By Liu Shijin

I. An Important Precondition: There Exists Immense Space for Reducing State-Held Shares

Thanks to the efforts in theoretical, policy and practical exploration in recent years, major progress has been made on the basic issue of strategic reorganization of the state-owned economy. Two important issues were raised at the 4th Plenary Session of the 15th Central Committee of the Communist Party of China. One is that under the new system, the state needs to maintain its control over certain areas, namely those that are important to state security, the areas of natural monopoly, the areas that provide public goods and services, and the key enterprises in the pillar industries and high-tech industries. The other is that the state-held shares in enterprises should be reduced. This is in fact an issue of how the state-owned capital should quit in the course of the strategic reorganization of the state-owned economy. With the two issues given greater attention, the general orientation of the reorganization of the state-owned economy and the reduction of state-held shares are clearly defined and meanwhile policy barriers are greatly reduced. Even so, there are still some cognitive and operational issues that need further exploration.

I.1 In principle, the state-owned capital can quit from the areas of general competitiveness that do not belong to those over which the state needs to maintain control. It is true that we can find a few state-owned enterprises that operate fairly well and we have reason to believe that the state-owned capital in these enterprises does not have to quit (that will help the state-owned capital preserve and increase its value). But in light of "major principles", it is perhaps a better choice for this kind of high-quality capital to quit and to replenish the social security funds when the state-owned capital is still limited in amount. In the areas where the state needs to maintain control, the so-called control can be in the form of exclusive state ownership and, in most cases, can be in the form of state share-holding, including absolute state share-holding, relative state share-holding or state stock participation. For some enterprises, we can even draw on foreign experience and introduce the "golden share" system, that is, the state has no direct investment in the enterprises but has the final veto power over them. It is a wise move to "control the same amount of other capital with as less state-owned capital as possible". So in the areas where the state needs to maintain its control, reducing state-owned capital is still highly possible. In these areas, telecom, electricity, petroleum and petrochemical industries are actually those, whose high-quality capital can be "sold at better prices".

I.2 One common-sense question that needs to be repeatedly emphasized is that the reduction and realization of part of the state-owned capital only changes the form of the existence of the state-owned capital and does not necessarily cause any loss to or "drain away" of such capital. As there exist defects in the link of transactions, it is indeed impossible to rule out the possibility of the state-owned capital being "drained away" in the course of stock reduction and realization. If so, the logic conclusion should be to rectify the existing defects rather than refusing to reduce and realize the state-held shares. One fundamental reality is that in market economy, trading and flowing of the state-owned capital is unavoidable. Conversely, refusing to reduce and realize the state-held shares can in no way guarantee that such capital will not "drain away". Numerous facts prove that when the state-owned capital does not flow, the asset depreciation due to the operating losses of the state-owned enterprises was the primary form of the draining away of such capital. Of course, one may find that after stock reduction and realization, the state-owned capital has avoided such depreciation or even increased its value because of higher liquidity.

I.3 The state-owned capital after stock reduction and realization can be used for many purposes. At present and in a foreseeable future, one priority is to use these funds to replenish the social security funds. In view of the history of the state-owned enterprises, such an option is entirely logical. When the state-owned enterprises were created, the wages received by their employees were only a portion of the total due to them, which is used to buy consumer goods. The remainder which should have been spent by them on housing, pension, health care, etc. was actually used collectively by the state. Between the employees and the state (or the state-owned enterprises), there in fact existed a contractual relationship that the state should provide the employees with housing, pension, health care and other benefits. But the portion controlled by the state was in most cases invested in the establishment of new enterprises. As the performance of the state-owned enterprises has been deteriorating since China began reform and opening up and as there have existed shortcomings in the cash basis system of these enterprises, the state (or specific state-owned enterprises) has found it impossible to perform the original contract. This problem is typically demonstrated in the insufficiency of the social security funds. Therefore, replenishing the social security funds with earnings from the reduction and realization of part of the existing state-held shares can be logically interpreted as the state performing the contract in another way.

I.4 The question that requires further exploration is that the state should control its economic resources by way of running enterprises or controlling non-stock and high-liquidity forms of assets, such as bonds, funds, cash and others. One mainstream view in the past was that the state must directly run lots of enterprises if it was to maintain control over the economy. In the age of the planned economy, such a choice was inevitable, for it was truly difficult to find other ways to manage more resources, except for controlling the enterprises in a material form. In market economy, however, one fundamental change is that resources or assets can break the confinement of material form and take the form of value, which has different levels of liquidity. If we continue to determine the amount of state-controlled resources in light of the number of the state-owned or state-run enterprises, we would make wrong judgment. We can make a simple hypothetical comparison: one scenario is that the state (governments at all levels) is in control of financial revenue equivalent to 20% of GDP and at the same time possesses the assets of the state-owned enterprises equivalent to another 20% of GDP, and that these enterprises are poorly operating, mostly making losses and having very little liquidity; another scenario is that the state (governments at all levels) is in control of financial revenue equivalent to 40% of GDP and at the same time possesses a certain amount of bonds, funds and other forms of assets in addition to very few state-owned enterprises. Which scenario, then, enables the state to control more resources and has stronger control over the economy? The answer is self-explanatory.

II. Reduce State-held Shares in Various Ways to Support the Restructuring of Large Enterprises

One important progress in the reform of state-owned enterprises in recent years has been that great breakthroughs have been made in restructuring small and medium-sized state-owned enterprises. Despite the lack of systematic data in this respect, observations indicate that most of them in many regions have been restructured in different ways. Now, attention is focused on the large state-owned enterprises, each of which generally has assets worth of several hundred million, or more than one billion or several billion yuan. The joint stock holding system, purchase by private capital or other methods used to restructure small and medium-sized enterprises do not suit the large enterprises. This is because the non-state-owned capital in China at present is not big enough to be able to purchase them. Therefore, one important question is how to find investors with adequate financial strength to replace the state-owned capital which is to quit from the large enterprises. Another question that cannot be ignored is that many of these large state-owned enterprises operate at a high level of worldwide division of labor and face intense market competition. Restructuring these enterprises must solve not only the issue of entry by new large investors, but also the issues relating to their technology sources, market position and management upgrading. As a result, it is preferable that the new entering investors have a competitive industrial background. This is why the restructuring and reorganization of large state-owned enterprises is much complicated than that of the small and medium-sized ones.

In this circumstance, reducing state-held shares must focus on the large state-owned enterprises and at the same time should cater to their restructuring and reorganization. Reducing state-held shares does not simply mean to cut the proportion of the state-held shares in the large state-owned enterprises. Rather, it should enable the enterprises to form effective internal governance and organizational structure and help them build rational market position and competitive edge. As to the specific methods to reduce state-held shares, there can be many options.

Reducing state-held shares can be realized by setting up joint or cooperative ventures with transnational corporations in the world that are leaders in their specific industries. In the course of restructuring and reorganizing the large state-owned enterprises, attracting transnational corporations that are industrial leaders in the international market can hit two birds with one stone: simultaneously meeting two requirements: large amounts of investment and industrial background. As most of China's large state-owned enterprises are not industrial leaders in the world, running joint or cooperative ventures with transnational corporations can be an effective way to help them join the rank of these transnational corporations in international division of labor. In recent years, many local governments and large enterprises began emphasizing the formation of joint or cooperative ventures with transnational corporations. In some regions, the slogan is to "walk with giants", meaning to strengthen cooperation with transnational corporations. This is a far-sighted and courageous move. However, they are not paying enough attention to the question of how to reduce the state-held shares by launching joint or cooperative ventures with transnational corporations. Or in another word, they are not considering issues from this angle. A prevailing method is to add the foreign capital to the stock of the existing state-owned assets. This is an "increase" rather than a "replacement", which cannot realize part of the state-owned assets through the entry of foreign capital. The inevitable result is to enlarge the scale of these large state-owned enterprises. To the industries with overcapacity, this is not a good option. The next step is to consider how to reduce the state-held shares through the participation of foreign capital, while keeping the scale of the enterprises basically unchanged, and to study how to solve the ensuing issues. In keeping with the development trend of international corporate mergers and acquisitions, we should then explore how to restructure and reorganize the large state-owned enterprises by the entry of transnational corporations through stock right purchase and other methods and how to reduce and realize the state-held stocks with the effect of some mechanisms. The final and also the most difficult step is how to separate the bad assets and resettle the redundant personnel in the course of forming joint or cooperative ventures with transnational corporations. Many of the joint or cooperative venture projects have been abandoned primarily for the failure in solving these problems.

Reduce the state-held shares by listing enterprises in the stock market. Listing the enterprises can directly link them with the broad masses of investors in society. Reducing the state-held shares by circulating in secondary market can avoid the problem to some extend that when they are not listed, some investors do not have adequate financial strength to purchase them. But, circulation of the state-held shares can pose pressure on the stock market, and therefore timing is essential. Reducing the state-held shares will bring about changes in the ownership structure of the enterprises, can promote the improvement of the corporate governance structure, and can change the state of some listed companies that emphasize financing but ignore restructuring. If conditions permit, introducing some strategic investors with industrial background can play a positive part in corporate reorganization. At present, the listed companies in China have about three-fourths of state-owned shares and corporate shares that are not circulating. If a certain percentage of such state-held stocks can be reduced and floated, that would be a considerable amount.

Reducing the state-held shares can be boosted by the existing state-owned investment corporations or the newly-established state holding companies. China now boasts some specialized state-owned investment companies. Generally speaking, these companies have professional personnel and organizations and have the entry permission for capital operation. And some of them have accumulated rich experience. Just as suggested by some scholars, the qualified state-owned investment companies can first of all take over part of the equity of these enterprises, reorganize these enterprises when necessary, and then reduce and realize these equity through the primary, "primary and half" markets or through other investment banks. We should say that this is a more feasible way for the reduction of state-held shares. Another similar way is to establish new state holding companies. One of the common methods used in the past to reorganize enterprises was to form a group by incorporating several enterprises or form enterprise groups by incorporating all the enterprises sponsored by a specific administrative department. In most circumstances, the group corporations (parent corporations) of these enterprises groups can first of all be transformed into holding companies, which keep investor-invested relations with their subsidiary enterprises. The main functions of these holding companies are to manage and reorganize stock rights, operate state-owned assets (including realization) and raise funds. They should gradually weaken their control over the production and management of their subsidiary enterprises. On the other hand, the subsidiary enterprises should also restructure and diversify their property rights, and independently carry out business and structural reorganization according to their industrial links. The holding companies can, through capital operation, reduce their holding of the stock rights in their subsidiary enterprises. They do not necessarily have controlling stocks; some of them can only have stock participation or can entirely withdraw from these subsidiaries. A holding company can be established on the basis of a certain listed company, such as the Shanghai Industrial Co. and Beijing Holding Co., which appeared in recent years. The holding companies can rearrange the state-held shares through capital operation, including reducing their holding of such stocks. Both the state-owned investment companies and different kinds of holding companies can set fine requirements for corporate reorganization and for investment business capacities. Besides, whether these companies have a good governance structure and incentive mechanisms is also of vital importance.

Reduce state-held shares by taking advantage of "debt-equity swaps" swapping debt into equity has been an important policy measure in recent years. It is also highly controversial. As a method to reorganize the debts of enterprises, debt-equity swap itself is undisputable. The question lies in the fact that in light of the current relations between banks and enterprises, how the debts can be swapped into equity and what the prospects will be for such operations. In this sense, the on-going option of debt-equity swap is highly probable. The prospects would be disappointing if debt-equity swap is only designed for the enterprises to reduce their debt burden and for the banks to get rid of the bad assets while failing to carry out fundamental transformation of losses and the mechanisms that caused such losses. The prospects would be even worse if the banks and enterprises shift responsibility to each other. A promising operating formula is that the asset management companies of the banks sell the equity to the Chinese or foreign non-state-owned investors through the stock market or through the operation of other investment banks after the enterprises’ debts have been turned into stock rights. This can reduce and realize the state-held shares, diversify the equity of the enterprises and therefore promote positive changes in the control and business structures of such enterprises.

Reduce the state-held shares by forming joint ventures with qualified non-state-owned enterprises. It is true that, generally speaking, the non-state-owned enterprises in China lack the strength to acquire or merge the large state-owned enterprises. But with the sustained growth of the economy, corporate polarization will intensify. Some of the non-state-owned enterprises, which are industrial leaders, will see their asset scale and market shares rapidly expanded. There will be more such enterprises that have the ability and willingness to establish joint ventures with the large state-owned enterprises. In face of this opportunity, the large state-owned enterprises should condescend to respond actively by offering the same conditions to the Chinese non-state-owned enterprises that would otherwise be offered to foreign transnational corporations.

Of all the methods to reduce state-held shares, stock market listing is receiving more attention. This is natural. But we cannot ignore other methods that have potentials and advantages. In practical operations, we can choose one of the above methods, or choose several methods at the same time. For example, a certain enterprise can let part of its state-held shares be purchased by foreign investors, part of them be listed on the stock market, part of them be held by the state-owned investment companies, part of them be held by its employees and part of them by the original shareholders. Besides, stocks can be mutually held by the enterprises, which have close operational links and need to maintain stable cooperation with each other such as coal and electricity corporations. Some of the methods appear to be good, but are very difficult to implement. Therefore, other methods are indispensable. In fact, an enterprise can adopt one feasible method or a combination of several feasible methods. If properly designed and operated, the combination of several feasible methods can demonstrate the advantage of better balancing the interests of different parties.

Here comes one important question – the relationship between the reduction of state-held shares and the reorganization of enterprises. There is no need to re-emphasize the importance of reducing the state-held shares. What is more important is the conditions of the enterprises after reduction. An ideal state is that after reduction, the succeeding investors can promote positive changes in the property right structure and the governance structure of these enterprises. Better still, they can bring about positive changes in the technology, management and market structures of the enterprises after an appropriate period of time. One possibility we cannot rule out is that some successors are not so "qualified" and do not constitute healthy factors for the development of enterprises. For example, we have seen in recent years that in the stock market, one certain highly speculative secondary market rigger purchased one listed industrial company by raising funds and became a major shareholder. But what the rigger cares is speculation rather than long-term growth of the enterprise. Moves of this nature are in fact harmful to the long-tern development of the enterprise. In order to minimize or prevent such cases, we should pay attention not only to the reduction of state-held shares but also to the corporate reorganization after reduction. We should give equal consideration to both stock reduction and corporate reorganization.

III. Focusing on Solving Historical Burden of Affected State-owned Enterprises: An Integrated Solution Involving Bond Issue, Shares Reduction and Restructuring

State-owned enterprises are characterized by problems such as heavy debts, redundant personnel, large amounts of non-performing assets arising from their social welfare undertakings, and inadequate funds for social security. All these are historical burdens. In the course of transition, personnel resettlement and social security are more difficult problems to the state-owned enterprises, compared with the treatment of their assets. The past experience indicates that some good solutions to the reduction of state-held shares and the reorganization of enterprises were impossible due to the difficulty of getting rid of their historical burden. We can expect that in the future shares reduction efforts, the historical burden will continue to be one of the most important obstacles to the state-owned enterprises.

Viewed from either the causes of the historical burden or the practical solution, the government is duty-bound to remove the historical burden of the state-owned enterprises. In recent years, the governments at all levels have made great efforts to pay some "costs of reform". However, the results have been unsatisfactory. One of the major reasons is that the funds for system transition have been used to meet urgent needs and overcome difficulties. The result is that the money has been spent but the problem remains unresolved. After a period of time, these enterprises went into difficulties again. Another reason is that the limited amount of funds was spent for extensive purposes rather than solution to the key problems. If we are to seek a major breakthrough in removing the historical burden of the state-owned enterprises under new circumstances, we must first of all reach consensus on the following important issues. (1) The governments at all levels must assume rather than shirk their responsibilities in removing the historical burden of the state-owned enterprises; (2) The problems should be viewed and solved in a historical perspective and funds pooled to cover the costs of system transition by restructuring and realizing the stock of state-owned resources; (3) The establishment of mechanisms needs money and removing historical burden should serve the change of system and mechanism; (4) Funds should be used in a unified way to tackle some tough issues.

In view of the above ideas, the government should consider raising funds through diverse channels in order to remove the historical burden. They include not only the funds allocated by the central government, such as the funds for writing off bad debts, premium loan for technological reform, social security fund subsidies and resettlement costs of the declining enterprises, but also the funds raised by the local governments through reduction of state-held shares, sale of part of state-owned land-use rights and other ways. These funds should be