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

March 13, 2019 - 04:31
CUHK Business School Research Reveals an Alternative Mechanism Governing listed State-Owned Enterprises in China

HONG KONG,CHINA - Media OutReach - March 14, 2019 - Corporategovernance has been getting more attention in China as the country takes theprominent stage in global economy. While most listed companies in China aremaking efforts in improving their accountability and transparency, a reportreleased by the Hong Kong-based non-profit organisation Asian CorporateGovernance Association (ACGA) shows that 68 percent foreign investors stillfind it very difficult to engage with A-share firms. So, what are thesolutions? How can Chinese authorities regulate the listed companies,especially the listed State-Owned Enterprise (SOEs) that are usually seen asless 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 corporategovernance mechanism of how observing peer companies being punished for wrongdoingswill have an effect among Chinese SOEs.


The study was conducted by Jin Xie,Assistant Professor of School of Accountancy at The Chinese University of HongKong (CUHK) Business School in collaboration with Prof. Francesco D'Acunto atBoston College and Prof. Michael Weber at the University of Chicago BoothSchool 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 inChina

"InChina, listed SOEs are seen as less disciplined by both internal and externalgovernance mechanisms due to massive state support and therefore are regardedas more difficult to regulate,"says Prof. Xie.


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


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


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


"The fear of reputationalsanctions is a relevant governance mechanism when other well-studied mechanismsare ineffective. This governance mechanism is inexpensive relative to thedirect monitoring of firms by activist shareholders or the direct investigationof listed firms by the market authority,"says Prof. Xie.


The Study

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


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


The results of the study confirm the researchers' hypothesis.


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


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


As thestudy reveals, loans to SOEs by the major Chinese banks account for the largestpart of the nonperforming loans in China, meaning most of the debtors are notable to make scheduled payments on time.


In the pastyears, Chinese regulators have increased the punishment for public firmstunnelling resources through inter-corporate loan guarantees. Tunnelling is atype of illegal financial practise. It usually involves top-level companyexecutives or majority shareholders transferring company assets or resourcesfor personal gain.

"We find thatafter Chinese regulators sanction a listed firm for tunnelling viainter-corporate loan guarantees, non-punished listed SOEs operating in the samelocation cut their loan guarantees to related private parties substantiallywhen compared to listed non-SOEs in the same location and to listed firms indifferent locations. This effect is economically and statistically large," Prof. Xie comments.


However,one might think those SOEs could merely move to more opaque forms of tunnelingafter a peers' punishment, andhence eliminating the sobering effect of punishment on the unpunished.


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


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


Future Studies

The study hasopened doors to many questions worth investigating in future.


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



D'Acunto,Francesco and Weber, Michael and Xie, Jin, Punish One, Teach A Hundred: TheSobering Effect of Punishment on the Unpunished (February 7, 2019). Fama-MillerWorking 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

CUHKBusiness School comprises two schools -- Accountancy and Hotel and Tourism Management -- and fourdepartments -- Decision Sciences andManagerial Economics, Finance,Management and Marketing. Established in Hong Kong in 1963, it is the firstbusiness 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 FinancialTimes 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 numberof business alumni (35,000+)among universities/business schools in Hong Kong-- many of whom are key business leaders. The School currently has about 4,400undergraduate and postgraduate students and Professor Kalok Chan is the Dean ofCUHK Business School.


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