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Issues Concerning the “System of Legal Entity at Multiple Levels” during the Restructuring of the Petroleum Corporation


Wu Jinglian

During the reform of enterprises over the past 20 years and more, many of the large and medium-sized state-owned enterprises have been transformed into companies operating under a system of legal entities at multiple levels. This system is an extremely queer enterprise system developed under the influence of the thinking of "devolution of power and concession of profits to enterprises" during the reform of enterprises. Economists have made in-depth analyses of the hideous evils of this system. I have pointed out, for instance, in “The Economic Reform in Contemporary China”, a book published at the beginning of this year, that the "system of legal entities at multiple levels" is a system of enterprise organization that has never been seen in the developed countries practicing a market economy and that it has been proved by Chinese experience to have more disadvantages than advantages. This system gives rise to infringement on each other's rights and the use of coercion against each other by the independent economic entities inside a company, endless bickering and friction, and heavy waste of resources. As a result, the system which was originally designed to arouse the enthusiasm of subordinate entities has ended up with undermining the foundation of the parent company by its affiliates. This phenomenon is omnipresent in the companies of petroleum, power, telecommunications, and other industries of China.

In this paper, by taking the Petroleum Corporation (CNPC) as an example, we will discuss ways and methods for turning existing companies following the system of legal entities at multiple levels into companies with an institutional system to be in conformity with the requirements of the international capital market.

I. The situation faced by the China National Petroleum Corporation (CNPC)

A major challenge faced by the China National Petroleum Corporation after its creation in 1998 through restructuring of the petroleum and the petrochemical sectors by the State Council was how to achieve the “integration of the upper-stream with the down-stream sectors, the domestic trade with foreign trade as well as production with marketing” for the purpose of sharpening the group's competitive edge at the international arena.

Almost all the international petroleum corporations take the reduction of costs as an important strategy for competition. This means that cost itself produces a decisive influence upon the international competitive power of the petroleum corporation.

According to estimates of the International Management Consultative Corporation, the average production costs of the oil and gas production enterprises of the Petroleum Corporation are 30 percent above those of their overseas counterparts, and the costs of refineries are also above the average international level in most cases. As China moves closer toward its membership in the World Trade Organization, its petroleum and petrochemical sectors face a stern challenge of international competition. Whether or not they can bring under control and cut their production costs quickly and effectively will be a key factor determining the survival or extinction of the Petroleum Corporation in the future.

The first measure for the Petroleum Corporation to adopt for the reduction of its costs is to streamline its oversized staff. Exxon/Mobil, the biggest Petroleum Corporation in the world, has a total number of 120,000 employees only. The staff of the petroleum group, however, is as big as 1.54 million, surpassing the total number of the employees of the world's top 10 petroleum corporations.

The raise of asset return rates and the expansion of financing sources are other decisive factors determining the survival of the Petroleum Corporation. The asset return rates are usually around 10 percent among international petroleum corporations whereas that of the China National Petroleum Corporation as a whole is only 2 percent. With the continuous decrease of the state investment funds, the Petroleum Corporation will have to pin its hope of development upon expansion of external fund-raising including direct fund-raising by way of listing. To raise the asset return rates to the level of international petroleum corporations would be an important precondition for attracting investors.

Either to cut costs or raise the asset return rates calls for the reform of the existing system of the Petroleum Corporation. In other words, the fetters of the system of legal entities at multiple levels should be broken, and the foundation that has propped up the phenomena of “all-embracing operations” in both big and small petroleum enterprises, duplicate construction, waste of resources, and low efficiency should be totally removed.

II. What are the evils of the system of legal entities at multiple levels?

Influenced by the thinking of “devolution of power and concession of profits to enterprises” in the reform of enterprises, the large state-owned enterprises of China have developed the system of legal entities at multiple levels, under which companies at all levels were granted the power to handle their business operations independently. In other words, a manager as a legal person of the parent company could make investment and establish a sub-company on his own accord without seeking any special authorization from the owner of the company. The manager of the sub-company would then follow suit. As a result, there has developed in the state-owned economic sector a phenomenon of "an endless line of offspring’s." This practice has caused the following problems:

1. Some big companies with branches at various levels would often harm their affiliates. With their affiliates numbering as many as more than 2,000 or 3,000, these parent companies or their branches could never make out the exact number of their affiliates. Such a situation often leads to conflicts of interests inside the company, scramble among independent economic entities for resources, infringement upon the rights of each other and endless bickering and friction.

2. Since all these independent entities hope to expand the business fields under their control and create kingdoms of their own, resources are dispersed and used ineffectively. The result is that no one has any interest in making investment in the main field of business, while each entity with a profit would become crazy about diversification of businesses that do not promise any benefits. A strange instance in this connection is that various companies and sub-companies make investment to build hotels.

3. Resources are not put into best use. Due to the split of power grids at the provincial level, for instance, some areas would rather use small generating units of their own with high costs and heavy consumption of energy than buy power from other areas at less costs and lower prices. This has resulted in appalling waste of water at some large and small hydropower stations such as the Gezhouba and the Ertan Power Stations.

4. Some law breakers would make use of the loopholes in financial management or take advantage of their position and power to appropriate public properties by extending loans, providing guarantees, or exploiting other means to transfer benefits to persons or groups connected with personal interests. Once there is a change in the organization or in the relationship of subordination, some subordinates would be nowhere to be found, carrying with them the properties of the parent companies.


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