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Ownership structure and the diversification and performance of publicly-listed companies in China
Business Horizons (2008) 51, 473—483
www.elsevier.com/locate/bushor
Ownership structure and the diversification and performance of publicly-listed companies in China Andrew Delios a,*, Nan Zhou b, Wei Wei Xu a a
National University of Singapore, 1 Business Link, Singapore 117592, Singapore Wharton School, University of Pennsylvania, 2048 Steinberg Hall — Dietrich Hall, 3620 Locust Walk, Philadelphia, PA 19104, U.S.A.
b
KEYWORDS Ownership structure; Ownership identity; Diversification; Performance
Abstract The growth and heightened competitiveness of listed companies in China share several central features. These include the gradual transition of state-owned assets to private investors, a rapid pace of product diversification, and impending rapid growth into international markets. In this article, we focus on measuring and identifying the implications of the ownership structure and diversification strategy of listed companies in China. We highlight recent developments in the ownership transition of China’s companies, and point to an ownership classification system that can better identify and address differences in the motivations, strategies, and performance of these companies. # 2008 Kelley School of Business, Indiana University. All rights reserved.
1. Company ownership and strategy in China For nearly two decades, China’s strong economic development has been a dominant story in the business press. Underlying and spurring this growth is the transition of state-owned assets to private ownership, facilitated by the creation in the early 1990s of the Shenzhen and Shanghai stock markets. Via these avenues, formerly state-owned firms began to shift ownership shares to various types of private owners, ostensibly independent from the state. * Corresponding author. E-mail addresses: [email protected] (A. Delios), [email protected] (N. Zhou), [email protected] (W.W. Xu).
While in many transition economies the shift from state to private ownership has been accomplished in one swift, wholesale transfer of formerly stateowned assets, the ownership transition in China has been gradual, albeit inexorable. With the reallocation in ownership shares of major companies (e.g., Sinopec, Qingdao, DoubleStar, Jiangling Motors) in China to increasingly high levels of private ownership has come a shift in their strategies and performance. Underlying this shift is the fact that the motivations, goals, and capabilities of a company are strongly related to the identity of its owners and how widely-held or dispersed is the shareholding in the company (Shleifer & Vishny, 1994). Companies that have widely-held shares by private investors, or those owned by institutional shareholders, tend to have a greater focus on shareholder wealth maximization strategies than do companies that have a dominant
0007-6813/$ — see front matter # 2008 Kelley School of Business, Indiana University. All rights reserved. doi:10.1016/j.bushor.2008.06.004
474 majority owner, or are state-owned. This consideration of the connection between company ownership and strategy means that the issue of ownership identity and concentration has critical implications for understanding the emerging strategies and performance of mainland Chinese companies that are listed in stock markets in China. This understanding is becoming increasingly crucial as China’s listed companies continue to grow strongly in domestic markets and assume dominant market positions in China, while also beginning to expand aggressively into international markets (Deng, 2007). In this article, we focus on measuring and identifying the implications of the ownership structure and strategy of listed companies in China. We contend that the strategies of these companies diverge along the dimensions of product and geographic growth, depending on the nature of ownership in these companies. This divergence extends from the multi-faceted nature of ownership structure in these companies. We highlight recent developments in the ownership transition of China’s companies, and point to an ownership classification system that can better identify and address differences in the motivations, strategies, and performance of these companies.
2. Ownership structure in China 2.1. Official ownership classification scheme A company in mainland China can be listed on either the Shanghai Stock Exchange (SHSE) or the Shenzhen Stock Exchange (SZSE). Regardless of which exchange it is on, the company can have several types of shareholders: the state, legal persons, employees, individual domestic owners of A shares, and foreign private owners of B shares. In addition, companies may issue shares in overseas exchanges, such as Hong Kong, where such shares are called H shares. This categorization of shareholders is defined by Chinese law in its official documents and regulations. It is designed to capture the shifts in ownership of these companies from state shareholders (state shares) to private shareholders of various types: legal person, employee, and private investors (A share, B share, and H share owners). More specifically, state shares are the shares held by the central government, local governments, or solely-government-owned enterprises. Legal person shares, which are roughly analogous to the institutional share-holder identity as recognized in the United States, are shares owned by domestic institutions which are themselves either independent
A. Delios et al. from or partially owned by the central or local government. A shares are similar to ordinary equity shares as generally accepted in other equity markets, except that they were exclusively available to Chinese citizens and domestic institutions. B shares are also similar to ordinary equity shares, but they were available to foreign individuals and institutions. For most listed companies, the top 10 shareholders are normally the state and legal persons. This commonly used ownership categorization scheme is the official one mandated by regulators in China. This scheme effectively classifies the shareholders of a firm into three dominant groups–—state, legal person, and tradable A and B shares–—which each hold approximately 30% of the total stock in these listed companies (Sun, Tong, & Tong, 2002). Importantly, however, this official categorization does not point out who ultimately owns the firm. Instead, it provides an approximation of the shift in ownership from the state to private individuals. Further, these owner categories have substantially ambiguous definitions and memberships, which makes it difficult to determine both the identity of owners and what might be their consequent motivations and skills to manage the firm. Consider that the state can own a public company in China through two types of shares: state shares (guojia gu) and state-owned legal person shares (guoyou faren gu). Under the official categorization, these two types of state owners fall into the state share and legal person share categories. From this, it is evident the official classification scheme fails to clarify that the identity of one type of legal person shareholder is actually a state shareholder. In fact, a close look at all listed companies in China reveals that a large portion of owners classified as legal person shareholders are, in fact, owners with strong state affiliations. Take, for example, the case of Yanjing Beer. The largest owner of Yanjing Beer is Beijing Yanjing Brewery Co., Ltd., which controls 70% of the shares and is classified under the official scheme as a legal person shareholder. According to this classification, one would expect the shareholder to be largely independent of the state. Yet, the Beijing Yanjing Brewery Co. is, in fact, controlled by the Beijing Municipal Government. As such, the ownership of Yanjing Beer still resides largely in the hands of the state, not the private sector as implied by the classification of the Beijing Yanjing Brewery Co. as a legal person shareholder.
2.2. Identifying who is who in China’s listed companies In our research, we refined the existing classification to overcome ambiguities in the official categorization
Ownership structure and the diversification and performance of publicly-listed companies in China scheme. We accurately identify who are the major owners in China’s listed companies, not only by name, but by the type of owner (Delios, Wu, & Zhou, 2006). In order to accomplish re-categorization from the official ownership scheme to our new ownership categorization, we analyzed the identities of more than 12,000 owners of the approximately 1,200 Chinese listed companies which were publicly traded in the mid-2000s. These owners held one of the top 10 equity positions in the listed companies in question. To develop this new categorization (Delios, 2006), we worked with the idea that we wanted to identify unique categories of owners, based upon such broad criteria as whether an owner was stateaffiliated, whether the owner was an institution or a private individual, and if state- or institution-affiliated, what was the origin of the state or institutional affiliation. The outcome from our examination of these 12,000 owners was categorization of all shareholders of listed companies in China into one of 16 different types of owners. Consequently, we now have a clearcut, reliable, and unambiguous classification of the identity of the owner of these companies. As shown in Table 1, these 16 categories of owners include the general categories of state and non-state types of owners, as well as banks, private institutions, private individuals, and foreign owners. Our 16 new categories provide us with good insight into who are the owners of listed companies in China by providing well-defined details on the identity of shareholders. That said, the owners’ identities across these 16 categories are too numerous to guide our analysis and understanding of the strategies and performance of these companies as it relates to ownership identity. A simple solution to this problem is to group the many diverse categories into a few broad categories, as in Table 1: government shareholding, marketized corporate shareholding, and private shareholding. In our three large categories, the new category we call government shareholding is analogous to state-shareholding, and is the largest group among the shareholders of China’s listed companies. In this category, we have identified those owners in which the government influences listed companies by direct control (a local government or a government ministry) or indirect control (such as a state asset management bureau). The marketized corporate shareholding category captures the identities of shareholders who can behave differently from government shareholders. Marketized corporate shareholdings are still ultimately owned by the government but, unlike the firms controlled by government shareholding, they are not constrained by heavy social and political
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burdens or objectives. Marketized corporate shareholders operate comparatively freely of government intervention, and are correspondingly independent to decide the firm’s strategy. We classify all other shareholders as private shareholders, because these are shareholders who are fundamentally and effectively independent of any state-level ownership and intervention. Private shareholders have a uniform, profit-seeking objective, which is shared by individual and institutional shareholders in developed country exchanges.
3. Ownership structure and diversification strategy Ownership structure–—the concentration in a firm’s ownership and the identity of a firm’s owners–— influences a firm’s corporate governance, its strategies, and its performance (Shleifer & Vishny, 1994). The separation of ownership and control provides managers with incentives for diversification or other activities that reduce shareholder value, but large shareholders can pressure managers to reduce diversification and increase company economic performance. Similarly, the identity of the owners of a company has implications for a company’s objectives and the way managers exercise their power. These aspects are reflected in a company’s strategy with regard to its profit goals, dividends, capital structure, growth rates, and diversification (Thomsen & Pedersen, 2000). Product diversification and geographic (international) diversification are critical elements in a firm’s growth. Firms are motivated to diversify in order to internalize market functions so as to overcome imperfect markets for sourcing goods, hiring personnel and managers, and raising capital. But, the diversification activities are constrained by the firm’s resources and capabilities. Ownership identities largely determine the differential opportunities and market imperfections faced by different firms, and also influence the firms’ resources and capabilities in the context of China. In the following sections, we will examine the impact of the type of ownership on product and geographic diversification strategies. These two strategic options of product and geographic diversification are particularly important to understand in the case of China’s listed companies. First, in the case of product diversification, since the creation of the Shenzhen and Shanghai stock exchanges in the early 1990s, we have seen a tremendous growth in the number of companies pursuing an unrelated, or conglomerate, diversification strategy. In such a strategy, a company moves into unre-
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Table 1.
Specific and broad categories of shareholders of China’s listed companies
Category of ownership type
Definition
Example
Broad category — Government shareholding Local government Government ministry Government bureau Industry company (previous Government ministry) State asset investment bureau
Local governments of counties, cities, and provinces Ministries of either the central or local government Departments of a local or central government Ministries of the central or local government before economic reforms Entities established to control state-owned assets
Yun Nan Province Government Water Ministry Department of Finance of Fuzhou Yun Nan Metallurgy Corporate Group
State asset management bureau
Research institute State-owned bank Broad category — Marketized corporate shareholding Infrastructure construction company Market-oriented state-owned enterprise Broad category — Private shareholding Security company Investment fund Private Individual Foreign (Hong Kong, Taiwan, etc.) Work union
Entities established to separate the government’s control from state assets and to manage and preserve the quality of state assets Research entities owned or led by research institutions or universities The five major state-owned banks in China
Beijing International Trust and Investment Co., Ltd. Jing Shan State Asset Management Bureau Fudan University Commercial Bank of China
Companies established when the government invested in infrastructure or construction projects, such as a highway or a port Companies owned by the state that have gone through a transition toward a market-oriented structure of for profit, private corporations
Hunan Highway Construction and Development Co., Ltd.
Investment bank or brokerage house Investment fund company Private owned companies Individual shareholders Foreign shareholders, including individual and institutions Entities set up by workers to collectivize their interests
Shenyin Wanguo Security Company Harvest Fund Management Co., Ltd. Shanghai Volkswagen Wu Xianxi Standard Chartered Bank Hong Kong Credit The Work Union of Hu Bei Fiber Ltd.
Bao Steel
A. Delios et al.
Ownership structure and the diversification and performance of publicly-listed companies in China lated lines of business–—for example, the Haier Group has diversified into 12 industries including electrical appliances, communications, information technology, real estate, and financial services–—and these unrelated lines of business account for a substantial portion of the company’s revenues. In the case of China’s listed companies, we have seen the percentage of conglomerate firms grow from an average of 15% of all listed companies in the mid1990s to nearly 40% by the year 2002. Second, in the case of international diversification, we have seen the small waves of foreign direct investment (FDI) that may precede a tsunami of FDI in the second decade of the 2000s. Increasingly, listed companies in China are looking to international markets for new growth opportunities (Deng, 2007). These international expansions are often made by international acquisitions (Child & Rodrigues, 2006) as companies seek new markets, natural resources, and technological upgrades to aid their competitiveness on the world stage. For listed companies in China, the number of FDIs doubled from 1995 to 1998, and then doubled again from 1998 to 2004.
4. Owner identity and diversification strategies Clearly, international markets are becoming an important part of Chinese listed companies’ strategic stances. This growth in international markets follows a recent period of rapid and unrelated growth in domestic product markets in China. We accordingly ask the questions: How is the ownership structure of publicly-listed companies in China connected to their strategy of product diversification?
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cation patterns of firms with different ownership structure. To develop a sense of the patterns of strategic diversification choices by China’s listed companies, we categorized the mid-2000s diversification strategies of the 815 Chinese listed firms in our data. We differentiated between these firms among the two strategic choice dimensions:
Product diversification - We defined firms as either having a single business (related) product diversification strategy, or pursuing a conglomerate (unrelated) diversification strategy (Rumelt, 1974), in which the firm has operations in many different lines of business (industries); and
International diversification - International diversification is still at a relatively early stage as a strategy among China’s listed companies. Accordingly, we simply looked at the companies in our data and identified those that had at least one foreign subsidiary, and those that did not. Those with a foreign subsidiary we classified as international, while the others are purely domestic companies. These strategic choices are shown in a two-bytwo matrix in Figure 1. The largest category in terms of the number of firms in a category is conglomerate domestic firms. The second largest category is single business domestic companies. The two final categories in our matrix are considerably smaller. Chinese firms are beginning to venture abroad, but the absolute numbers and proportion are still comparatively low. Overall, we can observe several trends in the relationship between ownership identities and diversification strategies:
and
The majority (52%) of firms controlled by govern-
How is the ownership structure of publicly-listed companies in China connected to their strategy of international diversification?
Firms controlled by marketized corporate share-
We approach these questions using the new ownership classification scheme we have developed to understand whether and why there are differences in these strategies across government-owned, marketized corporate-owned, and privately-owned firms in China. In approaching these questions, we try to understand how the motivations and abilities of an owner to manage a firm can influence its strategy. Before turning to a discussion of motives and abilities, we first provide details on the diversifi-
ment shareholders are in the conglomerate domestic strategy group;
holders had a marked tendency to adopt a domestic diversification strategy; and
Firms controlled by private owners showed a preference for international conglomerate and international single business diversification strategies. We capture these trends in Figure 2, where we have summarized the general strategic approaches to international and product diversification that publicly-listed companies in China have taken. We
478 Figure 1.
A. Delios et al. Implications of ownership structure on Chinese firms’ strategic choice
detail these strategies by the type of majority owner in the companies, in the following sections.
4.1. Government ownership and diversification strategy Government owners typically have motivations that are different from those of private owners, with their goals having a strong linkage to their political interests (Shleifer & Vishny, 1994). In the 1990s and the 2000s, the central government in China had several important policy objectives, including raising national foreign currency reserves, preserving and increasing the value of state properties, contending with the challenges of potential increases in unemployment, and managing the political implications of listing state-owned firms as it relates to unemployment. These objectives were managed directly through the implementation of government policies, and indirectly via the central government’s influence on chief executives and top management teams in firms with a substantial level of government shareholding. These central government objectives encouraged government-owned firms to pursue growth domestically, not abroad (see Figure 2). This influence is exercised through the central government’s linkages to the management of government-owned firms in China. A firm in China with a substantial government shareholding usually has political appointees as its top managers. These
managers retain their connections to the bureaucratic command system of the government. They tend to lack the experience and capabilities to deal with organizational and managerial complexities that come with diversification into new areas. In addition, these managers will face dual risks, both political risk and economic risk, when choosing to venture abroad. Thus, these executives tend to be ‘‘extra conservative’’ (De Mente, 1989), risk averse, and less innovative (Nee, 1992) than private sector managers. Consequently, government appointed managers refrain from adopting largescale, international diversification because of the risks associated with this strategy, and the desire to protect their political prospects and personal wealth. Although a government blockholder of shares can discourage a firm from international diversification, for certain government-owned firms with a very high proportion of government shareholding international expansion might be pursued to satisfy national as well as corporate interests. With the rapid development of the Chinese economy, the demand for energy and other natural resources has been rising. Accordingly, a substantial number of outward investments made by Chinese companies since 2001 have been in the natural resources sector. For example, in 2002, China’s state-owned energy company China National Offshore Oil Company (CNOOC) successfully acquired the Indonesian assets of
Ownership structure and the diversification and performance of publicly-listed companies in China Figure 2.
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Ownership identity and diversification strategies
Repsol Exploracion, a Spanish energy company. Similarly, PetroChina, a subsidiary of the China National Petroleum Corporation (CNPC), bought the Indonesian oil and gas assets of U.S.-based Devon Energy Corporation. In 2005, CNPC itself acquired the North Buzachi oilfield in Kazakhstan through its purchase of the Canada-based PetroKazakhstan. Consistent with this point, we see in our study of 1,178 listed companies in China’s Shanghai and Shenzhen Stock Exchanges that when the Chinese government’s proportion of shares was lower than 50%, a firm was less likely to invest abroad. However, when government shareholdings exceeded 50%, a firm showed a significantly higher tendency to invest abroad. Notably, the 100 firms that in 2002 had a government shareholding of at least 50% were mainly distributed in strategic asset industries, such as petroleum and utilities industries. Regarding product diversification, high-level government ownership can lead a firm to pursue a high level of product diversification. The Chinese government is aggressively supporting the growth of
national champions, which should develop their capabilities to compete effectively in international markets against other leading firms. The central government has been encouraging the development of conglomerates because a belief exists in the government that China can replicate the successes of Japan and Korea by using industry policy to support the growth of large conglomerates. The central government also regards conglomerates as a vehicle to absorb China’s growing number of lossmaking enterprises and unemployed workers (Shieh, 1999). We also found evidence in our study of Chinese listed firms that a positive relationship between government ownership and product diversification existed.
4.2. Marketized corporate ownership and diversification strategy The advantages of marketized corporate ownership for a firm’s diversification strategy primarily arise from the resource-related benefits that come from
480 the ownership of the firm by another corporate entity. This connection means that a firm with marketized, corporate-block shareholders is not only in a good position to develop its own resources, but also gains access to the corporate blockholder’s resources. This access can aid such a firm in gaining financial and other resources it requires for growth by diversification. In addition to financial resources, corporate blockholders can provide the technological, commercial, and organizational knowledge (Allen & Phillips, 2000) that firms need to build a competitive advantage in international markets. Managerial skills can play a prominent role in the success of a firm’s growth by diversification. With the support of another corporation, a firm can reduce the time and effort it requires to establish its knowledge of international markets, which encourages and facilitates its international expansion. With the availability of such capabilities and resources from its marketized corporate blockholder, these firms should have a greater level of international expansion. Firms with corporate blockholders may also be able to diversify into new product lines by successfully exploiting spillovers from group-level resources in a transfer of the resources of one firm in a group to another firm in the group. These firms may also be able to mobilize resources more readily or at lower costs than external agencies, because the presence of another corporation can provide reputation benefits and privileged access to resources. Corporate blockholders also contribute to the development of managerial and organizational skills, particularly with respect to managing the complex organizational structures that come with diversified operations. Aside from the benefits corporate blockholders provide with product diversification, there may be costs. A corporate blockholder’s objectives may actually restrict a firm’s diversification. For example, a firm’s diversification efforts can be impeded by the need to contribute firm resources to the group, or by constraints on expanding into businesses where other associated firms are incumbents or prospective entrants.
4.3. Private ownership and diversification strategy Private ownership provides its main benefits not through resource access, but instead through the motivations that private owners have, and how they translate these motivations into appropriate strategies for a firm. Private ownership is a crucial source of managerial incentive to direct a firm to pursue innovative and efficiency-seeking strategies.
A. Delios et al. A prominent type of firm that has large private ownership is one in which the private owners hold legal person shares as they founded the firm. These privately owned enterprises are young, and have a simple and flexible structure as compared to SOEs, or state-owned enterprises (Peng, Tan, & Tong, 2004). The owners of privately-owned firms have a strong interest in profit maximization, and sufficient control to have their interests respected and pursued by the firm’s management. Even though privately-owned firms can be resource poor, as compared to their SOE counterparts, the firm strategy is often characterized as aggressive entrepreneurship (Peng, 2001). Private owners in China react promptly to market opportunities, and adopt a prospector strategic perspective. This perspective implies that firms owned by private owners operate in a broad market domain. These firms often have a focus on innovation and change, and tend to have a flexible organizational structure (Peng, Tan, & Tong, 2004). One market opportunity that privately-owned firms pursue is international diversification, because it provides an opportunity to leverage a private owner’s entrepreneurial orientation. These firms are proactive in their strategy to reach new markets first. Privately owned firms therefore have an opportunity to develop a first-mover advantage in new markets as they rapidly introduce new products and process innovations. A second incentive for these firms to move into international markets comes from the institutional conditions in the firms’ home market. Private owners operate in a turbulent and uncertain institutional environment where the protection for property rights is poor and the legal system is weak. The weaknesses in the institutional environment create risks for the firm. Internationalization can reduce the degree of systematic risk by introducing foreign revenue streams into a firm’s operations. A third incentive for these firms to move into international markets comes from the tradable A shareholders in the secondary market, who are another category of private owners. Holders of A shares are likely to support international diversification because firms expanding to a new foreign country develop legitimacy in the stock market and hold the potential to bring shareholders significant, positive returns (Doukas & Travlos, 1988). These incentives can work together or separately to encourage a firm’s management to pursue a strategy of international diversification. Hence, we would expect that the higher the level of a firm’s private ownership, the more likely it will diversify internationally. It is important to note that a private shareholder in China does not have to consider the same
Ownership structure and the diversification and performance of publicly-listed companies in China political objectives that are important considerations faced by state and, to a lesser extent, marketized corporate shareholders. A private shareholder is also better equipped with the incentives and abilities to monitor a firm’s management and to exploit market opportunities. However, private owners’ incentives can be impeded in China because of the absence of efficient financial institutions, tight regulations on market entry, and local government protectionism. Market entry regulations are one example: state-owned enterprises are allowed to enter up to 80 sectors in China, while private-owned enterprises are permitted to enter only 40 sectors. Privately owned enterprises have historically been excluded from competing in the telecommunication, petroleum, education, medical, aviation, infrastructure, and media sectors. Consequently, we expect that both the motivations and abilities of private owners, as coupled with the restrictions on entry into specific industries, will jointly act to curtail the product diversification efforts of privately owned companies. A related consequence is that privately-owned companies will pursue growth in international markets, given the potential for restricted opportunities to grow in the domestic context.
5. Diversification and performance Performance is a challenging aspect of company performance to identify and interpret. In the case of listed firms in China, we need to consider that in an imperfect and under-developed market, such as China, diversified firms may enjoy several advantages. These advantages include a comparatively easy access to bank loans, and the consequent ability to utilize corporate capital to fund internal transactions and growth. Yet, increased diversification may also bring high control costs and coordination costs. Even with the challenges to understand why firms have different levels of performance, we can still identify how firms controlled by different types of Table 2. Ownership identity, product diversification, and performance Largest owner
Single business ROA (mean)
Government Marketized corporate Private Total
3.6% 4.3%
1.0% 3.7%
3.3% 4.0%
1.0% 2.3%
Conglomerate ROA (mean)
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Table 3. Ownership identity, international diversification, and performance Largest owner
Domestic ROA (mean)
International ROA (mean)
Government Marketized corporate Private Total
1.80% 3.60%
2.40% 2.00%
2.20% 2.53%
3.00% 0.87%
owners have performed under different diversification strategies (Table 2 and Table 3). In Table 2, we compare the performance of our three categories of owners by whether the firm has implemented a conglomerate-diversification strategy or a single business-focused strategy. The clearest trend in the table is the overall greater return on assets (ROA) on average by focused firms (4.0% ROA) versus conglomerates (2.3%). In fact, in all categories, focused firms outperform conglomerates. In Table 3, we compare the performance between firms implementing domestic strategy and internationalization strategy. We find a similar trend, as domestic firms in general outperform international firms (ROA of 2.53%, versus 0.87%). In Table 2, marketized, corporate-owned firms perform well under both focused (single business) and conglomerate strategies, with only a slight decline in ROA when a conglomerate-diversification strategy is pursued. Meanwhile, government-owned firms, which do comparatively well under a single business strategy (3.6% ROA), see a sharp drop-off in performance under a conglomerate-diversification strategy ( 1.0%). Privately owned firms likewise see a decline in performance when moving to a conglomerate-diversification strategy, but this decline is not as sharp for government-owned firms. Meanwhile in Table 3, marketized, corporateowned firms (3.6%) perform best under domestic strategy, but their performance drops when an internationalization strategy is implemented (2%). The performance of government-owned firms exhibits the same trend, as there is a sharp drop-off from the mean performance for a domestic strategy (1.8%) compared to one for an international diversification strategy ( 2.4%). Interestingly, privatelyowned firms see the opposite effect: they have an increase in performance when moving from a domestic strategy (2.2%) to an international diversification strategy (3%). Although government-owned firms have incentives to conduct diversification as discussed in the previous section, government shareholders have neither sufficient motivation nor expertise to effectively supervise the growth of a firm in the
482 conglomerate-diversification stage to effectively pursue profit maximization for the firm. Additionally, both the existence and enforcement of law-protecting, minority-shareholder rights are limited, and the information-asymmetry problem is severe between block shareholders and minority shareholders. A diversification strategy offers managers in government-owned companies the opportunity to pursue individual interests, or to pursue nonprofit-related goals, such as the pursuit of large firm size or large employment numbers of entry into ancillary but unprofitable businesses. In these ways, the performance of government-owned firms can decline with increasing levels of product diversification. Marketized, corporate-owned firms enjoy the benefits of resources provided by the government while also having the freedom to pursue strategies independent of state interests and objectives. Compared with government-owned firms, marketized corporate shareholders face more stringent budget constraints, leading to stronger concerns about a firm’s profitability and its financial status. These concerns are reinforced by the adoption of processes in corporate management that help enforce direct monitoring of the firm’s managers. In short, marketized corporate owners have both the motivation and capability to monitor a firm’s diversification strategy. With good access to resources, firms under marketized corporate ownership can perform relatively better than firms with other types of owners, when undertaking a product diversification strategy. Private ownership is similar to marketized corporate ownership in terms of the ability and motives of owners to monitor firm performance; however, unlike marketized corporate ownership, private owners face greater resource constraints in their pursuit of domestic firm growth. Hence, the performance of privately owned companies pursuing a diversification strategy will suffer a greater decline in performance than marketized corporate owners when pursuing a product diversification strategy.
A. Delios et al. One of the key areas in which Chinese firms differ is ownership structure. Unlike the private-equity, widely-held firms that dominate in many developed country markets, ownership identity plays a key role in understanding the strategies of emerging Chinese competitors. It is necessary for foreign companies first entering China to develop a detailed understanding of how their business will be affected by emerging competitors from China. A good grasp of the ownership structure of potential Chinese competitors is essential to developing an understanding of the companies’ competitive strengths and weaknesses, and, more importantly, their growth strategies. Chinese firms likewise face challenges and opportunities as the extent of their global competition grows. As the competitive imperative of mainland Chinese firms increases, and particularly if there is a slowdown in economic growth, there is a greater likelihood of an industry shakeout. Such a shakeout will lead to reduction in the number of domestic competitors in China. As has been experienced in countries such as Japan, South Korea, and Thailand during times of economic downturn, companies that have been pursuing growth at the expense of profitability targets are the ones most likely to be at risk of not surviving the downturn. As we have identified, for some types of owners, especially government—owned and controlled firms, the decision to diversify can be driven by political concerns rather than economic concerns. Such a motivation may be an effective one during periods of strong economic growth, but the long term viability of such a strategy is clearly at question.
Acknowledgment This research was generously supported by academic research grants from the National University of Singapore (NUS Academic Research Grants R-313000-083-112 and R-313-000-095-112). This article draws on research completed jointly by the authors and Wu Zhijian.
6. Strategic implications The rise of mainland Chinese firms in the global market, and even within the greater China market, is one of the most pronounced competitive threats to established firms in numerous industries. The entry of aggressive, low-cost Chinese competitors into established global industries can fundamentally change the industry’s competitive dynamics. Increasingly, there is a need to understand the strategies, objectives, and motives of these firms.
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Ownership structure and the diversification and performance of publicly-listed companies in China Andrew Delios a,*, Nan Zhou b, Wei Wei Xu a a
National University of Singapore, 1 Business Link, Singapore 117592, Singapore Wharton School, University of Pennsylvania, 2048 Steinberg Hall — Dietrich Hall, 3620 Locust Walk, Philadelphia, PA 19104, U.S.A.
b
KEYWORDS Ownership structure; Ownership identity; Diversification; Performance
Abstract The growth and heightened competitiveness of listed companies in China share several central features. These include the gradual transition of state-owned assets to private investors, a rapid pace of product diversification, and impending rapid growth into international markets. In this article, we focus on measuring and identifying the implications of the ownership structure and diversification strategy of listed companies in China. We highlight recent developments in the ownership transition of China’s companies, and point to an ownership classification system that can better identify and address differences in the motivations, strategies, and performance of these companies. # 2008 Kelley School of Business, Indiana University. All rights reserved.
1. Company ownership and strategy in China For nearly two decades, China’s strong economic development has been a dominant story in the business press. Underlying and spurring this growth is the transition of state-owned assets to private ownership, facilitated by the creation in the early 1990s of the Shenzhen and Shanghai stock markets. Via these avenues, formerly state-owned firms began to shift ownership shares to various types of private owners, ostensibly independent from the state. * Corresponding author. E-mail addresses: [email protected] (A. Delios), [email protected] (N. Zhou), [email protected] (W.W. Xu).
While in many transition economies the shift from state to private ownership has been accomplished in one swift, wholesale transfer of formerly stateowned assets, the ownership transition in China has been gradual, albeit inexorable. With the reallocation in ownership shares of major companies (e.g., Sinopec, Qingdao, DoubleStar, Jiangling Motors) in China to increasingly high levels of private ownership has come a shift in their strategies and performance. Underlying this shift is the fact that the motivations, goals, and capabilities of a company are strongly related to the identity of its owners and how widely-held or dispersed is the shareholding in the company (Shleifer & Vishny, 1994). Companies that have widely-held shares by private investors, or those owned by institutional shareholders, tend to have a greater focus on shareholder wealth maximization strategies than do companies that have a dominant
0007-6813/$ — see front matter # 2008 Kelley School of Business, Indiana University. All rights reserved. doi:10.1016/j.bushor.2008.06.004
474 majority owner, or are state-owned. This consideration of the connection between company ownership and strategy means that the issue of ownership identity and concentration has critical implications for understanding the emerging strategies and performance of mainland Chinese companies that are listed in stock markets in China. This understanding is becoming increasingly crucial as China’s listed companies continue to grow strongly in domestic markets and assume dominant market positions in China, while also beginning to expand aggressively into international markets (Deng, 2007). In this article, we focus on measuring and identifying the implications of the ownership structure and strategy of listed companies in China. We contend that the strategies of these companies diverge along the dimensions of product and geographic growth, depending on the nature of ownership in these companies. This divergence extends from the multi-faceted nature of ownership structure in these companies. We highlight recent developments in the ownership transition of China’s companies, and point to an ownership classification system that can better identify and address differences in the motivations, strategies, and performance of these companies.
2. Ownership structure in China 2.1. Official ownership classification scheme A company in mainland China can be listed on either the Shanghai Stock Exchange (SHSE) or the Shenzhen Stock Exchange (SZSE). Regardless of which exchange it is on, the company can have several types of shareholders: the state, legal persons, employees, individual domestic owners of A shares, and foreign private owners of B shares. In addition, companies may issue shares in overseas exchanges, such as Hong Kong, where such shares are called H shares. This categorization of shareholders is defined by Chinese law in its official documents and regulations. It is designed to capture the shifts in ownership of these companies from state shareholders (state shares) to private shareholders of various types: legal person, employee, and private investors (A share, B share, and H share owners). More specifically, state shares are the shares held by the central government, local governments, or solely-government-owned enterprises. Legal person shares, which are roughly analogous to the institutional share-holder identity as recognized in the United States, are shares owned by domestic institutions which are themselves either independent
A. Delios et al. from or partially owned by the central or local government. A shares are similar to ordinary equity shares as generally accepted in other equity markets, except that they were exclusively available to Chinese citizens and domestic institutions. B shares are also similar to ordinary equity shares, but they were available to foreign individuals and institutions. For most listed companies, the top 10 shareholders are normally the state and legal persons. This commonly used ownership categorization scheme is the official one mandated by regulators in China. This scheme effectively classifies the shareholders of a firm into three dominant groups–—state, legal person, and tradable A and B shares–—which each hold approximately 30% of the total stock in these listed companies (Sun, Tong, & Tong, 2002). Importantly, however, this official categorization does not point out who ultimately owns the firm. Instead, it provides an approximation of the shift in ownership from the state to private individuals. Further, these owner categories have substantially ambiguous definitions and memberships, which makes it difficult to determine both the identity of owners and what might be their consequent motivations and skills to manage the firm. Consider that the state can own a public company in China through two types of shares: state shares (guojia gu) and state-owned legal person shares (guoyou faren gu). Under the official categorization, these two types of state owners fall into the state share and legal person share categories. From this, it is evident the official classification scheme fails to clarify that the identity of one type of legal person shareholder is actually a state shareholder. In fact, a close look at all listed companies in China reveals that a large portion of owners classified as legal person shareholders are, in fact, owners with strong state affiliations. Take, for example, the case of Yanjing Beer. The largest owner of Yanjing Beer is Beijing Yanjing Brewery Co., Ltd., which controls 70% of the shares and is classified under the official scheme as a legal person shareholder. According to this classification, one would expect the shareholder to be largely independent of the state. Yet, the Beijing Yanjing Brewery Co. is, in fact, controlled by the Beijing Municipal Government. As such, the ownership of Yanjing Beer still resides largely in the hands of the state, not the private sector as implied by the classification of the Beijing Yanjing Brewery Co. as a legal person shareholder.
2.2. Identifying who is who in China’s listed companies In our research, we refined the existing classification to overcome ambiguities in the official categorization
Ownership structure and the diversification and performance of publicly-listed companies in China scheme. We accurately identify who are the major owners in China’s listed companies, not only by name, but by the type of owner (Delios, Wu, & Zhou, 2006). In order to accomplish re-categorization from the official ownership scheme to our new ownership categorization, we analyzed the identities of more than 12,000 owners of the approximately 1,200 Chinese listed companies which were publicly traded in the mid-2000s. These owners held one of the top 10 equity positions in the listed companies in question. To develop this new categorization (Delios, 2006), we worked with the idea that we wanted to identify unique categories of owners, based upon such broad criteria as whether an owner was stateaffiliated, whether the owner was an institution or a private individual, and if state- or institution-affiliated, what was the origin of the state or institutional affiliation. The outcome from our examination of these 12,000 owners was categorization of all shareholders of listed companies in China into one of 16 different types of owners. Consequently, we now have a clearcut, reliable, and unambiguous classification of the identity of the owner of these companies. As shown in Table 1, these 16 categories of owners include the general categories of state and non-state types of owners, as well as banks, private institutions, private individuals, and foreign owners. Our 16 new categories provide us with good insight into who are the owners of listed companies in China by providing well-defined details on the identity of shareholders. That said, the owners’ identities across these 16 categories are too numerous to guide our analysis and understanding of the strategies and performance of these companies as it relates to ownership identity. A simple solution to this problem is to group the many diverse categories into a few broad categories, as in Table 1: government shareholding, marketized corporate shareholding, and private shareholding. In our three large categories, the new category we call government shareholding is analogous to state-shareholding, and is the largest group among the shareholders of China’s listed companies. In this category, we have identified those owners in which the government influences listed companies by direct control (a local government or a government ministry) or indirect control (such as a state asset management bureau). The marketized corporate shareholding category captures the identities of shareholders who can behave differently from government shareholders. Marketized corporate shareholdings are still ultimately owned by the government but, unlike the firms controlled by government shareholding, they are not constrained by heavy social and political
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burdens or objectives. Marketized corporate shareholders operate comparatively freely of government intervention, and are correspondingly independent to decide the firm’s strategy. We classify all other shareholders as private shareholders, because these are shareholders who are fundamentally and effectively independent of any state-level ownership and intervention. Private shareholders have a uniform, profit-seeking objective, which is shared by individual and institutional shareholders in developed country exchanges.
3. Ownership structure and diversification strategy Ownership structure–—the concentration in a firm’s ownership and the identity of a firm’s owners–— influences a firm’s corporate governance, its strategies, and its performance (Shleifer & Vishny, 1994). The separation of ownership and control provides managers with incentives for diversification or other activities that reduce shareholder value, but large shareholders can pressure managers to reduce diversification and increase company economic performance. Similarly, the identity of the owners of a company has implications for a company’s objectives and the way managers exercise their power. These aspects are reflected in a company’s strategy with regard to its profit goals, dividends, capital structure, growth rates, and diversification (Thomsen & Pedersen, 2000). Product diversification and geographic (international) diversification are critical elements in a firm’s growth. Firms are motivated to diversify in order to internalize market functions so as to overcome imperfect markets for sourcing goods, hiring personnel and managers, and raising capital. But, the diversification activities are constrained by the firm’s resources and capabilities. Ownership identities largely determine the differential opportunities and market imperfections faced by different firms, and also influence the firms’ resources and capabilities in the context of China. In the following sections, we will examine the impact of the type of ownership on product and geographic diversification strategies. These two strategic options of product and geographic diversification are particularly important to understand in the case of China’s listed companies. First, in the case of product diversification, since the creation of the Shenzhen and Shanghai stock exchanges in the early 1990s, we have seen a tremendous growth in the number of companies pursuing an unrelated, or conglomerate, diversification strategy. In such a strategy, a company moves into unre-
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Table 1.
Specific and broad categories of shareholders of China’s listed companies
Category of ownership type
Definition
Example
Broad category — Government shareholding Local government Government ministry Government bureau Industry company (previous Government ministry) State asset investment bureau
Local governments of counties, cities, and provinces Ministries of either the central or local government Departments of a local or central government Ministries of the central or local government before economic reforms Entities established to control state-owned assets
Yun Nan Province Government Water Ministry Department of Finance of Fuzhou Yun Nan Metallurgy Corporate Group
State asset management bureau
Research institute State-owned bank Broad category — Marketized corporate shareholding Infrastructure construction company Market-oriented state-owned enterprise Broad category — Private shareholding Security company Investment fund Private Individual Foreign (Hong Kong, Taiwan, etc.) Work union
Entities established to separate the government’s control from state assets and to manage and preserve the quality of state assets Research entities owned or led by research institutions or universities The five major state-owned banks in China
Beijing International Trust and Investment Co., Ltd. Jing Shan State Asset Management Bureau Fudan University Commercial Bank of China
Companies established when the government invested in infrastructure or construction projects, such as a highway or a port Companies owned by the state that have gone through a transition toward a market-oriented structure of for profit, private corporations
Hunan Highway Construction and Development Co., Ltd.
Investment bank or brokerage house Investment fund company Private owned companies Individual shareholders Foreign shareholders, including individual and institutions Entities set up by workers to collectivize their interests
Shenyin Wanguo Security Company Harvest Fund Management Co., Ltd. Shanghai Volkswagen Wu Xianxi Standard Chartered Bank Hong Kong Credit The Work Union of Hu Bei Fiber Ltd.
Bao Steel
A. Delios et al.
Ownership structure and the diversification and performance of publicly-listed companies in China lated lines of business–—for example, the Haier Group has diversified into 12 industries including electrical appliances, communications, information technology, real estate, and financial services–—and these unrelated lines of business account for a substantial portion of the company’s revenues. In the case of China’s listed companies, we have seen the percentage of conglomerate firms grow from an average of 15% of all listed companies in the mid1990s to nearly 40% by the year 2002. Second, in the case of international diversification, we have seen the small waves of foreign direct investment (FDI) that may precede a tsunami of FDI in the second decade of the 2000s. Increasingly, listed companies in China are looking to international markets for new growth opportunities (Deng, 2007). These international expansions are often made by international acquisitions (Child & Rodrigues, 2006) as companies seek new markets, natural resources, and technological upgrades to aid their competitiveness on the world stage. For listed companies in China, the number of FDIs doubled from 1995 to 1998, and then doubled again from 1998 to 2004.
4. Owner identity and diversification strategies Clearly, international markets are becoming an important part of Chinese listed companies’ strategic stances. This growth in international markets follows a recent period of rapid and unrelated growth in domestic product markets in China. We accordingly ask the questions: How is the ownership structure of publicly-listed companies in China connected to their strategy of product diversification?
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cation patterns of firms with different ownership structure. To develop a sense of the patterns of strategic diversification choices by China’s listed companies, we categorized the mid-2000s diversification strategies of the 815 Chinese listed firms in our data. We differentiated between these firms among the two strategic choice dimensions:
Product diversification - We defined firms as either having a single business (related) product diversification strategy, or pursuing a conglomerate (unrelated) diversification strategy (Rumelt, 1974), in which the firm has operations in many different lines of business (industries); and
International diversification - International diversification is still at a relatively early stage as a strategy among China’s listed companies. Accordingly, we simply looked at the companies in our data and identified those that had at least one foreign subsidiary, and those that did not. Those with a foreign subsidiary we classified as international, while the others are purely domestic companies. These strategic choices are shown in a two-bytwo matrix in Figure 1. The largest category in terms of the number of firms in a category is conglomerate domestic firms. The second largest category is single business domestic companies. The two final categories in our matrix are considerably smaller. Chinese firms are beginning to venture abroad, but the absolute numbers and proportion are still comparatively low. Overall, we can observe several trends in the relationship between ownership identities and diversification strategies:
and
The majority (52%) of firms controlled by govern-
How is the ownership structure of publicly-listed companies in China connected to their strategy of international diversification?
Firms controlled by marketized corporate share-
We approach these questions using the new ownership classification scheme we have developed to understand whether and why there are differences in these strategies across government-owned, marketized corporate-owned, and privately-owned firms in China. In approaching these questions, we try to understand how the motivations and abilities of an owner to manage a firm can influence its strategy. Before turning to a discussion of motives and abilities, we first provide details on the diversifi-
ment shareholders are in the conglomerate domestic strategy group;
holders had a marked tendency to adopt a domestic diversification strategy; and
Firms controlled by private owners showed a preference for international conglomerate and international single business diversification strategies. We capture these trends in Figure 2, where we have summarized the general strategic approaches to international and product diversification that publicly-listed companies in China have taken. We
478 Figure 1.
A. Delios et al. Implications of ownership structure on Chinese firms’ strategic choice
detail these strategies by the type of majority owner in the companies, in the following sections.
4.1. Government ownership and diversification strategy Government owners typically have motivations that are different from those of private owners, with their goals having a strong linkage to their political interests (Shleifer & Vishny, 1994). In the 1990s and the 2000s, the central government in China had several important policy objectives, including raising national foreign currency reserves, preserving and increasing the value of state properties, contending with the challenges of potential increases in unemployment, and managing the political implications of listing state-owned firms as it relates to unemployment. These objectives were managed directly through the implementation of government policies, and indirectly via the central government’s influence on chief executives and top management teams in firms with a substantial level of government shareholding. These central government objectives encouraged government-owned firms to pursue growth domestically, not abroad (see Figure 2). This influence is exercised through the central government’s linkages to the management of government-owned firms in China. A firm in China with a substantial government shareholding usually has political appointees as its top managers. These
managers retain their connections to the bureaucratic command system of the government. They tend to lack the experience and capabilities to deal with organizational and managerial complexities that come with diversification into new areas. In addition, these managers will face dual risks, both political risk and economic risk, when choosing to venture abroad. Thus, these executives tend to be ‘‘extra conservative’’ (De Mente, 1989), risk averse, and less innovative (Nee, 1992) than private sector managers. Consequently, government appointed managers refrain from adopting largescale, international diversification because of the risks associated with this strategy, and the desire to protect their political prospects and personal wealth. Although a government blockholder of shares can discourage a firm from international diversification, for certain government-owned firms with a very high proportion of government shareholding international expansion might be pursued to satisfy national as well as corporate interests. With the rapid development of the Chinese economy, the demand for energy and other natural resources has been rising. Accordingly, a substantial number of outward investments made by Chinese companies since 2001 have been in the natural resources sector. For example, in 2002, China’s state-owned energy company China National Offshore Oil Company (CNOOC) successfully acquired the Indonesian assets of
Ownership structure and the diversification and performance of publicly-listed companies in China Figure 2.
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Ownership identity and diversification strategies
Repsol Exploracion, a Spanish energy company. Similarly, PetroChina, a subsidiary of the China National Petroleum Corporation (CNPC), bought the Indonesian oil and gas assets of U.S.-based Devon Energy Corporation. In 2005, CNPC itself acquired the North Buzachi oilfield in Kazakhstan through its purchase of the Canada-based PetroKazakhstan. Consistent with this point, we see in our study of 1,178 listed companies in China’s Shanghai and Shenzhen Stock Exchanges that when the Chinese government’s proportion of shares was lower than 50%, a firm was less likely to invest abroad. However, when government shareholdings exceeded 50%, a firm showed a significantly higher tendency to invest abroad. Notably, the 100 firms that in 2002 had a government shareholding of at least 50% were mainly distributed in strategic asset industries, such as petroleum and utilities industries. Regarding product diversification, high-level government ownership can lead a firm to pursue a high level of product diversification. The Chinese government is aggressively supporting the growth of
national champions, which should develop their capabilities to compete effectively in international markets against other leading firms. The central government has been encouraging the development of conglomerates because a belief exists in the government that China can replicate the successes of Japan and Korea by using industry policy to support the growth of large conglomerates. The central government also regards conglomerates as a vehicle to absorb China’s growing number of lossmaking enterprises and unemployed workers (Shieh, 1999). We also found evidence in our study of Chinese listed firms that a positive relationship between government ownership and product diversification existed.
4.2. Marketized corporate ownership and diversification strategy The advantages of marketized corporate ownership for a firm’s diversification strategy primarily arise from the resource-related benefits that come from
480 the ownership of the firm by another corporate entity. This connection means that a firm with marketized, corporate-block shareholders is not only in a good position to develop its own resources, but also gains access to the corporate blockholder’s resources. This access can aid such a firm in gaining financial and other resources it requires for growth by diversification. In addition to financial resources, corporate blockholders can provide the technological, commercial, and organizational knowledge (Allen & Phillips, 2000) that firms need to build a competitive advantage in international markets. Managerial skills can play a prominent role in the success of a firm’s growth by diversification. With the support of another corporation, a firm can reduce the time and effort it requires to establish its knowledge of international markets, which encourages and facilitates its international expansion. With the availability of such capabilities and resources from its marketized corporate blockholder, these firms should have a greater level of international expansion. Firms with corporate blockholders may also be able to diversify into new product lines by successfully exploiting spillovers from group-level resources in a transfer of the resources of one firm in a group to another firm in the group. These firms may also be able to mobilize resources more readily or at lower costs than external agencies, because the presence of another corporation can provide reputation benefits and privileged access to resources. Corporate blockholders also contribute to the development of managerial and organizational skills, particularly with respect to managing the complex organizational structures that come with diversified operations. Aside from the benefits corporate blockholders provide with product diversification, there may be costs. A corporate blockholder’s objectives may actually restrict a firm’s diversification. For example, a firm’s diversification efforts can be impeded by the need to contribute firm resources to the group, or by constraints on expanding into businesses where other associated firms are incumbents or prospective entrants.
4.3. Private ownership and diversification strategy Private ownership provides its main benefits not through resource access, but instead through the motivations that private owners have, and how they translate these motivations into appropriate strategies for a firm. Private ownership is a crucial source of managerial incentive to direct a firm to pursue innovative and efficiency-seeking strategies.
A. Delios et al. A prominent type of firm that has large private ownership is one in which the private owners hold legal person shares as they founded the firm. These privately owned enterprises are young, and have a simple and flexible structure as compared to SOEs, or state-owned enterprises (Peng, Tan, & Tong, 2004). The owners of privately-owned firms have a strong interest in profit maximization, and sufficient control to have their interests respected and pursued by the firm’s management. Even though privately-owned firms can be resource poor, as compared to their SOE counterparts, the firm strategy is often characterized as aggressive entrepreneurship (Peng, 2001). Private owners in China react promptly to market opportunities, and adopt a prospector strategic perspective. This perspective implies that firms owned by private owners operate in a broad market domain. These firms often have a focus on innovation and change, and tend to have a flexible organizational structure (Peng, Tan, & Tong, 2004). One market opportunity that privately-owned firms pursue is international diversification, because it provides an opportunity to leverage a private owner’s entrepreneurial orientation. These firms are proactive in their strategy to reach new markets first. Privately owned firms therefore have an opportunity to develop a first-mover advantage in new markets as they rapidly introduce new products and process innovations. A second incentive for these firms to move into international markets comes from the institutional conditions in the firms’ home market. Private owners operate in a turbulent and uncertain institutional environment where the protection for property rights is poor and the legal system is weak. The weaknesses in the institutional environment create risks for the firm. Internationalization can reduce the degree of systematic risk by introducing foreign revenue streams into a firm’s operations. A third incentive for these firms to move into international markets comes from the tradable A shareholders in the secondary market, who are another category of private owners. Holders of A shares are likely to support international diversification because firms expanding to a new foreign country develop legitimacy in the stock market and hold the potential to bring shareholders significant, positive returns (Doukas & Travlos, 1988). These incentives can work together or separately to encourage a firm’s management to pursue a strategy of international diversification. Hence, we would expect that the higher the level of a firm’s private ownership, the more likely it will diversify internationally. It is important to note that a private shareholder in China does not have to consider the same
Ownership structure and the diversification and performance of publicly-listed companies in China political objectives that are important considerations faced by state and, to a lesser extent, marketized corporate shareholders. A private shareholder is also better equipped with the incentives and abilities to monitor a firm’s management and to exploit market opportunities. However, private owners’ incentives can be impeded in China because of the absence of efficient financial institutions, tight regulations on market entry, and local government protectionism. Market entry regulations are one example: state-owned enterprises are allowed to enter up to 80 sectors in China, while private-owned enterprises are permitted to enter only 40 sectors. Privately owned enterprises have historically been excluded from competing in the telecommunication, petroleum, education, medical, aviation, infrastructure, and media sectors. Consequently, we expect that both the motivations and abilities of private owners, as coupled with the restrictions on entry into specific industries, will jointly act to curtail the product diversification efforts of privately owned companies. A related consequence is that privately-owned companies will pursue growth in international markets, given the potential for restricted opportunities to grow in the domestic context.
5. Diversification and performance Performance is a challenging aspect of company performance to identify and interpret. In the case of listed firms in China, we need to consider that in an imperfect and under-developed market, such as China, diversified firms may enjoy several advantages. These advantages include a comparatively easy access to bank loans, and the consequent ability to utilize corporate capital to fund internal transactions and growth. Yet, increased diversification may also bring high control costs and coordination costs. Even with the challenges to understand why firms have different levels of performance, we can still identify how firms controlled by different types of Table 2. Ownership identity, product diversification, and performance Largest owner
Single business ROA (mean)
Government Marketized corporate Private Total
3.6% 4.3%
1.0% 3.7%
3.3% 4.0%
1.0% 2.3%
Conglomerate ROA (mean)
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Table 3. Ownership identity, international diversification, and performance Largest owner
Domestic ROA (mean)
International ROA (mean)
Government Marketized corporate Private Total
1.80% 3.60%
2.40% 2.00%
2.20% 2.53%
3.00% 0.87%
owners have performed under different diversification strategies (Table 2 and Table 3). In Table 2, we compare the performance of our three categories of owners by whether the firm has implemented a conglomerate-diversification strategy or a single business-focused strategy. The clearest trend in the table is the overall greater return on assets (ROA) on average by focused firms (4.0% ROA) versus conglomerates (2.3%). In fact, in all categories, focused firms outperform conglomerates. In Table 3, we compare the performance between firms implementing domestic strategy and internationalization strategy. We find a similar trend, as domestic firms in general outperform international firms (ROA of 2.53%, versus 0.87%). In Table 2, marketized, corporate-owned firms perform well under both focused (single business) and conglomerate strategies, with only a slight decline in ROA when a conglomerate-diversification strategy is pursued. Meanwhile, government-owned firms, which do comparatively well under a single business strategy (3.6% ROA), see a sharp drop-off in performance under a conglomerate-diversification strategy ( 1.0%). Privately owned firms likewise see a decline in performance when moving to a conglomerate-diversification strategy, but this decline is not as sharp for government-owned firms. Meanwhile in Table 3, marketized, corporateowned firms (3.6%) perform best under domestic strategy, but their performance drops when an internationalization strategy is implemented (2%). The performance of government-owned firms exhibits the same trend, as there is a sharp drop-off from the mean performance for a domestic strategy (1.8%) compared to one for an international diversification strategy ( 2.4%). Interestingly, privatelyowned firms see the opposite effect: they have an increase in performance when moving from a domestic strategy (2.2%) to an international diversification strategy (3%). Although government-owned firms have incentives to conduct diversification as discussed in the previous section, government shareholders have neither sufficient motivation nor expertise to effectively supervise the growth of a firm in the
482 conglomerate-diversification stage to effectively pursue profit maximization for the firm. Additionally, both the existence and enforcement of law-protecting, minority-shareholder rights are limited, and the information-asymmetry problem is severe between block shareholders and minority shareholders. A diversification strategy offers managers in government-owned companies the opportunity to pursue individual interests, or to pursue nonprofit-related goals, such as the pursuit of large firm size or large employment numbers of entry into ancillary but unprofitable businesses. In these ways, the performance of government-owned firms can decline with increasing levels of product diversification. Marketized, corporate-owned firms enjoy the benefits of resources provided by the government while also having the freedom to pursue strategies independent of state interests and objectives. Compared with government-owned firms, marketized corporate shareholders face more stringent budget constraints, leading to stronger concerns about a firm’s profitability and its financial status. These concerns are reinforced by the adoption of processes in corporate management that help enforce direct monitoring of the firm’s managers. In short, marketized corporate owners have both the motivation and capability to monitor a firm’s diversification strategy. With good access to resources, firms under marketized corporate ownership can perform relatively better than firms with other types of owners, when undertaking a product diversification strategy. Private ownership is similar to marketized corporate ownership in terms of the ability and motives of owners to monitor firm performance; however, unlike marketized corporate ownership, private owners face greater resource constraints in their pursuit of domestic firm growth. Hence, the performance of privately owned companies pursuing a diversification strategy will suffer a greater decline in performance than marketized corporate owners when pursuing a product diversification strategy.
A. Delios et al. One of the key areas in which Chinese firms differ is ownership structure. Unlike the private-equity, widely-held firms that dominate in many developed country markets, ownership identity plays a key role in understanding the strategies of emerging Chinese competitors. It is necessary for foreign companies first entering China to develop a detailed understanding of how their business will be affected by emerging competitors from China. A good grasp of the ownership structure of potential Chinese competitors is essential to developing an understanding of the companies’ competitive strengths and weaknesses, and, more importantly, their growth strategies. Chinese firms likewise face challenges and opportunities as the extent of their global competition grows. As the competitive imperative of mainland Chinese firms increases, and particularly if there is a slowdown in economic growth, there is a greater likelihood of an industry shakeout. Such a shakeout will lead to reduction in the number of domestic competitors in China. As has been experienced in countries such as Japan, South Korea, and Thailand during times of economic downturn, companies that have been pursuing growth at the expense of profitability targets are the ones most likely to be at risk of not surviving the downturn. As we have identified, for some types of owners, especially government—owned and controlled firms, the decision to diversify can be driven by political concerns rather than economic concerns. Such a motivation may be an effective one during periods of strong economic growth, but the long term viability of such a strategy is clearly at question.
Acknowledgment This research was generously supported by academic research grants from the National University of Singapore (NUS Academic Research Grants R-313000-083-112 and R-313-000-095-112). This article draws on research completed jointly by the authors and Wu Zhijian.
6. Strategic implications The rise of mainland Chinese firms in the global market, and even within the greater China market, is one of the most pronounced competitive threats to established firms in numerous industries. The entry of aggressive, low-cost Chinese competitors into established global industries can fundamentally change the industry’s competitive dynamics. Increasingly, there is a need to understand the strategies, objectives, and motives of these firms.
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