MBOs (management buyouts) are once again at the center of
controversy. Larry Lang, a well-known professor from the Chinese
University of Hong Kong, recently criticized this method of
disposing of state-owned assets.
“The MBO is the best way to rob the state of its assets”, Lang
warned. “Harrowing losses are being incurred in state-owned
assets.”
His critical remarks have triggered a hot debate on the future
path of reform in the state-owned enterprises (SOEs). Insiders are
saying that the relevant government departments are already
actively discussing whether MBOs should be continued or not.
According to statistics from the State-owned Assets Supervision
and Administration Commission (SASAC), half of the SOEs have
already restructured their ownership through MBOs.
Last November Li Yizhong, vice director of SASAC, announced that
the commission had carried out a survey of the SOEs in 23 provinces
including 16 major cities. It showed that 85 percent of the
restructured SOEs had successfully completed the process of
transferring ownership.
The loss of state-owned assets during the MBO process is an
emotive subject. However, SOEs usually return good results after
their MBOs. In the past two or three years, MBOs have several times
been given the green light only to be stopped again. Reappraisal in
the light of experience, and the debate this gives rise to, will
directly influence both the direction and the pace of future SOE
reform.
Restructuring mostly successful
Zhou Fangsheng is a specialist who carries out research in the
field of SOE reform. He would not support a complete veto of MBOs.
The reality is that half of those enterprises that have
restructured have done so through MBOs. The rest have attracted
foreign investment or domestic private investment. Over 70 percent
of SOEs have been able to achieve a successful ownership
restructuring.
“There are no accurate figures available nationwide on the
operations of the restructured enterprises. This is because they
are no longer managed by government departments,” Zhou said.
“However for example, in Baotou City of Inner Mongolia Autonomous
Region and in Hebei Province, local officials say that some
enterprises are still in difficulties after restructuring, but over
70 percent of SOEs have seen significant changes.”
“The goals set for reform are being achieved,” Zhou said. “Why
are there so many MBOs and how do so many of the enterprises manage
to achieve a successful outcome? We need to analyze the feasibility
and appropriateness of MBOs for specific industries and different
types of enterprise.”
The statistics show that over 30 percent of state-owned
enterprises are in the red. Zhou said that for a variety of reasons
including the type of industry or its products, together with
considerations of profit, financial burdens and debt levels, many
medium and small state-owned enterprises have found it impossible
to attract either foreign investors or domestic private
investors.
“For those enterprises that can’t be sold even at a much reduced
price, it is only the enterprise management team that can offer a
viable option for restructuring. This is the reality that I found
in my research,” said Zhou.
The SASAC is directly affiliated to the State Council. It was
set up early last year to deal with SOE reform and the operation
and management of state assets.
Figures published by the SASAC last year showed that from 1998
to the end of 2002, the number of SOEs and state-owned holding
companies dropped from 65,000 to 43,000, a decrease of 34 percent.
However, during the same period, profits jumped from 74.3 billion
yuan to 263.6 billion yuan. Since ownership of the SOEs began
moving over to shareholders in 1999, the state-owned
small/medium-sized enterprise sector saw an upturn in 2000. This
followed six consecutive years of deficit. The state-owned
small/medium-sized enterprises realized profits of 7.3 billion in
2000, 10.98 billion in 2001 and 28.69 billion yuan 2002.
“This is most encouraging,” said Li Yizhong when publicizing the
SASAC research data at the end of last year, “The fact that reform
was successful in over 85 percent of the enterprises indicates that
the mechanisms of reform were well chosen for the local
small/medium-sized enterprises. The results speak for
themselves.”
However, Li Yizhong also said that the situation where some
state assets had been undervalued and sold off cheaply, “makes
people feel aggrieved.”
“It is a common international practice to use MBOs as a means of
transforming an enterprise’s property rights. It is an option here
too, but there have been problems due to gaps in the rules and
regulations. One very controversial question is how large a single
shareholding should be,” said Li. “If individuals hold too big a
stake then what has happened in Russia might also appear in China
and the reform of the SOEs would end up with the assets in the
hands of just a few people. Therefore MBOs need to be further
regulated, particularly as regards the size of individual
shareholdings that can be acquired by employees.”
Zhou Fangsheng agreed that gaps in the regulatory framework had
given rise to such malpractices as insider trading, lack of
transparency, the same person acting as both buyer and seller,
collusion, and deficit trading being contrived to ensure a bargain
price. Consequently, state assets have been lost. It was because of
all this that in March 2003 the Ministry of Finance abruptly froze
MBOs by issuing a key document entitled Suggestions on Suspending
Examination and Approval of MBOs. Insiders speak of a fierce
debate at that time. They say the departments involved in the
decision-making were divided on the issue of whether to stop MBOs
altogether or merely to regulate their operations more
strictly.
The moratorium on MBOs remained in force until December 2003
when the General Affairs Office of the State Council issued the
Opinions on Regulating Reform of SOEs. “This was interpreted as
lifting the total ban on MBOs and giving limited consent to
proceed,” said Zhou Fangsheng.
Regulatory issues
“In fact, besides the guidance effectively regulating MBOs
contained in these Opinions, other documents including
Measures on Managing the Procurement of Listed Companies issued by
the China Securities Regulatory Commission also limit and regulate
MBOs,” said Zheng Peimin, chair of the board of the Shanghai
Rongzheng Investment Consulting Company.
Zheng has been involved in the detailed operation of and
research into MBOs for six years. He said, “There are two sides to
every story and this includes MBOs. The malpractice of the same
person acting as both buyer and seller could be avoided completely
just by adhering to current policies and standard procedures. It
would be ridiculous to prohibit MBOs or even abandon
property-rights’ reform just because of some cases where the proper
procedures were not followed.”
Zhou Fangsheng was personally involved in drafting the
Opinions. He said, “We have plugged the MBO regulatory
loopholes with the policy contained in Article 10 of the
Opinions. However, even where there are strict laws in place
there are bound to be some criminals prepared to break these laws.
In practical terms, non-compliance with standard procedures cannot
be eradicated completely. There are real difficulties in
implementing some of the measures.”
Zhou Fangsheng explained that the Opinions now require the
principal operational features of MBO schemes to be determined by
the investors. Organizations acting as intermediaries must be
appointed by the investors not by the management of the enterprise
as had been happening previously. Similarly, the management cannot
set up the detail of the scheme themselves and must not interfere
in any part of the entire buyout process. Meanwhile, the management
cannot purchase the company with the company’s own funds or with
finance that has been guaranteed with the company’s own funds. Nor
can they use funds from other SOEs or other state-owned
shareholding companies. Furthermore, where a company shows a
sustained under-performance in the years leading up to reform and
this can be attributed to poor management, then that management is
not considered qualified to take part in the buyout of its own
company.
“In fact, these measures do prevent the management acting as
both buyer and seller or running the company into deficit to get a
low valuation enabling them to buy it at a knock down price.
However, we carried out research around the regions and we did find
some cases where the Opinions were not strictly followed,”
said Zhou Fangsheng. “For instance, some enterprises still develop
the details of the MBO in collaboration with the investors and fail
to distance themselves completely from the process. This is mainly
due to practical considerations where the investors cannot complete
the details of the scheme independently without the help of the
management. They need access to the professional expertise,
experience and detailed knowledge of the company that exists only
inside the enterprise. Therefore, there are some real difficulties
in the full practical implementation of the Opinions. Nevertheless,
it represents a major step forward that schemes are now mainly
guided and decided by the investors. The managements can no longer
take control of everything like they used to.”
To standardize or suspend?
“The ongoing MBO trend in China is totally different from what
happens in Western countries,” said Zhou Fangsheng. “So you can’t
look at MBOs in our country in the same way as in others.”
In the wider world, the MBO is the purchase of a company by its
existing management. The ownership changes but it is not a
wholesale transformation of the corporate system as is happening
with the SOEs in China.
MBOs in China usher in deep systemic changes in an economy that
is itself in a state of transition. Single ownership by the state
is being transmuted into multiple ownership by shareholders. In
addition, the property rights transfer is flexible and foreign
partners, private individuals and corporate management can all
participate.
There have been some MBOs, where incomers have been brought in
to run the company and they have turned out to be more effective
than the old management. However, this does not mean that all
existing managements are in some way inferior to outsiders.
“It’s true there are some cases where state-owned assets are
lost when ownership is transferred,” said Zhou. “But most
state-asset losses occur because of commercial factors. Price
should not be the only criteria used when considering these assets.
Long-term development and social benefits should be the ultimate
goal of enterprise reform.”
“The decision to reform the ownership structure of the SOEs’ is
a correct one, however we should be more specific about the rules
for MBOs,” added Zhou. “For example, we might prescribe which
industries were appropriate for MBOs.”
However, it is no easy matter to deal with the detail of
regulating SOE reform in China. It is a massive undertaking being
carried out in the context of complex national conditions.
Zheng Peimin, chair of the board of the Shanghai Rongzheng
Investment Consulting Company, and managing president Li Wei of the
Beijing Wanmeng Investment Consulting Co, believe that the reform
of the enterprise system shouldn’t be stopped just because there
have been some inappropriate cases.
Both have studied many examples of MBOs in practice. They are of
the view that there is no need to bring in additional detailed
regulations since individual MBOs can differ so much. “We only need
to regulate the overall operation of MBOs,” said Li Wei.
“We can’t just apply an inflexible formulaic approach to complex
social mechanisms,” said Zhou Fangsheng.
(China.org.cn September 22, 2004)