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People walk through the Shanghai Stock Exchange. "At the end of the day, we follow the arrangements of the big shareholder," said newly appointed China Mobile Chairman Yang Jie.   © Reuters
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Activist investors meet their match in China

Open attacks on Chinese corporate governance are rare from typically outspoken investors

HONG KONG -- To outside shareholders, the process of appointing a new chairperson at a Chinese state-owned enterprise can be a confusing affair. Take the recent example of two supposedly competing Chinese telecom carriers, China Mobile and China Telecom.

On March 4, two separate filings with the Hong Kong Exchange revealed that the chairmen of both companies were stepping down. Shang Bing of China Mobile was retiring, while Yang Jie of China Telecom was quitting -- and succeeding Shang at the rival company.

Yang's explanation for replacing his former top rival?

"At the end of the day," he later told the Nikkei Asian Review, "we follow the arrangements of the big shareholder." Both listed in New York and Hong Kong, the two telecom operators are more than 70% indirectly held by the Chinese government, which is in turn led by the Communist Party.

Even private companies cannot escape the influence of the party's leadership. Companies with more than three party members are required to set up an in-house organization -- a party committee.

Committee members usually take up seats on the board, while the committee takes on the "core leadership role" in many companies. A number of companies even stipulate that the chairman of the board and the secretary of the party committee must be the same person, as is the case with Industrial and Commercial Bank of China, the largest Chinese bank by assets.

While establishing a committee is not compulsory, Chinese private business leaders understand well the disadvantage of not doing so. In fact, these committees exist even in U.S.-listed Alibaba Group Holding and Baidu.

Over 90% of state-owned enterprises were believed to have established party committees by the end of 2017, compared with only 50% at the end of 2015. Under the leadership of President Xi Jinping, the rate had soared to over 70% by the end of 2017 -- even among private companies. His eventual aim, many believe, is 99.9% coverage.

Yet global investors cannot ignore China, the world's second-largest economy not just in terms of gross domestic product, but also stock market capitalization. MSCI, the index company, is gradually increasing the weight of mainland-listed, yuan-denominated stocks ("A-shares") in its emerging markets index. In February, it announced that it would increase the inclusion factor of A-shares to 20% by November, from the current 5%.

Many global investors benchmark the MSCI index, and adding more Chinese A-shares will mean index investors will divert more money to them. Credit Suisse estimates an inflow of $47 billion into A-shares by November 2019.

MSCI cites the modernization of the Chinese stock market as one of the reasons behind their weighting decision. Yet, as more global investors buy Chinese A-shares, the more they will have to face the state-influenced corporate governance of Chinese companies.

U.S. activist investors, who tend to be strong critics of corporate governance in other parts of Asia -- such as Japan and South Korea -- usually dare not openly attack the governance under the party's influence. The reason is clear: the fear of losing opportunities in China if their criticism irritates the party. One of the largest American activist investors, speaking on the condition of anonymity, said: "I need more, more, more research on Chinese companies before attacking publicly."

Chinese stocks have been relatively strong over 2019 to date, with the Shanghai Composite Index rising around 27%. Investors appear willing to shrug off China's variant of corporate governance -- at least while stock prices are rising.

Nikkei Asian Review chief business news correspondent Kenji Kawase contributed to this report.

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