Institutional Activism in Corporate Governance

Qualified Foreign Institutional Investors in China

Wenge Wang

• Publisher: Palgrave Macmillan
• Year: 2019
• Print ISBN: 9783030195762
• eBook ISBN: 9783030195779
• Topic: Business
• Subtopic: Business General
• Index: Business

Using both qualitative and quantitative methods, this book examines whether qualified foreign institutional investors (QFIIs), through their shareholder activism, have a meaningful positive impact on the corporate governance of firms listed on the mainland Chinese stock market. Capital flows into and out of China are still subject to tight controls, and the QFII scheme is one important avenue through which QFIIs can become invested in the Chinese stock market. This book is an invaluable resource for anyone interested in learning about ways to invest in one of the world's largest economies. Wang discusses in depth what specific opportunities, challenges and restrictions to expect in the process, and how investing in China differs from investing in countries with a more open capital account.

Part I

Introduction

Qualified Foreign Institutional Investors (QFIIs) potentially import practices of shareholder activism that can improve corporate governance in emerging economies’ stock markets. This monograph is a research project that scrutinizes this proposition in the context of China. To do this, it will explore the impact of QFIIs’ institutional activism, especially European QFIIs, on corporate governance in Chinese listed companies both in theory and in practice using the interdisciplinary methods of an economic analysis of law and quantitative analysis. The first objective is to conduct a theoretical analysis on the motivations behind QFIIs’ investments and their behaviour as shareholders, supported by an analysis of data on companies targeted by QFIIs between 2003 and 2016. The aim is to find out whether QFIIs engage in shareholder activism in corporate China, especially following Chinese policy changes in relation to the regulation of QFIIs in 2006 and 2012. The second objective is to conduct an empirical study by way of multiple regression on the correlation between QFIIs’ stockholding and the performance of Chinese listed companies over the same period, in order to identify the effectiveness of QFIIs’ institutional activism in improving corporate governance in Chinese listed companies. The working hypothesis of this research project is that QFIIs may not engage in activism because of the speculative nature of institutional investors, and therefore that policy changes of 2006 and 2012 may not have enhanced QFIIs’ activism in corporate China. This suggests that further policy changes may be required, both in China and in Europe, if QFIIs are to engage in activism which benefits both China and their end beneficiaries. An appropriate set of policy implications will be identified and addressed to policymakers and investors in both China and the EU.

This part is an introduction, which outlines the framework of this research project. This is to tell the reader why they should read this research monograph, what problems it addresses, how those problems are addressed and why it matters. Chapter 1 thus describes problems, questions, purposes and the organization of this research project.

© The Author(s) 2019

W. WangInstitutional Activism in Corporate Governancehttps://doi.org/10.1007/978-3-030-19577-9_1

Begin Abstract

1. Description of the Research

Wenge Wang¹

(1)

Anshan, Liaoning, China

Wenge Wang

End Abstract

1.1 Problem Statement

Socialist market economy is not the same as western market economy. Market Socialism as it is practiced in China means that things like investor activism may be changed to such a degree that they cannot really be equated with their so-called equivalents in the west. This is perhaps because there is a very different view of the rule of law and the operations of the market in China, where there is the phenomenon of Qualified Foreign Institutional Investors (QFIIs). In the circumstances of socialist market economy in China, the question is whether this QFIIs phenomenon can really be viable to proceed all that far when there are simply not the flows of information, and the manner of holding companies to account, or trying to influence them, which there are in the US or the EU (particularly in the UK).

QFIIs are foreign institutional investors permitted by Chinese government to invest in the Chinese stock market. They are expected to bring in good practice of corporate governance from their home jurisdictions so that they can help through their institutional investor activism to improve the corporate governance of Chinese listed companies. The rationale behind this expectation is that QFIIs come from international companies with good experience in corporate governance such as shareholder activism in the US and Europe. Institutional investor activism is the main form of shareholder activism in western corporate governance, which is just what is generally absent in corporate China. China is copying aspects of western corporate governance, but the result is something sui generis because of the role of the state in State Owned Enterprises (SOEs). One example is the legal transplantation of the independent director scheme from the US to China with the aim of compensating the dysfunction of the monitoring role of the supervisory board in Chinese listed companies. This is to internally influence the board of directors through the complementary monitoring role of independent directors, who however fail to function as effective monitors and thus have been dubbed “vase directors”. In view of this failure, QFIIs have been expected to externally influence the board of directors through their institutional investor activism as practiced in their home jurisdictions when they were brought in the Chinese stock market.

The reality is that QFIIs are reluctant to carry out their institutional investor activism in Chinese listed companies. This is apparently not in agreement with the expectation on them from Chinese policymakers and market regulators. Institutional investor activism is foreign to corporate China. It may come with QFIIs but cannot automatically work in China, depending on the circumstances of regulatory specifications and market operations in the Chinese stock market. This is a dilemma for Chinese policymakers and market regulators: QFIIs are expected to perform their institutional investor activism but they do not. This is the problem that needs to be addressed in corporate China. To encourage QFIIs to engage them in activism, Chinese government relaxed to some extent regulations on QFIIs several times in the past. The corollary is whether or not QFIIs actively engage in their activism in corporate China, responding to the relaxations of Chinese regulations on them. If not, the questions arise: Why QFIIs do not actively engage with Chinese listed companies? Are there barriers to, and prospects for, QFIIs engaging in corporate governance in the Chinese stock market?

This timely research project is to explore the barriers to, and prospects for, greater activism in corporate governance in China on the part of Qualified Foreign Institutional Investors (QFIIs), especially QFIIs across the EU. The rationale behind this exploration is that, at present, QFIIs do not appear to engage in activism in relation to Chinese listed companies. QFII schemes are an expediency policy introduced in transitional economies which are in the course of liberalization. Foreign investments in the capital market are controlled by the domestic government through the use of quotas, entry and exit restrictions, lock-in periods and limits on repatriation of earnings. China introduced a QFII scheme to its stock markets in 2002, with the twin aims of progressively liberalizing its capital market and improving the corporate governance of Chinese listed companies. In theory, giving QFIIs’ access to the Chinese stock markets ought to improve corporate governance in China. However, reality appears to contradict the theory and thus a working hypothesis is that QFIIs do not currently play an active role in the governance of listed companies in China. Given the European Commission’s corporate governance policy, QFIIs’ engagement appears “insufficient” (Directive 2014, 4). It also raises a difficult question for Chinese regulators: how to encourage QFIIs to engage in institutional activism so as to improve corporate governance in China, whilst keeping the Chinese stock market stable, with manageable volatility? This is an urgent policy issue, given the volatility of the Chinese stock market in recent times,¹ and academic research is required to provide effective policy suggestions. This research project will test this hypothesis and then suggest practical ways in which levels of activism might be improved, shedding new light on a pressing policy issue for both the EU and China.

Engaging shareholders, especially institutional investors, in corporate governance is one of three key objectives highlighted by the European Commission’s 2002 Action Plan (European Commission 2012, 4), which operates on the premise that “Effective, sustainable shareholder engagement is one of the cornerstones of listed companies’ corporate governance model” (European Commission 2012, 8). Institutional activism is the most important form of shareholder engagement. It aims to influence or change the processes and outcomes of particular companies within the investor’s portfolio by means of symbolic targeting,² as well as more conventional corporate governance interventions. The aim is to directly or indirectly affect outcomes in terms of strategic direction and performance of portfolio firms through refinements to corporate governance (Ryan and Schneider 2002, 555), corporate finance, assets holdings and strategy. Compared with the techniques of institutional activism commonly deployed in the US, such as jawboning, shareholder proposals, targeting signals and the “Wall Street Walk” (exit through share sales), Article 3f of the proposed EU Shareholder Rights Directive (Directive 2014) requires that institutional investors develop an “engagement policy”, detailing their approach to dialogue, exercise of voting rights, use of proxy services and coordinated shareholder activism (Directive 2014, 19). The EU’s approach is innovative, and contrasts with the US market-led approach. If adopted, it will rely on soft law to ensure better communication between shareholders and managers with the aim of creating long-term value for the end beneficiaries of financial institutions.

Ferreira et al. (2013) investigate the role of institutional investors in 27 countries and find that firms with higher foreign institutional share ownership have higher market capitalization and better operating performance. This suggests that foreign institutional investors may bring good corporate governance practices from their home jurisdictions to the firms they invest in. China’s QFII scheme is premised on the notion that activism on the part of QFIIs will improve corporate governance in Chinese listed companies. There is no systematic and in-depth research, either domestically or internationally, on QFIIs’ actual involvement in, and effects on, corporate governance in Chinese listed companies. Whether European QFIIs engage in the corporate governance of portfolio companies in China is therefore an important empirical question for policymakers, both in Europe, where it is increasingly sought to encourage engagement through soft law, and in China, where the recent volatility of a stock market dominated by small and highly leveraged shareholders has raised serious concerns. This research project aims to provide guidance to policymakers as to harnessing the potential of QFIIs in China.

1.2 Purposes of the Research

In the institutional investment world, activism is on the rise, a current trend in corporate governance that is expanding from the US to Europe and other parts of the world. The possible explanation for this trend is perhaps that activism today is a popular and powerful investment strategy to influence corporate strategy and hold management accountable for shareholders in underperforming companies. An activist intervention is thus seen as criticism of management, strategy or governance—or all three in such companies. Critics of activists may argue Gordon Gekko’s philosophy that “greed is good” to label the popular image of the activist investor in the film Wall Street. This philosophy is a two-sided story. Investment is to make profit on the one hand, whilst activism makes most of it on the other hand. The implication from this story is that activist investors can perform a valuable function, bringing new thinking to corporate strategy, acting as the voice of shareholders and improving firm performance. Considering this, activism does matter in corporate governance, suggesting that demand on activism may arise in certain circumstances.

The simple fact is that activism would not exist without a demand for it. Demand is not expectation and there is a difference between them. There is a need in the case of demand but just a desire in the case of expectation. A demand can arise when a desire becomes a need. In such a scenario, activism may work. The survival of activism is however dependent on the circumstances of legal and regulatory framework from where demand arises. This is evident in developed economies such as the US and the UK. The same is true of emerging economies like China, where QFIIs are expected to engage in activism with Chinese listed companies. This may lead to the issue as to whether or not there would be a need of activism on the part of QFIIs in Chinese listed companies. If in need, wo...

Table of contents

• Cover
• Front Matter
• Part I
• Part II
• Part III
• Part IV
• Part V
• Part VI
• Back Matter