A Matter of Independence

By+Yin+Pumin

The issue of independent directors in China has come under the spotlight recently， following the removal of two from office.

On May 29， Hangzhou Tianmushan Pharmaceutical Enterprise Co. in east Chinas Zhejiang Province announced that its restructuring plan had been delayed again. Before that， the Shanghai Stock Exchange-listed company fired two of its independent directors—Zheng Lixin and Xu Zhuangcheng， who questioned the validity of the companys finances and voted against the proposed restructuring， which mainly involved the acquisition of a pharmaceutical e-commerce website. The dismissals led to the inquiry from the Shanghai Stock Exchange requiring the company to explain its actions.

“The incident has brought independent directors to the fore once again—it is apparent they are not really ‘independent in Chinese companies，” said Song Yixin， a securities lawyer with the Shanghai Newhope Law Firm.

Whole new role

An independent director differs from an executive director who holds shares at a listed company. Independent directors do not have a material or pecuniary relationship with their company or related persons， with the exception of compensation paid to them. Their major task is to supervise the board of directors.

The independent director system originated in the United States during the 1930s， and has played an increasingly important role in the corporate governance practices of companies in Western countries since.

China formally introduced the independent director system in 2001.

A regulation issued by the China Securities Regulatory Commission in August 2001 defined an independent director as “a director who does not hold any position in the company other than director and who has no relationship with the listed company or its principal shareholders that could hinder them in making independent and objective judgments.”

The system of independent directors is intended to improve corporate governance， protect the interests of small and medium shareholders and enhance transparency at listed companies， according to the regulation.

In accordance with the document， independent directors are authorized to submit proposals to assemble shareholders meetings， recruit or dismiss accounting firms， invite independent auditors and offer independent financial reports apart from their normal duties as board members. They are also free to give independent opinions on major transactions with affiliated institutions， on assignment and payment of the managerial staff and to object in cases where the interests of smaller shareholders might be hurt.endprint

In October 2005， the Standing Committee of the National Peoples Congress， Chinas top legislature， adopted an amendment to the Corporate Law， which formally clarifies the legal status of independent directors.

“The system is aimed at constraining the power of management and better protecting the interests of minority shareholders. But its role has not properly implemented as Chinas listed companies are usually controlled by a single majority shareholder，” said Liu Jipeng， Director of the Capital Research Center at China University of Political Science and Law in Beijing.

By convention， to become an independent director， one should first be examined for qualifications for the post and then be nominated by the company before being voted in at a shareholders meeting， said Liu Guohua， head of the Guangzhou-based Benben Law Firm in south Chinas Guangdong Province.

However， most independent directors in China are actually recommended by the largest shareholders， which inevitably undermines their independence.

“Independent directors seldom dare to vote against those largest shareholders decisions，”said Dong Dengxin， Director of the Finance and Securities Research Center with Wuhan University of Science and Technology in Wuhan， central Chinas Hubei Province.

According to a report from the Shanghai Stock Exchange， only 38 independent directors across 26 companies raised objections to relevant company matters in 2011.

“Instead of inviting qualified and competent professionals to serve on their board， many public firms hire someone who will take their money and become a yes-man，” Liu said.

Liu said that much of Chinese public companies misconduct can be attributed to problematic corporate governance. He added that a public company is vulnerable to power abuse by a controlling shareholder—usually those who run the company—when independent directors do not do their job well.

“The reality has ruined the original intention of introducing the independent director system to protect smaller investors，” Dong said.

“If independent directors are handpicked by majority shareholders， how can they represent the interests of minority shareholders and turn against the people who brought them on board？” said Xu Feng， a partner at Shanghai Huarong Law Firm.

Xu believes it all boils down to the issue of representation. He cited a study his law firm conducted showing that most directors removed over the past few years had one thing in common： They failed to exercise their due diligence to ensure corporate compliance and represent minority shareholders.endprint

Xu urged regulators to reform the current system， under which many directors are nominated by majority shareholders.

“There should be voting proxies for small and medium shareholders. While retail investors can share the growth of a public company， they should have these proxies to decide company matters on their behalf，” Xu said.

“Such proxies have already been introduced to represent institutional investors such as private equities and other investment funds in public companies， and they could represent retail investors in the future，” he added.

Exodus

The employment of retired government officials as independent directors has been a target of criticism among the public.

In July 2013， Sinotruk Hong Kong Ltd.， a Hong Kong-listed subsidiary of state-owned China National Heavy Duty Truck Group， announced the appointment of three former senior officials as its independent directors.

The three appointees—Shi Xiushi， former Governor of southwest Chinas Guizhou Province； Han Yuqun， former Governor of east Chinas Shandong Province； and Cui Junhui， former Deputy Director of the State Taxation Administration—were each promised an annual pay of 180，000 yuan （$29，016）.

However， the three resigned amid public and media questioning only 20 days after their appointment. The public was worried about possible corruption and unfair market competition due to the influence of the former officials.

Statistics from the financial information server 10jqka.com.cn show that there were about 5，760 independent directors employed in companies listed on Chinas Shanghai and Shenzhen stock exchanges in September 2013， among whom 2，590， or 44.9 percent， had worked in government departments， according to a report of the China Youth Daily.

Their working areas were mainly related to auditing， taxation， finance， law and human resources， the report said. It also revealed that more than 30 of them were retired officials who had acted at the ministerial level， and more than 100 used to be mayors. More than 720 reportedly had assumed posts equivalent to head of a county.

“Connections with the government have been regarded by many companies as important corporate resources，” said Gao Minghua， an economics professor at Beijing Normal University.

“We tend to choose those who are wellconnected and can be helpful to the company，”a board secretary of a Shanghai-based listed company， surnamed Dong， told Xinhua News Agency.endprint

A public company manager， who declined to be named， admitted that companies employ former officials as independent directors for their influence and “coordination abilities” in business circles.

“However， it is just the extensive government connections owned by the ex-officialturned-independent directors that raises questions over ethical practices and breeds collusion between business and government，” said Zhang Huiming， a professor at the School of Economics at Shanghai-based Fudan University.

Besides， despite years of political experience， these former officials， some in their 70s， may not have sufficient economic expertise to perform their duties as independent directors.

“Some of these ex-officials dont even attend board meetings and dont vote on the major decisions of their companies，”said Liu with China University of Political Science and Law.

“The ideology of officials is to obey and implement， while what independent directors need to do is oppose，” said Gan Peizhong， a professor at Peking Universitys Law School.

In October last year， as part of an anti-corruption campaign， the Organization Department of the Communist Party of China（CPC） Central Committee issued a circular， banning incumbents and college personnel from assuming posts outside their office.

The circular also stipulates that only those retired from their government role for more than three years are allowed to take up jobs at companies under relevant authorities approval.

Public disclosures of more than 200 listed companies over the past months show that a number of former high-ranking government officials have given up board seats.

Peoples Daily， the CPCs flagship newspaper， said in a commentary on June 9 that the surge in resignations by ex-official-turned-directors has provided a good opportunity for the government to withdraw from the marketplace.

It also said that though hiring officials as board members may have proved beneficial in the short term， such decisions will not help a company in the changing market environment and does no good in cultivating sound corporate governance.

Some experts suggest transparency in the independent directors work and more supervision from the media and the public.

Zhu Lijia， a professor with the Chinese Academy of Governance， said that retired officials must be banned from assuming such posts in the industries and places they used to work in order to avoid nepotism.endprint