the board of directors of a
    company violates the above, shareholders may file a lawsuit in court for
    revocation of the resolutions of the relevant meeting.

    2.2.3.2.2 Enquiry right. Article 98 of the Company Law provides that a
    shareholder is entitled to make a proposal or enquiry concerning the way the
    company operates. Paragraph 1 of Article 151 further provides that when the
    general shareholders’ meeting requires a director, supervisor or executive to be
    present, they shall be present and answer the enquiries of shareholders. Article 29
    of the Rules for the General Meetings of Shareholders of Listed Companies,
    promulgated by the CSRC in 2006, provides that the directors, supervisors and
    senior managers shall provide explanations and responses to the enquiries of
    shareholders at the meetings.

    2.2.3.3 Principle II. C (3): Shareholders’ right to participate in corporate
    governance

    According to the Company Law, at the general shareholders’ meeting, shareholders
    are entitled to elect directors and supervisors, decide their remuneration, put forward
    proposals, vote on their proposals, put enquiries to the board of directors and executives,
    appoint and remove external auditors, and amend the articles of association.

    Furthermore, according to Article 37 of the Measures Governing Equity Incentive
    Plans of Listed Companies (Trial), promulgated by CSRC in 2005, general shareholders’
    meetings shall vote on the equity incentive plans of the company and the plan shall be
    adopted with two-thirds of the voting rights represented by shareholders attending the
    meeting.

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    36 CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011

    2.2.3.4 Principle II. C (4): Shareholders should be able to vote in person or in
    absentia, and equal effect should be given to votes whether cast in person or in
    absentia.

    According to Article 107 of the Company Law, a shareholder may attend a general
    meeting of shareholders by proxy. The proxy holder shall present the proxy statement
    issued by the shareholder to the company, and shall exercise his or her voting rights to the
    extent authorised by the proxy.

    Article 9 of the Code of Corporate Governance of Listed Companies provides that
    shareholders can either be present at the shareholders’ meetings in person or appoint a
    proxy to vote on their behalf, and both means of voting shall have the same legal effect.
    Article 10 of the Code further provides that the board of directors, independent directors
    and qualified shareholders of a listed company may solicit shareholders’ rights to vote in
    a shareholders’ meeting. No payment shall be made to shareholders for such solicitation,
    and adequate information shall be provided to the persons whose voting rights are being
    solicited.

    The CSRC introduced online voting in 2004. At present, active efforts are being made
    to use online voting for any resolution at the general shareholders’ meeting that bears on
    major rights and interests of shareholders. For further information, see
    Principle III. A (5) of Chapter 3.

    2.2.4 Principle II. D Capital structures and arrangements that enable certain
    shareholders to obtain a degree of control disproportionate to their equity
    ownership should be disclosed.

    When a shareholder attends the general shareholders’ meeting, each share is entitled
    to one vote. The principle of “one share, one vote” is followed in China.

    2.2.5 Principle II. E Markets for corporate control should be allowed to
    function in an efficient and transparent manner.

    2.2.5.1 Principle II. E (1): The rules and procedures governing the acquisition of
    corporate control in the capital markets, and extraordinary transactions such as
    mergers and sales of substantial portions of corporate assets, should be clearly
    articulated and disclosed so that investors understand their rights and recourse.
    Transactions should occur at transparent prices and under fair conditions that
    protect the rights of all shareholders according to their class.

    2.2.5.1.1 Article 85 of the Securities Law provides that investors may purchase a
    listed company by tender offer, agreement or other lawful means. Article 86 of the
    same law provides that where an investor possesses independently or jointly with
    other person(s) through agreement or other arrangements 5% of the stocks issued
    by a listed company through trading on the stock exchange, they shall, within
    three days, submit a written report to the securities regulatory body of the State
    Council and the stock exchange, notify the listed company, and make a public
    announcement. They are prohibited from buying or selling company’s stocks in

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    the period prescribed above. When an investor already possesses individually or
    jointly with other person(s) through agreement or other arrangement 5% of the
    stock of a listed company, they shall submit a report or make a public
    announcement in accordance with provisions of the preceding paragraph when the
    stocks of that company within their relevant joint possession increase or reduce by
    5% of the company’s total stocks. They are prohibited from buying or selling
    stocks of that company during the submission of the report and within two days
    after they make a public announcement. Article 88 further provides that when an
    investor, through trading on the stock exchange, possesses individually or jointly
    with other person(s) through agreement or other arrangement 30% of the stocks
    issued by a listed company and plans to make more purchases, he or she shall
    make a tender offer for all or part of the company’s shares to all shareholders as is
    required by law. The offer to purchase part of the shares shall include an
    agreement that when the amount of shares the shareholders commit to sell exceeds
    the offered amount to be purchased, the purchaser will make the purchase
    proportionately.

    2.2.5.1.2 The Administrative Measures on Takeover of Listed Companies,
    promulgated by the CSRC in May 2006, contain detailed procedures and
    information disclosure requirements for tender offer. To facilitate the acquisition
    of a listed company, the Measures also provide for exemptions. In cases
    consistent with Articles 62 and 63 of the Measures, the acquiring party may apply
    for an exemption on making a tender offer to the CSRC.

    2.2.5.1.3 Article 38 of the Administration Measures for Significant Asset
    Restructuring of Listed Companies provides that the shareholders or actual
    controllers of the listed company and relevant institutions and persons
    participating in the planning, negotiating and decision-making of significant asset
    restructuring shall report the relevant information to the listed company on a
    timely basis and accurately, and assist the listed company in making a disclosure
    in a timely, accurate and comprehensive manner. When the listed company has
    any knowledge of price-sensitive information, it shall apply to the stock exchange
    for trading suspension and disclose the information on a timely basis.

    2.2.5.1.4 The Listing Rules of the stock exchanges have similar provisions on
    information disclosure concerning the purchase and significant asset restructuring
    of listed companies.

    2.2.5.2 Principle II. E (2): Anti-takeover devices should not be used to shield
    management and the board from accountability.

    Article 8 of the Administration Measures on the Takeover of Listed Companies
    provides that the directors, supervisors and senior managers of an acquired company shall
    fulfil the loyalty and diligence obligations and treat all acquirers fairly. The decisions and
    measures of the acquired company’s directorate shall be conducive to maintaining the
    interests of the company and shareholders. The directorate shall not abuse its authority by
    setting unnecessary barriers to the acquisition, use the company’s resources to provide

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    financial aid in any form to the acquirers, or damage the lawful rights and interests of the
    company and its shareholders.

    2.2.6 Principle II. F: The exercise of ownership rights by all shareholders,
    including institutional investors, should be facilitated. Institutional investors
    acting in a fiduciary capacity should disclose their overall corporate governance
    and voting policies with respect to their investments, including the procedures
    that they have put in place for deciding on the use of their voting rights.
    Institutional investors acting in a fiduciary capacity should disclose how they
    manage material conflicts of interest that may affect the exercise of key
    ownership rights regarding their investments.

    2.2.6.1 Types of institutional investors in China

    Institutional investors in China mainly include securities investment funds, social
    security funds (administered by the National Council for the Social Security Fund),
    qualified foreign institutional investors, securities firms and insurance companies.
    According to statistics from the WIND database, up to 31 December 2009, the market
    value of A shares held by institutional investors accounted for 46.29% of the total market
    value of free-floated A shares.

    2.2.6.2 Ways for institutional investors to exercise their shareholders’ rights

    Article 11 of the Code of Corporate Governance of Listed Companies in China,
    promulgated by the CSRC in 2002, provides that institutional investors shall play a role in
    the appointment of company directors, the compensation and supervision of management
    and major decision-making processes. At present, securities investment funds in China
    have been proactive in participating in the governance of listed companies, either directly
    or indirectly.

    2.2.6.2.1 Indirect participation. Institutional investors, as important investors of
    the company, provide recommendations on decisions regarding company
    management, issue opinions on major corporate decisions and exercise their
    influence on the board of directors. Generally, after finding a target company, it is
    necessary for institutional investors to have effective communication and
    exchanges with the company management. Before further action is taken,
    institutional investors tend to solicit support from other major shareholders to
    convey a message of reform to the management, who is required to reform to
    increase the value of the company. If the company management pays no heed to
    such reform plans, a dispute over whether the management should be changed will
    be difficult to avoid.

    2.2.6.2.2 Direct participation. Institutional investors, as major investors of the
    company, participate in the operation and management of the company through
    the reorganisation of the board of directors, direct intervention in the company’s

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    major decisions, participation in the operation and management and the exercise
    of voting rights over proposals at the general shareholders’ meeting.

    Qualified foreign institutional investors do not usually participate directly in voting at
    the general shareholders’ meeting. When convened to a general shareholders’ meeting,
    they often entrust the board of directors of the listed company to vote on their behalf by
    delegating via the custodian bank.

    2.2.7 Principle II. G: Shareholders, including institutional shareholders, should
    be allowed to consult with each other on issues concerning their basic
    shareholder rights as defined in the Principles, subject to exceptions to prevent
    abuse.

    2.2.7.1 The Company Law provides that the shareholders of a limited liability
    company or a joint-stock limited company that individually or jointly hold 1% of
    the total shares may request in writing that the board of supervisors or the
    supervisors of a limited liability company without a board of supervisors file suit
    before a people’s court. Shareholders holding 3% of the total shares may put
    forward proposals, while and shareholders holding 10% of the total shares may
    convene a general shareholders’ meeting.

    2.2.7.2 Right to solicit voting rights. Article 10 of the Code of Corporate
    Governance of Listed Companies in China provides that the board of directors,
    independent directors and qualified shareholders of a listed company may solicit
    the shareholders’ rights to vote in a shareholders meeting. No payments shall be
    made to the shareholders for such solicitation, and adequate information shall be
    provided to persons whose voting rights are being solicited.

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    Chapter 3

    The equitable treatment of shareholders

    3.1 Introduction to the equitable treatment of shareholders

    There are two types of conflict of interest in corporate governance, one between
    majority and minority shareholders and the other between management and shareholders.
    These two types of conflicts of interest are manifested in different ways in different
    ownership structures. Generally, when ownership is spread among many shareholders, the
    conflict of interest between management and shareholders is more prominent. When the
    ownership is relatively more concentrated, the conflict of interest between majority and
    minority shareholders becomes comparatively more prominent. Although the level of
    ownership concentration decreased after the 2005 non-tradable share reform of the capital
    market, when Chinese listed companies are compared with those in the UK and the US,
    they show fairly concentrated ownership structures. Consequently, dealing with conflicts
    of interest between majority and minority shareholders is a core corporate governance
    question in China, in order to ensure that shareholders are treated equitably.

    There are three aspects to China’s institutional framework for the equitable treatment
    of shareholders.

    Firstly, the regime to ensure shareholders’ equitable participation in corporate
    governance includes, but is not limited to: equal voting power, low-cost participation in
    corporate governance by shareholders, inspection and enquiry rights, cumulative voting
    rights and the right to make proposals.

    Secondly, mechanisms to prohibit or regulate related-party transactions of majority
    shareholders include withdrawing voting rights from shareholders in a related-party
    guarantee, forbidding loans to related parties and the duty to compensate if damage is
    caused in related-party transactions.

    Thirdly, when the rights of medium and minority shareholders are infringed upon,
    mechanisms to ensure effective compensation and remedies include their rights to request
    the confirmation of the resolutions of general shareholder meetings’ and board meetings
    as null and void and thereby revoke them. They may also request compensation for
    damage done by controlling shareholders, compensation for damage done by directors or
    executives of the company, and are entitled to file derivative suits when the company’s
    interest is damaged by other person(s).

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    3.2 China’s practices compared with OECD principles

    3.2.1 Principle III. All shareholders of the same series of a class should be
    treated equally

    3.2.1.1 Principle III. A (1): Within any series of a class, all shares should carry
    the same rights. All investors should be able to obtain information about the
    rights attached to all series and classes of shares before they purchase. Any
    changes in voting rights should be subject to approval by those classes of shares
    that are negatively affected.

    The Company Law only provides for common shares and does not include preferred
    stock, deferred stock or golden shares. Hence in practice, there are no meetings for certain
    classes of shareholders. Article 104 of the Company Law provides that each share a
    shareholder holds is entitled to one vote.

    However, for companies listed not only on the Chinese mainland but also in the US,
    Hong Kong or elsewhere, shareholders may simultaneously hold A shares and H shares
    or A shares and N shares. In this situation, these companies need to hold shareholders’
    meetings for owners of different shares such as A, H or N for resolutions to be adopted
    separately. According to Article 79 of the Articles of Association of Companies Seeking a
    Listing outside the PRC Prerequisite Clauses, if the Company intends to change or
    abrogate the rights of shareholders of different categories it may do so only after such
    changes or abrogations have been approved by way of a special resolution of the general
    shareholders’ meeting and by a separate shareholders’ meeting convened by the affected
    shareholders of the relevant categories.

    3.2.1.2 Principle III. A (2): Minority shareholders should be protected from
    abusive actions by, or in the interest of, controlling shareholders acting either
    directly or indirectly, and should have effective means of redress.

    3.2.1.2.1 Right to convene general shareholders’ meetings

    Exercising voting rights at general shareholders’ meetings is the key channel for
    shareholders to exercise their rights. Therefore, when the rights and interests of minority
    shareholders are abused, whether they are entitled to convene a general shareholders’
    meeting and then exercise their voting rights at the meeting is a key indicator of the level
    of systematic protection of minority shareholders’ rights. Article 102 of the Company
    Law provides that where the board of directors or board of supervisors is unable or does
    not fulfil its duty to convene a general shareholders’ meeting, shareholders individually or
    jointly holding 10% of the company’s shares for 90 consecutive days or more may
    convene and chair a general shareholders’ meeting.

    3.2.1.2.2 Cumulative voting rights

    According to Article 106 of the Company Law, the general shareholders’ meeting
    shall adopt a cumulative voting system when voting on the election of directors or

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    supervisors in accordance with the articles of association or the resolution adopted by the
    general shareholders’ meeting.

    Article 82 of the Guidance for the Articles of Association of Listed Companies and
    Article 32 of Rules for the General Meetings of Shareholders of Listed Companies
    provide that when the general shareholders’ meeting votes on the election of directors or
    supervisors, the cumulative voting system may be implemented according to the
    provisions of the articles of association of the company or the resolution of the general
    shareholders’ meeting. Both documents require that companies make provisions in their
    articles of association pertaining to the method and procedure of appointing directors and
    supervisors and on cumulative voting rights. Certain Chinese listed companies have
    already included the cumulative voting system in their articles of association.

    3.2.1.2.3 Right to make proposals or motions and the right to proxy voting

    Article 103 of the Company Law provides that shareholders individually or jointly
    holding 3% of the shares of the company may, ten days prior to the general meeting of
    shareholders, submit a temporary written proposal to the board of directors. The board of
    directors shall, within two days of receiving the proposal, inform other shareholders and
    submit the proposal to the general meeting of shareholders for deliberation. Article 107
    provides that a shareholder may attend a general shareholders’ meeting by proxy, on
    condition that the proxy holder present the proxy statement issued by the shareholder to
    the company, and exercise the voting rights to the extent authorised by the proxy.

    3.2.1.2.4 Voting rights on major matters

    According to Articles 104 and 122 of the Company Law, a resolution adopted by the
    general meeting of shareholders requires affirmative votes by a majority of the
    shareholders attending the meeting. The resolution with regard to an amendment to the
    articles of association, an increase or reduction of registered capital, a merger, division or
    dissolution of the company or change in the form of the company as well as any purchase
    or sale of major assets within one year or provision of a security in an amount in excess
    of 30% of the total assets for a listed company, should be adopted by an absolute majority
    of voting rights in favour accounting for at least two-thirds of the voting rights
    represented.

    3.2.1.2.5 Equitable treatment of shareholders during the acquisition of a listed
    company

    3.2.1.2.5.1 Mandatory tender offers. According to Articles 88 and 96 of the
    Securities Law, when an investor, either through trading on the stock exchange or
    by agreement, owns 30% of the stocks issued by a listed company and plans to
    make more purchases, he or she shall make either a general or partial offer for a
    further shareholding increase to the company’s stockholders as is required by law.
    The provision protects minority shareholders from discriminative treatment in the
    process. The Administrative Measures on Takeovers of Listed Companies stresses

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    that if the acquirer makes a partial offer, the shares of shareholders who accept the
    offer must be acquired proportionately.

    3.2.1.2.5.2 Compulsory buy-outs. According to Article 97 of the Securities Law,
    upon the expiration of a tender offer, where the share distribution of the target
    company fails to fulfil the listing requirements, the listing of stocks of the said
    listed company shall be terminated by the stock exchange according to law.
    Shareholders who still hold the shares of the target company have the right to sell
    their shares pursuant to equal terms as stipulated in the relevant tender offer. The
    purchaser shall make the purchase.

    3.2.1.2.6 Repurchase request rights of dissenting shareholders.

    According to Article 143 of the Company Law, where shareholders of the company
    oppose the decision to merge or divide the company made at a general shareholders’
    meeting, they may request the company to purchase the shares they hold.

    3.2.1.2.7 Shareholder voting avoidance system in security provision to related
    party

    According to Article 16 of the Company Law, the security provided by a company to
    its shareholders or actual controller shall be determined by the shareholders meeting or
    the company’s general shareholders’ meeting. Such shareholders or the shareholders
    headed by the actual controller shall not participate in the voting process on the relevant
    matters. The vote on such matters shall be adopted by more than half of all the other
    shareholders attending the meeting.

    3.2.1.2.8 System of law suits filed by shareholder representatives

    According to Article 152 of the Company Law, when a director or executive is
    involved in the situation as described in Article 150, the shareholders of a limited liability
    company or a joint-stock limited company that individually or jointly hold 1% of the total
    shares for 180 consecutive days may make a written request to the board of supervisors to
    file suit before a People’s Court. Where a supervisor is involved in the circumstances
    described in Article 150, aforesaid shareholders may also make a written request to the
    board of directors to file suit before a People’s Court. Where the board of supervisors or
    the board of directors refuses to file suit after receipt of the written request mentioned
    above, or does not file suit within 30 days of receipt of the same, or comes across an
    emergency where, if no immediate actions are taken, the company’s interests shall be
    incurably impaired, then the shareholders may, in the interest of the company and on their
    own behalf, directly file suit before a People’s Court. Where the company’s legal rights
    and interests are violated by others and in the event of any losses incurred, the
    shareholders defined above may file suit before a People’s Court in accordance with the
    first two paragraphs of this Article.

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    3.2.1.2.9 Rights to compensation.

    Article 20 of the Company Law provides that the shareholders of a company shall
    exercise their shareholders’ rights in compliance with laws, administrative rules and
    regulations as well as the articles of association of the company. They shall not abuse
    their shareholders’ rights or go against the interests of the company or other shareholders.
    Where the abuse of shareholders’ rights causes any loss to the company or other
    shareholders, the shareholder who caused abuse shall be liable for compensation in
    accordance with the law. The law thereby establishes a fiduciary duty obligation for the
    controlling shareholders or actual controllers towards minority shareholders to prevent
    them from abusing their shareholders’ rights. Article 5 of the

    Guidance for the Controlling Shareholder and de Facto Controller of Companies
    Listed on SME Board issued by the Shenzhen Stock Exchange provides that the
    controlling shareholder and de facto controller shall shoulder loyalty and diligence
    obligations towards the listed company and minority shareholders. If their own interest is
    in conflict with that of the listed company or the minority shareholders the interests of the
    latter should be placed above their own.

    3.2.1.3 Principle III. A (3): Votes should be cast by custodians or nominees in a
    manner agreed upon with the owner of the shares.

    According to Article 107 of the Company Law, a shareholder may attend a general
    shareholders’ meeting by proxy. The proxy holder shall present the proxy statement
    issued by the shareholder to the company, and shall exercise the voting rights to the
    extent authorised by the proxy. Article 9 of the Code of Corporate Governance of Listed
    Companies in China further provides that shareholders may either be present at the
    general shareholders’ meetings in person or appoint a proxy to vote on their behalf. Both
    means of voting have the same legal effect.

    3.2.1.4 Principle III. A (4): Impediments to cross-border voting should be
    eliminated.

    Foreign shareholders of Chinese listed companies may directly participate in voting.
    There is no legal restriction to prevent this.

    3.2.1.5 Principle III. A (5): Processes and procedures for general shareholder
    meetings should allow for equitable treatment of all shareholders. Company
    procedures should not make it unduly difficult or expensive to cast votes.

    3.2.1.5.1 Rights to be informed about notice of a general shareholders’ meeting

    Notices of general shareholder meetings are all published in media available to the
    public. Minority shareholders may receive notices of general shareholders’ meetings at a
    low cost. Chinese law places do not require a shareholder to hold a particular number of
    shares to be eligible to attend a general shareholder meeting.

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    3.2.1.5.2 Right to make proposals

    Article 103 of the Company Law provides that shareholders individually or jointly
    holding 3% of the shares of the company may, ten days prior to the general shareholders’
    meetings submit a written proposal to the board of directors.

    3.2.1.5.3 Rights to online voting

    In order to protect the legitimate rights and interest of public shareholders, in
    December 2004 the CSRC promulgated the Regulations on Safeguarding Public
    Investors’ Interests. This document requires listed companies to provide an online voting
    platform for its shareholders when the general shareholders’ meeting discusses the
    following matters:

    (1) A public offering of new shares of the listed company (including overseas listed
    foreign shares or other types of warrants with a nature of shares), a public offering of
    corporate convertible bonds, and attribution of new shares to existing shareholders
    (except where the shareholder holding de facto control undertakes to make full cash
    subscriptions for the new shares before the general shareholders’ meeting is convened);

    (2) A major asset restructuring in which assets are acquired at a premium of more
    than 20% of the audited net assets value;

    (3) Repayment of debt owed by a shareholder in the form of equity reduction;

    (4) Overseas listing of subsidiaries that are significant to the parent company.
    According to the relevant provisions of the Guidance for the Articles of Association of
    Listed Companies in China, all listed companies in China have included in their articles
    of association clauses pertaining to providing facility for shareholders to attend general
    shareholders’ meetings via the internet. In 2004, both stock exchanges issued Detailed
    Rules on the Implementation of Online Voting at General Shareholder Meetings of Listed
    Companies, providing detailed rules for public shareholders to vote online.

    3.2.2 Principle III. B: Insider trading and abusive self-dealing should be
    prohibited.

    3.2.2.1 Principle III. B (1): Prohibition of insider trading

    By the end of the first half of 2010, the CSRC had investigated and taken action
    against 59 cases of insider trading. However, to date, there have been no civil suits
    involving insider trading.

    3.2.2.1.1 The Securities Law makes the “prohibition of insider trading” a basic
    principle (Articles 5 and 73). Article 76 of this law clearly provides that any
    insider who has access to insider information or has unlawfully obtained any
    insider information on securities being traded may not purchase or sell the
    securities of the relevant company, or divulge such information, or advise any
    other person to purchase or sell such securities. Where any insider trading incurs
    any loss to investors, the person responsible shall be subject to the liabilities of

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    compensation according to law. To define insider trading, the Securities Law also
    gives detailed provision on the scope of insiders and insider information (Articles
    74 and 75).

    3.2.2.1.2 Criminal liabilities of insider trading. According to Article 180 of the
    Criminal Law of the People’s Republic of China, any insider who possesses inside
    information about any stock exchange transactions or anyone who illegally
    obtains such information, prior to the publication of the information that concerns
    stock issuing or trading or that has a vital bearing on the stock price, buys or sells
    the very stock or divulges the very information shall be subject to criminal
    detention and/or confiscation of any illegal gains. If the circumstances are serious,
    they may be sentenced to fixed-term imprisonment of no more than five years.

    3.2.2.1.3 Administrative liability. According to Article 202 of the Securities Law,
    if an insider who has access to insider information of securities trading, or any
    person who has obtained insider information purchases or sells the securities,
    divulges the relevant information or advises any other person to purchase or sell
    the securities before disclosure of the information regarding the issuance or
    trading of securities or any other information that may have any significant impact
    on the price of the securities, he or she shall be ordered to dispose the securities as
    illegally held thereby according to law. The illegal proceeds shall be confiscated
    and a fine of 1 to 5 times the illegal proceeds shall be imposed. Where there are
    no illegal proceeds or the illegal proceeds are less than CNY 30 000 (EUR 3 255),
    a fine of CNY 30 000 (EUR 3 255) up to CNY 600 000 (EUR 65 100) shall be
    imposed. If an entity is involved in any insider trading, the person in charge and
    any other person directly responsible shall be given a warning and imposed a fine
    of CNY 30 000 (EUR 3 255), up to CNY 300 000 (EUR 32 550).

    Any official from a securities regulatory body that conducts any insider trading shall
    be given a heavier punishment.

    3.2.2.2 Principle III. B (2): Regulation of related-party transactions

    3.2.2.2.1 Shareholder voting avoidance system. Article 16 of the Company Law
    provides that where the company provides guarantees to its shareholders or actual
    controller, the shareholders or shareholders controlled by the actual controller
    shall not vote on the matter.

    3.2.2.2.2 Prohibition of lending to related parties. Article 116 of the Company
    Law provides that a joint-stock limited company must not lend money to its
    directors, supervisors or executives either directly, or through its affiliate
    companies.

    3.2.2.2.3 Decisions and disclosure of remuneration to the directors, supervisors
    and executives. According to Article 100 of the Company Law, the remuneration
    of the directors, supervisors and executives of shareholding companies shall be

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    determined by general shareholders’ meetings. Article 117 of the law further
    provides that a joint-stock limited company shall disclose the remuneration of its
    directors, supervisors and executives on a regular basis.

    3.2.2.2.4 Director voting avoidance system. According to Article 125 of the Company
    Law, the director of a listed company related to the enterprise involved in the matters
    discussed by the board of directors shall not exercise his or her own voting rights, or
    represent other directors to exercise voting rights on such matters. The meeting of the
    board of directors may be held when more than half of the unrelated directors are present.
    The resolution made by the board shall be adopted by more than half of all such directors.
    Where there are not more than three unrelated directors, the relevant matters shall be
    forwarded to the general meeting of shareholders for deliberation.

    3.2.2.2.5 General prohibition of related-party transactions by directors and executives.
    Article 149 of the Company Law provides that the director and executive may not execute
    any contract or engage in any transaction with the company in violation of the articles of
    association or without the approval of the general shareholders’ meeting.

    3.2.2.2.6 Damage compensation liability. Article 21 of the Company Law provides
    that the controlling shareholders, actual controllers, directors, supervisors or
    executives of a company shall not take advantage of their affiliations with others
    in an attempt to harm the company’s interests and where any losses are incurred in
    related violation, shall be liable for compensation.

    3.2.2.2.7 Criminal liability. The Amendment 6 to the Criminal Law adopted in
    2006 provides that where any director, supervisor or senior manager of any listed
    company goes against his or her fiduciary duty to the company and takes
    advantage of his or her position to manipulate the company in unfair, inequitable
    related-party transactions to transfer assets of the listed company resulting in it
    suffering serious loss, he or she shall be sentenced to fixed-term imprisonment of
    no more than three years, or detention, and/or shall be fined. If the listed company
    suffers from extremely serious losses, the person shall be sentenced to fixed-term
    imprisonment of no fewer than three years but no more than seven years, and shall
    be fined.

    3.2.3 Principle III. C: Members of the board and key executives should be
    required to disclose to the board if they have a material interest in any
    transaction or matter directly affecting the corporation, either directly,
    indirectly or on behalf of third parties.

    Article 21 of the Company Law provides that the controlling shareholders, actual
    controllers, directors, supervisors or executives of a company shall not take advantage of
    their affiliations with others in an attempt to harm the company’s interests and, where any
    losses are incurred in related violation, the company shall be liable for compensation.
    Article 149 of the Company Law contains a non-compete clause, prohibiting transactions
    with the company in violation of the articles of association and other prohibitions. Article
    48 of the Administrative Measures on Information Disclosure by Listed Companies
    promulgated by the CSRC provides that the directors, supervisors, executives,

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    shareholders with 5% or more of shares, and persons acting in concert with such
    shareholders and de facto controllers of a listed company shall submit a list of the listed
    company’s interested parties and an explanation of the interested-party relationships to
    the board of directors of the listed company. The listed company shall perform review
    procedures for interested-party transactions and strictly implement a system of vote
    abstention in interested-party transactions. The parties involved in an interested-party
    transaction must not circumvent the listed company’s interested-party transaction review
    procedures and information disclosure obligations either by concealing the interested-
    party relationship or by any other means.

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    Chapter 4

    Information disclosure

    4.1 Introduction to information disclosure

    Disclosing information is a legal obligation for listed companies. This does not only
    directly influence transparency and pricing efficiency – the critical basis upon which
    investors make investment decisions – on the securities market, but also serves as the
    lawful foundation of its principles “openness, fairness and impartialness” and the core of
    supervision over the market. In the course of capital market development and corporate
    governance reform, all the Chinese legislative bodies and relevant government agencies,
    regulatory institutions and self-regulatory organisations have attached great importance to
    the development of corporate information disclosure, and actively promoted its
    improvement in terms of quality and transparency. Some positive progress has been
    achieved in the form of an Omni-directional and multi-tier information disclosure
    regulatory framework. The laws that make up the bulk of this framework are
    supplemented by regulatory documents, such as relevant administrative laws and
    provisions, as well as ministerial rules and regulations. The regulations are consistent
    with international practices regarding normative principles, operational specifications,
    and disclosure methods and contents. Overall, information disclosure by listed companies
    has improved year by year, with constant progress in terms of the accuracy, scope and
    depth of disclosed information as well as its use by investors and intermediaries.

    At the same time, Chinese accounting standards and auditing standards are of a high
    quality and have met recognised international standards. The Chinese Accounting
    Standards Board signed the joint declaration with the International Accounting Standards
    Committee, indicating that Chinese accounting standards have achieved substantial
    convergence with international financial reporting standards.

    4.1.1 Basic principles of information disclosure

    Information disclosure is not only a legal obligation for listed companies but also the
    key channel for investors to keep track of them and for regulatory agencies to supervise
    them. Listed companies must take responsibility for the veracity, accuracy and
    completeness of the disclosed information. Article 63 of the Securities Law stipulates that
    the information disclosed by issuers and listed companies in accordance with the law
    must be authentic, accurate and complete, and may not contain false records, misleading
    statements or major omissions. Listed companies shall observe the following principles in
    disclosing information:

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    1. Principle of authenticity. The information disclosed by listed companies must be
    objective, consistent and standardised and may not contain false records.

    2. Principle of accuracy. The information disclosed by listed companies must be
    accurate and may not use vague expressions or misleading statements that cause
    confusion.

    3. Principle of completeness. Listed companies must make public the relevant
    information in compliance with laws, regulations and rules of securities
    regulatory institutions and stock exchanges and no major omissions are allowed.

    4. Principle of timeliness. Listed companies must disclose relevant information
    insofar as is possible without delay.

    5. Principle of fairness. Listed companies must treat all their investors in the same
    manner and must not disclose information to some certain investors only.

    4.1.2 Basic contents of information disclosure

    The Administrative Measures on Information Disclosure by Listed Companies
    stipulate that if the occurrence of a significant event is likely to have a marked impact on
    the trading prices of a company’s securities and derivatives, and the investors have yet to
    be informed, the listed company shall make a timely disclosure to declare the cause, the
    current status and the likely effect of the event. Thus, information disclosure shall not
    only refer to the reports that shall be disclosed regularly in accordance with the law, but
    also those transactions, which require timely disclosure by law.

    4.1.2.1 Information disclosure relating to issuance

    The Company Law, Securities Law, Administrative Measures on Information
    Disclosure by Listed Companies and the Standards on the Contents and Formats for
    Information Disclosure by Companies Offering Securities to the Public have made
    provisions on information disclosure related to issuance, including the disclosure of
    important documents such as prospectuses, statements of public security offerings by
    listed companies, statements of public bond offerings by listed companies, plans for
    private stock offerings and outcome reports, reports of major asset reorganisations by
    listed companies and the listing particulars.

    The main contents that should be disclosed are: basic information on the issuance and
    the issuer, major risk factors, the main business of the issuer and the industrial
    circumstances, horizontal competition and related-party transactions, the remuneration,
    irregular income, etc. of directors, supervisors, senior management and core technology
    personnel, corporate governance, financial and accounting conditions, discussions and
    analysis of management and business development targets, the situation of funds obtained
    through public or private offering and dividend policies.

    4.1.2.2 Regular reports

    The Company Law and Securities Law stipulate that listed companies shall disclose
    regular reports on a timely basis. These include annual reports, half-yearly reports and

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    quarterly reports. Administrative Measures on Information Disclosure by Listed
    Companies and the Standards on the Contents and Formats for Information Disclosure
    by Companies Offering Securities to the Public, the Rules of Contents and Formats for
    Information Disclosures by Companies Offering Bonds to the Public, etc. contain detailed
    stipulations on the contents and formats of regular reports.

    4.1.2.2.1 Annual reports. Listed companies and companies whose bonds are
    traded on stock exchanges shall submit annual reports to the CSRC and stock
    exchanges, and announce them within four months after the end of every
    accounting year. Annual reports shall disclose the basic information about the
    company, key accounting data and financial indices, information on shareholders,
    information on the appointment of directors, supervisors and executives, changes
    to their shareholdings, their annual remuneration, operating conditions, major
    events, the board of directors’ report, management discussions and analysis, the
    financial accounting report and auditing report, etc.

    4.1.2.2.2 Semi-annual reports. Listed companies and companies whose bonds are
    traded on stock exchanges shall submit half-yearly reports to the CSRC and stock
    exchanges. These reports should be announced within two months of the end of
    every first-half of each accounting year. The half-yearly report shall disclose basic
    information about the company, main accounting data and financial indices, and
    any changes among the controlling shareholders and actual controlling parties of
    the company, management discussions and analysis, major matters in litigation or
    arbitration, and other significant events that occurred during the reporting period
    and their effect on the company, the financial accounting reports, etc.

    4.1.2.2.3 Quarterly reports. A quarterly report shall be compiled and disclosed
    within one month of the end of every quarter. The time of publication of the first
    quarterly report shall not be earlier than the time of publication of the annual
    report for the preceding year. A quarterly report shall include basic information
    about the company, main accounting data and financial indices, etc.

    4.1.2.3 Ad-hoc reports

    Unlike regular reports, ad hoc reports are one-off announcements. The Administrative
    Measures on Information Disclosure by Listed Companies require that where the
    occurrence of a significant event is likely to have a marked impact on the trading prices
    of a company’s securities and derivatives, and the investors have yet to be informed, the
    listed company shall make a disclosure to declare the cause, the current status and the
    likely effect of the event on a timely basis. These events may be divided into transactions
    and non-transactions, and transactions may be divided into general transactions and
    related-party transactions.

    4.1.2.3.1 Transactions. Transactions refer to the activity of transferring resources
    or obligations between the listed company or its holding subsidiaries and trading
    partners. These transactions are not usually directly connected to the company’s

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    production or operations and occur in a non-recurrent (or sporadic) manner. They
    include: activities outside the company’s daily business operations, such as asset
    purchases and divestments, external investments, providing financial aids and
    guarantees, asset renting and leasing, management contracts, donations, debt
    restructuring and the transfer of R&D projects. Detailed standards for accounting
    transactions that require disclosure are clearly stipulated in the Administrative
    Measures on Information Disclosure by Listed Companies and the Measures for
    the Administration of Material Asset Reorganisations by Listed Companies, the
    Listing Rules made by the stock exchanges. The information disclosed includes
    the announcement of transactions, relevant agreements and contracts. If there are
    related board decisions, government approvals, financial reports of the
    transaction, appraisal reports, auditing reports, legal opinion papers or financial
    consultation reports issued by intermediaries, they should also be disclosed.

    4.1.2.3.2 Related-party transactions. Related-party transactions refer to the transfer
    of resources or obligations to and from the listed company, its subsidiaries and
    related-party entities. The Securities Law and Administrative Measures on
    Information Disclosure by Listed Companies, etc. prescribed requirements for
    undertaking related-party transactions. A related-party transaction shall disclose the
    voting results of the board of directors, the time at which an agreement is signed,
    the time and place of the transaction, the relationship between all the related parties,
    the subject of the transaction, pricing policies, main contents of the contract, the
    purpose of the transaction, its implications for the listed company and conditions
    enabling the transaction to come into effect, etc. More specifically, it should include
    the opinions of independent directors, reports by relevant intermediaries, the
    situation concerning to the withdrawal of related directors from board voting,
    special explanations by the board on whether this related-party transaction is
    beneficial for the listed company, board of directors’ decisions, the agreement on
    the related-party transaction, records of disagreement or reservations on the part of
    directors who do not wish to speak at the board meeting.

    4.1.2.3.3 Announcement of non-transactions. Non-transactions mainly include
    information on shareholders, the board of directors, the board of supervisors, the
    announcement of decisions taken at the shareholders’ meeting, the distribution of
    dividends, converting the reserved funds into increased capital, changes to issued
    funds, significant matters on litigations and arbitrations, business result forecasts,
    etc. The scope of significant events is stipulated in the Securities Law,
    Administrative Measures on Information Disclosure by Listed Companies, Listing
    Rules, etc.

    4.1.2.3.4 Information disclosure on acquisition.

    In accordance with the Administration Measures on the Takeover of Listed
    Companies, if shares held by an investor represent 5% of a listed company’s issued
    shares, the investor shall make a report on the alteration to share entitlement within three
    days after the fact, submit a written report to the supervisory bodies, notify the listed
    company and make a public announcement. Investors may not buy or increase the stocks

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    of the aforementioned listed company again before making the public announcement.
    Once shares held by an investor reach 5% of a listed company’s issued shares, or if the
    shares in question increase or decrease by 5% in securities transactions on the stock
    exchange, the investor shall provide a report and make an announcement within three
    days after the fact, and shall not buy shares within five days and may not increase shares
    before making a public announcement. When a purchaser holds 30% of shares, and
    continues to increase the stake, a general or partial tender offer is required, unless
    exemption is obtained from the CSRC.

    In addition to the above conditions, the Shenzhen and Shanghai Stock Exchanges
    have both issued documents entitled Guidance on Internal Control of Listed Companies,
    with a chapter dedicated to information disclosure regarding internal control. The chapter
    provides that a listed company should report to its board of directors on a timely basis
    when it finds major flaws or risks in internal control during its inspection or supervision
    process. The matter should be reported to the relevant stock exchange by the board of
    directors on a timely basis. Upon confirmation by the stock exchange, the board of
    directors should issue a public notice, in which the relevant flaw in internal control, its
    consequence, accountability and proposed remedies should be described.

    4.1.3 The Construction of Extensible Business Reporting Language (XBRL)

    Stock exchanges have been receiving annual reports submitted by listed companies
    through XBRL since December 2008. The Shanghai Stock Exchange can even receive
    half-yearly reports and quarterly reports through XBRL. At the Shenzhen Stock
    Exchange, the XBRL service platform has the function to search and display information
    and customers can download the XBRL documents with regular reports of all listed
    companies.

    4.2 China’s practices compared with OECD principles

    4.2.1 Principle V. A Disclosure should include, but not be limited to information
    on: 1. companies’ financial and operating results; 2. company objectives;
    3. major share ownership and voting rights; 4. remuneration policy for
    members of the board and key executives, and information on directors,
    including their qualifications, the selection process, other company
    directorships and whether they are regarded as independent by the board;
    5. related-party transactions; 6. foreseeable risk factors; 7. issues regarding
    employees and other stakeholders; 8. governance structures and policies, in
    particular, the content of any corporate governance code or policy and the
    process by which it is implemented.

    4.2.1.1 Principle V. A (1): Financial and operating results of the company

    4.2.1.1.1 Regularly published financial reports

    Article 165 of the Company Law stipulates that a company shall prepare its financial
    reports and accounts after the end of each financial year, and they shall be audited by an
    accounting firm in accordance with the law.

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    When disclosing annual financial reports, Chinese listed companies are required to
    observe the General Regulations on Financial Reports issued by the CSRC. Chinese law
    stipulates that annual reports shall be audited by accounting firms qualified to carry out
    audit securities and futures activities, and the auditing reports shall be stamped by the
    aforesaid firms and (?) stamped or signed by two or more of their registered accountants.
    The annual reports of the company compiling and consolidating financial statements,
    consolidated companies and special purpose entities (SPEs), as well as those of affiliated
    companies and joint ventures, which have enormous influences upon a company’s annual
    reports, shall be audited by the accounting firm qualified to audit the items pertaining to
    securities and futures activities. Financial statements disclosed shall include the balance
    sheet, profit statement, cash flow statement, and statement of any changes in equity. The
    company that compiles consolidated financial statements shall also provide the financial
    statements of its parent company separately. The listed company shall compile and
    publish notes to financial statements. The principle of priority shall be applied in
    compiling and disclosing those notes. Notes to financial statements shall provide clear,
    accurate and comprehensive explanations on transactions and events mentioned therein.

    In accordance with the Administrative Measures on Information Disclosure by Listed
    Companies, besides publishing annual reports, half-yearly reports must be prepared and
    disclosed within two months of the end of the first half of each fiscal year; and quarterly
    reports shall be prepared and disclosed within one month of the end of each fiscal year’s
    third and ninth months. The half-yearly reports and quarterly reports do not need to be
    audited by external accountants, but they have to comply with the contents and formats
    set by the CSRC.

    4.2.1.1.2 Regular disclosure of management discussions and analyses

    The Standards on Contents and Formats for Annual Reports and the Standards on
    Contents and Formats for Half-yearly Reports stipulate that listed companies shall
    discuss and analyse major events that occur in the reporting term in the Director’s Report
    section to facilitate investors’ understanding of operating results and financial conditions.
    These discussions and analyses shall not merely repeat the contents of financial reports,
    but focus on major events and uncertainties, which may cause difficulties, and which are
    difficult for financial reports to reflect. These may concern the company’s future
    operating results and financial conditions and matters that influence them, but also
    matters that have a significant effect on the reporting term, but not on the future.

    4.2.1.2 Principle V. A (2): Company objectives

    A company is an organisation set up to make a profit through business activities or for
    other purposes. The Company Law stipulates that in seeking to make a profit, a company
    shall also take into consideration the interests of its creditors, employees and the general
    public, and assume its social responsibility.

    Often, the objectives of a company are recorded in its Articles of Association. The
    Guidance for the Articles of Association of Listed Companies stipulates that a listed
    company shall explicitly define its business aims when developing its Articles of
    Association.

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    In addition to the Articles of Association, the Standards on the Contents and Formats
    for Annual Reports stipulates that a listed company shall describe in the Director’s Report
    section of its annual report its vision for the company’s future, including its strategy for
    corporate development in the future, new business, new products to be developed, new
    projects requiring investment, as well as the related plans for financing and funding.
    Moreover, the company shall also disclose all possible risks, which may adversely
    influence the corporate development strategy and the achievement of its business goals.

    4.2.1.3. Principle V.A (3): Major ownership and voting rights

    4.2.1.3.1 Information disclosure requirements for Initial Public Offerings (IPO)

    In accordance with the Securities Law and relevant CSRC regulations, and before
    making an IPO and going public, a company shall provide detailed information in its
    prospectus on the founder, the major shareholders holding 5% or more of the shares, the
    actual controllers, the controlling shareholders, and other enterprises controlled by the
    controlling shareholders and actual controllers, and changes to stock ownership since the
    establishment of the company. The Company Law defines an actual controller as anyone
    who is not a shareholder but is able to hold actual control over a company’s acts by
    means of investment relations, agreements or other methods. Opinion No.1 in The
    Application of Securities and Futures Laws: the Interpretation and Application of “no
    alteration of the actual controller” in Article 12 of the Measures for the Administration
    of Initial Public Offering and Listing of Stocks, the control of a company refers to the
    power to exert an influence on the resolutions of shareholders’ meetings or to control the
    company as a result of direct or indirect equity investment in the company. In this
    connection, in order to determine the control of a company, corresponding equity
    investments should be reviewed and analysis should be made concerning the substantive
    influence by the relevant persons on the decisions of shareholders’ and board meetings
    and on the nomination and appointment of directors and senior executives according to
    the specific situations. Any information disclosure concerning a company’s actual
    controllers shall be extended to the persons, state-owned asset management bodies or
    other organisations, or persons who have reached certain agreements or assented to
    certain arrangements among the shareholders, including the situation where actual control
    is realised by means of trust.

    4.2.1.3.2 Information disclosure requirements for periodic reports

    In line with relevant CSRC regulations, all listed companies shall disclose
    information on the ownership and voting rights of its major shareholders in annual reports
    and half-yearly reports. This information should include: the total number of shareholders
    by the end of the reporting period, basic information and shareholding information for
    shareholders holding 5% or more of the company’s stock, as well as changes in shares
    within the reporting period. Any listed company, when disclosing its annual report, shall
    disclose the information on the actual controllers and the property and control
    relationships between the company and its actual controllers.

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    4.2.1.3.3 Information disclosure requirements for major equity changes

    All listed companies in China shall disclose information when certain thresholds of
    ownership are passed. In accordance with the Administration Measures on the Takeover
    of Listed Companies, a change-in-equity report should be compiled when the equity of an
    investor and persons acting in concert with that investor reaches 5% or more of a listed
    company’s total issued shares by trading on the stock exchanges, within three days after
    the fact. Moreover, a written report shall be submitted to the CSRC and the stock
    exchanges, and a copy filed to the CSRC branch(es) in the place where the listed
    company’s headquarters are located. The listed company shall also be informed, and a
    change-in-equity announcement made.

    When the equity of an investor and persons acting in concert with that investor
    reaches 5% of a listed company’s total issued shares, this must be reported and
    announced in line with the preceding paragraph, when shareholdings are increased or
    decreased by 5% through trading on the stock exchanges.

    The said investor and persons in concert with that investor may not purchase or sell
    company shares until the report and announcement are made.

    4.2.1.4. Principle V.A (4): The remuneration policy for members of the board and
    key executives, and information on directors, including their qualifications, the
    selection process, other company directorships and whether they are regarded as
    independent by the board.

    4.2.1.4.1 Basic information on directors, supervisors and senior managers

    The Standards on Contents and Formats for Annual Reports stipulate that any listed
    company shall disclose certain information on its directors, supervisors and senior
    managers, including:

    • Their names, gender, age, term of office, shares held at the beginning and end of
    the reporting year, stock options, amount of restricted shares conferred, changes
    in shares within the reporting year and reasons for the changes.

    • The directors, supervisors and senior managers shall meet the qualifications
    provided by the Company Law and the Guidance for the Articles of Association of
    the Listed Companies (see “Chapter V Responsibilities and Supervision of the
    Board of Directors (V) Principle VI.E”).

    • If a director is independent, this shall be indicated separately. For more
    information about the independent director standards and system, please refer to
    “Chapter V Responsibilities and Supervision of the Board of Directors (V)
    Principle VI.E”.

    • Major working experience over the past five years. If any director holds a position
    in a shareholder’s company, his duties in the company and directorships in other
    companies shall also be indicated.

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    4.2.1.4.2 Qualifications and independence

    Article 147 of the Company Law provides that a person in any of the following
    categories may not serve as a director, supervisor, or senior executive of a company: (1) a
    person without civil capacity or with limited civil capacity; (2) having been sentenced to
    criminal punishment for crimes of embezzlement, bribery, conversion of property,
    misappropriation of property, sabotage of socialist market economic order in the previous
    five years, or having been deprived of political rights as a result of a criminal conviction
    in the previous five years; (3) having served as a director, factory chief, or general
    manager of a company or enterprise, which filed for bankruptcy or liquidation and being
    personally responsible for such bankruptcy in the previous three years; (4) having served
    as the legal representative of a company or enterprise whose business licence was
    revoked due to violation of the law and being personally responsible for such revocation
    in the previous three years; or (5) in default of personal debt of a significant amount. The
    Guiding Opinion on the Establishment of the Independent Directors’ System by Listed
    Companies (2001) provides qualifications for independent directors of listed companies.
    The CSRC Notice on General Managers and Executives of Listed Companies May Not
    Hold Concurrent Positions in the Organisations of Controlling Shareholders states
    clearly that the general manager of a listed company must work full-time and may not
    hold any post other than a director in the organisation of the controlling shareholder and
    that general managers and executives (deputy general manager, chief financial officer and
    secretary of the board of directors) must be remunerated by the listed company and may
    not receive a salary from the controlling shareholder.

    4.2.1.4.3 Remuneration of directors, supervisors and senior managers

    The Company Law stipulates that a company shall disclose to its shareholders the
    payment received by its directors, supervisors and senior managers.

    The Standards on Contents and Formats for Annual Reports provide that the total
    pre-tax remuneration (including basic pay, bonuses, allowances, subsidies, welfare
    benefits, insurance premiums, accumulation funds, annuities and other forms of payment
    by the company) received by the directors, supervisors and senior managers of a listed
    company within the reporting period shall be disclosed. Moreover, stock options shall
    also be indicated separately in line with the volume of outstanding shares, volume of
    strike shares, the strike price and market price by the end of the reporting period.

    Apart from remuneration information, all listed companies shall also disclose
    information on the decision-making process concerning the remuneration of directors,
    supervisors and senior managers, the basis on which remuneration is established, and the
    actual payment of the remuneration.

    The Code of Corporate Governance of Listed Companies stipulates that the board of
    directors of a listed company may establish a remuneration and appraisal committee in
    accordance with the resolutions of the shareholders’ meetings. It shall be composed solely
    of directors and chaired by an independent director, and independent directors shall
    constitute the majority of the committee. The main duties of the remuneration and
    appraisal committee are to study the appraisal standard for directors and management
    personnel, to conduct an appraisal and make recommendations, and to study and review
    the remuneration policies and schemes for directors and senior managers.

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    Senior managers of a listed company may not receive payment from any other
    company controlled by the controlling shareholders and actual controllers of the listed
    company. In case the directors and supervisors do not receive any payment or subsidies
    from the company, it must be explicitly indicated whether they receive any payment or
    subsidies from the shareholders’ companies or any other associated organisations.

    In accordance with the Administration Measures on Equity Incentives of Listed
    Companies, a listed company’s equity incentive plan shall be approved by a vote of more
    than two-thirds of the directors attending the shareholders’ meeting, and the resolution
    and related documents shall be disclosed on a timely basis. A listed company shall
    disclose the implementation of the equity incentive plan in its periodic report within the
    reporting period, including: the scope of incentives within the reporting period; the
    aggregate amount of rights and interests granted, exercised and invalidated within the
    reporting period; all previous adjustments to the granted price and strike price within the
    reporting period; exercise of incentive rights objects; equity changes due to the exercise
    of incentive rights objects; and accounting methods dealing with equity incentives.

    4.2.1.4.4 Election of directors, supervisors and senior managers

    The Company Law stipulates that the non-employee directors and supervisors of a
    joint-stock company shall be elected during the shareholders’ meeting; all employee
    representatives who serve as a director or supervisor shall be elected by employees
    through the employee representatives’ meeting. CSRC has laid down the requirements
    and standards for the election and appointment process of directors and supervisors.
    These stipulate that a listed company shall provide for the election and appointment
    process of directors and supervisors in its Articles of Association. Detailed information
    on candidate directors and supervisors shall be disclosed in advance before the
    shareholders’ meeting is convened in order to ensure that the shareholders have sufficient
    information about the candidates when voting. The resolution of the shareholders’
    meeting on the election of directors and supervisors shall be announced in a timely
    manner in the newspapers and on the websites designated by the stock exchanges.

    The Company Law provides that the board of directors shall decide on the
    employment of managers and their remuneration, as well as the employment of other
    senior managerial personnel in line with nominations put forward by managers. Any
    decision of the board of directors on the employment and appointment of managers and
    other senior managerial personnel shall be announced in the newspapers and on the
    websites designated by the stock exchanges on a timely basis.

    The Code of Corporate Governance of Listed Companies stipulates that the board of
    directors may establish a nomination committee in accordance with the resolutions of the
    shareholders’ meetings. It shall be composed solely of directors, chaired by an
    independent director, and independent directors shall constitute the majority of the
    committee. The main duties of the committee are to study standards and procedures for
    the election of directors and make recommendations, to extensively seek qualified
    candidates for directorship and management, and to review the candidates for directorship
    and management and make recommendations.

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    4.2.1.5 Principle V.A (5): Related-party transactions

    4.2.1.5.1 Affirmation of related-party relationship

    Related-party transactions are a key issue for the corporate governance and
    supervision of China’s listed companies. The Company Law stipulates that the related-
    party relationship refers to the relationship between company’s controlling shareholders,
    actual controllers, directors, executives and the enterprises it controls directly or
    indirectly, and other relationships which may influence the company’s current
    shareholding structure. However, state-owned holding enterprises are not considered to
    be in a related-party relationship merely because they are controlled by the state as well.

    The affirmation of related-party relationships has been stipulated in the Listing Rules
    of the stock exchanges in detail: the connected persons of the listed companies shall
    include the connected legal personalities or entities and natural persons or individuals,
    among which:

    The connected legal personalities shall include: (1) the legal person directly or
    indirectly who controls the listed company; (2) and the directly or indirectly controlled
    legal person (excluding the listed company and its subsidiaries); (3) the legal person
    directly or indirectly controlled by the connected natural person of the listed company or
    taking the positions as directors and executives (excluding the legal person from the listed
    company and its subsidiary); (4) the legal person holding more than 5% of the shares of
    the listed company; (5) and other legal persons determined by the CSRC, stock exchanges
    or listed companies in accordance with the principal of “substance overweighs forms”
    having a special relationship with the listed company, which may result in the interests of
    the listed company favouring them.

    The connected individuals shall include: (1) the natural person who directly or
    indirectly holds more than 5% of the shares of the listed company; (2) the directors,
    supervisors or executives of the listed company; (3) the directors, supervisors or
    executives of the connected legal persons; (4) the family members having a close
    relationship with the persons mentioned in Item (1) and (2) of this Article, including the
    spouse, parents, parents of the spouse, brothers and sisters and their spouses, the children
    aged 18 years old or above and their spouses, brothers and sisters of the spouses, as well
    as parents of their children’s spouses; (5) other natural persons determined by the CSRC,
    stock exchanges or listed companies according to the principal of “substance outweighs
    forms” having a special relationship with the listed company, which may result in the
    interests of the listed company favouring them.

    In addition, those who qualify as the above-mentioned connected legal persons and
    natural persons within the next 12 months or previous 12 months shall also be considered
    as connected persons.

    The Accounting Standards for Enterprises No.36—Disclosure of Related Parties also
    require the affirmation of the connected parties, when: a party controls, jointly controls or
    exercises significant influence over another party, or when two or more parties are under
    the control, joint control or significant influence of the same party, related-party
    relationships are constituted. In accordance with accounting standards, the following
    parties constitute related parties of an enterprise: (1) the parent company thereof; (2) the
    subsidiaries thereof; (3) other enterprises under the control of the same parent company;
    (4) investors having joint control over the enterprise; (5) the investors with significant
    influence upon the enterprise; (6) joint ventures thereof; (7) the associated enterprises

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    thereof; (8) the main individual investors and the close family members thereof. A main
    individual investor refers to an individual investor who can control or jointly control an
    enterprise, or has significant influence thereof; and (9) key managerial personnel refers to
    those who have the power of and responsibility for planning, directing and controlling the
    activities of the enterprise. The close family members of a main individual investor or of
    a key managerial person refer to the family members who may influence or be influenced
    by that individual in handling transactions with the enterprise; (10) other enterprises
    significantly influence by the main individual investors, key managerial personnel, or
    close family members of such individuals.

    4.2.1.5.2 Affirmation of related-party transactions

    As in the regulations in the Listing Rules of stock exchanges, the related-party
    transactions of a listed company refer to matters concerning transferring resources or
    obligations between the company/its subsidiary and the connected person(s), which
    include purchasing or selling assets; investments (including consigned financing,
    consignment loan, investment in subsidiary, etc.); providing financial aid; providing a
    guarantee; renting or leasing assets; signing a management contract (including entrusted
    operations, trustee operations, etc.); granting or donating assets; credit or debt
    restructuring; transferring of R&D projects; purchasing raw materials, fuel and power;
    sales of products and commodities; rendering or receiving labour services; trustee sales;
    joint investment by both the connected parties; and other matters that may result in
    transferring resources or obligations through the agreement.

    The Administrative Measures on Information Disclosure by Listed Companies
    stipulate that the term “related-party transaction” refers to an event in which a transfer of
    resources, labour services or obligations takes place between related parties, irrespective
    of whether money is charged. The types of related-party transaction usually include the
    following: (1) purchases or sales of goods; (2) purchasing or selling assets other than
    goods; (3) rendering or receiving labour services; (4) guaranteeing; (5) providing capital
    (including loans or equity contributions); (6) leasing; (7) acting as an agency; (8) transfer
    of research and development projects; (9) licence agreements; (10) settling debts on
    behalf of an enterprise or by an enterprise that represents another party; and (11)
    remuneration for key managerial personnel.

    4.2.1.5.3 Disclosure of related-party transactions

    A company shall satisfy the conditions of operational independence before an IPO,
    i.e., the business of issuers shall be independent of the controlling shareholders, actual
    controllers and other enterprises controlled by it, and shall not conduct horizontal
    competition or unfair related-party transactions with the aforesaid parties. Issuers shall
    fully disclose the relationship between the connected parties and appropriately disclose
    the said transactions in accordance with the materiality principle. The related-party
    transactions shall ensure fair prices and not allow for a situation in which profits are
    manipulated through the transactions.

    After the companies are listed, the Administrative Measures on Information
    Disclosure by Listed Companies stipulates that directors, supervisors, executives,
    shareholders with 5% or more of shares and persons acting in concert with such

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    shareholders and de facto controllers of a listed company shall submit, on a timely basis,
    a list of the listed company’s related parties and an explanation of the relationships to the
    board of directors of the listed company. The listed company shall perform review
    procedures for interested-party transactions and strictly enforce a system of vote
    abstention in interested-party transactions. The parties to an interested-party transaction
    must not circumvent the listed company’s interested-party transaction review procedures
    and information disclosure obligations by concealing the interested-party relationship or
    by any other means.

    In accordance with the regulations of the Listing Rules stipulated by the stock
    exchanges, the Report on Disclosure of Related Party Transactions by Listed Companies
    shall be fixed with the official seal of, and issued by, the company’s board of directors. If
    a listed company engages in a transaction with the related natural persons of more than
    CNY 300 000 (EUR 32 550), and if a listed company engages in a transaction with the
    related legal persons of more than CNY 3 million (EUR 325 500), which accounts for
    more than 0.5% of the absolute value of the latest audited net assets of the company, it
    shall disclose such matters promptly.

    The Standards of Related-Party Transactions, which are required to be submitted to
    the board of directors for review, shall be formulated in accordance with the company’s
    articles of association. The Listing Rules stipulate that the said standards that need to be
    examined by the general meeting of shareholders shall be formulated as follows: if a
    listed company engages in a related-party transaction (unless the listed company is
    accepting the donation of cash assets and providing the guaranty) with the related parties
    of more than CNY 30 million, accounting for more than 5% of the absolute value of the
    latest audited net assets of the listed company, it shall, apart from disclosing such matters
    promptly, also arrange for an intermediary institution qualified to conduct securities and
    futures businesses to conduct the audit and evaluation of the transaction target and submit
    the transaction to the shareholders general meeting for deliberation. When the board of
    directors or shareholders’ general meeting of the listed company examines the relevant
    matters of related-party transactions, the connected directors or shareholders shall
    withdraw from voting. The related-party transactions (according to the terms of the
    above-mentioned standards) shall be partly disclosed in the financial statements of the
    annual report.

    The Accounting Standards for Enterprises No.36–Disclosure of Related Parties
    stipulate that an enterprise shall, in its financial statements, disclose relevant information
    on all related-party relationships and the transactions among them. If it offers
    consolidated financial statements to outsiders, it is not required to disclose the
    transactions among the enterprises that have been included in the consolidation, but it
    shall disclose the related-party relationships and transactions beyond the scope of
    consolidation.

    If a listed company avoids information disclosure and reporting obligations by
    concealing related-party relationship or taking other measures, it shall be punished by the
    CSRC in accordance with Article 193 of the Securities Law.

    4.2.1.6 Principle V.A (6): Risk factors

    The Standards on Contents and Formats for Information Disclosure of Prospectus,
    issued by the CSRC, require that companies applying for an IPO shall abide by the

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    materiality principle in its prospectus, since disclosing according to priority may directly
    or indirectly have a significant adverse impact upon issuers’ production and operation
    status, financial situation and sustained profitability. The company shall disclose its risk
    factors, which shall be described in a complete, accurate and specific manner based upon
    its actual conditions. It shall conduct a quantitative analysis on the risk factors disclosed
    and make a targeted qualitative description of those without access to quantitative
    analysis.

    The Standards on Contents and Formats for Annual Reports stipulate that a listed
    company shall comply with the materiality principle in the Director’s Report section of
    the Annual Report, disclose all the risk factors (including macro-policy risk, market and
    business operation risk, financial risk, technical risk, etc.) that may exert an adverse
    impact upon the realisation of its future development strategies and business objectives.
    The company shall disclose risk factors in light of its own characteristics, and the
    contents disclosed shall be complete, accurate and concrete. In addition, the company
    may introduce, based upon its actual situation, the countermeasures and solutions adopted
    or to be adopted with specific contents and operability.

    In the process of the acquisition and major asset reorganisation of a listed company,
    the acquirer or the listed company intending to conduct material asset reorganisation shall
    disclose the influences and risks of such an acquisition or reorganisation to the listed
    company, in accordance with the Standards on Contents and Formats for Acquisition
    Reports of Listed Companies and the Standards on Contents and Formats of the
    Application Documents for Material Asset Reorganisation by Listed Companies.

    4.2.1.7 Principle V.A (7): Employees and stakeholders

    A listed company shall disclose at length in its prospectus and annual reports its staff
    situation, including the quantity, major composition (i.e. production staff, sales personnel,
    technicians, financial staff, administrative staff) and the educational background of the in-
    service employees, as well as the number of retired workers, the costs for whom shall be
    borne by the company.

    In order to promote sustainable socio-economic development and encourage listed
    companies to actively assume their social liabilities, the Shanghai Stock Exchange and
    Shenzhen Stock Exchange have drawn up the Code of Corporate Governance of Listed
    Companies. The Code describes the listed companies’ social responsibilities for the
    overall national and social development, natural environment and resources as well as
    with regard to stakeholders, such as shareholders, creditors, employees, clients,
    customers, suppliers, and communities. A listed company shall actively fulfil its social
    responsibilities and regularly evaluate such fulfilment. It may also disclose its CSR
    (corporate social responsibility) report.

    4.2.1.8 Principle V.A (8): Corporate governance structure and decision-making
    procedure

    According to the relevant rules prescribed in the Company Law, the CSRC requests
    that a listed company periodically disclose its governance status.

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    Meeting the relevant corporate governance requirements is one of the pre-conditions
    for a company to conduct an IPO and go public. The prospectus shall disclose in detail
    the establishment, improvement and operation of the shareholders’ meeting, the board of
    directors, the supervisory board, independent directors and the board of directors’
    secretariat, and explain the duties and responsibilities of the abovementioned bodies and
    personnel.

    The Guidance for the Articles of Association of Listed Companies stipulates that a
    listed company shall specify in its articles of association, the governance structure and
    decision-making procedure of the shareholders’ meeting, the board of directors, the
    supervisory board and senior managerial personnel. The Guidance has provided the
    essential and compulsory requirements on the contents to be included in the articles of
    association of a listed company.

    As per the Annual Report Standards, a corporate governance report shall be included
    in the annual report disclosed by a listed company on a regular basis. In accordance with
    the Code of Corporate Governance of Listed Companies, the company shall state, at the
    beginning of the governance report, whether discrepancies exist between the actual
    governance conditions and the requests of the Code, and explicit statements shall be made
    in the case of discrepancies. Furthermore, the company shall also successively describe
    the performance of independent directors’ duties within the reporting period, whether
    there is a separation between the company and its controlling shareholders in terms of
    business, personnel, assets, bodies, finance, etc., the establishment and improvement of
    internal control systems with regard to production and operation, financial management,
    information disclosure, the appraisal and incentive mechanism for senior managerial
    personnel during the period, and the establishment and implementation of the award
    /incentive system concerned.

    4.2.2 Principle V.B Information should be prepared and disclosed in
    accordance with high-quality standards of accounting, financial and non-
    financial disclosure.

    4.2.2.1 The new system of Accounting Standards for Business Enterprises tends to
    converge with international standards

    Relevant Chinese laws, regulations and department rules explicitly state that a listed
    company shall prepare and disclose its financial statement in its prospectus, annual report
    and list of particulars in accordance with unified accounting standards. At present, China
    has high-quality accounting standards, which have been internationally recognised.

    Article 8 of the Accounting Law states that China shall implement a uniform
    accounting system drawn up and issued by the Ministry of Finance. On February 15,
    2006, the new system of Accounting Standards for Business Enterprises enacted by
    China’s Ministry of Finance, which came into force among listed companies on January
    1, 2007, signified the formal establishment of China’s enterprise accounting standards
    system and the CPA auditing system. The new system has drawn substantially from and
    is hence similar to the International Financial Reporting Standards. As a comprehensive
    accounting standards system, Standards are composed of a total of 39 items covering the
    accounting changes of all types of economic transactions and affairs of various
    enterprises. Many directors and technical experts from the China Accounting Standards

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    Committee (CASC) and the International Accounting Standards Board (IASB) have
    conducted item-by-item comparisons, studies and in-depth discussions, and reached a
    consensus on convergence. A joint statement has been signed between CASC and IASB,
    indicating that China’s accounting standards have achieved substantial convergence with
    international financial reporting standards.

    4.2.2.2 Requirements of financial information disclosure

    According to the new system of Accounting Standards for Business Enterprises, the
    financial statement disclosed in the prospectus, the annual report and the particulars of the
    listed company shall meet four requirements, to: (1) be comprehensive; (2) be
    understandable to investors; (3) reflect the uniformity of accounting standards
    application; (4) be comparable for all accounting periods.

    4.2.2.2.1 Comprehensiveness

    Essential information related to business finance may be guaranteed for disclosure in
    accordance with the new accounting standards and the requirement of CSRC-related
    information disclosure standards. The Accounting Standards for Business Enterprises –
    Basic Standards stipulate that a financial statement is made up of a financial statement
    and annotations. The statement includes: a balance sheet, profit statement, cash flow
    statement and statement of changes in ownership equity, etc. The specific standards for
    business enterprise accounting not only provide for the confirmation and measurement of
    accounting items, but also specify disclosure-related requirements. The General
    Provisions on Financial Reporting further stipulate that the financial statement disclosed
    shall include a balance sheet and cash flow statement, as well as a statement of changes in
    ownership equity. The Provisions also detail disclosure requirements of financial
    statement annotations.

    4.2.2.2.2 Understandable to investors

    The new accounting standards require that financial statements facilitate investors’
    comprehension and its application. Article 14 of the Accounting Standards for Business
    Enterprises – Basic Standards stipulate that “The accounting information provided by
    enterprises shall be clear for users to understand and apply”.

    4.2.2.2.3 Reflecting the uniformity of accounting standards application

    The application of new accounting standards must be consistent.

    The Accounting Standards for Business Enterprises No.28 – Changes in Accounting
    Policies and Estimates and Corrections of Errors specify that identical accounting policies
    shall be adopted by enterprises to tackle the same or similar transactions or items. The
    accounting policies adopted by enterprises shall be consistent for each accounting period
    and any earlier and later stages without arbitrary changes. If any change is required,
    relevant details shall be disclosed in accordance with the provisions of the standards, which
    specify that the application of the accounting standards should be harmonised.

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    4.2.2.2.4 Comparable for all accounting periods

    The new accounting standards specify that accounting information should be
    comparable from one accounting period to another.

    Article 15 of the Accounting Standards for Business Enterprises – Basic Standards
    stipulate that the accounting information provided by enterprises shall be comparable and
    consistent, that accounting policies shall be adopted for identical or similar transactions or
    items incurred in one company during different periods without arbitrary changes. Any
    change, if required, shall be stated in the annotations. Accounting policies shall be
    adopted for identical or similar transactions or items incurred in different enterprises to
    ensure the uniformity and comparability of accounting information.

    For the incurred changes in accounting policies and corrections of errors, as stipulated
    by the Accounting Standards for Business Enterprises No.28—Changes in Accounting
    Policies and Estimates and Corrections of Errors, a retrospective approach shall be
    adopted to adjust preliminary comparable data and earlier restatements shall be adopted
    to correct important preliminary errors and financial statements, if more reliable and
    relevant accounting information is provided by the changes in accounting policies.

    Listed companies that correct preliminary errors shall make announcements and
    audits and disclose the corrected financial statements in accordance with the Correction
    and Relevant Disclosure of Financial Information promulgated by the CSRC.

    4.2.3 Principles V.C & V.D: An annual audit should be conducted by an
    independent, competent and qualified auditor in order to provide an external
    and objective assurance to the board and shareholders that the financial
    statements represent the financial position and performance of the company
    fairly in all material respects. External auditors should be accountable to the
    shareholders and are duty-bound to the company to exercise due professional
    care in conducting the audit.

    4.2.3.1 New accounting standards and international convergence

    The audited financial statement in the prospectus, annual report, and listing
    particulars of the listed company shall be audited in accordance with comprehensive
    auditing criteria. China’s auditing standards are of a high quality and have now reached
    the standards that are accepted internationally.

    In 2006, the Ministry of Finance promulgated a new 48-point auditing standards
    system—China Auditing Standards for CPA. The system took effect in all domestic
    accounting firms on January 1, 2007. These new auditing standards cover almost all items
    of international auditing criteria, including the auditing objective and principle, evaluation
    and risk management, access to auditing evidence and evidence analysis, drafting and
    report of auditing conclusions, as well as formulation of professional responsibilities. The
    new standards are based on the structure of international auditing standards and cover
    nearly all of its items. They adopt all the basic principles and core procedures of the
    international standards. Major aspects such as the auditing objective and principle,
    evaluation and risk management, access to auditing evidence and evidence analysis,
    drafting and report of auditing conclusions, as well as formulation of professional
    responsibilities are in conformity with international auditing standards. China’s auditing
    standards now substantially converge with international auditing standards.

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    4.2.3.2 Auditors’ professional qualifications

    4.2.3.2.1 Qualifications

    Auditors require a CPA certificate to practice in China. Acquiring a CPA certificate
    requires passing the CPA examination and completing registration. The Law of the
    People’s Republic of China on Certified Public Accounts stipulates that the unified
    examination system for certified public accountants is implemented nationwide. Article 8
    lists the relevant qualifications for applicants sitting the examination i.e. Chinese with
    college degree or above; or with accounting or other related majors with mid-level
    professional and technical titles or more. Article 9 states that applicants, who pass the
    national examination for certified public accountants and have participated in the auditing
    business for two years or more, are entitled to apply to the provincial associations of
    CPAs for registration. Eligible applicants shall be approved for registration by the
    provisional association of CPAs, who report to the Ministry of Finance.

    4.2.3.2.2 Revoking qualification

    An auditor who is unable to maintain the specified qualifications and competency
    standard or does not apply moral or auditing standards, shall lose his or her qualification.
    Article 13 of the Law of the People’s Republic of China on Certified Public Accounts
    specifies the situation in which auditor qualifications will be cancelled.

    4.2.3.3 The independence of the external auditor

    All China’s related laws, statutes and departmental ordinances require that a CPA be
    independent.

    Article 45 of the Securities Law of the People’s Republic of China stipulates that
    securities service agencies and personnel offering auditing reports for stock issuance are
    not entitled to trade those stocks within their underwriting periods and for six months
    after they expire. In addition to the provisions above, securities firms and personnel who
    provide auditing reports for listed companies are not entitled to trade those stocks from
    the date they were hired until five days after the said documents are published.

    Article 22 of the Law of the People’s Republic of China on Certified Public Accounts
    prohibits CPAs from conduct that would undermine their independence, including trading
    stocks and bonds of the audited units, charging for premiums outside the contract, etc.
    The Basic Standards of Professional Ethics for China’s Certified Public Accounts and
    Guidance on the Standards of Professional Ethics for China’s Certified Public Accounts
    also require auditors to be independent and stipulate that certified public accounts shall
    maintain their independence in form and substance. Chapter Two of the Basic Standards
    of Professional Ethics for China’s Certified Public Accounts states that certified public
    accountants shall maintain their independence in form and substance for auditing or other
    verification work. Accounting firms whose independence may be undermined by clients
    are not entitled to undertake commissioned auditing or other verification work. Certified
    public accountants, who conduct auditing or other verification work and are in conflict
    with clients on possible impacts to their independence, shall make an announcement to
    their accounting firms and abstain from such activity. Certified public accountants are not
    entitled to incorporate additional businesses or concurrently hold other posts that are

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    incompatible with auditing or other verification work conducted. Certified public
    accountants, when conducting business, shall be practical and realistic and not be
    influenced by others nor let personal interests affect the objectivity of their analysis and
    judgment. Certified public accountants shall be forthcoming, honest and impartial in
    handling conflicts of interest. Articles 8 to 12 of the Guidance on the Standards of
    Professional Ethics for China’s Certified Public Accounts describe the factors that may
    undermine their independence, including economic interest, self-evaluation, connections,
    relationships and external pressure. They also describe the situations that risk affecting
    auditors’ independence. Furthermore, Article 13 and 15 define specific measures to be
    adopted in order to ensure independence.

    The Provision on Regular Rotation of Certified Public Accountants That Sign the
    Audits of Securities and Futures (2003), promulgated by the CSRC, contains explicit
    clauses on the independence of the responsible certified public accountants. Normally, a
    certified public accountant should not provide auditing services to a specific company for
    five consecutive years. The continuous auditing services provided to a given company by
    the same certified public accountant who signs the accounts while serving different
    accounting firms should be considered together. The period of continuous auditing
    services to a listed company whose listing was handled by the same certified public
    accountant who provided auditing services to the relevant company’s IPO should be no
    more than two complete fiscal years.

    4.2.3.4 Procedures for the designation, appointment and replacement of external
    auditors

    According to the Relevant Questions Concerning the Hiring and Changing of
    Accounting Firms (Audit Firms) by Listed Companies, published by CSRC, any issues
    concerning the employment, dismissal or discontinuing further employment of
    accounting firms shall be determined by shareholders’ meetings, and the decisions taken
    shall be implemented. Furthermore, in accordance with the regulations of the “Special
    Committee of the Board of Directors” (Chapter Six of the Code of Corporate Governance
    of Listed Companies), an audit committee reporting to the board of directors of a listed
    company shall be responsible for proposals on the employment or changes to the
    employment of external auditing firms. Most of the auditors working for external audit
    firms shall be independent. The convener of the meetings shall be independent and at
    least one independent director shall be a professional accountant.

    4.2.3.5 The legal responsibilities of external auditors

    Article 173 of the Securities Law states that when an auditing firm produces auditing
    reports for listed companies, it shall be diligent and responsible, and examine and verify
    the authenticity, accuracy and integrity of the contents of the documents it is working on.
    If any false records, misleading statements or major omissions in the documents
    produced, incur any loss to any other person, the institution shall bear joint liability
    together with the relevant issuer and listed companies, unless the auditing institution is
    able to prove it is not at fault. Article 223 of the Securities Law states that when a
    securities service institution fails to fulfil its accountability in a diligent manner, resulting
    in documents containing false records, misleading statements or major omissions, it shall
    be ordered to correct it. The proceeds generated from this business shall be confiscated

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    and its securities business licence suspended or revoked. A fine of one to five times its
    related business income shall be imposed. The person in charge and any other person
    directly responsible shall be given a warning and imposed a fine of CNY 30 000 to CNY
    100 000 and the relevant securities practice qualifications shall be revoked. In addition to
    the sanctions imposed by the Securities Law, the Administrative Methods on Information
    Disclosure by Listed Companies stipulate that the CSRC may adopt such supervisory
    measures as ordering corrections, supervising discussions, sending warning letters and
    making records in the “credit records” to the above securities service agencies in
    accordance with law. When administrative sanctions are imposed, the CSRC shall enforce
    the sanction by law.

    In addition to the liability for damage of civil affairs, related personnel shall be held
    criminally responsible for the serious false content of auditor reports. Article 229 of the
    Criminal Law states that a person of an intermediary organisation performing such
    functions as asset evaluation or examination, certificate examination, accounting,
    auditing, legal services, who provides intentionally false documentary evidence, shall be
    sentenced to fixed-term imprisonment of not more than five years or criminal detention,
    and fined concurrently if the circumstance is serious. A person who extorts another
    person’s property or accepts another person’s property illegally, thus committing a crime
    under the preceding paragraph, shall be sentenced to fixed-term imprisonment of not less
    than five years and not more than ten years and fined. A person who seriously neglects
    his or her duty and provides documentary evidence which is inconsistent with the facts,
    thus causing a serious consequence, shall be sentenced to fixed-term imprisonment of not
    more than three years or criminal detention, and fined.

    4.2.4 Principle V.E: Channels for disseminating information should provide for
    equal, timely and cost-efficient access to relevant information by users.

    4.2.4.1 The principle of equal and timely access to information

    The Securities Law and Administrative Methods on Information Disclosure by Listed
    Companies stipulate that a listed company shall do their best to fulfil the obligation of
    information disclosure, and disclose all the major events that may have a significant
    impact on its share trading price. CSRC announced further requirements in the Notice on
    Regulating Disclosure of Listed Companies and the Acts of All the Related Parties,
    prescribing not only that a listed company shall strive to fulfil the obligation of
    information disclosure, but also disclose all sensitive and major events that may have a
    great impact on the stock price to all its investors fairly, to give them all access to the
    same information. It shall not disclose information selectively or to specific persons in
    advance. Such persons include – but are not limited to – the institutions and individuals
    that engage in securities investment, securities analysis, consultancy or other securities
    service industries, and the related parties of the said institutions and individuals. CSRC
    branches and stock exchanges shall supervise and oversee the implementation of the
    principle of equity of information disclosure by listed companies. Listed companies and
    any other relevant person responsible who violate the regulations shall be investigated
    and dealt with in accordance with the law.

    The Securities Law and Administrative Methods on Information Disclosure by Listed
    Companies and other relevant laws and regulations state that the listed companies shall
    undertake the obligations of continuous information disclosure, and disclose the

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    information to investors that may have a great impact on their decision-making on a
    timely basis. Information may be disclosed in two forms: periodic reports and temporary
    reports (see details in “V.A material information” in this chapter). The Company Law
    prescribes that listed companies shall set up a secretariat for the board of directors, acting
    as a senior manager of a company, specialised in dealing with information disclosure to
    guarantee continuous and timely information disclosure.

    4.2.4.2 Timely and low-cost information dissemination channels

    The CSRC has made detailed provisions regarding dissemination channels for
    information disclosure. The Administrative Methods on Information Disclosure by Listed
    Companies stipulate that the information disclosed shall be published through the media
    designated by the CSRC. Information shall not be published on corporate websites or any
    other media prior to this designation. Press releases and Q&A interviews may not be used
    to replace the reporting and announcing obligation, not shall periodic reports replace
    extraordinary reporting.

    Newspapers and websites are the media designated by CSRC, ensuring the
    convenient and low-cost information dissemination to all the investors.

    4.2.4.2.1 Newspapers and periodicals

    The newspapers and periodicals used for listed companies designated by the CSRC
    include the following: China Daily, China’s Reform Report, Securities Journal, China
    Securities Journal, Shanghai Securities News, Securities Times, Financial Times and
    Securities Market Weekly. The initial disclosure of important information from listed
    companies, periodic reports and temporary reports, shall be published at least in one
    designated newspaper or periodical. When the CSRC, stock exchanges, securities firms
    and other market participants release major news or important measures, they also need
    the media’s cooperation on reporting.

    4.2.4.2.2 Websites

    Information to be disclosed by listed companies to stock exchanges shall be disclosed
    free of charge on the stock exchange website. Investors and other users can access them
    free of charge on those websites.

    The Growth Enterprise Market (GEM) established at the Shenzhen Stock Exchange
    makes further efforts to promote paperless information disclosure through the full use of
    information technologies characterised by low costs and high efficiency. The following
    five websites are designated for GEM information disclosure: CNINFO, CS, CNSTOCK,
    SECUTIMES, CCSTOCK. These designated websites shall provide specialised platforms
    for legal information disclosure of GEM-listed companies and publish free of charge all
    the GEM listed companies’ prospectus, listing particulars, temporary announcements,
    periodic reports and other information such as relevant policies and law regulations
    published by the CSRC and the Shenzhen Stock Exchange.

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    4.2.5 Principle V.F: The corporate governance framework should be
    complemented by an effective approach that addresses and promotes the
    provision of analysis or advice by analysts, brokers, rating agencies and others,
    that is relevant to investors’ decisions, free from material conflicts of interest
    that might compromise the integrity of their analysis or advice.

    4.2.5.1 Qualifications of security consultancy agencies, and information
    disclosure requirements

    In order to strengthen management of the securities and futures investment
    consultancy business, the CSRC released the Interim Procedures on the Administration of
    Securities and Futures Investment Consultancy. This focuses on the activities of the
    agencies and their consultants engaged in the securities and futures consultancy business,
    which include direct or indirect paid consultancy services for securities and futures
    investors or clients with securities and futures investment analyses, forecasts or proposals
    and other services. These activities involve: (1) accepting the entrustment of an investor
    or client and providing securities and futures investment consultancy services; (2) holding
    seminars, lectures and analysis meetings on securities and futures investment
    consultancy; (3) publishing articles, commentaries and reports on securities and futures
    investment consultancy in newspapers and periodicals, and providing securities and
    futures investment consultancy services through the mass media (radio stations, television
    stations, etc.); (4) providing securities and futures investment consultancy services
    through telephone, fax, computer networks and other telecommunications systems;
    (5) other forms authenticated by the CSRC. In China, the above-mentioned investment
    consultancy businesses must obtain the permission of the CSRC. No institution or
    individual may engage in the above-mentioned business without permission.

    A person who engages in the securities and futures investment consultancy business
    must obtain the relevant employment qualifications and join an agency with operational
    qualifications for securities and futures investment consultancy before engaging in the
    business. He or she must have at least a university education, pass the qualification
    examinations for securities and futures and have more than two years’ experience in the
    securities or futures business before obtaining the employment qualifications for
    securities and futures investment consultancy.

    Interim Procedures on the Administration of Securities and Futures Investment
    Consultancy stipulates that a securities and futures investment firm and its investment
    consultants shall provide their services to investors and clients with the required attitudes
    of the trade: discretion, honesty, diligence and fulfilment of responsibility. They shall use
    the relevant information and materials completely, objectively and accurately to provide
    investment analyses, forecasts and proposals, and must not quote or alter relevant
    information and materials out of context. They shall provide the sources and copyright
    owners when quoting relevant information and materials. A securities and futures
    investment firm and its investment consultants must not provide investment analyses,
    forecasts or proposals to investors or clients on the basis of false information, market
    rumours or inside information. When publishing articles, reports or views on investment
    consultancy in newspapers, periodicals, radio stations, television stations or other media,
    a securities and futures investment consultant must provide the name of the securities and
    futures investment consultancy agency in which the person is employed, give the person’s
    real name and a detailed explanation of investment risks. A securities and futures
    investment firm must provide the name and address of the agency, the telephone

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    number(s) and the name(s) of the contact when providing securities and futures
    investment consultancy faxes to investors or clients.

    In order to avoid a conflict of interest between the investment consultancy agency or
    its investment consultants and investors, the Securities Law requires that no securities and
    futures investment firm and its investment consultants may engage in the following
    activities:

    1. Securities and futures buying and selling as an agent of investors;

    2. Agreement with investors on the sharing of returns or losses of the investment;

    3. Buying and selling of stocks and other securities and futures on their own behalf;

    4. Manipulating the market or engaging in insider trading by exploiting the
    consultancy services in collaboration with others;

    5. Other fraudulent acts in securities and futures prohibited by laws, rules and
    regulations.

    Investment firms and rating organisations engaged in the securities service business
    shall charge fees according to standards prescribed by the State Council’s relevant
    administrative departments.

    The investment analyses, forecasts or proposals provided to different clients on the
    same issue by a securities and futures investment firm shall be consistent. Securities firms
    with a consultancy business shall be consistent in providing suggestions on the same
    question to the consultancy business and to the public. It shall not mislead the public in
    the interest of profit-gaining for its own benefit. The underwriter, sponsor or relevant
    securities firm of the company whose public issuance of shares has been approved by the
    CSRC may not publish in the mass media its investment analysis report written for
    clients.

    Recently, the CSRC took action to regulate the behaviour of securities research
    institutes when publishing research reports. Securities firms are required to act in strict
    accordance with the provisions of the Securities Law, Rules on Supervision over
    Securities Companies, Interim Measures for the Administration of Securities and Futures
    Investment Consultancy, Provisions on Strengthening the Administration of Securities
    and Futures Information Communication, Guidance for Internal Control of Securities
    Firms and Notice on Several Issues Concerning Standardisation of the Business of
    Securities Investment Consultancy for Public. They are required to standardise the
    publication of their research reports and strengthen management over participation in
    securities programmes in the media. Securities firms are banned from manipulating
    securities prices, interest transfer, engaging in securities trading with insider information
    or misleading investors. While publishing research reports and participating in securities
    programmes in the media, securities firms should observe the principle of being
    independent, objective, equitable, respecting their fiduciary duty and be professional
    when making comments on the macro economy, industrial analysis and market trends,
    and exercise prudence on opinions when analysing specific securities. They must not
    spread false, partial or misleading information or make definitive judgments on the rise or
    fall of securities prices or market trends.

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    4.2.5.2 Brokers

    In order to bolster the supervision and administration of securities brokers,
    standardise their professional behaviour and protect the legitimate rights and interests of
    their clients, the CSRC formulated the Interim Regulations on the Administration of
    Securities Brokers (2009), which clearly defines securities brokers as the natural persons
    outside securities companies who accept the commissions of the securities companies to
    engage in activities including client solicitation and services on their behalf. Securities
    brokers, who are securities practitioners, must pass the examination to qualify as
    securities practitioners and meet the stipulated professional conditions. Securities
    companies can engage in certain activities including client solicitation and services
    through their staff or by entrusting persons external to the companies. Securities brokers
    are required to follow the Rules on Supervision of Securities Companies to entrust
    activities to external persons. Securities companies shall establish a sound administration
    system for securities brokers, take effective measures, implement centralised and unified
    management towards the securities brokers and their practice, guarantee the basic
    professional ethics and business qualities of the securities brokers, and prevent the
    securities brokers from breaking the laws and regulations, acting beyond the agency
    authority and going against clients’ legal rights and interests.

    4.2.5.3 Credit-rating agencies

    In order to promote the standardised development of the securities market credit-
    rating business, enhance the efficiency and transparency of the securities market and
    protect the legitimate rights and interests of investors and social public interests, the
    CSRC published the Interim Measures for the Administration of the Credit-Rating
    Business Regarding the Securities Market (2007). Credit-rating agencies should apply to
    the CSRC for a securities rating business permit, without which no organisation or
    individual may engage in the securities rating business. Securities rating agencies should
    follow the consistency principle while engaging in the securities rating business, i.e.,
    consistent rating criteria and work procedures should be followed for subjects of the same
    category or in follow-up ratings on the same subject. When rating criteria is readjusted,
    full disclosure should be conducted. Securities rating agencies should formulate scientific
    rating methods and a fully fledged quality control system, follow industrial standards,
    professional ethics and code of business conduct with fiduciary duties, and be diligent in
    carrying out their duties and prudent in their analyses.

    4.2.5.4 Asset appraisal institutions

    In order to strengthen the administration of asset appraisal institutions engaging in the
    securities and futures-related business, maintain order on the securities market and protect
    the legitimate rights and interests of investors and public, the Ministry of Finance and the
    CSRC jointly issued the Notice on Issues Concerning Asset Appraisal Agencies Engaging
    in Business Relating to Securities and Futures, requiring asset appraisal institutions to
    obtain the relevant qualifications to engage in securities-related business. The following
    asset appraisal agencies may not apply for securities rating qualifications: a) those that
    have been penalised criminally or administratively in business operations (for three years
    upon completion of penalty), or b) those whose qualification was revoked on the grounds
    that they obtained securities appraisal qualification by deception or other irregular means

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    (for three years after their rights were revoked), or c) those whose application was not
    accepted or approved on the grounds that information was concealed or false (for three
    years after the issuance by the authority of a non-acceptance or non-approval document).

    4.2.5.5 Legal obligations

    The Securities Law stipulates that any investment consultancy agency, financial
    consultancy agency, assets evaluation organisation and accounting firm that engages in
    the securities service business without permission shall be ordered to suspend business
    and will be confiscated of the illegal gains and imposed a fine greater than the value of its
    illegal gains and less than five times the value of illegal gains.

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    Chapter 5

    Board and supervisory board: responsibility and supervision

    5.1 Overview of the board of directors and supervisory board system in China

    The Company Law governing listed companies in China was promulgated in 1993. It
    introduced boards of directors and supervisory boards, and clearly provided that
    companies limited by shares should set up shareholders’ meetings, a board of directors
    and a supervisory board. Since then, Chinese listed companies have made great progress
    in the establishment of a board system, gradually introducing an independent director
    system and a specialised committee system and laying the foundations for the board’s
    independence and effective operations. Meanwhile, the establishment of mechanisms
    such as the election, terms of reference and responsibility investigation has paved the way
    for the board to provide strategic guidance, effective supervision over management and
    protection of the interests of companies and shareholders. In the creation and
    construction of the supervisory board, the Company Law amended in 2006 expanded the
    functions and power of the supervisory board, enabling it to play its role of supervision to
    the full.

    5.1.1 The main features of the Chinese board system

    5.1.1.1 Strengthening the board’s loyalty, due diligence and protection of the
    benefits of companies and shareholders

    In 2006, the Company Law was revised for the first time and clearly presented the
    primary function of the board: “to abide by the law, administrative laws and regulations,
    and articles of incorporation and have the duty of loyalty and diligence to companies”.
    The meaning of the duty of loyalty and diligence indicates that Chinese law and
    regulations are designed to protect the benefits of companies and shareholders.

    Hereafter, the Listed Company Director Selection and Conduction Guidance and
    SME Board Listed Company Director Conduct Guidance, both issued by the Shenzhen
    Stock Exchange have more detailed and specific requirements on the directors’ duty of
    loyalty and diligence.

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    5.1.1.2 Establishing mechanisms for the board’s supervision and restraints over
    management

    The Company Law provides that limited companies should have managers, who are
    hired and dismissed by the board. The corporate board may decide that a member of the
    board can also serve as a manager. On the one hand, the board may evaluate and
    supervise the operation and achievements of management by selecting managers. On the
    other hand, centralised power makes management teams realistically emphasise the
    efficiency of decision-making to improve companies’ performance.

    By hiring independent directors, establishing management’s remuneration and setting
    up an audit committee, nomination committee and remuneration and appraisal committee,
    listed companies supervise and motivate managers. Companies also regularly disclose
    directors’, supervisors’ and senior managers’ remuneration to shareholders.

    5.1.1.3 The establishment of the independent director system

    An independent director is a director who holds no other position than that of an
    independent director in the company. He or she has no relations that prevent them from
    making an independent and objective judgment. An independent director shall perform
    his or her duty independently and not be influenced by the main shareholders, actual
    controllers, or other entities or individuals which have significant relations with the listed
    company.

    In China, an independent director may in principle serve on the board of at most five
    listed companies as an independent director and ensure that he or she has enough time
    and energy to effectively perform the duty of an independent director. The Code of
    Corporate Governance of Listed Companies in China stipulates that independent
    directors shall account for more than one-third of the board in a listed company.
    Independent directors shall be independent of their employer and the company’s main
    shareholders. Independent directors shall hold no other position but that of independent
    directors.

    5.1.1.4 Establishing special committees of the board

    In China, special committees of the board on the one hand take charge of the daily
    operations and decisions in comparatively independent fields, and on the other hand,
    provide consultation and suggestions to the board on important decisions in the field. To a
    large degree, the special committee is the extension of the independent director system
    and is good for improving the independence and effectiveness of the board’s operations
    as well as controlling risks.

    The Code of Corporate Governance of Listed Companies in China stipulates that
    according to the resolution of the general shareholders’ meeting, a listed company’s board
    may set up special committees on strategy, audit, nomination, remuneration and appraisal,
    etc. All of the special committee members are directors. Thereinafter, independent
    directors shall account for more than half of the committee members and act as conveners
    in audit committees, nomination committees and remuneration and appraisal committees.
    In audit committees, at least one independent director should have an accounting
    background.

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    5.1.2 The main features of the supervisory board

    5.1.2.1 Strengthening the basic duties of the supervisory board: loyalty, diligence
    and protection of the interests of companies and shareholders.

    In China, the supervisory board is also obliged to be loyal and diligent and to protect
    the interests of the company and shareholders. The Company Law revised in 2006 clearly
    provides that the supervisory board is obliged “to abide by the law, administrative laws
    and regulations and the articles of association of the company and have the duty of
    loyalty and diligence for companies”.

    The Shenzhen Stock Exchange has issued Guidance on the Operation of Companies
    Listed on the Main Board, Guidance on the Operation of Companies Listed on the SME
    Board and Guidance on the Operation of Companies Listed on the Growth Enterprise
    Board, defining more detailed and specific requirements on the supervisors’ duty of
    loyalty and diligence.

    5.1.2.2 Establishing mechanisms of supervision and restraint over the board of
    directors and the management by the supervisory board

    The supervisory board is a permanent supervisory body under the leadership of, and
    responsible to, the shareholders’ meeting. It exercises its supervisory power over the
    board of directors, management and the whole company independently. To ensure the
    independence of the supervisors and supervisory board, the supervisors may not
    concurrently take the office of director or senior executive. The supervisory board carries
    out comprehensive supervision of the company’s operations and management including:
    inspecting the company’s financial status, supervising the performance of duty by
    directors and senior executives, and proposing to remove from office any director or
    senior executive that has violated the law, regulations, articles of association or resolution
    of the shareholders’ meeting, requesting directors and senior executives to rectify their
    behaviour when it undermines company interest, initiating ad hoc shareholders’ meetings,
    calling upon and presiding on shareholders’ meetings when the board of directors fails to
    do so, according to law, tabling draft resolutions for the shareholders’ meetings and filing
    suit against directors and senior executives under certain conditions.

    5.1.2.3 Mutual complementarily with the role of independent directors

    Independent directors and the supervisory board both act as a company’s internal
    supervision mechanisms. They each have their respective features and attend to their own
    duties and are mutually complementary rather than conflicting with each other. Relatively
    speaking, independent directors, an important component of the company’s decision-
    making body, are in a position to take up in the decision-making process over major
    company affairs and therefore provide ex ante supervision. The supervisory board mainly
    plays a role of ex post supervision.

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    5.2 China’s practices compared with the OECD principles

    5.2.1 Principle VI. A states that directors and supervisors should act on a fully
    informed basis, in good faith, with due diligence and care and in the best
    interests of the company and its shareholders

    This OECD Principle points out the two key elements of the responsibilities of
    directors and supervisors, two duties: care and loyalty. The Company Law and a number
    of regulations issued by the stock exchanges all clearly require the two duties on the part
    of board members.

    Article 148 of the Company Law provides that the board of directors and supervisory
    board are required “to abide by the law, administrative laws and regulations and the
    articles of association of the company and have a duty of loyalty and diligence to
    companies. The directors shall not, by taking advantage of their positions and powers,
    accept bribes or other unlawful incomes, nor may they misappropriate the property of the
    company.”

    5.2.1.1 Duty of loyalty

    Article 149 in the Company Law stipulates that directors shall comply with the duty
    of loyalty to the company and shall not commit any of the following acts. The company
    will confiscate any unlawful income if the regulation is not followed, for example:

    5.2.1.1.1 Directors shall not divert, misappropriate or lend the company’s capital,
    or serve as guarantors of the company’s capital. They shall not misappropriate the
    company’s funds, deposit the company’s assets in their own personal accounts or
    in personal accounts of other individuals in violation of the company’s articles of
    association and without the consent of the general shareholders’ meeting or the
    board of directors. They shall not lend the company’s funds to others or use the
    company’s property to provide a guarantee to others.

    5.2.1.1.2 Directors shall not enter into contracts or conduct transactions with the
    company in violation of the company’s articles of association or without the
    consent of the shareholders’ meeting, the shareholders’ general meeting or the
    board of directors, They shall not take advantage of their positions, seek for
    themselves or others a commercial opportunity that should fall to the company, or
    conduct the same business as the company for themselves or others. They shall
    not accept a commission in a transaction between others and the company.

    5.2.1.1.3 Directors shall not disclose the company’s secrets without authorisation
    or commit other acts in violation of their duty of loyalty to the company.

    Article 97 in the Guidance for the Articles of Association of the Listed Companies
    also follows the regulation on directors’ duty of loyalty in the Company Law, and points
    out that if a director causes damage to the company, he or she shall assume their
    compensation liability. The company may, in accordance with specific circumstances,
    add other requirements in the Articles of Association upon the directors’ behalf. Article

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    136 of the Guidance for the Articles of Association of the Listed Companies provides for
    the supervisors’ duty of loyalty, while Article 141 prohibits supervisors from
    undermining company interests by using their affiliations, and provides that where a
    supervisor causes damage to the company, he or she shall assume the responsibility of
    compensation.

    Chapter 3 of the Guidance on Appointment and Activities of Directors of Listed
    Companies of the Shanghai Stock Exchange specifies the duty of loyalty stipulated in the
    Company Law. Firstly, directors shall not harm the interest of a listed company due to a
    third party’s interest; and if discovering that the behaviour of a listed company or the
    third party may harm the company’s interest, directors shall require them to explain and
    correct the damage and make a report to the board on a timely basis. When necessary, the
    convening of the directors is advised for the review. Secondly, a director shall disclose to
    a listed company matters such as horizontal competition, business contact, debtor-creditor
    relationship, shareholding and other business connections or conflicts of the director
    himself and his close relatives. Related directors shall avoid voting. Thirdly, a director
    shall keep a listed company’s secrets and shall not release material information that a
    listed company has not released to the public through designated media.

    Article 4 of the Shenzhen Stock Exchange Small and Medium Enterprise Board
    Director Conduct Guidance sets out the basic principles of the duty of loyalty: a director
    shall be loyal to the company, its shareholders, and their interests, exercising power
    within the scope of their functions and powers with the company’s interest as a starting
    point, and strictly avoiding conflict between their own and the company’s interests.

    5.2.1.2. Duty of care

    Articles 150 and 151 of the Company Law stipulate that the director, supervisor and
    top managerial personnel shall be liable, if they violate any regulations, laws,
    administrative rules or articles of association of the company and caused damage to the
    company when they exercise their functions on behalf of the company. The shareholders’
    meeting or the general shareholders’ meeting requires that the director, the supervisor and
    top managerial personnel shall be present at the meeting and that the director, the
    supervisor and top managerial personnel shall accept the shareholders’ enquiry. The
    director and top managerial personnel shall provide the board of supervisors with the true
    relevant situation and materials and shall not prevent the board of supervisors from
    exercising their power.

    Article 98 of the Guidance for the Articles of Association of Listed Companies
    stipulates that the director is also responsible for the company’s duty of diligence. This
    involves: ensuring that the company’s behaviour complies with the laws, administrative
    regulations and various economic policies in China, that commercial activity not exceed
    the business scope stipulated by the business licence, and that shareholders be treated
    fairly. The director is also required to know the company’s operational and management
    situation on a timely basis and draft signed, written confirmation opinions regularly that
    ensure that the information disclosed by the company is true, correct and complete, and
    the company may add more requirements on the company’s duty of diligence in its
    articles of association according to the specific situation. Article 136 of the Guidance for
    the Articles of Association of Listed Companies provides for the supervisors’ duty of
    diligence, while Article 141 provides that any supervisor violating the law, regulation,
    department decree or the company’s articles of association in the performance of his or

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    her duty and causing damage to the company shall assume the responsibility of
    compensation.

    Chapter 4 of the Guidance on Appointment and Activities of Directors of Listed
    Companies of the Shanghai Stock Exchange provides the details of the director’s duty of
    diligence and points out that claiming for removing exemption from an obligation is not
    allowed except in the case of unfamiliarity with the business or unawareness of relevant
    items.

    Article 4 of the Shenzhen Stock Exchange SME Board Listed Company Director
    Conduct Guidance prescribes the basic principles of the director’s duty of diligence.
    Directors shall be diligent and responsible, shall positively strive to perform their duties
    using their knowledge, skills and experience, help the company abide by laws,
    regulations, rules, the related rules of the Exchange and the articles of association of the
    company, and endeavour to protect the rights and interests of the company, shareholders,
    and especially the public shareholders.

    5.2.1.3 Report on the board of directors’ work

    Articles 28 and 29 of the Rules for the General Meetings of Shareholders of Listed
    Companies stipulate that at the annual shareholders’ meeting, the board of directors and
    supervisory board shall report their work conducted during the year running up to the
    meeting and every independent director shall report on his or her work. The directors and
    supervisors shall offer explanations and clarification to shareholder enquiries. These
    annual reports on the work of the board of directors and the supervisory board provide an
    institutional mechanism for the two boards to effectively implement their duties.

    5.2.2 Principle VI. B: Where board decisions may affect different shareholder
    groups differently, the board should treat all shareholders fairly.

    Article 113 and 148 of the Company Law stipulates that directors shall carefully carry
    out the duties prescribed by the relevant laws, regulations and articles of association of
    the company, ensure that the company should abide by them, treat all the shareholders
    fairly and take into account the interests of other stakeholders.

    5.2.2.1 Directors prohibited from voting at board meetings

    Directors are prohibited from voting at board meetings in China in the case of related-
    party transactions. Article 125 of the Company Law stipulates that where any director of a
    listed company has a related-party relationship with enterprises related to matters to be
    resolved at the board of directors’ meetings, the director is not entitled to exercise his or
    her voting rights upon such resolutions nor exercise the voting rights on behalf of other
    directors. Board of directors’ meetings may be held only if more than half of the directors
    having no such related-party relationship attend the meetings.

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    5.2.2.2 Requirements on the minimum number of unrelated directors

    Article 125 of the Company Law stipulates that the resolution made at the board of
    directors’ meeting shall be passed by more than half of directors having no related-party
    relationship. Where the number of attending directors having no such related-party
    relationship is less than three, such matters shall be submitted to the shareholders’ general
    meeting for examination and discussion.

    5.2.2.3 Cumulative voting system

    Article 106 of the Company Law stipulates that when a shareholders’ general meeting
    elects directors, the cumulative voting system may be practised in accordance with the
    provisions of the articles of association or the resolution of the shareholders’ general
    meeting. The cumulative voting system referred to in this Law comes into play when a
    shareholders’ general meeting elects directors. Each share has the voting rights equal to
    the number of directors to be elected, and the concentrated use of the voting rights held
    by a shareholder is permitted.

    When a shareholder votes for directors, the total vote is the product of the number of
    the person’s shares and the number of directors to be elected. In the process of voting,
    shareholder may concentrate their votes on one or several director candidates. With the
    partially concentrated voting method, minority shareholders are able to elect directors in
    line with their own interests and avoid the appointment of all directors being monopolized
    by majority shareholders. This is to ensure that the board of directors acts on behalf of the
    interests of all shareholders.

    5.2.3 Principle VI. C: The board of directors and the supervisory board should
    apply high ethical standards. They should take stakeholders’ interests into
    account.

    5.2.3.1 Employee directors and supervisors should play their due role in
    safeguarding the rights and interests of employees.

    According to Article 109 of the Company Law, the board of directors of a company
    limited by shares may include representatives from among the staff and workers of the
    company. The inclusion of an employee representative on the board may to a certain
    extent guarantee the presence of workers’ representatives and therefore their interests in
    its decision-making process. Article 118 of the same law provides that a company limited
    by shares shall have a supervisory board composed of no fewer than three members, that
    the supervisory board shall include representatives of shareholders, the staff, and workers
    of the company in an appropriate proportion and no fewer than one-third of the total
    number of supervisors as determined by the company’s articles of association, and that
    the representatives of the staff and workers on the supervisory board shall be
    democratically elected by the staff and workers of the company at a conference or general
    meeting, or similar occasion of the representatives of the staff and workers.

    Article 85 of the Code of Corporate Governance of Listed Companies stipulates that a
    listed company shall encourage feedback from its employees regarding the company’s
    operating and financial situations and important decisions affecting employees’ benefits

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    through direct communications with the board of directors and the supervisory board.
    This encourages employees to actively express their opinions to the board of directors and
    supervisory board to be taken into consideration in the decision-making process.

    5.2.3.2 Respect the rights and interests of the stakeholders and provide the
    necessary conditions to safeguard their rights and interests

    Chapter 6 of the Code of Corporate Governance of Listed Companies’ Stakeholders,
    and Article 81, in particular, stipulate that a company shall respect the legal rights of its
    stakeholders, including banks and other creditors, employees, customers, suppliers, and
    the community. As the decision-making board of a company, the board of directors shall
    take into consideration and respect the benefits of stakeholders when making decisions.

    In addition, Chapter 6 also stipulates that a company shall provide the necessary
    means to ensure the legal rights of its stakeholders, who shall be entitled to the
    opportunities and channels for redress of any infringement upon their rights. A company
    shall provide the required information to banks and other creditors to enable them to
    make judgements and decisions about the company’s operating and financial situation.

    5.2.4 Principle VI. D: The board should fulfil certain key functions

    5.2.4.1 Principle VI. D 1: The key functions of the board are: reviewing and
    guiding corporate strategy, major plans of action, risk policy, annual budgets and
    business plans; setting performance objectives; monitoring implementation and
    corporate performance; and overseeing major capital expenditure, acquisitions
    and divestitures.

    Article 47 of the Company Law stipulates that the functions and powers to be
    exercised by the board of directors include: deciding the business plans and investment
    plans of the company; drawing up the annual financial budget plan and final accounts
    plan; formulating plans for mergers, divisions, dissolutions or changes to the company’s
    corporate form; convening shareholders’ meetings and reporting on its work therein;
    implementing the resolutions of the shareholders’ meetings; formulating plans for profit
    distribution, and for making up for corporate losses; formulating plans for the increase or
    reduction of the registered capital and issue of company bonds; deciding on the
    establishment of the company’s internal management bodies; formulating the company’s
    basic management system, and; exercising other functions and powers prescribed in the
    company’s articles of association.

    Article 124 of the Guidance for the Articles of Association of Listed Companies
    stipulates that the manager and deputy manager are employed and can be dismissed by
    the board of directors. Article 106 stipulates that, within the scope authorised by the
    shareholders’ meetings, the board of directors decides on the matters concerning the
    company’s external investment, buying and selling assets, etc. Article 110 stipulates that
    the board of directors shall set forth the scope of external investment, buying and selling
    assets, establish strict procedures of examination and decision-making. Major investment
    items shall be subject to the evaluation of the relevant experts and professionals and be
    submitted to the shareholders’ meeting for approval.

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    5.2.4.2 Principle VI. D 2: Monitoring the effectiveness of the company’s
    governance practices and making changes as needed.

    Through the selection and replacement of executives, the board of directors may
    adjust the company’s operations and governance practices. It is stipulated in the Code of
    Corporate Governance of Listed Companies that the key functions of the nomination
    committee include: studying the criteria and procedures for selecting directors and
    managers as well as making suggestions; extensively seeking qualified directors and
    manager candidates and; examining director and manager candidates and making
    suggestions.

    On June 28, 2009, the Basic Standard for Enterprise Internal Control was released
    jointly by the Ministry of Finance, the National Audit Office, the CSRC, CBRC and
    CIRC. Article 12 stipulates that the board of directors is responsible for the establishment,
    improvement and effective implementation of internal control; Article 13 specifies that an
    enterprise shall establish an audit committee reporting to the board of directors. The audit
    committee shall be responsible for examining the internal control of the company,
    overseeing the effective implementation and self-evaluation of internal control,
    coordinating the internal control auditing and other relevant matters. Article 45 stipulates
    that an enterprise shall formulate its policy to identify weaknesses in its internal control,
    analyse the nature and causes of the internal control defects discovered during the
    monitoring process, put forward the improvement plans and report to the board of
    directors, board of supervisors and managerial personnel on a timely basis and in an
    appropriate manner.

    5.2.4.3 Principle VI. D 3: Selecting, compensating, monitoring and, when
    necessary, replacing key executives and overseeing succession planning.

    Article 47 of the Company Law stipulates that the board of directors may decide on
    matters concerning the recruitment or dismissal of the company’s manager and their
    remuneration, and decide, based upon the manager’s appointment, on the recruitment or
    dismissal of the company’s deputy manager(s) and persons in charge of financial affairs
    as well as matters concerning their remuneration.

    Articles 77-80 of the Code of Corporate Governance of Listed Companies provide
    that a listed company shall establish an incentive mechanism linking the managerial
    personnel’s remuneration with the company’s performance and the individuals’
    performance. The performance assessment of management personnel shall become a
    basis for determining the compensation and other rewarding arrangements for the person
    reviewed. The managerial personnel’s remuneration distribution plan shall be subject to
    approval by the board of directors, explained at the shareholders’ meeting and disclosed.
    The company shall specify in its articles of association the managerial personnel’s duties
    and responsibilities. If the managerial personnel violate laws, regulations and the
    company’s articles of association, and cause damages to the company, the board of
    directors shall actively take measures to investigate and pursue the legal liabilities of such
    personnel.

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    5.2.4.4 Principle VI. D 4: Aligning key executive and board remuneration with the
    longer-term interests of the company and its shareholders.

    Article 56 of the Code of Corporate Governance of Listed Companies stipulates that
    the main duties of the remuneration and appraisal committee are (1) to study the appraisal
    standard for directors and managerial personnel, to conduct appraisals and make
    recommendations; and (2) to study and review the remuneration policies and schemes for
    directors and executives.

    Articles 69-70 stipulate that a listed company shall establish fair and transparent
    standards and procedures for the assessment of the performance of directors, supervisors
    and executives. The evaluation of the directors and executives shall be conducted by the
    board of directors or by its remuneration and appraisal committee. The evaluation of the
    performance of independent directors shall be conducted through a combination of self-
    review and peer review.

    5.2.4.5 Principle VI. D 5: Ensuring a formal and transparent board nomination
    and election process.

    Article 28 of the Code of Corporate Governance of Listed Companies stipulates that a
    company shall establish a standardised and transparent procedure in its articles of
    association for the election of directors to ensure the openness, fairness, impartialness and
    independence of the election.

    Articles 29-30 stipulate that detailed information regarding the candidates for
    directorship shall be disclosed before the shareholders’ meeting is convened to ensure
    that shareholders have adequate knowledge about the candidates at the time they vote.
    Candidates for directorship shall accept their nomination in writing, to warrant the
    authenticity and completeness of the information provided to the candidate and publicly
    disclosed, and shall promise to perform their duties in earnest once elected.

    Articles 31-32 specify that the election of directors shall fully reflect the opinions of
    minority shareholders. A cumulative voting system shall be advanced in shareholders’
    meetings for the election of directors. Listed companies with over 30% their shares
    owned by controlling shareholders shall adopt a cumulative voting system. These
    companies shall stipulate the detailed implementation of rules and regulations for the
    cumulative voting system in their articles of association. Appointment agreements shall
    be entered into by a listed company and its directors to clarify such matters as the rights
    and obligations between the company and the director, the term of the directorship, the
    director’s liabilities in the case of a breach of laws, regulations or articles of association,
    and compensation from the company in case it violates the appointment agreement and
    terminates the contract earlier than planned.

    5.2.4.6 Principle VI. D 6: Monitoring and managing potential conflicts of interest
    of management, board members and shareholders, including misuse of corporate
    assets and abuse in related-party transactions.

    In order to prevent conflicts of interest, the Company Law stipulates that the related
    directors shall avoid voting on certain matters (see details VI.B of this chapter).

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    Articles 12-14 stipulate that written agreements shall be entered into for related-party
    transactions between a listed company and its connected parties and the relevant matters
    shall be disclosed. Listed companies should adopt efficient measures to prevent related
    parties from interfering with the company’s operations and damaging the company’s
    interests by monopolising purchase or sales channels. The company shall adopt efficient
    measures to prevent its shareholders and their related parties from misappropriating or
    transferring capital, assets or other resources of the company through various means.

    The Fifth Part of the Guiding Opinions on the Establishment of the Independent
    Director System by Listed Companies (Listed Companies Should Fully Exploit the Role
    of Independent directors) specifies that major connected transactions (namely proposed
    connected transactions between the listed company and a connected person with a total
    value of more than CNY 3 million (EUR 325 500) or more than 5% of the listed
    company’s most recently audited net asset value) should be submitted to the board of
    directors for deliberation after approval by independent directors;

    Article 96 of the Guidance for the Articles of Association of Listed Companies allows
    the manager or other top managerial personnel to serve concurrently as the director.
    However, such directorship concurrently assumed by the manager or other senior
    managerial personnel or employee representatives shall not exceed half the total number
    of board of directors. The conflict of interest caused by the situation in which the board of
    directors is controlled by management can be effectively prevented by limiting the
    number of members of the board and the managerial personnel on the board who overlap.

    5.2.4.7 Principle VI. D 7: Ensuring the integrity of the corporation’s accounting
    and financial reporting systems, including the independent audit, and that
    appropriate systems of control are in place for risk management, financial and
    operational control, and compliance with the law and relevant standards.

    The board of directors’ audit committee shall ensure the effectiveness of enterprise
    internal control and the authenticity and accuracy of financial data.

    Article 54 of the Code of Corporate Governance of Listed Companies lays down that
    that the main duties of the audit committee are: (1) to recommend the engagement or
    replacement of the company’s external auditing institutions; (2) to review the internal
    audit system and its implementation; (3) to oversee the interaction between the
    company’s internal and external auditing institutions; (4) to inspect the company’s
    financial information and its disclosure; and (5) to monitor the company’s internal control
    system.

    The amended Company Law (2006) grants the supervisory board the right to carry out
    an investigation when it finds the company operation abnormal and, when necessary, to
    hire accounting firms to assist in its investigation, with the company covering their
    expenses. Article 60 of the Code of Corporate Governance of Listed Companies also
    provides that the supervisory board may independently hire intermediary institutions to
    offer professional opinions.

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    5.2.4.8 Principle VI. D 8: Overseeing the process of disclosure and
    communications

    Article 3 of the Administrative Measures on Information Disclosure by Listed
    Companies states that the directors of issuers and listed companies shall perform their
    duties faithfully and diligently, and ensure the veracity, accuracy, completeness,
    timeliness and impartiality of the information disclosed. Article 24 stipulates that the
    directors of a company shall sign and endorse regular reports. If directors are unable to
    ensure the veracity, accuracy and completeness of a regular report or differing views are
    held, their reasons and opinions shall be stated and disclosed.

    Article 90 of the Code of Corporate Governance of Listed Companies specifies that the
    secretary of the board of directors shall be in charge of information disclosure, including
    drawing up rules for information disclosure, receiving visits, providing consultation,
    contacting shareholders, providing publicly disclosed information about the company to
    investors. Articles 87-89 stipulate that information disclosure is an ongoing responsibility
    for listed companies. A listed company shall disclose information truthfully, accurately,
    completely and in a timely manner, as required by laws and regulations and the company’s
    articles of association. In addition to disclosing mandatory information, a company shall
    also voluntarily disclose all other information that may have a material effect on the
    decisions of shareholders and stakeholders, and shall ensure equal access to information for
    all shareholders, on a timely basis. Information disclosed by a listed company shall be
    easily comprehensible. Companies shall ensure cost-effective, convenient and speedy
    access to information through various means (such as the Internet).

    5.2.5 Principle VI. E: The board should be able to exercise objective
    independent judgement on corporate affairs

    5.2.5.1 Principle VI.E.1: Boards should consider assigning a sufficient number of
    non-executive board members capable of offering independent judgement when
    there is a potential for conflict of interest, for example, in ensuring the integrity of
    financial and non-financial reporting, reviewing related-party transactions,
    nominating board members and key executives, and board remuneration.

    5.2.5.1.1 The significance of independent directors

    The first part of Guiding Opinion on the Establishment of Independent Director
    Systems by Listed Companies (Listed Companies Should Establish Independent Director
    Systems) claims that the term “independent director of a listed company” means a
    director who does not hold any position in the company other than director and who has
    no relationship with the listed company or its principal shareholders that could hinder him
    or her from making independent and objective judgements.

    An independent director has a fiduciary obligation and an obligation of diligence
    toward the listed company and all its shareholders. An independent director should
    safeguard the company’s overall interests and, in particular, the lawful rights and interests
    of minority shareholders. An independent director should perform his duties and
    responsibilities independently, without interference from the main shareholders or actual
    controllers, or other entities or individuals that have a material interest in the listed
    company.

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    5.2.5.1.2 The quantity and independent standard of independent directors

    The Guiding Opinion requires that at least one-third of the members of the board of
    directors should be independent directors, and at least one of the independent directors
    should be a professional accountant.

    In order to ensure that independent directors be truly independent, the Guiding
    Opinion stipulates that the following persons may not hold the position of independent
    director: persons holding a position in the listed company or a subsidiary thereof and their
    lineal relatives and major social relations (the term “lineal relatives” meaning spouses,
    parents, children, and the term “major social relations” meaning siblings, parents-in-law,
    children-in-law, siblings’ spouses, spouse’s siblings); individual shareholders who
    directly or indirectly hold not less than 1% of the issued shares of the listed company or
    who rank in the top ten shareholders of the listed company, and their lineal relatives;
    persons who hold positions in entities that directly or indirectly hold not less than 5% of
    the issued shares of the listed company or that rank in the top five shareholders of the
    listed company, and their lineal relatives; persons who, at some time in the previous year,
    have joined one of the three above categories ; persons who provide financial, legal,
    consultancy or similar services to the listed company or its subsidiaries.

    5.2.5.1.3 Independent directors’ special functions and powers

    In the Guiding Opinion, independent directors are clearly required to safeguard the
    company’s overall interests and, in particular, to ensure that the lawful rights and interests
    of minority shareholders are not prejudiced. Listed companies should grant independent
    directors a number of other tasks and powers, in addition to their legal functions and
    powers. Once independent directors have approved a major transaction, they should
    submit their decisions to the board of directors for deliberation. Before pronouncing their
    decision, independent directors may engage an intermediary organization to issue an
    independent financial report for use as a basis for their judgement. They should submit
    their decisions to the board when they propose the engagement or dismissal of an
    accounting firm, convene a meeting or an extraordinary shareholders’ general meeting,
    engage external auditing institutions and consultancies or openly solicit shareholders’
    voting rights before a shareholders’ general meeting.

    Independent directors should obtain the consent of at least half their number before
    exercising the afore-mentioned functions and powers. If any of the aforementioned
    proposals are not accepted or any of the afore-mentioned functions and powers could not
    be exercised normally, the listed company should disclose the details thereof.

    An independent director should express his or her independent opinion on six
    categories of significant matters such as the nomination, appointment and removal of
    directors, the engagement or dismissal of executives. Independent opinions can be
    expressed by agreement; reservation and reasons; objection and reasons; no comments
    and obstacles. The listed company should make a public announcement of the above
    independent opinions. If the independent directors fail to reach a consensus in their
    opinions, the listed company should disclose each of the independent directors’ respective
    opinions.

    According to the provisions of the Guiding Opinion on the Establishment of
    Independent Director Systems by Listed Companies, listed companies should provide the
    necessary conditions to ensure the effective performance of functions and expression of
    independent opinions by independent directors. Firstly, listed companies should make

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    sure that their independent directors enjoy the same rights to information as other
    directors. On all matters to be decided upon by the board of directors, the law requires
    that a listed company must inform its independent directors in advance and provide them
    with sufficient materials at the same time. Independent directors may request extra
    materials when they find them insufficient. Secondly, the secretary of the board of
    directors should actively brief the independent directors on the relevant situation and
    provide materials. Meanwhile, other personnel of the listed company should actively
    support the independent directors in their performance of duty. Thirdly, independent
    directors may hire intermediary institutions and solicit opinions from independent
    external consultants, the cost of which shall be borne by the listed company, as are the
    costs related to the performance of their functions.

    5.2.5.2 Principle VI. E. 2: When committees of the board are established, their
    mandate, composition and working procedures should be well-defined and
    disclosed by the board.

    It is stipulated in the Code of Corporate Governance of Listed Companies that the
    board of directors of a listed company may establish a corporate strategy committee, audit
    committee, nomination committee, remuneration and appraisal committee and other
    special committees in accordance with the resolutions of the shareholders’ meetings. The
    Code gives clear descriptions of the functions of special committees. Article 58 stipulates
    that each special committee shall be accountable to the board of directors. All proposals
    by special committees shall be submitted to the board of directors for review and
    approval.

    Article 52 stipulates that all committees shall be composed solely of directors.
    Independent directors shall chair the audit committee, the nomination committee and the
    remuneration and appraisal committee, and independent directors shall constitute the
    majority of the committees. At least one independent director from the audit committee
    shall be an accounting professional.

    5.2.5.3 Principle VI. E. 3: Board and supervisory board members should be able
    to commit themselves effectively to their responsibilities.

    5.2.5.3.1 Training of the members of the board of directors and the supervisory
    board.

    The CSRC has issued a number of regulations related to the training of members of
    the board, such as Guidance for the Training of Senior Managerial Personnel in a Listed
    Company, Implementing Regulations on the Training of the Board Chairman and General
    Manager in a Listed Company, Implementing Regulations on the Training of Directors
    and Supervisors in a Listed Company, Implementing Regulations on the Training of
    Independent Directors in a Listed Company and Implementing Regulations on the
    Training of Board Secretaries in a Listed Company.

    Article 4 of Guidance for the Training of Senior Managerial Personnel in a Listed
    Company stipulates that executives of a listed company shall accept the ongoing
    education and training, and obtain a training certificate when they hold their positions.
    The Department of Listed Company Supervision of the CSRC provides guidance and

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    coordination for the training, and organises training in collaboration with CSRC agencies
    and stock exchanges. The trainees include the chairman of the board of directors,
    directors, supervisors, independent directors, general managers, chief financial officers
    and secretary of the board of directors. The training is designed for these senior
    executives to gain a better understanding of the relevant laws and regulations and the
    securities market, improve their business level, strengthen awareness of self-discipline
    and standard operations and improve the corporate governance structure of listed
    companies. Trainers are professionals from the CSRC, stock exchanges, higher education
    institutions and other professional institutions. The CSRC records the training for listed
    companies executives and their training examination results into a credit records
    database.

    5.2.5.3.2 The qualification of directors and supervisors

    To ensure that the company directors and supervisors are able to effectively exercise
    their functions and duties, the laws and regulations in China include a series of
    regulations on the qualification of the board members.

    Article 95 of the Guidance for the Articles of Association of Listed Companies
    stipulates that a person may not act as a director if: they are without civil capacity or with
    limited civil capacity; they have been sentenced to prison for embezzlement, bribery,
    conversion of property, misappropriation of property, sabotage of social economic order,
    and completed the sentence less than five years earlier; they have been deprived of
    political rights as a result of a criminal conviction, and completed repaying the sanction
    less than five years earlier; they have served as a director, factory manager, or the
    manager of a company which went bankrupt as a result of mismanagement, were
    personally responsible for the bankruptcy, and completed the liquidation less than three
    years ago; they have served as the legal representative of a company whose business
    license was revoked due to a violation of the law, were personally responsible for such
    revocation, which occurred less than three years ago; they have an unpaid personal debt
    of a significant amount; they have been banned by the CSRC from access to the securities
    market and the ban has not expired. Article 135 provides that the stipulations on
    disqualifications of directors also apply to supervisors. The directors, general manager
    and other senior executives may not concurrently serve on the supervisory board.

    Article 23 of the Code of Corporate Governance of Listed Companies stipulates that
    in the case where a member of a controlling shareholder’s senior management
    concurrently holds the position of director of the listed company, he or she shall ensure
    adequate time and energy to perform the work required by the listed company. Article 52
    stipulates that an independent director shall chair the audit committee, the nomination
    committee and the remuneration and appraisal committee, and independent directors shall
    constitute the majority of the committees. At least one independent director from the
    audit committee shall be an accounting professional. Article 64 provides that supervisors
    shall have professional knowledge or work experience in areas such as law and
    accounting, and that the members and the structure of the supervisory board shall ensure
    its capability to independently and efficiently supervise its directors, managers and other
    senior management personnel and supervise and examine the company’s financial
    matters.

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    5.2.5.3.3 Laws and regulations provide constitutional protection for the board of
    directors and the supervisory board to effectively fulfil their duties

    A series of laws, regulations and self-disciplinary rules such as the Company Law,
    Code of Corporate Governance of Listed Companies, Guidance for the Articles of
    Association of Listed Companies, Shanghai Stock Exchange Guidance on Appointment
    and Activities of Directors of Listed Companies, Shenzhen Stock Exchange Small and
    Medium Enterprise Board Director Conduction Guidance, Shenzhen Stock Exchange
    Guidance on Standard Operations of Companies Listed on the Main Board, Shenzhen
    Stock Exchange Guidance on Standard Operations of Companies Listed on the SME
    Board and Shenzhen Stock Exchange Guidance on Standard Operations of Companies
    Listed on Growth Enterprise Board define the responsibilities and duties of the members
    of the board of directors and the supervisory board, ensuring the performance of functions
    by the two boards in accordance with the laws.

    5.2.6 Principle VI. F: In order to fulfil their responsibilities, directors and
    supervisors should have access to accurate, relevant and timely information.

    5.2.6.1 The audit committee is responsible for the accuracy of corporate financial
    information

    Article 52 of the Code of Corporate Governance of Listed Companies stipulates that
    at least one independent director from the audit committee should be an accounting
    professional. Article 54 stipulates that the main duties of the audit committee are to
    inspect the company’s financial information, disclose that information and monitor the
    company’s internal control system to ensure that the board of directors obtains the correct
    financial information. The audit committee is a special committee of the board of
    directors. The expertise of its personnel and the inspection of the internal control system,
    including the financial system, ensure that directors may obtain correct information.

    5.2.6.2 Timely and adequate information for directors and supervisors

    Article 46 of the Code of Corporate Governance of Listed Companies stipulates that
    the meetings of the board of directors of a listed company shall be conducted in strict
    compliance with the prescribed procedures. The board of directors shall send a notice to
    all directors in advance, at the stipulated time, and shall provide sufficient material,
    including relevant background material for the items on the agenda and other information
    and data that may assist the directors in their understanding of the company’s business
    development. When two or more independent directors deem the materials inadequate or
    unclear, they may jointly submit a written request to postpone the meeting or to postpone
    the discussion of the related matter, which shall be granted by the board of directors.
    Article 61 of the Code of Corporate Governance of Listed Companies provides that a
    listed company shall adopt measures to ensure supervisors’ rights to learn about company
    matters, and shall provide the necessary assistance to supervisors for their normal
    performance of duties. Article 61 insists that no one shall interfere with or obstruct the
    supervisors’ work and that a supervisor’s reasonable expenses necessary to perform the
    duties shall be borne by the listed company. According to Articles 65 to 67 of the Code, a
    listed company shall formulate in its articles of association standardised rules and

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    procedures for the supervisory board and the supervisory board’s meetings shall be
    convened in strict compliance with the rules and procedures. The supervisory board shall
    meet periodically and shall convene interim meetings in a timely manner when necessary.
    If for any reason a supervisory board meeting cannot be convened as scheduled, an
    explanation shall be made publicly. The supervisory board may ask directors, managers
    and other senior management personnel, internal and external auditors to attend the
    supervisory board meetings and to answer the questions that the supervisory board is
    concerned with.

    5.2.6.3 Hiring of external experts for professional opinions

    Article 57 of the Code of Corporate Governance of Listed Companies stipulates that
    each special committee may engage intermediaries to provide professional opinions, and
    the relevant expenses shall be borne by the company. Article 60 provides that supervisors
    shall have the right to learn about the operating status of the listed company and the
    corresponding obligation of confidentiality and that the supervisory board may
    independently hire intermediary institutions to provide professional opinions.

    Independent directors should provide objective and fair opinions, especially when the
    company decision is controlled by internal personnel or there are conflicts of interest with
    controlling shareholders. In this connection, the independent directors of many listed
    companies have hired external independent advisors such as professional appraisers,
    auditors, financial advisors and consultants. In order to allow independent directors to
    play their role to the full and perform their duty, and protect the rights and interests of
    minority shareholders, the Guiding Opinion on the Establishment of Independent Director
    Systems by Listed Companies provides that a listed company should grant its independent
    directors the power to independently hire external auditing and consulting agencies and to
    make proposals to the board of directors on the hiring or firing of accounting firms.

    Article 13 of the Guidance for Shanghai Exchange Listed Company Corporate
    Governance stipulates that independent directors shall provide objective and fair
    opinions, and especially when the company decision is controlled by internal personnel,
    and that there are conflicts of interest among shareholders, independent directors may
    consult external independent advisors. The company shall provide the necessary
    conditions for this. Article 21 stipulates that the board of the company shall designate the
    independent director to judge whether the related-party transaction is good for the
    company in terms of objective standards. When necessary, professional appraisers and
    independent financial advisors may be employed.

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    Chapter 6

    Stakeholders and corporate social responsibility

    After the Chinese government released the Scientific Outlook on Development which
    puts people’s interests first and stresses an all-round, balanced and sustainable
    development model, and defined the strategic mission of building a harmonious socialist
    society, Corporate Social Responsibility (CSR) has drawn increasing attention from
    different sectors across the country. This indicates a crucial transformation in China’s
    development model, a shift from a one-sided focus on the economic growth rate to a
    scientific development model that stresses balance among economic, social and
    environmental development and sustainable growth. At the micro-economic level, instead
    of maximising shareholders’ interests alone, companies now take a more holistic view of
    how their decisions and actions might affect stakeholders and make compensation or
    repayments accordingly. They have begun to undertake varied forms of social
    responsibilities across economic, legal, moral and charity issues, resulting in a beneficial
    interaction with stakeholders and an internal and external environment favourable to their
    own long-term operations.

    Respecting the legal rights and interests of stakeholders, protecting the environment
    and delivering social responsibility have become a code of conduct for businesses in
    China. Listed companies, deemed the best among them, have achieved certain progress in
    CSR enforcement.

    6.1 China’s legal guarantee for the protection of stakeholder interests

    CSR is both an obligation that businesses undertake to account for social
    communities and stakeholders and a right that social communities and stakeholders are
    entitled to assert to businesses. A scientific and comprehensive legal system is
    instrumental for CSR enforcement and to protect the legal rights and interests of
    stakeholders. Laws and regulations in China contain compulsory provisions on certain
    fundamental and instrumental CSR issues. A wide range of standards is also in place,
    including standards for environmental protection, product quality, a minimum wage and
    workplace safety. Penalties for violation of CSR obligations are defined, including forced
    closure, revocation of business licences, compensation for economic loss and execution
    of criminal liability. All this has made the businesses feel more responsible for CSR
    enforcement.

    There are also certain specially designed provisions that provide taxation, credit and
    other policy incentives for CSR enforcement. For instance, the Income Tax Law provides
    that businesses engaged in approved environmental protection and water or energy
    conservation projects are entitled to income tax reductions or exemptions. Meanwhile, the

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    purchasing costs of facilities for the purposes of environmental protection, water or
    energy conservation, and workplace safety are subject to certain tax allowances.

    Stakeholders’ participation in CSR and protection of their own interests are also
    written into China’s laws and regulations. For instance, under the Company Law, staff
    representatives are allowed to participate in meetings of board directors and supervisors,
    and in specific circumstances decisions on major events shall be approved by creditors’
    meetings.

    6.1.1 Provisions on protection of stakeholders’ interests

    6.1.1.1 Provisions on protection of creditors’ interests

    Debt financing always accounts for a high percentage of the capital structure of
    Chinese businesses. It takes the form of short-term loans, short-term financing bills, long-
    term loans, corporate bonds and convertible corporate bonds. Mechanisms that protect
    creditors’ interests are defined in the Company Law, the Law on Commercial Banks, the
    Securities Law and the Law on Enterprise Bankruptcy.

    The Company Law bans shareholders from abusing independent entities with legal
    personality status and their limited responsibilities to the detriment of creditors’ interests.
    Those who do so and evade debt obligations to the serious detriment of creditors’
    interests shall assume collateral responsibility to respond to the creditors. The company
    shall cover its previous losses and make allocations to the statutory reserve funds before
    distributing profits to shareholders. Otherwise shareholders shall return to the company
    the profit shared in violation of the above provision.

    The Law also provides that in the case of a merger, division or registered capital
    reduction, the company shall prepare a balance sheet and property list and notify its
    creditors within ten days of the adoption of the resolution and publish a notice within 30
    days. Upon receiving the notice, creditors are entitled to protective measures such as
    claiming full debt payment or requiring assurance of payments from the company.

    The Law also provides that a liquidation committee shall be formed within 15 days
    after the date of the dissolution decision. The committee shall notify the creditors within
    ten days of its establishment and make a public announcement in the newspaper within 60
    days. Creditors may file for their rights with the committee after receipt of the notice. The
    company shall pay off liquidation expenses, employee payments, insurance fees, statutory
    compensation and unpaid tax and debts before distributing remaining assets to
    shareholders.

    In 2003 and 2005 the General Office of the State Council issued two documents
    produced by the State-owned Assets Supervision and Administration Commission on
    standardising the ownership reform of SOEs, which clearly provides that the reform must
    explicitly maintain financial creditors’ rights and materialise financial debts according to
    law, and that the reform plan should be agreed upon by the financial institution creditors.

    The Law on Enterprise Bankruptcy adopted in August 2006 sets out regulations for
    bankruptcy procedures and the settlement of creditors’ rights and obligations. According
    to the Law, if the company fails to pay off mature debts and has insufficient assets to pay
    off total debt or evidently lacks the ability to do so, either the debtor or creditor may file
    for bankruptcy settlement with the People’s Court. Article 84 of the Code of Corporate

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    Governance of Listed Companies provides that listed companies shall provide the
    required information to the bank and its debtors for them to make judgements and
    decisions on the company’s operational status and financial situation. The creditors are
    entitled to the right to know as necessary.

    6.1.1.2 Protection of employee rights

    With the growing trend to strive to protect human rights and ensure people’s
    livelihood, the Chinese government has stepped up legislative efforts on the protection of
    employee rights. A number of laws and regulations have been developed and amended,
    including the Company Law, Labour Law, Law on Employment Contracts, Employment
    Promotion Law, Production Safety Law, Law on Prevention and Control of Occupational
    Diseases and Regulation on the Collection and Payment of Social Insurance Premiums.
    The system that protects employees’ rights in fair employment opportunity, health and
    safety, payments and social insurance has gradually been improved. Under the Company
    Law, companies are required to protect the legal rights and interests of their employees by
    signing work contracts with them, participating in social insurance, and adopting more
    protective measures for workplace safety. Companies are also required to provide more
    professional education and training in different forms to enhance employees’
    qualifications.

    In China, employees are allowed to participate in the management of their company
    through trade unions, the board of directors, the board of supervisors and the employee
    representative conference. Article 18 of the Company Law allows employees to organise
    trade unions and requires the company to provide operational means for trade union
    activities. Trade union representatives shall sign a collective contract with the company
    on issues of payments, working hours, pensions, insurance and workplace safety. In the
    case of major decisions on reorganisation and operations, and key regulations, the
    company shall listen to the voice of the trade union and collect views and advice from
    employees through the employee representative congress or in other forms. Article 4 of
    the Law on Employment Contracts provides that when an employer draws up, revises or
    decides on rules and regulations or material matters that have a direct bearing on the
    immediate interests of its employees, such as those concerning compensation, working
    hours, breaks and leave, workplace safety and hygiene, insurance and benefits, employee
    training, work discipline or work quota management, these shall all be discussed by the
    employee representative congress or all the employees. The employee representative
    congress or all the employees, as the case may be, shall put forward a proposal and
    comments, whereupon the matter shall be determined through consultations with the trade
    union or employee representatives conducted on a basis of equality. The Company Law
    allows for the presence of employee representatives at board meetings and requires a
    minimum one-third share of employee representatives on the board of supervisors.
    Employee representatives are to be selected by means of democratic elections through the
    employee representative congress, the employee congress or other forms. The Law on
    Enterprise Bankruptcy requires the presence and opinions of employees and trade union
    representatives at the debtors’ meeting if the company enters a bankruptcy reorganisation
    phase.

    The Law on Employment Promotion adopted in August 2007 provides for the right of
    equal employment opportunities.

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    6.1.1.3 Regulations on consumer rights protection

    China released a great number of laws and regulations on the protection of consumer
    rights and interests with a view to protecting them and maintaining a proper market order.
    These include provisions on the social responsibilities that businesses are required to
    assume for consumers. Directly related laws and regulations are the Law on the
    Protection of the Rights and Interests of Consumers, Measures to Handle Fraudulent
    Behaviours against Consumers, Penalties on Fraudulent Behaviours against Consumers,
    Interim Measures on Consumer Complaints Handled by Business and Commerce
    Administrative Authorities. Laws on product quality include the Law on Product Quality,
    Law on Food Safety and Pharmaceutical Administration Law.

    6.1.2 Laws and regulations on CSR enforcement

    The Code of Corporate Governance of Listed Companies provides that while
    ensuring sustained growth and maximum shareholder interests, listed companies shall
    also be committed to community welfare, environmental protection and charity issues and
    be focused on their own social responsibilities. Other laws and regulations also contain
    detailed provisions on the enforcement of CSR.

    6.1.2.1 Provisions on Environmental Protection

    According to the Measures for the Administration of Initial Public Offerings of
    Shares and the Listing Thereof and Administrative Measures for the Issuance of
    Securities by Listed Companies released by the CSRC, companies that have violated laws
    and administrative regulations on environmental protection within the recent 36 months
    and were subject to administrative penalties with serious circumstances shall not be
    allowed to apply for initial public offerings. Listed companies shall not engage in re-
    financing. Listed companies’ initial public offerings and new share issues shall also meet
    regulations on environmental protection.

    The State Administration on Environmental Protection (SEPA) issued the Measures
    on Environmental Information Publicity (on Trial) in 2007, encouraging businesses to
    disclose their own environmental information on a voluntary basis. The 2008 SEPA
    Guiding Opinion on Strengthening the Regulatory Work on Listed Companies in Respect
    of Environmental Protection provides that listed companies shall immediately disclose to
    investors who have no prior knowledge major events with potential substantial impacts
    on the transaction price of securities and derivatives, and relevance to environmental
    protection, illustrating the cause, status quo and possible impacts of the event. In 2008,
    the Shanghai Stock Exchange issued the Guidelines on the Disclosure of Environmental
    Information of Listed Companies, clarifying the compulsory disclosure requirements for
    listed companies that appear on the government list of “most seriously polluted
    companies” or have experienced major environmental events, and the requirements of
    voluntary disclosure.

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    6.1.2.2 Regulations against corruption and bribery among businesses

    Under the Law against Unfair Competition published in 1993, companies are required
    to observe the principle of voluntariness, equality, justice, honesty and integrity and the
    agreed commercial morals. In 1996, the Interim Provision on Banning Commercial
    Bribery was published by the State Administration for Industry and Commerce. In 2005,
    China joined the United Nations Convention against Corruption and has enhanced
    international co-operation against corruption. The Criminal Law also defines severe
    criminal punishments of bribery.

    6.1.2.3 Regulations on Donations to Charity

    The Welfare Donations Law was issued in 1999, proving for donations to charities by
    individuals, businesses and other organisations. These charity actions include community
    and individual activities such as disaster relief, poverty relief and reduction and assistance
    for the disabled; facility-building projects for education, science, culture, healthcare,
    sports, environmental protection and communities; and non-profit public and welfare
    activities for the benefit of social progress.

    Based on the latest Corporate Income Tax Law amended and released in 2007, the
    proportion of charity and welfare expenses that is within 12% of annual profits shall be
    deducted from tax payments.

    6.2 China’s practices compared with the OECD principles

    6.2.1 Principle IV. A: The rights of stakeholders that are established by law or
    through mutual agreements are to be respected.

    The principle provisions on the basic content and form of CSR delivery within
    China’s laws and regulations, lay down the legal basis for CSR. Article 5 of the Company
    Law provides that “when undertaking business operations, a company shall comply with
    the laws and administrative regulations, social morality and business morality. It shall act
    in good faith, accept the supervision of the government and the general public, and bear
    social responsibilities”. The Code of Corporate Governance of Listed Companies
    stipulates that listed companies shall respect the legal rights of stakeholders such as
    banks, creditors, employees, consumers, suppliers and communities; create conditions as
    required for the maintenance of such rights and interests; and arrange compensation
    which the stakeholders shall have access to and the opportunity to receive whenever their
    legitimate interests are violated. Apart from legal provisions, the Shanghai and Shenzhen
    Stock Exchanges have actively played their role as the supervisors of listed companies’
    self-discipline and made great efforts in to make it easier for listed companies to protect
    stakeholder interests and fulfil their social responsibilities to the full.

    In 2006, the Shenzhen Stock Exchange released the Guidelines on Social
    Responsibilities of Companies Listed at the Shenzhen Stock Exchange, under which listed
    companies are required to actively protect the legitimate rights and interests of debtors
    and employees while pursuing economic benefits and protecting shareholder interests;
    treat suppliers, customers and consumers with good faith; take an active part in
    environmental protection, community development and other public causes; and develop
    a balanced and harmonious relationship with the communities. Listed companies are

    6. STAKEHOLDERS AND CORPORATE SOCIAL RESPONSIBILITY

    100 CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011

    encouraged to develop social responsibility systems, conduct regular inspection and
    assessment of the progress made in implementing the systems and issues to be addressed,
    and regularly draft and release reports on social responsibilities. The TEDA
    Environmental Protection Index, the first index on social responsibility on China’s capital
    market, was launched by Shenzhen Securities Information Company, a subsidiary of the
    Shenzhen Stock Exchange.

    In 2008, the Notice on Enhancing CSR Requirements for Listed Companies was
    issued by the Shanghai Stock Exchange, which emphasises the non-commercial
    contribution by stakeholders, society, environmental protection and resource uses. While
    setting up a CSR strategy, programme and working mechanism, a listed company is
    encouraged to disclose its special practices and achievements in CSR delivery and release
    its annual CSR report along with its annual report. It is also encouraged to make public its
    social contribution value per share, which is the equivalent of additional value per share
    calculated on the basis of profits per share with the addition of values created for
    stakeholders including the annual taxes to the country, payments to employees, loan
    interests to banks or other creditors, and external donations, and the deduction of
    environmental pollution costs and other forms of social costs. It is designed to give the
    public a more comprehensive picture of the real value that businesses can create for their
    shareholders, employees, clients, creditors, communities, and society as a whole. In
    August 2009, the Shanghai Stock Exchange and China Securities Index Company jointly
    launched the SSE Social Responsibility Index, which selects from the sample stocks 100
    corporate stocks with the highest social contribution value per share and puts them into
    new sample stocks.

    6.2.2 Principle IV. B: Where stakeholder interests are protected by law,
    stakeholders should have the opportunity to obtain effective redress for violation
    of their rights.

    6.2.2.1 Compensation mechanism for creditors with damaged interests

    First, Article 20 of the Company Law provides for the denial of the company’s legal
    personality status. In other words, where a shareholder of a company evades the payment
    of its debts by abusing the independent status of legal personality or the shareholder’s
    limited liabilities, and thus seriously damages the interests of any creditor, it shall bear
    joint liabilities for company debts. Where any shareholder attempts to transfer or possess
    the company’s property by abusing shareholders’ rights, the creditors may demand debt
    liabilities to be answered for.

    Second, creditors may execute their rights of guarantee. The Guarantee Law provides
    that in economic activities such as borrowing, buying and selling, transporting goods,
    possessing and outsourcing, creditors may initiate a guaranty by way of assurance,
    mortgage, pledge, lien or down-payment to ensure the fulfilment of their rights as
    debtors.

    Third, creditors may exercise subrogation rights. Article 73 of the Contract Law
    provides that if the debtor delays in exercising its creditor’s right against a third person,
    thereby harming the creditor, the creditor may petition the People’s Court for subrogation
    and the necessary expenses for subrogation by the creditor shall be borne by the debtor.

    6. STAKEHOLDERS AND CORPORATE SOCIAL RESPONSIBILITY

    CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011 101

    Fourth, creditors may petition the court to cancel debtors’ behaviour of handling
    abnormal assets. Article 74 of the Contract Law provides that where the debtor waives its
    creditor’s right against a third party or assigns its property without reward, thereby
    harming the creditor’s interests, the creditor may petition the People’s Court for
    cancellation of the debtor’s act. Where the debtor assigns its property at a low price
    which is manifestly unreasonable, thereby harming the creditor’s interests, and the
    assignee is aware of the situation, the creditor may also petition the People’s Court for
    cancellation of the debtor’s act. The expenses necessary for the creditor to exercise the
    right to cancel shall be borne by the debtor.

    Fifth, debtors may initiate a civil litigation at the Court based on the provisions of the
    Civil Procedure Law. Before or during the process of litigation, debtors may apply for
    protective measures such as closure, seizure and asset freezing.

    6.2.2.2 Settlement mechanism for labour disputes

    According to the Labour Law, Trade Union Law and the Law on Mediation and
    Arbitration of Labour Disputes, labour disputes between employees and employers may
    be resolved by filing applications for mediation or arbitration, initiating litigation, or
    through consultation.

    In the case of bankruptcy liquidation, the Enterprise Bankruptcy Law provides that
    bankruptcy property shall first be applied for repayments of wage arrears, healthcare, and
    subsidies for disabled people and survivor pension. The repayments shall be assigned into
    employees’ pension insurance, health insurance and other forms of compensation before
    being applied to repay other insurance expenses, taxation and ordinary bankruptcy
    credits.

    6.2.2.3 Settlement mechanism for consumer rights disputes

    The Law on the Protection of Consumer Rights and Interests provides that consumer
    rights disputes between consumers and businesses may be settled peacefully through
    consultation, filing for mediation by a consumer association, filing a complaint with
    authorities in charge, applying for arbitration and initiating litigation with the court. If the
    health or property of consumers or other victims suffer from goods defects, they may
    demand compensation from the sellers and producers. The Measures against Deceptive
    Behaviour against Consumers released by the State Administration for Industry and
    Commerce in 1996 provides that where fraud is found in goods or services, sellers shall
    provide additional compensation to make up for the consumer losses of the consumers;
    the compensation value shall be the same as the purchasing price of the goods or twice
    the service charge.

    6. STAKEHOLDERS AND CORPORATE SOCIAL RESPONSIBILITY

    102 CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011

    6.2.3 Principle IV. C: Performance-enhancing mechanisms for employee
    participation should be allowed to develop.

    6.2.3.1 Means of employee participation in corporate governance

    Employees in China can access the management and operation of their companies in
    different ways. They can be elected into the board of directors or as members of the board
    of supervisors. The board of supervisors shall have a minimum of one-third of employee
    representatives. Employees are entitled to a range of rights such as examining the
    company’s financial situation, supervising the behaviours of directors and senior
    management in delivering their duties, and raising proposals at the shareholders’
    meetings. The trade union, as an important organisation in the protection of employees’
    legal rights, also plays a major role in the enforcement of employees’ democratic rights,
    providing guidance to employees on signing collective contracts with the employer and
    overseeing the enforcement of labour-related laws and regulations by the companies.

    6.2.3.2 Employees shall be allowed to be widely engaged in the equity incentive
    program.

    The Measures for the Administration of the Equity Incentives of Listed Companies
    (Trial Implementation) provides that board directors, senior management, core
    technological (business) professionals and other employees may benefit from these
    incentives.

    6.2.4 Principle IV. D: Stakeholders should have access to relevant, sufficient
    and reliable information on a timely and regular basis.

    Strict requirements on information disclosure by listed companies can be found in a
    range of laws, regulations and self-disciplinary rules such as the Securities Law,
    Administrative Measures on Information Disclosure of Listed Companies and the Listing
    Rules of the Stock Exchange. Regular and ad hoc reports released by listed companies are
    published on websites designated by CSRC and one or more nationwide securities
    newspapers as free public resources. All stakeholders can read this information in real-
    time and free of charge.

    They may also learn from the CSR Report issued by listed companies about what has
    been done to protect employee rights and interests, guarantee product safety, and in the
    areas of environmental protection, charity and welfare. As required by the Notice on
    Producing a Proper Annual Report in 2008 by the Listed Companies, listed companies
    that are on Shenzhen Securities 100 Index shall follow the regulation in the Guidance on
    Social Responsibilities of Listed Companies to disclose social responsibility reports along
    with the disclosure of their 2008 annual reports, while encouraging other listed companies
    to disclose similar reports. In the Notice on 2008 Annual Reports of Listed Companies,
    SSE sample companies, companies with overseas foreign investment offerings, and
    financial companies shall disclose CSR reports and encourage other listed companies to
    do so when conditions are ready.

    It is estimated that for 2008 162 listed companies in Shenzhen and 290 in Shanghai
    disclosed their reports.

    6. STAKEHOLDERS AND CORPORATE SOCIAL RESPONSIBILITY

    CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011 103

    6.2.5 Principle IV. E Stakeholders should be able to freely communicate their
    concerns about illegal or unethical practices to the board and their rights
    should not be compromised because of this.

    An important issue in corporate internal control is the possibility for stakeholders to
    file a complaint with competent institutions within the company regarding illegal or
    unethical practices existing therein. Basic Norms on Corporate Internal Control sets out
    four basic requirements:

    6.2.5.1 Information on internal control shall be sent to different management
    levels, competent offices and business sections, and shall be communicated to
    external investors, creditors, customers, suppliers, intermediaries and supervisors
    requesting their feedback. Issues identified in this way shall be reported and
    addressed immediately. Key information shall be transmitted to the board of
    directors, the board of supervisors and management immediately.

    6.2.5.2 An anti-fraud mechanism shall be put in place. The principle of
    punishment and prevention with the focus on prevention shall be adhered to. Key
    areas, links and institutional obligations shall be clearly defined. Procedures for
    whistle-blowers, investigation, settlement, reporting and remedies shall be
    standardised.

    6.2.5.3. Systems for whistle-blowing and complaints against and the protection of
    whistle-blowers shall be put in place. A hot line shall be set up. Handling
    procedure, time limits and settlement requirements shall be clearly defined to
    ensure that whistle-blowing and complaints are important means of information-
    gathering. The abovementioned systems shall be made known to all employees in
    a timely manner.

    6.2.5.4 Self-assessments on the validity of internal control shall be conducted on a
    regular basis in line with the progress of internal supervision, and reports made
    accordingly.

    The presence of an internal auditing institution is also required for listed companies in
    China. Directly accountable to the board of directors or the auditing committee, this body
    is supported by full-time auditors to oversee whether internal control is set up and
    delivered to the full. When internal or external auditors identify major defects on the
    internal control of complaints-handling, relevant information shall be reported and
    communicated to management, the auditing committee and board of directors.

    While sending in its IPO application papers to the CSRC, the company shall submit a
    report confirming the validity of the internal control prepared by certified accountants,
    who verify that the internal control system is sound, effectively implemented and can
    ensure the reliability of its financial statements, legitimacy of the company’s operations
    and manufacturing activities and their efficiency and effects. Rules on the Content and
    Format of Annual Reports encourage all listed companies controlled by state-owned
    enterprises, in the financial sector or otherwise qualified to disclose the self-assessment
    report on internal control prepared by the board of directors and verified by the auditing

    6. STAKEHOLDERS AND CORPORATE SOCIAL RESPONSIBILITY

    104 CORPORATE GOVERNANCE OF LISTED COMPANIES IN CHINA © OECD 2011

    authorities. In its Notice on Doing a Good Job on 2008 Annual Reports by Listed
    Companies, the Shanghai Stock Exchange requires that sample companies on the SSE
    corporate governance board, companies that issue foreign shares listed aboard and
    financial companies disclose the self-evaluation reports by their boards of directors, while
    disclosing the 2008 annual reports. This encourages other viable listed companies to
    disclose their internal control reports at the same time as their 2008 annual reports, and
    encourages listed companies to engage audit firms to check and appraise their internal
    control. The auditor’s opinion on such appraisal should also be disclosed. The Guidance
    on Internal Control of Companies Listed on the SME Board requires the companies listed
    on the small business board to put out a self-assessment report on internal control on an
    annual basis and the accounting firm to present a verification report on the validity of the
    report every other year. No. 1141 of the Auditing Rules of Certified Accountants—
    Considerations of Bribery in the Auditing of Financial Statements provides that whenever
    a certified accountant notices, during the auditing process, major defects in the design or
    implementation of the company’s internal control system, originally designed to prevent
    or identify bribery, he or she shall inform the management at the appropriate level.

    6.2.6 Principle IV. F: The corporate governance framework should be
    complemented by an effective, efficient insolvency framework and by effective
    enforcement of creditor rights.

    The Company Law and the Enterprise Bankruptcy Law constitute the fundamental
    legal framework for corporate insolvency. The latter provides for the insolvency
    procedure, the repayment of property and the basic rights of creditors, introduces the
    system of bankruptcy managers, standardises the procedures of restructuring and
    settlement, and ensures the transparency, efficiency and effects of insolvency. In this
    process, the creditors have a large degree of autonomy. If the company is unable to repay
    its mature debts, creditors may file applications for restructuring or bankruptcy with the
    court. On the sidelines of the creditors’ meeting, the company is required to be present
    and answer questions from the creditors. In the selection and overseeing of managers, if
    the creditors’ meeting views the manager unable to perform their duty in a lawful and fair
    way, or for other reasons, it can apply for a change at the court. While performing their
    duties, managers are likely to be overseen by the creditors’ meeting and creditors’
    committee. In the reorganisation procedure, creditors may file a direct application with
    the court, and the creditors’ meeting has the right to vote on the draft reorganisation
    programme, which is subject to a group voting by creditors of different types. Under the
    Company Law and Enterprise Bankruptcy law, creditors are entitled to participate in
    bankruptcy liquidation procedures and in the mechanism of active protection of their own
    legal rights and interests.

    ORGANISATION FOR ECONOMIC CO-OPERATION
    AND DEVELOPMENT

    The OECD is a unique forum where governments work together to address the economic, social and

    environmental challenges of globalisation. The OECD is also at the forefront of efforts to understand and

    to help governments respond to new developments and concerns, such as corporate governance, the

    information economy and the challenges of an ageing population. The Organisation provides a setting

    where governments can compare policy experiences, seek answers to common problems, identify good

    practice and work to co-ordinate domestic and international policies.

    The OECD member countries are: Australia, Austria, Belgium, Canada, Chile, the Czech Republic,

    Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, Korea,

    Luxembourg, Mexico, the Netherlands, New Zealand, Norway, Poland, Portugal, the Slovak Republic, Slovenia,

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    OECD Publishing disseminates widely the results of the Organisation’s statistics gathering and

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    OECD PUBLISHING, 2, rue André-Pascal, 75775 PARIS CEDEX 16

    (26 2011 08 1 P) ISBN 978-92-64-11908-6 – No. 59011 2011

    OECD-China Policy Dialogue on Corporate Governance

    Corporate Governance of Listed Companies
    in China
    SELF-ASSESSMENT BY THE CHINA SECURITIES REGULATORY
    COMMISSION

    This report looks at the institutional framework of corporate governance in China through the prism of the
    OECD Principles of Corporate Governance and is a product of the ongoing OECD-China Policy Dialogue on
    Corporate Governance. By assessing a broad range of laws, regulations and codes, it provides a valuable
    reference for understanding how much has been achieved in Chinese corporate governance and the main
    ambitions of future reform efforts.
    The report shows that corporate governance has improved signifi cantly since the Chinese stock market
    was created in 1990, with important achievements in establishing and developing the legal and regulatory
    framework. The OECD-China Self-Assessment represents a thorough review of all laws, regulations and codes
    that relate to every principle recommended by the OECD Principles of Corporate Governance. It documents
    the advances in the Chinese Corporate Governance framework. Building on this report, bilateral co-operation
    between China and the OECD will continue to enhance the understanding of China’s corporate governance
    system and how it impacts on company and investor behaviour.
    Contents
    Preface by Shang Fulin, Chairman, China Securities Regulatory Commission
    Preface by Richard Boucher, Deputy Secretary-General, OECD
    Chapter 1. The corporate governance framework in China
    Chapter 2. Shareholders’ rights
    Chapter 3. The equitable treatment of shareholders
    Chapter 4. Information disclosure
    Chapter 5. Board and supervisory board: responsibility and supervision

    Chapter 6. Stakeholders and corporate social responsibility

    ISBN 978-92-64-11908-6
    26 2011 08 1 P -:HSTCQE=VV^U][:
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    OECD-China Policy Dialogue
    on Corporate Governance

    Corporate Governance of
    Listed Companies in China
    SELF-ASSESSMENT BY THE CHINA SECURITIES
    REGULATORY COMMISSION

    Please cite this publication as:
    OECD (2011), Corporate Governance of Listed Companies in China: Self-Assessment by the China Securities
    Regulatory Commission, OECD Publishing.
    http://dx.doi.org/10.1787/9789264119208-en
    This work is published on the OECD iLibrary, which gathers all OECD books, periodicals and statistical
    databases. Visit www.oecd-ilibrary.org, and do not hesitate to contact us for more information.

      Foreword
      Table of Contents

    • Preface by SHANG Fulin
    • Preface by Richard Boucher
      The corporate governance framework in China
      The history and development of corporate governance in China
      The legal framework of corporate governance for listed companies in China
      Institutional framework for the corporate governance of listed companies in China
      Notes
      Shareholders’ rights
      Introduction to shareholders’ rights
      China’s practices compared with OECD principles
      The equitable treatment of shareholders
      Introduction to the equitable treatment of shareholders
      China’s practices compared with OECD principles
      Information disclosure
      Introduction to information disclosure
      China’s practices compared with OECD principles
      Board and supervisory board: responsibility and supervision
      Overview of the board of directors and supervisory board system in China
      China’s practices compared with the OECD principles
      Stakeholders and corporate social responsibility
      China’s legal guarantee for the protection of stakeholder interests
      China’s practices compared with the OECD principles

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