Total surrender. That’s what the New York Times reported the Chinese government expects of its business sector, following Beijing’s recent signals not to resist government influence.
Curtis Milhaupt, the William F. Baxter-Visa International Professor of Law at Stanford Law School, has been researching China’s state capitalism for nearly a decade, and worries that U.S. efforts to respond to its challenges have been ineffective. His new study, detailed in the latest issue of the Journal of Legal Studies, together with his publicly filed comments on a new U.S. law aimed at countering Beijing’s influence over Chinese firms accessing the U.S. capital market, suggest why.
Milhaupt sees two main challenges: The first has to do with what the U.S. actually knows—and, more importantly, doesn’t know—about how much power the Chinese government and Communist Party exert over Chinese companies. The second concerns whether the United States alone can successfully manage China’s distinct form of capitalism.
“It’s important to recognize that the channels of party-state influence in the corporate sector are actually very complex and subject to some universal constraints such as agency problems and market discipline,” says Milhaupt. His previous research has detailed the ownership structures of Chinese state-owned enterprises (SOEs) and has shown that the Chinese government has exercised less control over these firms than is often assumed. “But at the same time, global regulatory systems never contemplated the partial fusion of political and economic interests we see in many Chinese companies.”
Milhaupt’s latest research—conducted with Lauren Yu-Hsin Lin, an associate professor at City University of Hong Kong School of Law and graduate of Stanford’s JSD program—underscores both points.
In their study, Milhaupt and Lin uncover evidence indicating that, from 2015-18, some 90 percent of publicly traded Chinese SOEs have amended their articles of incorporation to give the Chinese Communist Party formal status in their operations. The amendments came in response to a 2015 policy requiring all SOEs to formalize and elevate the role of the party in their corporate governance.
Some of the adopted measures are purely symbolic, but others highly substantive. Milhaupt and Lin, for example, find that 75 percent of the SOEs require their board of directors to consult with an internal Communist Party committee before making a major business decision. Sixty-six percent allow the committee to nominate directors and senior managers. (Virtually all organizations in China, including corporations, have internal Communist Party committees whose importance and function vary—from appointing personnel to addressing corruption to propagating political campaigns.)
“In these cases, the party committee is above the board of directors as the highest decision-making body within the corporation,” says Milhaupt. “To put it mildly, these steps are inconsistent with globally-accepted governance principles,” he says.
Underscoring the reach of the Communist Party beyond the state business sector, the researchers also find that almost 6 percent of private firms with shares listed on China’s stock markets voluntarily adopted measures giving the party committee formal status, and in some cases, a governance role within the company.
These measures also have important U.S. policy implications. Case in point: draft Securities and Exchange Commission regulations implementing a newly-enacted federal law that aims to counter Beijing’s restrictions on how much financial information U.S.-listed Chinese companies disclose to American regulators. The interim regulations require a U.S.-listed foreign company that refuses an audit inspection to reveal any government ownership stake in its business, the identities of Chinese Communist Party officials serving on its board, and whether its articles of incorporation refer to the party’s constitution. Companies that do not comply for three consecutive years face delisting.
Milhaupt says in their current form, these disclosure requirements are not likely to be very helpful to U.S. investors and regulators in understanding the degree of influence the Chinese government and Communist Party exert over a given company. For example, virtually every executive of a Chinese SOE is a member of the Communist Party. And as Milhaupt’s recent research indicates, references to the party constitution are often symbolic and can be found in virtually all SOE charters and some private company charters as well.
A more effective approach, says Milhaupt, would be to require U.S.-listed Chinese companies to specify their board members’ current and past ranks within the Chinese government and/or the Communist Party, whether they also serve on the internal party committee, and the actual role of the party committee in the company’s governance.
“The law and implementing regulations seem to betray a lack of understanding about how Chinese firms are actually influenced by the Chinese government and Communist Party,” says Milhaupt, who outlined this and other suggested fixes in a public comment letter to the Securities and Exchange Commission in response to the draft regulations it issued this spring.
Even so, Milhaupt acknowledges that China’s state capitalism poses challenges to a world order that the United States can’t address effectively on its own. He points out that threatening to delist Chinese firms from U.S. stock exchanges, for example, may be ineffective given that capital markets are global, and Beijing wants these firms to list their shares in the mainland or Hong Kong in any event.
“We risk entering into a race to the bottom with China through ad hoc retaliatory measures that, in the end, are likely to be symbolic and possibly even counterproductive,” says Milhaupt, who is also a Senior Fellow, by courtesy, at Stanford’s Freeman Spogli Institute for International Studies. “There needs to be a coalition of western governments and investors, and a major rethinking of global regulatory systems, to effectively respond to China’s distinctive form of capitalism.”