Corporatization and Stock Exchange Listing, Essay Example

Introduction

Within the past few decades corporatization has been the main mechanism of handling state-owned enterprises (SOEs) in China. State ownership remains the central mainstay in China, as well as in many other countries. The organizational form of traditional SOEs is an enterprise with shares that are administratively subordinate to a government agency. The Chinese government exerts a strong controlling influence over its country’s internal economy, and as a result has experienced challenges when attempting to establish power in the outside market. Since the mid-twentieth century, the SOEs have been undergoing major reforms in order to better develop the finances of the Chinese economy. The corporatization of SOEs has been subject to questioning its effectiveness in increasing the SOE’s efficiency and profitability. There are many obstacles which China must overcome, yet it appears that the corporatization of its SOEs is continuously evolving. The Chinese government appears to be making the necessary reforms in order to establish China’s success on the international market. The purpose of this paper is to discuss how the corporatization and stock exchange listing of SOEs has contributed to an improvement in their corporate governance and in reducing agency costs.

State-Owned Enterprises

 An SOE is a government-owned corporation, business or legal entity created by the government to undertake commercial activities on behalf of itself as owner government. SOEs were created in order to provide support to their country. Consumers in SOEs benefit from better products and services at a lesser cost, and the workers are rewarded and are able to enjoy improvements in employment. Under each government, the legal status varies as being into stock companies by a regular stockholder.

SOEs are a major part of the economic development of their countries. Today they have grown to be among the largest and fastest expanding multinational companies. They compete against private firms for consumers, resources, and ideas in international and domestic markets. Within the world, 10% of the largest firms are state owned, and they come from 37 different countries with total sales totaling over $3.6 trillion. Among the countries with the top firms are China, the United Arab Emirates, Russia, Indonesia, and Malaysia. SOEs in these countries control sectors such as telecommunications, mining support activities, air transport, warehousing, mining of coal and natural gas, civil engineering, and electricity. SOEs are encouraged in some countries because they can be used as tools for industrial policies that pursue technology and knowledge for their national interests, and maintain a defensive quality that promotes state ownership in certain economic factors.

In order to guard against domestic competition, governments encourage foreign operations of SOEs to protect their revenue streams. SOEs are a major source of global competition, and the governments serve as enforcers, regulators, and owners of the assets that give them favor when opening up other enterprises. SOEs support government with higher revenues, which are then regulated to other parts of the government, such as education and national defense. SOEs create advantages backed by the government and provide public goods, direct subsidies, concessionary financing, and exemptions from antitrust enforcement.

Another advantage which SOEs have is complete competitive advantage over their rivals, because they are created by the government and can misconstrue the competition in the market. The direct subsidies artificially lower the costs of SOEs and enhance their ability to prime better than their competitors. The financial banking is evident when banks offer below market interest rates, which also reduce the risks of borrowing creating more advantages over competitors. Recently the importance of the structures of SOEs is played out on the stock exchange markets were SOE equities are locked-in so that control cannot be transferred like privately owned firms. SOEs then do not have to pay dividends or expected return to shareholders. Equities which are locked-in protect them from accumulate losses that result oftentimes in bankruptcy, and exclusionary pricing strategies, that protect them against takeovers.

Necessary Reforms for SOEs in China

 Like any business enterprise, reforms with SOEs must be made in order for them to be successful. By making certain reforms, it allows them to be more compatible with the market economy. SOE reforms in China began in the mid-twentieth century, but by the 1980s and early 1990s, it became evident that their profitability had been deteriorating for quite some time. From 1984-1993, the SOEs began major reform and they were given the responsibility for dealing with their own gains and losses in the market. Incentive contracts were used to govern the relationship between the State and SOE managers. The poor performance of SOEs was due primarily to increased competition with private and foreign companies, poor sales price due to excess supply which stemmed from the 1992-1994 investment booms. The efficiency of SOEs in China was poor and needed to be improved. In 1992, the Socialist Market Economy was established in China and resulted in the need for SOEs to be suitable for a market economy and be more like incorporated business entities rather than “remaining as de facto state production units” ¹. The Chinese government implemented measures to improve SOEs such as “financial support, layoffs, buy-out and action against corporate insolvency” [1]. The government also implemented debt reduction, debt-equity swap, and technology improvement support. In 1993, the Corporate Law was introduced and the internal governance system of SOEs was restricted along the pattern of a modern corporation. The Corporate Law required that SOEs have a structure which included shareholders and a board of directors. The Corporate Law introduced two new office positions: a chief executive officer (CEO) and a chair of the board of directors. However, though this was modeled after western corporations, in China, the state remained in control of the SOEs. What resulted was that smaller SEOs were dealt with through buyouts and allowed bankruptcy, so the government was able to concentrate on improving larger SOEs. The corporate restructuring process was implemented simultaneously with the financial restructuring of state-owned commercial banks. The bad loans against problematic SOEs were dealt with by creating four Asset Management Corporations which helped “4,000 out of 6,599 money-losing SOEs” to become profitable by the end of 2001¹.

The system of Corporate Law aimed to provide a more sophisticated corporate governance and property rights structure. Its goal was to convert SOEs into modern corporations. SOEs were divided into two categories: closely held corporations, including state-owned and foreign-invested corporations, and publicly held corporations, including listed and non-listed corporations. Listed corporations are those whose shares are listed on a stock exchange. Non-listed corporations are not suited for investors on the stock exchange; usually they are too small, or in the case of China, there is a high amount of governmental control.

In publically held corporations, there are four organization forms: limited liability companies, limited liability stock companies, employee shareholding cooperatives, and private enterprises. The publically held corporations must form the following governing bodies: shareholders, board of directors, a board of supervisors, and a CEO. In state-owned corporations, two corporate bodies are required: the CEO and the board of directors. Shareholder meetings are not required, since the state is the owner.

Corporatization and Corporate Governance Reform

 Corporatization is a process that transforms state assets and government agencies into corporations. Corporatization has been the main method with governments on reforming their SOEs in order to build their modern enterprise into a market system. The development of the SOEs to stock market exchange listings have resulting in trillions in market capitalization. Blanding (2013) quotes Musacchio in his observation that many major SOEs are becoming like private corporations, as they are traded in stock exchanges and have boards of directors. Some SOEs even have external managers. [2]

Corporatization is designed in order to strengthen the autonomy of the SOEs by separating them from their statutory authority into a distinct legal identity. Just because SOEs are becoming corporatized, does not necessarily mean that they must become privatized. Privatization is one step in reforming SOEs, but corporatization helps to free SOEs from the bureaucratic restraints and guarantees accountability. Corporatization is then reinforced in the corporate governance of the country’s political systems.

The main elements in Chinese reforms of the corporate governance of SOEs in addition to corporatization, are the “Modern Enterprise System,” the supervisory system reform, and the reform of large-scale SOEs. In the early 1990s, the Modern Enterprise system was established with four pillars: the clarification of property rights, the clarification of each entity’s rights and responsibilities, the separation of bureaucracy from business, and scientific management. The Modern Enterprise System established an indirect and three-tier ownership of SOEs. The central Chinese government is established at the first level of the hierarchy. The second hierarchical level is the SOEs’ direct shareholders, which consist of the large conglomerates, state asset share holding companies or even non-corporate organizations. The actual functioning SOEs are at the third level of hierarchical control.

According to Lee (5)[3], the dominance of the Communist part in China has a significant effect on the Chinese economy. A few sectors under control of the central government have helped to establish the party’s dominance and can be seen in the party’s approach to prioritize companies according to their importance. As a result, larger and more powerful companies were assisted, while smaller companies were eliminated. Lee’s opinion is that the Chinese government’s intent was not to build a traditional market economy, rather a socialist market economy, so they could establish a high amount of control.

Like China’s government, their corporate governance wants to maintain full control over enterprises in major sectors in order to maximize the wealth through the commercial lines of service. Clarke (27)[4] reports that corporate governance aims to convert SOEs into a “modern enterprise system so that to clarify the rights and the responsibilities.” The corporatization of SOEs is pursued with the ideal forms being limited share companies or share holding companies.

Corporatization differs from privatization because it aims to raise the equity of capital for SOEs when they convert to the corporate form. SOEs can leverage the state control through the different sectors and improve the management of state assets through tie implementation of a new form of organizational. The results of the study by Aivazian, Ge, and Qui (2003)[5] indicate that corporatization is beneficial for SOEs and may be good for governments to do this before privatization. Privatization for SOEs has been increasing and may help to solve some of the problems which SOEs are facing. The study raises the question if SOEs can be successfully corporatized without being privatized.

The difficulty with Chinese corporate governance is that the state wants to retain full ownership and control of the SOEs in several major sectors, while expecting these enterprises to run along commercial lines in the service of wealth maximization. However, these two goals are not compatible because in order to maximize financial returns, the Chinese state must either sell or hold “depending on which strategy offered the best financial return, rather than foreclosing the option of sale from the outset” ⁴The state’s goals are not wealth maximization; rather they have goals such as employment, control over sensitive industries, and politically-motivated job placement. Unfortunately, these goals can create administrative problems because they are difficult to measure, and there is a conflict of interest between the state and other shareholders. The Chinese government is very controlling and making it difficult for privatization to occur internally. Clarke points out that corporatization has actually increased the control that China has on its people.

Even though corporatization increases state control, it also helps SOEs to become more efficient and profitable. Corporatization accomplishes this by eliminating major problems in the traditional management of SOE. The bureaucratic interference arising from the state being both the owner and the manager of the enterprise is restricted, and the confusion arising from multiple state agencies having overlapping authority over the SOEs is reduced. By establishing a single or dominant owner to whom managers must report creates accountability.

Clarke (29)[6] conversely states that corporatization incorrectly assesses the problems and therefore, solutions are unreliable and flawed. Corporatization is supposed to separate state ownership from state control, which is supposed to remove any interference from managers so they can focus more on efficiency and profit. However Clarke states that there is no significant change because managers were always distinct from the state who owned the enterprise. Though the corporatizing model assumes that the goal of the SOEs are to maximize wealth; control is much more the focus.

Mahadevan (2010)[7] reports that SOEs increase the value to China’s industrial production and states that the Chinese government has approximately “17,000 partially owned enterprises” including petroleum, telecommunications, steel, electric power, and a monopoly on tobacco. Even though the number of private enterprises may be increasing, the Chinese government still controls the legal, political, social, and economic aspects of Chinese life. “Investment can be channeled to favor certain corporations, labor can be moved to favor certain industries, regulations can be applied without approval as long as the regulations don’t violate international treaties and don’t prejudice China’s commitments to the World Trade Organization”⁷. Even though free enterprise is allowed, the government still controls many aspects of the life of Chinese citizens.

The reform of the Chinese SOE has attracted a large amount of attention because of China’s increasing power in the global economy. China has also adopted a gradual approach to SOE reforms and thereby was successful (Aivazian et al 794)[8]. Because the incentives in the 1980s to early 1990s, which were meant to increase productivity failed, the Chinese government found that it was necessary to launch the corporatization process.

The study conducted by Aivazian, et al⁸ researched the impact of corporatizations on the performances of SOEs. When SOEs first were corporatized, they faced several barriers, and their performances were measured by the efficiency, profitability, and investment. Profitability was measured by examining the return on assets and the return on sales. Profitability is one of the main measures of success for SOEs. Investments measure the budget constraints of the government. According to Aivazian et al[9], SOEs corporatization was effective in improving profitability and efficiency because the government has strong incentives to prevent bankruptcy and lend financial support. The corporatization of SOEs without first privatization had a significant impact on the performances of SOEs. The change in the internal corporate governance instead of just corporatization had a greater impact on the investment levels, and the level of efficiency.

The corporatization of SOEs in China increases their profitability and efficiency because it offers a better monitoring of managers, improvements in information-sharing channels, and a reduction in governmental political intervention. It may also affect the incentives and objectives of managers by tightly linking enterprise performance with the evaluation and remuneration of mangers ⁹.

Corporatization consequences of public listings are dependent on the extent of political interference from the different structures of governance.

 Corporatization and the External Stock Market

 Corporatization is a measure of SOEs efficiency in the stock market. When companies opted to corporatize their SOEs, they allowed them to trade publically on international stock exchanges. The behavior of the investment firms have a clear relationship with the financial constraints and agency problems that they face. The challenges that SOEs face are internal financing, agency problems, transaction costs, and risk-taking over investments. When SOEs become aware and confront financial constraints, they have more internal funds, which means that they are able to invest more money. However, those with negative cash flow underinvest; a high sensitivity of the cash flow is evidence of financial constraints. There is positive correlation between the cash flow and investments that reflect agency cost: the more free cash flow, the more that countries will invest and resolve agency problems. Confronting agency problems is necessary because agency problems can prevent shareholders from making optimal investment decisions, and increase the sensitivity of investment expenditure to cash flow. However, corporatization and publically listing of SOEs helps to loosen the financial constraints faced by the firms with lower their leverage ratios.

“Corporate governance specifies the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs” (Guariglia, Yang)[10]. SOEs performances are greatly affected by the public listing of SOEs change the dynamics of corporate governance. Managers are closely monitored in order to ensure that public interest is protected and SOEs are following the rules of the public market. The main goals that corporate governance should accomplish are to reduce contract costs by providing shareholder protection, lower agency costs by providing tools for controlling mangers, and protect human capital investments. In order to reduce agency costs, the power of other sectors of corporate governance are reduced. The weak legal systems, as well as they poor level of minority protection, reflect the lack of interest of the controlling shareholder and the other investors. Guariglia and Yang note that “controlling shareholders may make self-interested and entrenched decisions and prefer to spend the firm’s free cash flow on unprofitable projects rather than paying dividends to shareholders, resulting in over-investment.”[11]

In the case of China listing its SOEs, it reduced the state ownership and increased managerial autonomy, but increased agency costs. Agency costs have been a significant issue of corporate governance and have been the key factors that reflect the efficiency and effectiveness of corporate governance. When China decided to publically list SOEs in the stock markets, they had to change the structure of their corporate governance to implement a board of directors to hold the SOEs accountable. In doing so, the goal among others listed was to lower agency costs. Incentives given to managers motivate them to maximize the wealth of its shareholders.

China’s external markets are limited due to financing and the allocation of resources. The dominant state-owned banks are not efficient due to the number of nonperforming loans issues, and the support given to the unprofitable SOEs. Chinese firms significant problems in allocating resources and relieving of the financial constraints that do not improve agency costs. Due to poor regulation and the majority of listed SOEs are state owned, the Chinese stock market is small compared to other international markets. SOEs can largely not be traded freely, it cannot be adequately measured for efficiency, nor can the stock markets prices reflect their values. China places much of its economic growth on investments that are responsible for over 50% of the GDP growth. China’s poor corporate governance attributes to relatively high agency costs and problems, which are created by lack of creditors and shareholders protection.

Problems with Managerial Relationships

 In China, SOEs that are affiliated with the local government face higher agency costs than non-state controlled firms. The agency problems persist with the relationship between managers and shareholders. Managerial ownership is a problem that is mitigated through corporate governance in order to find ways to reduce the magnitude of the conflicts that affect the firm’s value. Research suggests that managerial ownership aligned with the interests of both of the claimholder can reduce the total agency costs. However, over time managers focus on external activities, enjoy private benefits, and undertake projects with higher risks to avoid takeover at the expense of other investors. It can be shown that the relationship of managerial ownership and the agency costs is dependent on the tradeoff of the managers’ behaviors and interest. When there is conflict between the two agencies, costs increase. When firms are managed by a shareholder agency, costs are reduced. The concentrated ownership of China’s SOEs listing complicate the agency costs of the controlling shareholder and the minority investors. China’s legal system and corporate governance mechanisms do not protect minority shareholders from controlling majority shareholders. The majority shareholders can help in reducing agency problems but can also cause conflict between small and large shareholders. Tunneling a factor common in China’s stock market negatively affect agency costs.

The concentrated ownership of SOEs has main control even with low state of shares, which lead to high levels of agency costs. The concentrated holding decrease diversification, market liquidation, and the ability of the stock to grow which increase the incentive to expropriate resources. The lack of managerial ownership is a factor in maximizing shareholder value that is not capable of reducing agency costs. When there is lower incentive to tunnel there are lower agency costs when the primary owner has majority of the shares. Controlling shareholders’ ownership of stakes decrease the conflict between managers and shareholders. In sum the level of ownership stake of the controlling shareholder, usually the state, has an effect on the agency costs. Steps have been made to improve corporate governance of listed SOEs and firms by increasing the market transparency and protecting investors.

Agency Costs in Relation to Corporatization and the Listing of Stock Exchange

 An agency cost is a type of internal expense that arises from exists as a payment to an agent acting on behalf of a principal. Agency costs may arise because a conflict of interest between shareholders and management and are related to financial constraints. They are a key factor in the reflection of the success of corporate governance and corporatization of SOEs. The study by Guariglia and Yang[12] found that both financial constraints and agency problems result in investment inefficiency. Investments were positively associated with free cash flow for under-investing firms with negative free cash flow. The study also found that there was a positive association between investment and free cash flow for overinvesting firms with positive free cash flow. Managerial ownership reduces Chinese listed firms’ agency costs because managers who own the firm are more likely to have closer interests with shareholders. The highest agency costs are firms with a medium percentage of shares owned by the largest shareholder. External split shares reform reduced agency costs faced by state controlled firms.

Junwei, Guiquin, and Pin (258)[13] quote Williamson when proposing “agency costs at first and compared agency costs of internal organization and external market, which the scope of agency cost is transaction costs mainly”… “Agency conflicts and governance cost have a significant impact on financial decision-making, investment decisions and firm value.” Junwei et al¹³ also states that agency costs and financial constraints are related in a negative correlation between internal equity, debt, and dividend payments. Having lower agency costs can be beneficial and show improvement in the performance of SOEs. Lower agency costs were associated with certain characteristics in corporate governance. These characteristics include board size, board composition, the duality of the CEO and chairman of the board, board composition and independence, and managerial remuneration and structure. Regarding the duality of the general manager or chief executive officer and the chairman, the separation of them as a single entity could lead to a better performance for the SOE and reduce any conflicts.

Managerial remuneration is important in the success of corporate governance because it is good for managers to implement incentive compensation (Junwei et al 261)[14]. There is a positive correlation between managerial remuneration in motivating managers to take action to maximize the shareholders’ wealth. This would also help to increase the desire for shareholders to invest in certain SOEs. Caution must be taken so there is no conflict of interest because remuneration packages may include certain benefits related to entertainment and recreation.

When SOEs are publically listed on the stock market, agency costs are reduced. Public listing by using corporatization as a reform for SOEs has several benefits that include improvements to the corporate governance. The primary objective of the corporatization of SOEs is to increase the capital that usually relies on state bank loans as their source of finance. Not only does it raise capital and increase corporate governance, but also decreases the financial constraints from agency costs. As the level of capital expenditure increases, it reduces the debt-asset ratio, and they are able to maintain the pre-listing sales growth. In the case of China, it reduces state ownership and increases managerial autonomy. However, while this helps within other areas of SOEs it can potentially increase agency costs. When countries corporatize small and poor-performing companies, they are not profitable. Countries only want to publically list SOEs on the stock market in order to raise capital, even if they are not privatized. China is able to moderate agency costs because the primary owners in China have large control of the operations even when holding low numbers of stakes through cross-holdings and pyramid structures. There are lower agency costs when there is less incentive to tunnel if the primary owner’s controlling rights is greater than the ownership rights. Lower agency costs are derived when the expected highest percentage of shares held by the primary shareholder has a lower separation of voting and cash-flow rights. The larger the ownership claim, the stronger the interest in profit maximization and a higher incentive to oversee and monitor managers. Agency costs in correlation with corporate governance, that are a relationship of conflict between firm managers and shareholders, decline with controlling shareholders ownership stake. Chinese SOEs are characteristically listed as the largest shareholder with dominant control over the firm. The rest of the large shareholders have only small ownership. There is a decrease in tunneling when the large shareholders are able to put pressure on the largest shareholder. This helps to overcome the challenges of agency problems and costs and avoid tunneling. When SOEs are underperforming large shareholders that usually run the listed SOEs have the power for corporate control with the incentive to monitor the management that improves corporate governance and reduces agency costs. Corporatization of SOEs listed in stock exchange has proven that with improvements the structure of control of that it not only improves corporate governance of countries but also reduces agency costs.

The size of the SOE board has a significant effect on their success on agency costs and the success on the international market. Boards with a larger size are usually more powerful and are able to achieve better results. SOEs with large board sizes may be able to access better resources to strengthen relation between internal and external SOE communication. However, the SOE boards with larger sizes may have increased difficulty with coordination, communication, and decision-making. The Chinese government may be equipped to deal with this problem, as they exert such a high level of control on the economy. Conflicts may arise if corporatization is enforced too quickly, but the gradual progression they are implementing seems to be effective in the success of SOEs.

The composition of SEO boards is also influential on their success. SEO board composition is affected by the proportion of independent directors on the board, the duality of the general manager and chairman affect corporate governance. For example, a board with a large proportion of independent directors, the independent directors could restrain the application of management discretion through exercising their power to protect their reputation as independent decision makers. Junwei et al (260)[15] state that there is a positive correlation with the proportion of independent directors and company performance. The fear of laws and market for their services may motivate independent directors to be very effective in monitoring the board’s decisions. Stock prices may react favorably to appointing outside directors. For China, this is a very crucial matter, as letting go of government control can be difficult.

SOEs on an International Level

 The strong control that the Chinese government has on its internal economy is evident. However, in order for it to have success on the global market, even greater reforms need to be made. The Chinese government will have to consider international issues such as regional free trade agreements, projects involving the development of natural resources, and other market trade regulations. It will also help many SOEs be listed on the stock exchange so international shareholders are able to invest.

By establishing a strong international presence, the Chinese government can attain its goals. Scarcity among the people in China would be reduced because China would have better access to natural resources and better technological developments. Increasing the attainment of foreign natural resources and better technology would serve to strengthen China’s place in the market economy. A strong presence on the international market would enhance the corporate brand values of Chinese SOEs. For example the barriers against the “made in China” goods would be reduced and consumers would not be as reluctant to invest in Chinese brands.

Lee (10)[16] states that the Chinese government initiated policies to promote the internationalization of SOEs. The Ministry of Finance and the Ministry of Commerce collaborated to support start-up funds for overseas investments. The National Development and Reform Commission and the Bank of Export and Import made policies regarding the creation of loan programs and restructuring overseas investment procedures to support important overseas economic developments. Since 2000, Chinese SOEs have invested a significant amount in the foreign market.

In 2006, 81% of FDI [Foreign Direct Investment] comes from SOEs, and among those SOEs 82% of FDI was made by central SOEs. The fact that SOEs are dominant players in overseas investments for acquiring high technologies and corporate brand recognition is largely focused on large scale SOEs, while the overseas resource development is done solely by large scale SOEs (Lee 10)[17].

Oil is an example of the acquisition of Chinese natural resources. The China Petroleum & Chemical Corporation and the China National Petroleum Corporation are investing a significant amount of money and resources into attaining more oil for China. Chinese SOEs are also increasing their technological power with well-known companies such as IBM and Schneider Electronics. These investments and acquisitions only serve to make China a more powerful country. However, China’s contribution to foreign trade has been diminishing since 2002, as their annual rate of export declines.

In order to exist on a more global market, China has had to adapt itself and initiate reforms to transition to a “Modern Enterprise System” and develop a more corporate structure. This means that the SOEs must become publically listed on the stock market so shareholders can invest. The tight reign of control China has on its economy and SOEs can be problematic when dealing with external trade. It was not until 2005 that China began to allow more trade in the stock market and lift restrictions on state and legal entity shares. These shares had not been allowed to participate in the stock market. Even after 2005, the shares listed SOEs were still concentrated on state ownership, allowing the government to exercise complete monopoly and control as its largest shareholder. As a result, individual shareholders have minimal power in listed SOEs.

The listed SOEs which do have power are the larger companies. Lee¹⁷ reports that even though many SOEs were listed, the underdevelopment of the corporate financing market resulted in the local governments treating them as a method of accessing direct financing. As a result, the competition among local governments to obtain a share of the limited number of listing licenses is high. The State Assets Optimization Plan was established to ensure that one financially superior company is set to be the core and the most valuable assess of any of its branches are transferred to the core company. These larger companies with strong cores are able to meet the qualifications of the stock market listing requirements.

 Conclusion

Chinese SOEs are constantly undergoing a system of reform in order to move into a more modern enterprise and compete on an international scale. China has reformed their SOEs several times, including privatization that had a significant explosion in the 1980s through the mid-1990s. However, privatization did not help the deteriorating system of SOEs that were plagued with several problems including political interference, corruption, anti-competitive attitudes, and several essential issues that harmed the economies of developing companies. The move to privatization still proved to have major problems including inadequate market structure, poorly developed infrastructure, less manpower, inefficient private sector, and partially commercialized industries and services.

Corporatization became an alternative solution to helping ailing SOEs and raise their capital on the stock market exchange. Corporatization is the main method of the Chinese government on reforming its SOEs in order to build the modern enterprise into a market system. The development of the SOEs to stock market exchange listings have resulted in a substantial increase in market capitalization. Corporatization is designed in order to strengthen the autonomy of the SOEs by separating them from their statutory authority into a distinct legal identity. This structure is pertinent in improving corporate governance by making firms accountable by implementing board members, monitoring mangers, giving mangers incentives, and maximizing the wealth of shareholders.

Agency costs have been a significant issue in the corporate governance in China. Agency costs are the main variables which reveal the efficiency and effectiveness of corporate governance. The agency costs are dependent on the structure of ownership concentration, the manger’s relationship with other shareholders, and managerial ownership. Steps have been made to improve corporate governance of listed SOEs and firms by increasing the market transparency and protecting investors.

China’s move from a controlling central government to a more distributed version of economic power has presented challenges with the market economy. However, their determination to establish themselves as a dominant global power has driven them to modify their SOEs to make them suitable for listing on the stock market exchange. Corporatization has proven to be a beneficial factor in the public listing of SOEs. Even if SOEs are not privatized, China is finding a way to integrate its centrally controlled culture with the rest of the world in the economic market. Their process of gradual corporatization has a good chance of raising capital, increasing corporate governance, and reducing agency costs. This ongoing process will help China to improve its economy by making its SOEs more attractive for investors.

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[1] Lee, Junyeop. “State Owned Enterprises in China: Reviewing the Evidence.” OECD Working Group on Privatization and Corporate Governance of State Owned Assets. (2005): n. page. Print.

[2] Blanding, Michael. “What Capitalists Should Know About State-Owned Enterprises.” Forbes. 22 February 2013: n. page. Web. 20 Feb. 2014. <http://www.forbes.com/sites/hbsworkingknowledge/2013/02/22/what-capitalists-should-know-about-state-owned-enterprises/>.

[3] Lee, Junyeop. “State Owned Enterprises in China: Reviewing the Evidence.” OECD Working Group on Privatization and Corporate Governance of State Owned Assets. (2005): n. page. Print.

[4] Clarke, Donald. “Corporatization, Not Privatization.” China Economic Quarterly. 7.3 (2003): 27-30. Web. 24 Feb. 2014. <http://docs.law.gwu.edu/facweb/dclarke/pubs/ceqarticle.pdf >.

[5] Aivazian, Varouj, Ying Ge, and Jiaping Qui. “Can Corporatization Improve the Performance of State-Owned Enterprises Even Without Privatization?.” Journal of Corporate Finance. (2005): 791-808. Web. 24 Feb. 2014. <http://profs.degroote.mcmaster.ca/ads/jiaping/paper/corporatization.pdf>.

[6] Clarke, Donald. “Corporatization, Not Privatization.” China Economic Quarterly. 7.3 (2003): 27-30. Web. 24 Feb. 2014. <http://docs.law.gwu.edu/facweb/dclarke/pubs/ceqarticle.pdf >.

[7] Mahadevan, H. “Resurgence of State Owned Enterprises.” World Federation of Trade Unions. 10 Dec, 2010. Web. 15 Aug, 2013. <http://www.riab.kerala.gov.in/soekerala-docs/Strengthening%20Environment,%20Social%20and%20Governance%20Policies%20of%20SOEs.pdf>.

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[9] Aivazian, Varouj, Ying Ge, and Jiaping Qui. “Can Corporatization Improve the Performance of State-Owned Enterprises Even Without Privatization?.” Journal of Corporate Finance. (2005): 791-808. Web. 24 Feb. 2014. <http://profs.degroote.mcmaster.ca/ads/jiaping/paper/corporatization.pdf>.

[10] Guariglia, Alessandra, Yang, Junhong. “A Balancing Act: Managing Financial Constraints and Agency Costs to Minimize Investment Inefficiency in the Chinese market.” Oct. 2012. Web. 16 Aug, 2013 <http://www.nottingham.ac.uk/gep/documents/seminars/2012/15-10-12-guariglia.pdf>.

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[12] Guariglia, Alessandra, Yang, Junhong. “A Balancing Act: Managing Financial Constraints and Agency Costs to Minimize Investment Inefficiency in the Chinese market.” Oct. 2012. Web. 16 Aug, 2013 <http://www.nottingham.ac.uk/gep/documents/seminars/2012/15-10-12-guariglia.pdf>.

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[14] Junwei, Wang, Guiqin, Lu, Ping, He. “Study on the Relationship Between Agency Costs and Governance Mechanisms: Evidence from China’s A-share Listed Companies.” M&D Forum. 2011. Web. 15 Aug, 2013. <http://www.seiofbluemountain.com/upload/product/201108/2011gszlhy02a12.pdf>.

[15] Junwei, Wang, Guiqin, Lu, Ping, He. “Study on the Relationship Between Agency Costs and Governance Mechanisms: Evidence from China’s A-share Listed Companies.” M&D Forum. 2011. Web. 15 Aug, 2013. <http://www.seiofbluemountain.com/upload/product/201108/2011gszlhy02a12.pdf>.

[16] Lee, Junyeop. “State Owned Enterprises in China: Reviewing the Evidence.” OECD Working Group on Privatization and Corporate Governance of State Owned Assets. (2005): n. page. Print.

[17] Lee, Junyeop. “State Owned Enterprises in China: Reviewing the Evidence.” OECD Working Group on Privatization and Corporate Governance of State Owned Assets. (2005): n. page. Print.