Foreign Company Ethical Issues in China

China moral hazards

David Wolf of Silicon Hutong just did a post on ethical issues in China, Business Ethics and Culture Clashes in China and I love it for three reason. First, it is very well written. Second, it imparts very useful advice. Third, and most importantly, it says many of the things we repeatedly preach. In fact, replace the word “ethics” with “following the law” and you have one of our standard posts.

The gist of David’s post is that if you are a foreign company you will be under a microscope in China and you will be held to a higher standard than your Chinese competitors and you need to strategize about how you are going to deal with this before you go into China.

Before I write more about David’s post, I am going to divide up the way companies approach ethical issues in China, going from bottom to top:

1. The it is so fun to ignore the laws in China and to act like I am a Chinese company and I pity the naive foreign companies that don’t realize how things are really done in China company. We usually tell this sort of company not to hire our law firm because there is no point in paying for expensive international lawyers if you are going to be at huge risk for getting in trouble or getting shut down for operating illegally in any event. I love emailing these companies a year or two later to see how they are doing in China.

They typically do not respond or when they do, they give some really vague answer. A few of the more honest ones admit to having gotten into trouble or to having “given up” on China.

2. The we will just leave it up to our Chinese partner on how to handle things in China because they know how to deal with things there company. I try to talk this sort of company out of relying too much on their China partner (be it their general manager, their JV partner or whatever). I tell them horror story after horror story to try to convince them that their Chinese partner may know China, but that does not mean this person or company knows anything at all about how foreign companies need to operate there. I ask them how many non-lawyers or even lawyers they know in the United States or in Europe (or wherever they may be from) that know the laws for foreign companies. All this works maybe fifty percent of the time and when it doesn’t, I typically tell this sort of company that it does not make sense for them to hire us because their Chinese partner almost certainly will not allow us or them to do things correctly in China. For more on this type of company, check out Your Chinese-American VP Don’t Know Diddley ‘Bout China Law And I Have Friggin Had It.

3. The we are going to need to figure out how to handle China without self-immolating company.
These sorts of companies make up at least 95% of the companies that seek to retain my law firm and a huge percentage of our client base. It is this sort of company to which Wolf seems to be directing his post.

As David so succinctly puts it, the ethical issues foreign companies will face in China cannot be ignored:

Ethical conflicts are endemic to foreign businesses operating in China. Failure to recognize this represents either obfuscation or denial. The best way to deal with most of them is to avoid them altogether, and for the rest there has to be an iron set of principles to guide managers.

David then sets out the following five ethics-related questions foreign companies need to ask themselves before they go into China:

1. What do our local competitors do to get and keep customer business? Is there anything that they do as a matter of habit that is simply out of the question for us?

2. What would our joint-venture partner really do if we had to make a hard choice between ethics and sales?

3. Can we turn our more ethical behavior into a business advantage, or indeed lead the industry to more ethical practices, or are we shooting ourselves in the foot by trying to play a “cleaner” game than our competition?

4. Are foreign companies held to a higher ethical standard in our industry than local companies?

5. Do our customers care whether we do things better? Or do they only care about price?

All but one of these are great questions. The only one I do not like is number 4, “Are foreign companies held to a higher ethical standard in our industry than local companies? The only reason I do not like this question is because there is no need even to ask this question because the answer will always be “yes.”

David sees the above questions and their answers as determinative on “whether a venture will succeed or fail” in China and he also thinks these “same questions need to be asked about quality, and whether customers and consumers really care about the value we see in our products and services, or whether price is all.” I agree.

David then states that once in a China venture, the above questions become moot and all “that is left is for the company to determine where it draws the line between sales and ethics.” According to David, foreign companies doing business in China need to give their managers “a clear set of non-negotiable principles on matters ranging from worker safety to kickbacks to employee infractions, but a guarantee from the company that losing sales for reasons of ethics will not count against sales targets and budgets.” Again, I agree.

David notes that ethics in China costs money and companies need to budget for this and count the expenditure “as a long-term investment in corporate reputation.” I would add that smart companies do this wherever they do business, not just in China. If the cost of acting ethically means losses for the company, it “might make sense to cut those losses and run.” My advise is even stronger. If profits depend on your company operating on the margins in China, do not bother because your ability to operate on the margins will probably not last long enough to make going to China worth your while.

David then addresses in detail the double standard between what is expected/required of Chinese companies and what is expected/required of foreign companies:

One area not touched upon by the case is the issue of government and popular expectations. As I’ve discussed before, foreign and private enterprises operating in China are held to a higher standard of operational ethics than local and state-owned enterprises. The ethical playing field is not level, so behaving unethically just because the local competition does is not an acceptable defense. Indeed, the government is more likely to make an example out of the foreign enterprise that behaves badly than local companies that do so.

David sees operating as a joint venture as providing no real additional cover, “especially when the brand on the joint venture is – or includes – the name of the foreign enterprise. A joint-venture is as good as a foreign company when it comes to juicy targets for fines and other forms of prosecution.” He is 100% right on this; if your joint venture goes up in flames, it will be you as the foreign company that will pay the price, not your Chinese joint venture partner.

Lastly, David posits that unethical behavior by a foreign company will eventually come out, and usually sooner rather than later:

Another point that the beleaguered manager can toss at his joint venture partner is the inevitability that the unethical behavior will become public knowledge, and that such knowledge could be even more disastrous than missed sales targets. Some of the best investigative journalists in China have chosen to make a career out of catching unethical businesses in the act, and while taking on locally powerful SOEs can be tricky, they have editorial carte blanche to target foreign enterprises. Add the media bulldogs to the prospect of a frustrated competitor or disgruntled employee, and engaging in unethical behavior looks plain stupid.

And if you think your “connected” local partner is going to provide you with sufficient cover, you are probably thinking wrong:
Some local partners, especially the larger, better connected ones, will protest that they have the ability to put the muzzle on the local media. This may have been the case a decade or more ago, but it is no longer. There are simply too many reporters and too many outlets, a growing number of whom seek to build their careers as either muckrakers or crusaders against shoddy business practices. Lenovo, Li-Ning, and Mengniu Dairies comprise a short list of notable companies who have discovered that the number of reporters in China who can be bought is shrinking, as is the number of reporters who will stay bought once they have been paid off.

So based on the above, when should foreign companies deal with their ethical issues related to their China entry? Now:

All of which serves to reinforce the most important point: the time to deal with ethical problems in China is at the point of entry, not when the problem shows up like a letter-bomb on an executive’s desk.

I also have to bring up one of my China lessons, as taught by Pipi of the late and great Sinocidal blog:

When in China, do as the law says, not as the Chinese do. The laws are not intended to be enforced fairly – they are thereto be interpreted and enforced as the government sees fit to protect their clan, kin and cash-cows.

What do you think? Is there still a double standard in China regarding the expectations/requirements/treatment of foreign companies as compared to Chinese domestic companies? Is this gap between foreign and domestic companies any smaller now than it was five years ago or is it even larger? What are you seeing out there?

22 responses to “Foreign Company Ethical Issues in China”

  1. The flip side about foreign companies in China being held to a higher standard is that foreign investors in Chinese companies are almost completely ignored. Re the recent spate of financial scandals involving Chinese companies listed overseas. The irregularities, if true, are committed on Chinese soil by Chinese nationals, and yet, I have not heard of a single case of those responsible being investigated, much less charged (or executed, lol.)

  2. The flip side about foreign companies in China being held to a higher standard is that foreign investors in Chinese companies are almost completely ignored. Re the recent spate of financial scandals involving Chinese companies listed overseas. The irregularities, if true, are committed on Chinese soil by Chinese nationals, and yet, I have not heard of a single case of those responsible being investigated, much less charged (or executed, lol.)

  3. @LoKokKee — tell that to the China Mobile executive who has just received the death penalty for taking bribes from Siemens. He must have seriously let his country down.

  4. I enjoyed this blog entry very much. Just wanted to add that the most significant ethical issues my clients deal with in Asia are not those which are self-generated, but rather those that are generated by differing values from culture to culture regarding the propriety of certain behaviors — those that we here in the States might consider “bribery,” while in China, this is an age old acceptable “tradition” of favors, one hand washing the other. Of course, with the FCPA (and especially the proposed amendments to it) as well as recent legislation in the U.K. and in China, this is likely to change, gradually. But until then, traditional principles of Guanxi will, in all likelihood prevail and continue to be misinterpreted by us as lacking in moral justification. Enjoyed this exchange. Thank you.

  5. @LoKokKee — tell that to the China Mobile executive who has just received the death penalty for taking bribes from Siemens. He must have seriously let his country down.

  6. I enjoyed this blog entry very much. Just wanted to add that the most significant ethical issues my clients deal with in Asia are not those which are self-generated, but rather those that are generated by differing values from culture to culture regarding the propriety of certain behaviors — those that we here in the States might consider “bribery,” while in China, this is an age old acceptable “tradition” of favors, one hand washing the other. Of course, with the FCPA (and especially the proposed amendments to it) as well as recent legislation in the U.K. and in China, this is likely to change, gradually. But until then, traditional principles of Guanxi will, in all likelihood prevail and continue to be misinterpreted by us as lacking in moral justification. Enjoyed this exchange. Thank you.

  7. Hummel: those that we here in the States might consider “bribery,” while in China, this is an age old acceptable “tradition” of favors, one hand washing the other.
    The problem is that sometimes in China it *is* considered bribery. China has a legal system that is less developed than that of the United States, and just because Chinese companies do it doesn’t mean that they like to do it. More importantly, it means that you aren’t going to get public sympathy or avoid punishment if you get caught.
    On the bright side, one reason that foreign companies are allowed to do business in China in the first place is because they are generally considered to be cleaner. If you destroy that reputation, you undermine the reason you were invited in in the first place.
    Hummel: But until then, traditional principles of Guanxi will, in all likelihood prevail and continue to be misinterpreted by us as lacking in moral justification.
    Guanxi merely means networking. How to keep networking from turning into bribery is something that people in China are trying to figure out. Part of the problem in China is that we are still two decades from Mao, and under Mao all forms of profit seeking were considered corruption, so people are still in the process of putting together rules to figure out what to do.
    Two data points that illustrate that these things are not cultural dependent are Singapore and Hong Kong, both of which are Chinese societies, which are “clean” and both of which are considered models by Beijing for where they want mainland China to go. Hong Kong is particular is an interesting situation because in the 1970’s, there were a set of massive corruption scandals, and they were able to actually clean things up.

  8. Harris: we will just leave it up to our Chinese partner on how to handle things in China because they have to know better than us how to deal with things there company.
    In other words, I’m about to hand over the keys to the kingdom and control over my China operation to someone that may be doing something dishonest. However, that’s fine because I know that he isn’t going to take the rope and knives that I hand him and stab me in the back, and I can trust him to hand me the profits, because well …. Um Uhhhh
    Also, I do know local companies that do ethically questionable things, but I don’t know of any local company that *likes* doing it. They really hate the system, and the only reason they do it is that they get shut down if they don’t. Foreign companies have the advantage that they can walk.

  9. Although I agree with many things said in this entry, I am altogether uncomfortable with painting all foreign companies as either completely ignorant or up-and-up abiding citizens. While it may be true when it comes to small and medium enterprises, many of the larger OEM’s have learned and put in use through their Chinese intermediaries quite a number of practices, including phantom scare tactics and bureaucratic-system-gerrymandering, which are not illegal per say, but quite dark on a black and white ethical scale. I think I’m a lot more comfortable with you replacing the title with “following the law” compared with “ethical”.

  10. Hummel: those that we here in the States might consider “bribery,” while in China, this is an age old acceptable “tradition” of favors, one hand washing the other.
    The problem is that sometimes in China it *is* considered bribery. China has a legal system that is less developed than that of the United States, and just because Chinese companies do it doesn’t mean that they like to do it. More importantly, it means that you aren’t going to get public sympathy or avoid punishment if you get caught.
    On the bright side, one reason that foreign companies are allowed to do business in China in the first place is because they are generally considered to be cleaner. If you destroy that reputation, you undermine the reason you were invited in in the first place.
    Hummel: But until then, traditional principles of Guanxi will, in all likelihood prevail and continue to be misinterpreted by us as lacking in moral justification.
    Guanxi merely means networking. How to keep networking from turning into bribery is something that people in China are trying to figure out. Part of the problem in China is that we are still two decades from Mao, and under Mao all forms of profit seeking were considered corruption, so people are still in the process of putting together rules to figure out what to do.
    Two data points that illustrate that these things are not cultural dependent are Singapore and Hong Kong, both of which are Chinese societies, which are “clean” and both of which are considered models by Beijing for where they want mainland China to go. Hong Kong is particular is an interesting situation because in the 1970’s, there were a set of massive corruption scandals, and they were able to actually clean things up.

  11. Harris: we will just leave it up to our Chinese partner on how to handle things in China because they have to know better than us how to deal with things there company.
    In other words, I’m about to hand over the keys to the kingdom and control over my China operation to someone that may be doing something dishonest. However, that’s fine because I know that he isn’t going to take the rope and knives that I hand him and stab me in the back, and I can trust him to hand me the profits, because well …. Um Uhhhh
    Also, I do know local companies that do ethically questionable things, but I don’t know of any local company that *likes* doing it. They really hate the system, and the only reason they do it is that they get shut down if they don’t. Foreign companies have the advantage that they can walk.

  12. One other thing is that good compliance policies allow people to “save face” (i.e. I’d like to accept this gift, but unfortunately legal and compliance won’t let me).
    One problem for China is that under Mao any sort of profit making was consider corruption, and so there was a period in which you could justify “going against the rules” in economic terms. If all private profit-making was bad, then you can’t run an economy.
    However, what’s happening is that people are coming to a conclusion about what types of profit-making are “good” and what types of profit-making are “bad”, and the rules are adjusting. Stuff that is “good” tends to be eventually made legal, and stuff that is “bad” tends to be eventually made illegal.
    Chris: Ethical business practice takes legal compliance as a given and then seeks to go well beyond legal minimums in the treatment of customers, suppliers and staff
    There are situations in which you have to break the law to remain ethical. These are becoming more and more rare, but they do exist. If I have to pay a bribe and break the law to save a life, I’ll pay the bribe and break the law.

  13. @ Denise
    Bribery is bribery and not a “cultural tradition”. “Guanxi” is a different concept altogether and real “guanxi” doesn’t need to be oiled by fat red envelopes of cash.
    There are tens of thousands of arrests and prosecutions in China each year for the giving and taking of bribes. Only a few get highlighted by either domestic or international media, and these tend to be more spectacular cases. The rest are far more mundane. Very few involve foreign enterprises.
    Good ethical practice is fundamental to the conduct of a successful business in China. While it can result in the loss of some business, in reality, that type of business partner tends to be poor payers, endlessly change contract arrangements and seek new terms (and its awkward for the briber to refuse) and have worse commercial terms for the enterprise than a straight forward and honest deal. Corruption is destructive to staff morale and you lose good people because of it. It results in corrosive internal practices where staff seek personal benefit from other deals, suppliers etc. It distorts the focus of the business and results in sales staff in particular disconnecting completely from the core focus of the business and the creation of profitable cash flows.
    Ethical business extends well beyond bribery and anti-corruption. Do you pay your suppliers within reasonable time frames? Do your customers get access to reasonable refund policies and procedures? Do you treat staff well and honestly pay salaries, bonuses and benefits? Can your staff get reimbursed fairly for business travel expenses? How tax compliant is the business?
    Ethical business practice takes legal compliance as a given and then seeks to go well beyond legal minimums in the treatment of customers, suppliers and staff.

  14. Although I agree with many things said in this entry, I am altogether uncomfortable with painting all foreign companies as either completely ignorant or up-and-up abiding citizens. While it may be true when it comes to small and medium enterprises, many of the larger OEM’s have learned and put in use through their Chinese intermediaries quite a number of practices, including phantom scare tactics and bureaucratic-system-gerrymandering, which are not illegal per say, but quite dark on a black and white ethical scale. I think I’m a lot more comfortable with you replacing the title with “following the law” compared with “ethical”.

  15. One other thing is that good compliance policies allow people to “save face” (i.e. I’d like to accept this gift, but unfortunately legal and compliance won’t let me).
    One problem for China is that under Mao any sort of profit making was consider corruption, and so there was a period in which you could justify “going against the rules” in economic terms. If all private profit-making was bad, then you can’t run an economy.
    However, what’s happening is that people are coming to a conclusion about what types of profit-making are “good” and what types of profit-making are “bad”, and the rules are adjusting. Stuff that is “good” tends to be eventually made legal, and stuff that is “bad” tends to be eventually made illegal.
    Chris: Ethical business practice takes legal compliance as a given and then seeks to go well beyond legal minimums in the treatment of customers, suppliers and staff
    There are situations in which you have to break the law to remain ethical. These are becoming more and more rare, but they do exist. If I have to pay a bribe and break the law to save a life, I’ll pay the bribe and break the law.

  16. Quote ” All but one of these are great questions. The only one I do not like is the next to the last one, “Are foreign companies held to a higher ethical standard in our industry than local companies? The only reason I do not like this question is because I am of the view that one need not even bother asking it because the answer will always be “yes.” ”
    One of the most horrible statements I have ever read. Is that a quotation from “clash of the civilizations”?
    Ethical behaviour or not is a question of individual behaviour of managers and companies but not whether a company is local or foreign.
    “Union bashing” for example was not invented in China. Or do you judge this as ethical corporte behaviour?

  17. Quote ” All but one of these are great questions. The only one I do not like is the next to the last one, “Are foreign companies held to a higher ethical standard in our industry than local companies? The only reason I do not like this question is because I am of the view that one need not even bother asking it because the answer will always be “yes.” ”
    One of the most horrible statements I have ever read. Is that a quotation from “clash of the civilizations”?
    Ethical behaviour or not is a question of individual behaviour of managers and companies but not whether a company is local or foreign.
    “Union bashing” for example was not invented in China. Or do you judge this as ethical corporte behaviour?

  18. @Volker Muller,
    I don’t even know what you are talking about. You have completely misread what I said. I did NOT say foreign companies are always more ethical. I did not even make any comment on the relative ethical standards of foreign and local companies. ALL that I said was that the Chinese government requires foreign companies to meet a higher standard than local companies. Do you have a beef with that? Do you understand what I am saying?

  19. @Volker Muller,
    I don’t even know what you are talking about. You have completely misread what I said. I did NOT say foreign companies are always more ethical. I did not even make any comment on the relative ethical standards of foreign and local companies. ALL that I said was that the Chinese government requires foreign companies to meet a higher standard than local companies. Do you have a beef with that? Do you understand what I am saying?

  20. @ Denise
    Bribery is bribery and not a “cultural tradition”. “Guanxi” is a different concept altogether and real “guanxi” doesn’t need to be oiled by fat red envelopes of cash.
    There are tens of thousands of arrests and prosecutions in China each year for the giving and taking of bribes. Only a few get highlighted by either domestic or international media, and these tend to be more spectacular cases. The rest are far more mundane. Very few involve foreign enterprises.
    Good ethical practice is fundamental to the conduct of a successful business in China. While it can result in the loss of some business, in reality, that type of business partner tends to be poor payers, endlessly change contract arrangements and seek new terms (and its awkward for the briber to refuse) and have worse commercial terms for the enterprise than a straight forward and honest deal. Corruption is destructive to staff morale and you lose good people because of it. It results in corrosive internal practices where staff seek personal benefit from other deals, suppliers etc. It distorts the focus of the business and results in sales staff in particular disconnecting completely from the core focus of the business and the creation of profitable cash flows.
    Ethical business extends well beyond bribery and anti-corruption. Do you pay your suppliers within reasonable time frames? Do your customers get access to reasonable refund policies and procedures? Do you treat staff well and honestly pay salaries, bonuses and benefits? Can your staff get reimbursed fairly for business travel expenses? How tax compliant is the business?
    Ethical business practice takes legal compliance as a given and then seeks to go well beyond legal minimums in the treatment of customers, suppliers and staff.

Leave a Reply

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