CUHK Business School Research Reveals an Alternative Mechanism Governing listed State-Owned Enterprises in China

 - Media OutReach - March 14, 2019 - Corporate
governance has been getting more attention in China as the country takes the
prominent stage in global economy. While most listed companies in China are
making efforts in improving their accountability and transparency, a
released by the Hong Kong-based non-profit organisation Asian Corporate
Governance Association (ACGA) shows that 68 percent foreign investors still
find it very difficult to engage with A-share firms. So, what are the
solutions? How can Chinese authorities regulate the listed companies,
especially the listed State-Owned Enterprise (SOEs) that are usually seen as
less disciplined than non-SOEs?


Entitled "Punish One,
Teach A Hundred: The Sobering Effect of Punishment on the Unpunished
the research study by CUHK Business School looks in an alternative corporate
governance mechanism of how observing peer companies being punished for wrongdoings
will have an effect among Chinese SOEs.


The study was conducted by Jin Xie,
Assistant Professor of School of Accountancy at The Chinese University of Hong
Kong (CUHK) Business School in collaboration with Prof. Francesco D'Acunto at
Boston College and Prof. Michael Weber at the University of Chicago Booth
School of Business. Their paper was awarded "Best English Research Paper"
at the China Financial Research Conference 2018 held in Beijing in July.


The Fear of Reputational Sanctions in

China, listed SOEs are seen as less disciplined by both internal and external
governance mechanisms due to massive state support and therefore are regarded
as more difficult to regulate,
says Prof. Xie.


The study
further explains that listed SOEs are more insulated than listed non-SOEs from
internal and external governance mechanisms, such as shareholder activism,
board monitoring, or governance through trading. Salience of peers
' punishment should therefore affect the
former more than the latter, for which traditional governance mechanisms are
already in place.


managers of SOEs often expect a low probability of punishment, because the
Chinese government -- their main shareholder -- can exert moral suasion on
regulators. The salience of punishment might therefore affect SOEs' belief
about the future punishment on their own firms more than non-SOEs.


In light of
this conundrum, the researchers tested an ancient theory -- Observing punishment
of others would discourage potential offenders among Chinese listed SOEs and
this method can be a more cost-effective way of governing listed SOEs.


"The fear of reputational
sanctions is a relevant governance mechanism when other well-studied mechanisms
are ineffective. This governance mechanism is inexpensive relative to the
direct monitoring of firms by activist shareholders or the direct investigation
of listed firms by the market authority,
says Prof. Xie.


The Study

For the purpose of the study, the researchers gathered information about
the Chinese listed firms mainly from the
China Stock
Market and Accounting Research (CSMAR)
database, which began disclosing identities of
listed firms' controlling shareholders and ultimate owners since 2003.


To investigate the extent of loan guarantees listed firms provide to
their related parties, the researchers compiled a list of 254 corporate fraud
events of irregular loan guarantees involving public companies and related
parties in the period of 1997 to 2014. They compared the yearly outcomes of
firms before and after the first time a peer firm was punished across the
listed SOEs and non-SOE firms in the same region where the SOE and non-SOE
firms are based.


The results of the study confirm the researchers' hypothesis.


First, the researchers find that SOEs in the same location with a
punished peer firm are 43 percent more likely to adopt a more independent board
structure than the usual CEO duality structure in which the CEO is both the
president and the board of directors. "And the effect is stronger when the
peer punishment event is more salient. Non-SOEs, however, do not react to any
type of events," say Prof. Xie.


Second, these SOEs also reduce the amount of loan guarantees over total
assets by 2.4 percent.


As the
study reveals, loans to SOEs by the major Chinese banks account for the largest
part of the nonperforming loans in China, meaning most of the debtors are not
able to make scheduled payments on time.


In the past
years, Chinese regulators have increased the punishment for public firms
tunnelling resources through inter-corporate loan guarantees. Tunnelling is a
type of illegal financial practise. It usually involves top-level company
executives or majority shareholders transferring company assets or resources
for personal gain.

"We find that
after Chinese regulators sanction a listed firm for tunnelling via
inter-corporate loan guarantees, non-punished listed SOEs operating in the same
location cut their loan guarantees to related private parties substantially
when compared to listed non-SOEs in the same location and to listed firms in
different locations. This effect is economically and statistically large,
" Prof. Xie comments.


one might think those SOEs could merely move to more opaque forms of tunneling
after a peers
' punishment, and
hence eliminating the sobering effect of punishment on the unpunished.


"Contrary to
this interpretation, we find that the cut in inter-corporate loan guarantees
has real effects on listed SOEs
private related parties, who cut their investment in fixed assets and reduced
bank borrowing significantly after the drop in guarantees,
" Prof. Xie says. "We also find evidence that SOEs' total
factor productivity (TFP) has increased after the first peer punishment in
their location, compared to before and to non-SOE firms in the same location.


"Our results
have shown that in China, punishing the wrongdoing of one firm might eliminate
the misbehavior of peer firms without the need to monitor or investigate them,
" he says.


Future Studies

The study has
opened doors to many questions worth investigating in future.


"Is the
sobering effect of peers
punishment a permanent change in agents
behavior? Does this effect revert over time? Further research using field data
and experimental research designs might provide insights on these questions,
" Prof. Xie says.



Francesco and Weber, Michael and Xie, Jin, Punish One, Teach A Hundred: The
Sobering Effect of Punishment on the Unpunished (February 7, 2019). Fama-Miller
Working Paper; Chicago Booth Research Paper No. 19-06. Available at SSRN: or


This article was first published in the China Business Knowledge (CBK)
website by CUHK Business School:

About CUHK Business School

Business School comprises two schools -- Accountancy and Hotel
and Tourism Management -- and four
departments -- Decision Sciences
Managerial Economics, Finance
Management and Marketing. Established in Hong Kong in 1963, it is the first
business school to offer BBA, MBA and Executive MBA programmes in the region.
Today, the
School offers 8 undergraduate programmes and 20 graduate programmes including MBA, EMBA,
Master, MSc
, MPhil and Ph.D.


In the Financial
Global MBA Ranking 2019, CUHK MBA is ranked 57th. In FT's 2018 EMBA ranking, CUHK EMBA is ranked 29th in the world. CUHK Business School has the largest number
of business alumni (3
among universities/business schools
in Hong Kong
-- many of whom are key business leaders. The School currently has
about 4,400
undergraduate and postgraduate students and Professor Kalok Chan is the Dean of
CUHK Business School.


More information is available at or by
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