By Zhang Wenkui

In recent years, tile State-owned enterprise reform has achieved significant progress. However, the reform is far from complete and we should adopt pertinent measures to further deepen this reform.

I. The "Separation of Government Functions from Enterprise Management" as well as the "Linking Ups" and the "Restructuring" Deriving from Government Institutional Reform

Tile government organizational reform which started in 1998 has canceled the specialized ministries, while enterprises originally affiliated directly to various ministries have also "separated government functions from enterprise management" by detaching themselves from the specialized ministries. The detachment promoted tile "separation of government functions and enterprise management" to some degree. In the meantime, however, these enterprises had to be "linked up" to other government and Party organs, for after all, the state-owned or the state-controlled enterprises are the carriers of state assets, so it is impossible for them to break away entirely from government management.

1. The "linking ups" and the state asset management system

There are three types of"linking up". The first one includes large enterprises still controlled by the Central Government. They must ''link up" with the Ministry of Finance in terms of assets, and with the newly established Central Enterprise Working Committee or the Organization Department of the CPC Central Committee in terms of personnel management. The second type includes enterprises handed over to the localities. They must "link up" with the local governments. The third group includes enterprises smaller or of relatively less importance. As designed by the government, they should face the "restructuring" consequence of the previous two types of enterprises and "link up" with them. In fact, the government has thus entrusted tile first two types of enterprises to manage the third group, as well as to supervise and press them to maintain or increase the value of state-owned assets.

Obviously, it is "detachment" on the one hand and "linking up" on the other. To certain degree, it is similar to the distributing of enterprise management authority among specialized and comprehensive departments as well as among the central and the local governments over the past years. It means that we have not found a way to separate the government functions from enterprise management at all.

After the "detachment", the government is faced with the test on how to exercise effective control over the state-owned assets. On the one hand, the government tries to maintain and increase the value of the state-owned assets through authorization of management contracts. On the other hand, it supervises the enterprises and their managerial personnel through special inspectors (who have been changed to external inspectors) and its appointed accountants.

Undoubtedly, the authorized management contracts increase the responsibilities of and the pressures on the enterprises and their managers, and the special inspectors and the appointed accountants fortify the supervision. However, the contracted state-owned asset management system cannot effectively solve the problem of remnant controlling power. In addition, it is difficult for the special inspectors and the appointed accountants to establish clear interface with enterprise decision-making procedures.

2. The "restructuring" and the enterprise incentive mechanism

In fact, the "restructuring" mentioned above is also a form of the state-owned asset management institution. However, it has generated significant impact on the original system of the enterprises. Since the reform and opening up, the remnant claiming and controlling powers of the state-owned enterprises have been ill effect shared by managers and staff and workers of the enterprises.

Actually, after 20 years'' reform and opening up, the state-owned enterprises are no longer the "purely state-owned enterprises", but "shared enterprises with state ownership". It is just the shared ownership that has provided the incentive mechanism. However, as the "restructuring" dismantles the stability of the controlling power and the distribution system of the third group of enterprises, it may damage a reliable incentive mechanism. Without introducing a new and effective incentive mechanism, the "restructured" state-owned enterprises will suffer from insufficient development drive, or their assets may be squandered or displaced.

II. The Enterprise System Reform Promoted by the "Dilution" and "Exit" of the State-owned Stock Equities

The so-called system reform is to reform the traditional state-owned enterprises and set up corporations with diversified equity ownership. In recent years, the system reform of the large and medium-sized state-owned enterprises has been implemented widely in China, while that of the small state-owned enterprises is already basically completed in most areas in China.

1. The basic types of diversified equity ownership

In terms of the identities of the new shareholders, the diverse equity ownership may include "external diversification of equity ownership" and "internal diversification of equity ownership". If the new shareholders mainly consist of internal staff and workers, including the managerial personnel, it belongs to "internal diversification of equity ownership". If the new shareholders are mainly composed of external legal and natural persons, it belongs to "external diversification of equity ownership". In terms of the total size of the equity and the total size of the state-owned equity, there are "diversification of equity ownership through dilution" and "diversification of equity ownership through exit". Capital expansion through listing and targeted stock floating is "diversification of equity ownership through dilution", which dilutes the state-owned shares in stock with the non-state-owned shares .Whereas, the selling and transfer of the state-owned shares belong to the "diversification of equity ownership through exit".

The state-owned enterprises controlled by the Central Government have mainly achieved their diversification of equity ownership through "external diversification" and "diversification through dilution". Whereas, most of the state-owned enterprises and the "restructured" enterprises controlled by local governments realized their equity diversification through the combination of "external diversification" and "internal diversification", and the combination of "diversification through dilution" and "diversification through exit". The specific ways include the following: transferring or selling the state-owned shares or the state-owned assets to managerial personnel and staff and workers of enterprises, private enterprises and external natural persons; capital expansion by selling stocks to managerial personnel and staff and workers; and establishing joint ventures. Through the system reform, many state-owned enterprises and "restructured" enterprises controlled by local governments have become non-state-owned enterprises.

2. The debate on the loss of state-owned asset has become a focus in system reform.

Notably, in the system reform, there is an absence of a state-owned share transfer and state-owned asset selling system that is transparent, competitive and acceptable to the creditors. This is apt to generate the debate on whether the transfer and the selling prices are reasonable, and whether there is an intention of debt evasion. If the prices are regarded as too low, the case may be ruled as "loss of the state-owned assets". In reality, such debates can hardly be settled satisfactorily. It is especially so when the transfer and the sale are made to the managerial personnel and staff and workers. As the state-owned enterprises have already become the "shared state-owned enterprises" since the reform and opening up, the managerial personnel and the staff and workers only wish to turn such "sharing" from implicit to explicit .Because the debate cannot be settled satisfactorily, the "loss of the state-owned assets" or the debt evasion intention usually becomes the obstacle to the "exit", "dilution" and system reform.

The debate on the loss of the state-owned assets is also related to the incompleteness of the social security system. The pension insurance of the state-owned enterprises has not been based on a funded system over a long time, and the staff and workers consider that they should be compensated through the preferential transfer prices of the state-owned shares and assets. It has become fashionable to use the state-owned assets to "repay" the social security debt, and there are many loopholes that merit special attention.

3. The emergence of spontaneous "unauthorized privatization"

The absence of a state-owned share transfer and selling system that is transparent, competitive and acceptable to the creditors makes "internal diversification of equity ownership" and "diversification of equity ownership through exit" extremely attractive to the state-owed enterprises. For they can at least make the "sharing" legitimate and clear, or may gain in actual state-asset losses. As large enterprises Face more ideological risks by adopting "diversification of equity ownership through exit", their managerial personnel split the enterprises and adopt "internal diversification of equity ownership" and "diversification of equity ownership through exit" in the separated parts of their enterprises to avoid risks. Usually, the separated parts of the enterprises are the best and the most profitable assets of the enterprises.

In addition, some managerial personnel have transferred the profits from large state-owned enterprises to their separated parts by means of internal transaction, and thus quickly drained the profits of the large state-owned enterprise.

The combination of the "internal diversification of equity ownership" and the "diversification of equity ownership through exit" is in fact an "unauthorized privatization". As it happens within the enterprises, it is more difficult to establish a system that is transparent, competitive and acceptable to the creditors, and therefore, it is apt to harm the interests of the owner of the state-owned assets and the creditors. Because the managerial personnel can usually gain more shares than ordinary staff and workers, the "unauthorized privatization" is apt to generate inequality.

4. Unauthorized fund-raising and implicit problems in the system reform of small state-owned enterprises

The system reform of small state-owned enterprises is more flexible and daring, and with more characteristics of "unauthorized privatization". Many small state-owned enterprises have been reformed into the so-called enterprises with the "joint-stock system", which are actually held mainly by their staff and workers (including the managerial personnel). Enterprises can let their staff and workers hold shares through capital expansion by selling stocks to the employees, as well as by selling a proportion of the state-owned shares to the staff and workers. In most cases, they have combined tile two methods.

In fact, raising capital by selling shares to the staff and workers is an unauthorized security issuance act. Most of the staff and workers are not rich, nor are they the qualified investors for unauthorized fund-raising, nor the so-called "shrewd" investors.

They lack due judging ability for the risks of unauthorized investment. Such fund-raising has always been ascribed to voluntary acceptance of the staff and workers , however, they were actually being placed under great pressure. For an enterprise with profit, the number of managerial personnel who have bought tile shares may 15ir exceed that of ordinary staff'' and workers, and the rate of dividends may be very high. In an enterprise with loss, the number of managerial personnel who have bought tile shares may not differ too much from that of tile ordinary staff and workers. Tile unauthorized capital-raising with mandatory and misleading characteristics may ill turn distort enterprise actions, such as excessive distribution of dividends. If the enterprise dividend distribution drops, the investment of the staff and workers is difficult to recover, the enterprise will decline faster.

Meanwhile, there will be a stronger presser from the staff and workers-held shares for trading, and the internal shares of many enterprises have already started to leak out, which is apt to lead to over-the-counter trading markets.

III. Policy Recommendations

1. The effective state-owned capital management system can only be established by adjusting the distribution scale of the state-owned capitals

The most in-depth and most fundamental cause of difficulty to streamline the relationship between government and enterprises is the lack of a proper state-owned capital management system. It is a difficult problem not only for China, but also for the whole world. As the state-owned capitals are distributed too extensively in China, it is actually not possible to exercise effective management to the state-owned capitals that are present widely in the generally competitive fields. The "linking ups" after tile "detachment" and the authorized management have not fundamentally solved tile problems of state-owned capital management system.

Therefore, we must follow the principles laid down at the Fifteenth National Congress of the CPC and the Fourth Plenary Session of the Party''s Fifteenth Central Committee to attach more emphasis to adjusting the distribution of the state-owned economy and actually "make entries and exits, as well as actions and in actions." If the state-owned capitals can really be confined in areas of natural monopoly and areas that provide major public products and services, as well as in the few key enterprises of major industries, the reform of the state-owned capital management system will be much easier. For example, the special legal person is a system that may be considered.

2. "Open privatization'' may be adopted to avoid the spontaneous "unauthorized privatization" and the loss of state-owned assets.

"The loss of state-owned assets" is a factor of uncertainty in further reforming the state-owed enterprises. The so-called "loss of state-owned assets" is very complicated in reality. There may be real loss as well as loss out of subjective judgment. With extensive "unauthorized privatization" during the state-owned enterprise reform, the loss of state-owned assets actually happens in the operation process. In the transferring the state-owned shares and selling the state-owned assets to staff and workers, including the managerial personnel, it is difficult to escape the pressures of "sharing" and "repayment". The State has to give in under such pressure, or make more external transfers and sales.

Therefore, "open privatization" may be adopted with maximum possibility to avoid the spontaneous and extensive "unauthorized privatization". For example, the state-owned shares may be openly sold to the strategic investors outside China. "Open privatization" will certainly arouse ideological debates, but during "open privatization", it is easier to establish a transparent and competitive market mechanism. With the function of such a mechanism, prices cannot be used as the basis to judge whether there is "loss or not".

If the appropriate "open privatization" can be accepted, there should be more "diversification of equity ownership by exit" rather than "diversification of equity ownership by dilution". The former should also be oriented to external legal and natural persons, namely, to realize the combination of "external diversification of equity ownership" and "diversification of equity ownership by exit".

3. Incorporating unauthorized capital-raising and over-the-counter trade of unauthorized securities into the policy framework

The restructuring with unauthorized capital-raising targeted on staff and workers is extensively practiced in the small and medium-sized enterprises in various localities. Even some large enterprises also partially adopted this method. Although this method appears to be unproblematic, it conceals many conflicts and disputes. If the interests of the ordinary staff and workers are encroached and deprived, the enterprises will fail to develop in the long-term. Therefore, unauthorized capital-raising must be turned into the legal track and stipulations must be made to the qualification and the number of the capital raiser, and the amount and the way of capital-raising. Meanwhile, after the system reform, there will be ever greater demand for trading the unauthorized securities. If we do not give due consideration to the issue, or do not integrate them into the legal framework and carry out supervision, we may lose control, cause risks and increase social problems. Therefore, unauthorized share issuance and over-the-counter market should all be incorporated into the policy framework.

4. Avoiding "repayment" of social security debt with state-owned assets and accelerating the establishment of the social security system

The backward development of the social security system is one of the key restrictive factors in further deepening the state-owned enterprise reform. In addition, the extensive use the state-owned assets to "repay" social security debt at present is far from standard and has significant loopholes. The next step of the state-owned enterprise reform must aim at accelerating the establishment of the social security system and stripping the enterprises of their social functions, so as to improve their efficiency and competitiveness.

Enterprise Research Institute

April 2002