'Rent' in Exchange for Loyalty - SOAS China Institute

//‘Rent’ in Exchange for Loyalty

‘Rent’ in Exchange for Loyalty: Costs and Benefits to China’s State-Owned Economy of the Anti-Corruption Campaign

China Railway Group Limited (2020). – Photo credit: N509FZ (Wikimedia Commons)

By Jane Du | 16 August 2022

Unlike in private firms, appointments to executive positions in China’s state-owned enterprises (SOEs) are strongly determined by political criteria. Executives working in SOEs are not only business managers but also government agents with a political as well as operational role within the firm. For SOE executives, a successful career path is normally defined in terms of political promotion, rather than in terms of professional managerial advancement. In short, the corporate governance of China’s SOEs comprises a dual hierarchy: between the government and executives, and between executives and the firm. The nature of their role requires SOE executives to act as political entrepreneurs encompassing the two hierarchies, assuming political responsibility for managing state assets through their participation in business markets.

 

As a result of this dual hierarchy, the management incentive system in SOEs fulfils three main functions:

 

1) at the executive level within the firm, to stimulate SOE executives to maximise the return to state capital;

 

2) in executive terms vis-a-vis the government, to facilitate access to resources by encouraging SOE executives to strengthen their rapport with relevant government agencies;

 

3) to incentivise executives appointed to SOEs to establish their own political career trajectory.

 

These three main functions have constituted the nodes of a stable triangular dimension to SOE’s corporate governance comprising the following three elements: an aberrant system of perks; the potential for private and political gains available to SOE executives from this system; and all (the monetary costs) that paved the way for their political promotion.

 

From a political perspective, SOE executives’ non-economic identity requires them to mobilise additional perks in order to soften supervisory officials in order to enhance their political prospects. From an economic perspective, it is widely accepted that the Chinese government has adopted a variant of Lee Kuan Yew’s ‘Paying for Honesty’ maxim, whereby civil servants’ remuneration is matched to that of their counterparts in the private sector. The absence of a market-based criteria in determining the pay structure of the public sector in China explains why SOE executives receive salaries that are lower than those in the private sector. For this reason, Chinese SOEs have adopted the convention of offering “perks in exchange for loyalty” as a means of narrowing the pay gap with the private sector, as well as protecting state assets in market operations.

 

The flipside of the ‘Eight-Point Regulation’ has resulted in excessive asset extraction by SOEs

 

On 4 December 2012, Xi Jinping’s ‘Eight Rules Relating to Improvements in Work Style and Forging Close Links with the Population’ were issued by the Politburo of the Chinese Communist Party Central Committee. At the heart of the document were new austerity regulations designed to encourage greater thrift and control public expenditure within the rubric of Xi’s far-reaching anti-corruption campaign. With the deepening of this campaign, officials and SOE executives who violate the ‘Eight-Point Regulation’ face the possibility of criminal prosecution. As a result, across the entire political party system, spending on perks was drastically reduced.

 

While anti-corruption measures have no doubt reduced perks, straitened personal finances threaten to undermine SOE executives’ efforts to build networks, thereby having the unexpected consequence of causing SOE executives to convert firm assets into monetary gains and/or relocate them in order to circumvent anti-corruption regulations. External monitoring systems no doubt can prevent direct asset embezzlement by SOE executives; but it is still possible for the activities of executives who seek to extract extra ‘rent’ by mobilising particular types of firm assets to be sufficiently well concealed to escape being uncovered by existing accounting and auditing rules. In turn, SOE executives’ excessive asset extraction activities and an undermining of their entrepreneurship capabilities could jointly affect corporate performance, leading to a depreciation in SOE corporate value.

 

Discussion

 

As early as the beginning of economic reform in the 1980s, finding ways of enhancing SOEs’ economic performance and improving their corporate governance were core issues that plagued China’s policymakers. After decades of trials and setbacks, China’s state-owned economic sector began to become profitable in the mid-2000s. With the rapid expansion of the state-owned economy, SOE executives began to lose ground in the political arena to their colleagues and competitors working in the government since they were forced to devote most of their time to running business operations rather than accumulating the social capital necessary for establishing a political network. The widespread use of perks in fact provided SOE executives with alternative ways to gain political advancement, which enabled them to enhance their career trajectories.

 

When the anti-corruption campaign led to a significant reduction in perks, policymakers failed to provide alternative incentive packages that would strengthen SOEs’ economic performance, thereby prompting SOE executives to seek other means either of bypassing normal advancement paths, or of increasing personal incomes. If personal gains come to outweigh conventional future career prospects, SOE executives certainly possess more than enough first-hand knowledge of how to bypass any macro-regulation measures akin to the 2012 ‘Eight-Point Regulation’ and extract ‘rents’ in other covert ways.

 

Anti-corruption measures have effectively reduced the sum of utilised perks, but they have also effectively strengthened the asset management capacity of SOE executives to extract value from the liquidation of state-owned assets. The anti-corruption campaign has fundamentally changed China’s politico-economic environment. Especially noteworthy is that as anti-corruption enforcers have no direct decision-making powers to control SOE corporate governance, a dissonance between SOE executives’ opportunistic activities and anti-corruption regulations has complicated the management and operations of the entire Chinese state-owned sector.

Dr Jane Du is a Research Associate at the SOAS China Institute.

The views expressed on this blog are those of the author(s) and are not necessarily those of the SOAS China Institute.

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