Chinese Companies and Pots of Cash

The China price

I rarely have revelations, but after being knocked over the head countless times over the years, I finally got one regarding how Chinese businesspeople tend to view their businesses differently from how Western businesspeople tend to view theirs.

The other day, a deal my law firm had been working on for a US company fell through, much to the consternation of nearly everyone involved. By everyone, I mean our China lawyers on both sides of the Pacific, the accountants, and — most importantly the US company we represented. The only party that did not want the deal to go forward was the Chinese company.

I am going to have to be incredibly vague here, for attorney-client and confidentiality reasons, but the main reason the deal fell through was because the Chinese company did not like how the American company had so little cash on hand. The Chinese company kept insisting that it did not want to give up its cash position, even though everyone else kept insisting that cash had nothing to do with the deal and that cash on hand could be equalized.

At around that same time, a couple of my law firm’s international dispute resolution attorneys were communicating with two different Chinese companies that were owed considerable sums by US companies and both of these Chinese companies were unwilling to spend any money to try to collect those sums. Our dispute resolution lawyers could not understand why these Chinese companies were unwilling to risk relatively small amounts to fund litigation to recover relatively big amounts, particularly since in both instances it was pretty clear that if these two Chinese companies did not get more aggressive in their debt collections, they would never get paid and their businesses would go under. For more on this phenomenon with Chinese companies being unwilling to pursue their creditors, check out Ranking Creditors. China Comes In Dead Last.

Then it struck me. The typical Chinese business owner is far more protective of his or her cash and far less protective of his or her business than the typical Western business owner. American and European and Australian businesspeople (I list these because most of our law firm’s clients come from North America, Latin America, Europe and Australia) frequently put cash into their businesses to keep them going, whereas Chinese businesspeople seem rarely to do so. I suspect the following reasons for this, but would LOVE to hear other potential reasons from you, our dear readers:

1.  Our law firm’s business-owner clients always talk about “building” a business. They run their businesses for more than just money. They are run as something to pass on to one’s children. They are run for the employees. I am not saying money is not a big factor, but I get the sense it is much less of a factor for non-Chinese business owners than for Chinese ones.

2. Our clients tend to put their lives into their businesses. Many Chinese do also, but many also are there in large measure due to their government connections and to government largess. I suspect this too plays a part in the differences between how Chinese business owners view their businesses as compared to non-Chinese business owners.

3. American/European/Australian business owners do not typically fear the government will shut down their business. This is less true in China.

4. American/European/Australian business owners generally know that if they put their own money into their business and their business collapses, they themselves will likely avoid personal liability. This encourages them to borrow to try to save their own businesses. Chinese individuals have not had such ready access to credit nor is failing to pay one’s business debts in China treated the same as in the West.

These are the reasons I believe Chinese businesspeople tend to emphasize cash much more than American/European/Australian businesspeople and why American/European/Australian businesspeople tend to emphasize saving and growing their business more than Chinese businesspeople.

Again, what do you think? Am I off base here? If I am right, how does this affect how one should deal with a Chinese company?

32 responses to “Chinese Companies and Pots of Cash”

  1. Americans seem more easily to understand their ideal business model for growth is a corporation, a company which should be divorced from personal interests and run by professional managers, rather than a family enterprise run by family members which basically describes most Chinese businesses no matter how large.
    Cash allows the Chinese to exercise another basic trait – opportunism which often turns to speculation, especially in traditionally cash-heavy transactions such as real estate.
    Also, most Chinese are overly suspicious of others and very tight with their money. I emphasize “suspicion” which goes far beyond skepticism or prudence.
    I pointedly do not consider these characteristics unique to mainland Chinese.

  2. Yes, you are onto something here.
    That’s probably the fundamental reason why Chinese suppliers (in general, not all of them) look so “unpredictable” to Western buyers.
    If something happens (e.g. a sudden cost increase, or the rise of the RMB, or product to rework) and the Chinese supplier has to be at a loss on this one order just to keep the relationship going, he often decides to pass it on to the buyer at the last moment and risk breaking the relationship.
    And it is an explanation for “China quality fading”. The margin is too small? The buyer squeezed the price? Let’s take less care of this order. It will be more cash now for sure, and maybe one lost customer later.
    This is not about all Chinese suppliers, though. Some of them, particularly in the most competitive industries, have learned the hard way and run their businesses more like Westerners.

  3. I think it has to do what you sort of alluded to – the time horizon that people work with. Like Scott Loar – I don’t think it has to do with being a mainlander.
    If you look at the tumultuous history and environment that most Chinese people have grown up in, is it any wonder that their thinking is far more short term than say that of American firms? Cash is real where as “earnings” / accrual accounting can be fudged – and I’m sure you’ve seen more than your share of this of companies on the mainland.
    Then look at the education of most of these business owners who very seldom have formal education in any area of business let alone finance or marketing. In the west, it’s really not uncommon for small business owners to do cash accounting when thinking about their own businesses. And often it’s difficult for businesses to get “to the next level” without changing the way things are done on a wholesale level. In China however, because of circumstances / rising tide I find a lot of these owners have never really needed to think differently in order to achieve the success that they enjoy today.
    Clement

  4. I’m a halfpat residing in Beijing and am currently working on a small entrepreneurial endeavor with local Chinese friends. From my limited exposure to the Chinese side of the post’s topic, my impression is that things change so rapidly here that there is not much of a sense for institution-building. There’s so much creative destruction taking place that the local mentality accepts this for granted, like an ingrained survival instinct–basically always knowing you can be shut down at anytime. In this way, it is difficult for companies in Beijing to make long-term plans, I suspect.
    Lastly, I would like to point out that cash, in addition to its many advantages, can open doors as well as guanxi, which is absolutely essential to a successful endeavor.

  5. I think you’re right about the passing-the-business-to-children part. I have a feeling that in China, people traditionally view having a business almost as a “dirty job”, something you do so that your kids will have the money to get a better life. Unless they are extremely successful, many Chinese businesspeople don’t expect or want their child to take over the business.

  6. While I agree with all the reasons given above for the Chinese preference for cash business, I think there is one other that has been left out: viz., Chinese suspicion of government. During the past 60 years mainland Chinese in particular have seen some very erratic changes in policies and regulations. Consequently they tend to trust institutions and systems much less than the money you can put under the mattress. Therefore dealing with cash-rich companies for them is going to be a better deal than companies that are dependent on banks and government policies to hold up their end of a bargain. And that is probably all the more so given the global financial crisis.

  7. Isn’t it a simpler explanation that the Chinese company is simply fearful of the whole credit crisis? In that there are many stories(like the Republic Window mess) of cancelled orders, American companies having the carpet pulled from under by the bank slashing their commercial credit?
    Sorry to say but American clients simply ain’t what they used to be. In Taiwan, we have seen some “complications” for whatever reasons from our American customers and they are put on the “watch list”, which almost never happened before.
    I guess one way to look at this is that Chinese simply don’t view litigation as a regular part of business dealing. If a deal has even a remotest possibility of lawsuit, don’t go ahead. Not the happy attitude lawyers look for…

  8. There are really only two classes of assets over here: cash and real estate. Assets have to be very tangible. Equities were popular because of the bull market, but I don’t think any Chinese really felt they were investing in the underlying business of the shares they purchased. They were just playing the market.
    Dan, I think one big reason why Chinese creditors are unwilling to fund collection actions in the US is because they have no way to influence the outcome. They can’t even get insider information. They have no friend of a friend of a friend in the court clerk’s office. They can’t corroborate anything you tell them. They won’t put blind faith in you. They’re assuming that you will pocket most of whatever settlement you get and present them a fraudulent settlement figure at a low number. Hell, they would do the same.
    Anytime an activity or asset is controlled by an institution that lies outside their nexus of control, they’re not going to play.

  9. I generally agree with all the comments above. The constant reminder that change is coming is something that leads people to stay liquid with their funds. Given the history of China, Open and Reform (改革开放) is only 30years old. But much less in practice, even less for the non-coastal cities.
    Moreover, my experience is that Chinese business people are not in for the long-haul. “Take the money and run” is the tune their singing. I have seen acquisitions go down , throw money at the owner to stick around to run the place and then take off in a couple years to create a competing entity. And I cant blame them , because the idea of future pay-out does not look that good in China. Given with what he knows, that future pay-out might never come in a rapidly changing China.

  10. RE: the Chinese company is really an American-Chinese company run by a Chinese family.
    What is an American-Chinese company? Is it located in the states, or in China? Thanks.

  11. This is one of those things that completely obvious if you are in a culture.
    A lot of it has to do with incentives. The head manager of an American business tends to be compensated based on profit rather than on cash, whereas Chinese business people tend to be compensated based on the amount of cash they have in the bank.
    Also large American corporations really can’t have too large a cash holdings without being threatened by a corporate raid. Whereas Chinese companies tend to be extremely closely held.
    Finally, having lots of cash saves your rear end when everything falls apart. I do expect that in five years, you’ll see American businesses look a lot more like Chinese businesses when it comes to holding cash, because any business that didn’t have large amounts of cash would be dead.
    4. Americans generally know that if they put their own money into their business and their business collapses, they themselves can declare personal bankruptcy and start their personal financial life over again.
    Actually if you have a well organized business and the business collapses, you can liquidate the business without it have any impact on your personal finances. It’s trivial to start a corporation in the United States, whereas it’s not as trivial to start a corporation in China.
    Also, if you are in China, and your business collapses, there is often an implied personal commitment to assume the debts of the corporation so there really isn’t very much of a “corporate veil.”

  12. Quote: American businesspeople frequently put in their cash into their businesses to keep it going, whereas Chinese businesspeople seem not to.
    Personally I don’t think that American businessmen put their cash into their businesses more often than Chinese people do. They might be more likely to put *other people’s cash* into a business.
    This also makes a big difference. If you put your cash into a business, then no one cares what you do with it. If you put someone else’s cash (i.e. a bank or VC money) into a business and you don’t do anything with it, they are going to get very, very annoyed with you. Why should a bank or VC give you money, if all you do is to put it into a checking account.
    Loar: Americans seem more easily to understand their ideal business model for growth is a corporation, a company which should be divorced from personal interests and run by professional managers, rather than a family enterprise run by family members which basically describes most Chinese businesses no matter how large.
    It also describes businesses in most of the world. It’s not the Chinese business structure that is unusual, it’s the American business structure. Brad Delong has written some papers on how the US business structured evolved, and something very interesting and odd happened between 1915 and 1930 that gave professionally managed business.
    robert: They’re assuming that you will pocket most of whatever settlement you get and present them a fraudulent settlement figure at a low number. Hell, they would do the same.
    Actually I don’t think they would. Most people turn out to be quite honest, the trouble is that its often hard or impossible to tell the difference between an honest person from a dishonest person.
    One problem in debt collection, is that even after you get a judgment, you can run into problems collecting on the settlement. This tends not to be a problem with large established companies, but in dealing with small or middle sized companies, this can be a major problem.
    There comes a point when you just say to yourself, it’s not worth the trouble since I’m not likely to make as much money from the settlement as I’d lose, and if you have large amounts of cash and you aren’t desperately in need of money, then it’s an easier call to make to just write off the debt.

  13. This is a very good topic.
    I think you need to differentiate between the big public or state-owned corporations and the small and medium enterprises (SME). You would also need to look at the issue from three different dimensions: legal/institution, access to capital and personal/culture.
    For small and medium companies, cash flow is always more important than profit; this is true regardless the host countries. Chinese companies in general operates in an environment where contract terms may not always be followed and might not be easy to enforce if violated. This is why you have a lot of chain-debts problem in China and why a lot of Chinese companies would prefer export business even if the margin is lower. The Chinese business environment is generally a low-trust environment where personal relationships are very important between trading/business partners. This does not necessarily mean Chinese business hold cash more tightly; in fact once some kind of relationship is established, many Chinese companies skip the necessary legal procedures to protect themselves (and thus may run into the uncollected payment problems).
    In China, access to loans and capital have always been a problem for small and medium business. This is less a problem in the US.
    (In a related note, it’s much easier to get personal loans in the US than in China. Well, that’s why we get into the sub-prime problems)
    For the big state-owned companies, it’s a different situation. In recent years, many large Chinese state-owned companies are very profitable, to the point that there have been a public outcry and pressure for them to pay dividends – these companies are usually publicly-listed and very few of them pay cash dividends.
    Holding a lot of cash is generally not an efficient deployment of capital. For US public companies, holding a lot of cash either attract criticism from shareholders or takeover interest. In an efficient capital market as in US in general, public companies have easy access to capital and credit and do not need hold lots of more cash.
    The problem is, when we have a credit crunch or financial crisis like we have now, the credit and capital markets are severely disrupted and in distress. This is when the advantage of holding a lot of cash becomes apparent. To use a manufacturing analogy, just-in-time production is a more efficient production system and utilizes capital (inventory) much better, but if an earthquake strikes or a fire sets off in a certain node of the supply chain, holding a lot of inventory (safety stock) protects the production system from severe disruption. The same thing can be said of just-in-time capital.
    It’s hard to say which system has the absolute advantage, it depends on the operating environment of the business …

  14. Twofish, my point was more subtle than your comment addressed, and I never implied nor may a reasonable reading infer that the US corporation is more common than family enterprises. As a business model the US corporation IS an ideal business model for growth regardless of its genesis, and among others McDonald’s and KFC (in marked contrast to family enterprises) have brought that example to many Asian countries and reared an entire class of professional managers. An obverse example is the Korean family chaebol which hogged most government loans, performed badly and gave little return on investment.

  15. wow,wow,wow, I love this discussion. First, Dan put in clear words what was vaguely on my mind when I wrote my comment to his July 5, 2007 article, Chinese Exporters Making Right Move To Shed “Made In China” Taint. For easy reference, I’ll just put my then comment below:
    “I sense there are simply not enough entrepreneurs in China who aim at building a lasting brand. Most are in for maximized short-term returns that’ll be enough to keep themselves, and maybe their immediate heir rich. Even the current shift to heightened focus on branding is not about branding itself. The trend is forced by a difficult marketing position and there’s little real long term thinking in it. It’s all about keeping profits, now.
    You’d say, all businesses are just about profits. That’s right. But an exclusive focus on raking in profits NOW makes producers brazen cheaters. ”
    Then, there are all these highly sensible comments above.
    man, it feels great just reading through.

  16. Just as I was gathering thoughts out of my excitement, here it comes, greg’s freshly released comment, which in a way, grouped all reasons thus far thrown on the table into three dimensions, legal/institution, access to capital and personal/culture.
    Well done, greg!
    Would just like to add that the personal mentality and business culture factor is partly a function of the accumulated experience with, in China’s case, unreliable institution and poor capital access. The mentality then becomes a more independent thing, to the point that some SME owners can’t really explain why they insist on a high cash holding, except saying that it makes them uneasy if the holding is low.
    The cultural factor, of course, also has a distinctly cultural origin as well. I can share an anecdote where the husband of a friend of my mom’s ran off years ago with his mistress, each taking away some 500,000 rmb borrowed money. The abandoned wife has had to be paying back these debts over the years. Recently, the son of the family got wedded, and the debters gathered in an attempt to ruin the wedding. They asked why there was money spent on a wedding instead of paying them back. The poor mother had to kneel down to beg them away.
    Such is the different debt culture. Dig deeper and you come to the also widely discussed difference between US and China in family cohesion, which has implications not just for business culture, but pension system, caretaking of the old, and beyond.

  17. Why wouldn’t a Chinese entrepreneur think of only the short term? What’s the use of passing it on to your heirs when it won’t last three generations anyway? (富不过三代 )

  18. Chinese think of their family the way Americans used to think of business per your definition. (I say “used to” because one thing the credit crisis has taught us is that Wall Street was set up to optimize sales of debt and creating leverage, not for passing a business down to one’s heirs.)

  19. Loar: As a business model the US corporation IS an ideal business model for growth regardless of its genesis, and among others McDonald’s and KFC (in marked contrast to family enterprises) have brought that example to many Asian countries and reared an entire class of professional managers.
    There are well run American companies, there are badly run American companies. McDonald’s and KFC are well run American companies. General Motors, Enron, and Lehman Brothers were badly run American companies. Also companies can go from well-run to badly run and back again.
    I don’t doubt that China can learn from how to run American companies, but …..
    1) I really think that the factors are more important than corporate structure.
    2) Even if you were to conclude that American companies are generally better run than Chinese companies, it’s not clear what you can or should do. If you try to take American business practices and put them into a Chinese context, you could end up with the best of both worlds, or the worst.
    Even in food service, there is some value in diversity. McDonalds is one way to run a restaurant, but it’s not the *only* way to run a restaurant.
    Also, the US corporate structure is very atypical. Most German companies are owned by banks. Also in 1998, you could argue that it was self-evidently obvious that US companies were better. You can’t really argue that in 2008.
    Loar: An obverse example is the Korean family chaebol which hogged most government loans, performed badly and gave little return on investment.
    Hard to say. The trouble with this idea is that South Korea did extremely well in the 1960’s and they haven’t done so badly in 2000. Also the balance of power might be different. If you have a massive family run business, then maximizing return on investment (i.e. the amount of money that family makes) may not be a particularly useful goal.

  20. greg: Chinese companies in general operates in an environment where contract terms may not always be followed and might not be easy to enforce if violated.
    This tends to be true for all small companies. Generally if you are a small company, the transaction cost for trying to resolve a legal dispute through litigation is huge compared to the rewards.
    greg: The Chinese business environment is generally a low-trust environment where personal relationships are very important between trading/business partners.
    I also don’t think that this is a Chinese/American difference. The US is a high-trust environment for a lot of transactional things (like stocks), but it is low-trust for trading/business partners. Something about the Madoff case reveals is how informal trust networks are important in high wealth money management and what can happen when those trust networks don’t work.
    One other thing is that China has a very high trust environment for some things. Checking accounts in large banks, for example. There is also a reasonable amount of trust in the currency. The fact that people hold cash in China is very interesting, because people in Russia and Latin American *don’t* hold cash if they can avoid it.
    greg: It’s hard to say which system has the absolute advantage, it depends on the operating environment of the business …
    I don’t think that thinking in terms of better or worse systems is very useful. It’s better to think in terms of economic ecosystems.
    greg: The problem is, when we have a credit crunch or financial crisis like we have now, the credit and capital markets are severely disrupted and in distress. This is when the advantage of holding a lot of cash becomes apparent.
    And if you are in an environment in which disrupted and distressed credit and capital markets are common, then….

  21. Glen, isn’t 富不过三代 is more a result of Chinese family culture and, partly, business culture, than the cause of the business attitude?

  22. Oh my, where to begin?
    Twofish;
    Of course corporations can be badly run or well run; what’s the issue? I maintain that the US corporation run by professional managers and responsible to shareholders is longer-lived, inherently more stable and a better engine for growth than family enterprise run and staffed by family members regardless of their business acumen or qualifications, the usual and deciding qualification of import being that as family members they are trusted more than outsiders. This is as true in China as in Korea or Indonesia which examples – and consequences – should be well known.
    Many Chinese companies in Taiwan, Hong Kong, and especially Singapore (I pointedly exclude Singapore’s government) have transited beyond family enterprise to become corporations and successfully exercise American business practices (look to this forum for previous discussions and examples); why would mainland China prove differently? Indeed, many mainland Chinese – no matter blue collar or white collar – prefer working for foreign corporations (I pointedly exclude Korean, Taiwanese and to a lesser extent Hong Kong firms) exactly because the US-style structure and environment allow greater chances of promotion and learning experience.
    I never maintained that McDonald’s is the only way to run a restaurant nor even the best way. I do maintain McDonald’s corporate structure, as a mundane example, has reared a class of professional managers in numbers and quality which family enterprises could not allow. McDonald’s is a very visible and public example of a US corporation at work.
    US corporations depend on shareholders for capitalization, German and Japanese by obverse example depend on bank loans, but no matter the source of capitalization it must be repaid with dividends.
    “South Korea did extremely well in the 1960’s” because it began from a very low capital base and so experienced the high growth rates typical of developing countries that become a source of offshore manufacturing and exporter for the North American and European markets (sound similar to another country?). As its economy and foreign reserves grew the South Korean government elected to encourage aggrandizement (which it believed would create large corporations capable of successfully competing world-wide) by offering progressively steeper tax breaks and bank loans to firms which exported more and more. The consequence was Korean family enterprises became chaebol, hogged bank loans which starved entreprenuers and lesser companies, became influential in governance and government officials’ personal affairs (sound similar to another country?) and in the financial crisis of 1997 the chaebol’ collective return on investment was miniscule compared to investment.
    Maximizing return on investment IS a particularly useful goal if the source of that investment is government loans and influence wanting the attendant results of employment, national economic development and even greater national prestige no matter the US, Korea or China, and the family enterprise is a poor vehicle to pull that off no matter how much money is thrown at them.

  23. Really interesting topic.
    I buy the argument that the Chinese preference for holding lots of cash is not necessarily a virtue, even if the US model sometimes swings too far the other way.
    On the one hand, Chinese managers hoard cash because they fear for what will happen tomorrow – i.e. institutions are weak.
    On the other other hand, they hoard cash because financing is hard to come by. This is also an institutional weakness, although cultural preferences are probably an important factor, too.
    It’s not a coincidence that China has many small private companies, but very few large ones.

  24. Loar: I maintain that the US corporation run by professional managers and responsible to shareholders is longer-lived, inherently more stable and a better engine for growth than family enterprise run and staffed by family members regardless of their business acumen or qualifications.
    And I maintain that this isn’t obviously true. The question really isn’t who *runs* the company, but who *owns* the company.
    The thing about family owned companies is that they do have professional managers (look at Samsung for example). The difference between a South Korean chaebol and an American corporation is that there often are no checks on the managers who are then encouraged to take the money and run, whereas having capital owned by a family trust makes it impossible to do this.
    To give a specific example, look at the New York Times (which is run by a family trust) via the Tribune Group, or Hyundai versus General Motors, and that granddaddy of the family owned business, WalMart. Or for that matter Lehman Brothers in 1960 when it was still mostly a family partnership via Lehman Brothers in 2008.
    Loar: Many Chinese companies in Taiwan, Hong Kong, and especially Singapore (I pointedly exclude Singapore’s government) have transited beyond family enterprise to become corporations and successfully exercise American business practices (look to this forum for previous discussions and examples); why would mainland China prove differently?
    Companies in Taiwan and South Korea and Hong Kong have hired professional managers with MBA’s. However, the corporations are still owned by family pyramidal groups in which the family has the final say in which MBA’s get hired and fired.
    Also if you look at different countries, the corporations are ultimately owned by a different group of people. In Germany, the banks own corporations. In Japan, they are owned by interlocking cross holdings. In South Korea, Canada, and Sweden, they are owned by the major families. In Mainland China, it appears that the ultimate share holder for most of the large corporations is going to be the state.
    I’d argue that *NO* other country has the corporate structure that the United States has and every country has a different corporate structure. Yes, they all have professional managers, but it’s really only in the United States and maybe Britain, the you have professional managers control the board of directors.
    Loar: I do maintain McDonald’s corporate structure, as a mundane example, has reared a class of professional managers in numbers and quality which family enterprises could not allow.
    Samsung, Hyundai, LG and the South Korean chaebol contradict this. As far as McDonalds goes. The main corporation for McDonald’s is a diversified company, but many perhaps most of the franchisees are family owned businesses. In Taiwan, 7-11 is owned by UniPresident chain stores which owned by a family.
    You need professional managers to run things, but it’s only in the United States where it is common in large corporations for professional managers it have total control of the corporation, and without the “creative tension” between owners and managers, bad things tend to happen because at that point the board of directors becomes a rubber stamps and the managers write themselves huge checks for doing nothing.
    People have tried to fix the problem in US corporations mainly through institutional investors.
    Loar: The consequence was Korean family enterprises became chaebol, hogged bank loans which starved entreprenuers and lesser companies, became influential in governance and government officials’ personal affairs (sound similar to another country?) and in the financial crisis of 1997 the chaebol’ collective return on investment was miniscule compared to investment.
    Which doesn’t explain why Samsung and Hyundai have been doing well recently even though there hasn’t been any sort of massive change in the way South Korean business have been structured.
    The problem is that you need to be careful not to assume causation. South Korea had chaebol. South Koreas economy in 1998 was a mess. These two statements may or may not be related. In 1999, you could say that American systems of corporate governance were obviously better and have people generally agree, but after Enron and Lehman Brothers, you can no longer do this.
    The thing about corporate governance structures is that they are so different from country to country that when something goes wrong, it’s easy to point to this and say “aha!!! that’s why the economy is in good shape or in bad shape.” So in 1990, the ideal was Japan. In 1999, it was the United States.
    If you look at what is actually going on within the corporation, my conclusion is that corporations work best when you have “creative tension” between different groups of people. So good things happen if you have managers arguing with a family trust or institutional investors or even in situations where you allow for easy corporate raids, bad things happen when professional managers become all powerful and they are able to get decisions rubber stamped by complaint boards of directors.
    Also too much focus on return on investment may be a bad thing because you get yourself in situations where the managers end up maximizing returns to get fat bonuses which leaves the corporation dead (i.e. Enron) or very dangerously susceptible to economy downturns (i.e. General Motors).
    Loar: Maximizing return on investment IS a particularly useful goal if the source of that investment is government loans and influence wanting the attendant results of employment, national economic development and even greater national prestige no matter the US, Korea or China, and the family enterprise is a poor vehicle to pull that off no matter how much money is thrown at them.
    Again, it’s very hard for me to accept the argument that Samsung, LG, and Hyundai are corporate failures that the world can learn nothing from. There are also enough well run family enterprises (like the New York Times, Walmart, IKEA or Hilton Hotels) that I think its a bad idea to automatically dismiss them.
    Even if you conclude that family firms are a bad way to go, then there are dozens of ways of structuring corporations that don’t involve families. German corporations are radically different from American corporations.

  25. As far as transparency, it’s sometimes really hard to figure out who really owns a company in the United States. One of the differences between US corporations in 1975 and US corporations in 1995 is the growth of private equity, and so one very common structure is one in which you have a corporation owned by private equity group or hedge fund which has a large holding from a family trust. Because the corporation isn’t public traded, it’s difficult to follow the money to see who owns what.
    One of my annoyances is when people talk about an “American model” when they are in fact talking about an idealized system that bears no resemblance to how things actually work.
    My personal preference for how to structure Chinese industry is the “Calpers” model in which you have state holding companies serve as institutional investors, and one reason I think that Mainland China is going to move even more in that direction is that there are a lot of out of work portfolio managers that are available right now.
    Something that is interesting is that corporate structure is something that evolves, so if the goal is to make Chinese corporations look like American corporations, you have to ask American corporations in what year?
    Also efforts at “engineering” corporate structure often have very unexpected results. The two examples in which the United States tried to impose the “American model of corporate governance” are Japan in 1950 and Russia in 1990, and in both cases you ended up with systems that were wildly different than what the planners had in mind.
    One other thing is that it is quite unclear how the American system of powerful managers developed. In 1915, the big American corporations were mostly family-run business groups, but by 1932, the big families had lost control of their corporations to the professional managers. I don’t think that it’s totally clear to anyone exactly what happened. Brad Delong has written some essays describing the process, and you read them and get the feeling that something is missing.
    Also there are large parts of the American financial system that the PRC has adopted. In many ways, PRC and American corporations resemble each other more so than either resembles a German or Japanese or South Korean corporation. There are a number of reason for this. One is that Chinese students go to the United States to study business rather than go to Germany, Japan, and South Korea. Another is that both the Chinese and US governments are extremely suspicious of large concentrations of private wealth that can control or challenge state authority, more so than I think Japan is.
    I do think that US corporate structure is going to start copying Chinese corporate structure, and there are interesting parallels. No one in the US government is actively and intentionally embracing “Chinese socialism” but then again in 1985, no one in the Chinese government was actively and intentionally embracing “American capitalism” and a lot of the decisions that were made were decisions that external events forced them to do it.
    The other parallel is that I doubt anyone in the US government will say “China has a great idea let’s copy it.” But then again, Chinese policy makers in 1990, didn’t say “lets copy the United States”, they just did it.

  26. One final thing. Someone that argues that family run/influenced businesses are inherently worse than those run by anonymous professional managers needs to explain why the Ford Motor Company is in so much better shape than General Motors.

  27. Good discussion.. if rule of law ever takes hold, maybe the future of China will look like somewhere between Taiwan and Hong Kong. I’m sure the American companies Dan referred to weren’t in terrible shape, but a company with lots of debt and little cash can be a problem – any downturn and the drying up of credit could be devastating (ie, look at Tribune), and it’s not unreasonable to avoid those companies. And if you really want to go back to history, the rise of professional companies really started with the English and Dutch. And going off base entirely, wasn’t that always the rub against the Chinese – their technology was superior (shipbuilding, gunpowder, etc) around the Middle Ages, but one reason they didn’t advance was because of a lack of a business structure that allowed resources to be pooled for profit.

  28. People mean different things when they say “rule of law” but I’d argue that given the obvious definition that power comes from following legal processes, that China is a “rule of law” state. The reason that I think so is that Hu Jintao has power but Jiang Zemin does not. Hu Jintao has power because he was elected according to the procedure outlined according to the PRC Constitution. Without rule of law it is impossible to peacefully transfer power or have the leader retire instead of being killed, exiled, or imprisoned.
    This is why the Communist Party supports “rule of law” since the law determine which Communists rule and prevents fights that would weaken the Party.
    Andy: And going off base entirely, wasn’t that always the rub against the Chinese – their technology was superior (shipbuilding, gunpowder, etc) around the Middle Ages, but one reason they didn’t advance was because of a lack of a business structure that allowed resources to be pooled for profit.
    You need to read Kenneth Pommeranz. His main point is that a lot of times people say “China was backward because it didn’t have X while Europeans did.” The problem with that argument is that you find out that this isn’t true. Pommeranz doesn’t raise this point with respect to corporate law, but let me….
    For example, China adopted its first Company Law in 1904, which sounds backward until you realize that the first state in the United States to adopt a general corporations act (New Jersey) didn’t do that until 1896, and and the first special corporations acts in the US in which people could form corporations without a special charter from the legislature were in the 1850’s.
    In 1840, if you wanted to form a large scale business in the United States, you had two choices, you could either get a charter from the legislature or you could form a trust. The reason why there is a body of law called “anti-trust” is that US corporation law in 1880 didn’t allow you to do what you could do as a trust.
    The thing about Chinese law is that both an something like an “royal charter” or a “trust” where bothi recognized in the 19th century and were both commonly used.
    Also just to show you how various corporate forms are, the modern British corporation comes out of a different body of law than the modern American corporation. The modern American corporation is a descendant of English royal land grant companies. The modern British company is a descendant of partnerships, since joint stock corporations were banned in England from 1720 to 1825, while this ban was generally ignored in the colonies.
    The other thing is that innovation in corporate law hasn’t stopped. The preferred form of small corporations in the United States, the Limited Liability Company, didn’t exist in the US until 1977 and it was copied from the Germans.

  29. The only certainty in China is that there is none, either in one’s personal life or in business.
    1. There is no social safety net in China; therefore the Chinese are extremely protective of their cash reserves. Medical care is on a “pay as needed” basis. Without notice one’s home can be condemned with the occupants dispossessed and forced to relocate.
    2. Business also relies on cash rather than credit. The initiation and continued success of a Chinese business is dependant on government relations and connections. These can change rapidly as a result of the realignment of government officials due to promotions or replacements in connection with corruption prosecutions. If a Chinese businessman falls out of favor he will loose business opportunities and support or worse see his businesses shuttered due to suspensions of licenses or permits.
    3. The Chinese are apprehensive about the future having endured historical disruptions. They are focused on today and in commerce want to know how soon they can realize a profit. Rather than dealing with five-year projections they want to recoup an investment and turn a profit within the year. Any expenditure of capital which will not result in a return in the foreseeable future is viewed as suspect
    In view of the foregoing, the Chinese are reluctant to pay cash retainers or deposits in connection with either financing transactions (even where they have the opportunity to secure significant equity capital for their businesses) or to preserve or recover assets through proactive legal tactics. Alternatives, which are more in line with traditional Chinese business practices, must be implemented.

Leave a Reply

Your email address will not be published. Required fields are marked *