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Competition or Privatization: China’s Experience in SOE Reform

Zhibin Zhang, Nanyang Technological University, Singapore


China is usually recognized in economic transition literature as a special case which achieved tremendous economic success simply through competitive market forces, without fundamental reforms in ownership system. That is, the Chinese model is generally regarded as an alternative to the privatization approach which was widely adopted in East Europe and Russia for economic and especially State Owned Enterprise (SOE) reform1.

This paper examines the characteristics of the Chinese model and identifies the exact nature of China’s SOE reform. For this purpose, this research adopted a comprehensive literature review as methodology, with particular focus on existing empirical studies on China’s SOE reform and Share Issuance Privatization (SIP). Specifically, first, this paper will describe the process and consequences of economic and SOE reforms in China. Second, it will identify the patterns and features of China’s privatization.


China officially started economic reform in December 1978. The process of economic reform or more precisely the process of SOE reform2, according to its coherence to certain targets, can be divided into four phases: expanding SOE autonomy and fiscal decentralization, contract responsibility system and dual track system, corporatization and market economy, and privatization. The major events and policy initiatives since 1978 are summarized in table 1. The first part of this paper will briefly discuss the first three stages, leaving privatization to be examined separately in more detail. The first part of this paper will also review the debate on the nature of Chinese reform, including the arguments and empirical evidences presented in both schools. It then concludes with the identification of existing problems in SOEs.

Table 1: Major Events and Policy Initiatives of Economic and SOE Reforms, 1978-20043


Events and Policy Initiatives

New Laws and Regulations


Economic reform officially launched


SOE decision-making autonomy and profit retention expanded

Development of Township and Village Enterprises encouraged

Law of Joint Venture


Individual business encouraged to reduce unemployment

Contract Law


Commission for Restructuring the Economic System established

New Constitution


‘Tax for Profit’ and ‘Loan for Appropriation’

The share of contract workers increased; the use of bonus expanded

Party leaders and SOE managers separated

Interim Provisions on SOEs


Contract Responsibility System (CRS)

Law of Foreign Funded Enterprises


The share of planning economy dropped to 50%

70% of SOEs implemented CRS at the end of 1987


Price decontrol tried but failed

Competitive mechanism in the selection of SOE managers adopted

Small SOEs allowed to be leased to private sector

Constitution amended to recognize private sector



Shanghai Stock Exchange inaugurated


Shenzhen Stock Exchange inaugurated


The momentum of economic reform renewed by Deng Xiaoping

Socialist Market Economy defined as ultimate goal of reform


Large-scale layoffs

Price decontrol restarted

Futures Market inaugurated

Constitution amended to remove ‘plan economy’


Deng Xiaoping, the greatest man in modern China, died

Large scale privatization of small SOEs started

Price Law


Layoffs in SOEs accelerated

Central government reorganized


Constitution amended to support private sector


Private Enterprise Law


Access to WTO


Communist Party opened door for private entrepreneurs


New State Assets Management Commission established

Proposed constitutional amendment backs private property


Constitution amended to back private property

Expansion of SOE Autonomy and Fiscal Decentralization (1978-1983)

China started economic reform in industry4 with the initiatives of expanding SOE autonomy and promoting incentives, aiming at improving the operation of SOEs5. In 1979, SOEs were granted marginal authority and control over decisions about marketing, technical innovation, and, most importantly, the quantity and variety of output beyond mandatory planning targets. Meanwhile, SOEs were allowed to retain part of their total profit. The retained profit was required to deposit into three different funds – welfare, bonus, and investment6. Consequently, worker bonuses were adopted widely and rapidly in SOEs as a major component of employee compensation to boost incentives.

Besides granting SOEs autonomous authority and control over operation, the Chinese government decentralized its fiscal system as well. In 1980, a revenue sharing system was established for the central and local governments to ‘eat at separate kitchens,’ encouraging local governments to develop their own revenues7.

Contract Responsibility System and Dual Track System (1984-1991)

The second phase of economic reform witnessed further expansions of SOE autonomy and the introduction of a dual track (plan and market) system with an attempt to strengthen the responses of SOEs to market forces. Dating from 1984, the contract responsibility system was implemented to supplant plan targets and to promote additional enterprise autonomy. Under this system, SOE managers or the entire work force signed a contract with the supervising government to fulfill specific total profit targets, long-term profit remittances, productivity increases, in return for extensive control over enterprise operations, including production plan inside the enterprise, substantial retention of excess profit, and wage distribution8. The contract responsibility system then spread through other areas of economic reforms.

In the beginning of economic reform, SOEs were allowed to transact marginal supplies and commodities outside the plan at market prices which responded increasingly to the forces of demand and supply, with the persistence of compulsory deliveries at state fixed prices in the planning sectors. A dual track system of plan and market, namely the coexistence of commending plan and market channel for resource allocation and goods pricing, emerged, evolving into a most striking feature of the Chinese approach to reform9. This Chinese characteristic then pervaded every aspect of economic reform, including sectoral reform, regional development, price decontrol, labor market development, foreign trade promotion, central-local fiscal arrangement, and even ownership reform10.

Corporatization and Market Economy (1992-1996)

Due to political turmoil in 1989, Chinese reform retrenched till 1992 when Deng Xiaoping renewed the reform momentum. In October 1992, the 14th Communist Party Congress proclaimed that the ultimate objective of economic reform was a “socialist market economy”. The year of 1992 marked an irreversible turn for China toward a market economy.

At the apogee of marketization, problems in SOEs persisted, leading to a widely accepted recognition that the root of the poor performance of SOEs could not be just from the lack of market mechanisms. Ownership transformation, however, was politically and ideologically constrained as a solution. Instead, China put its stakes in a Modern Enterprise System (MES), attempting to commercialize SOEs into modern corporations through introducing the private corporate governance practices. The establishment of two stock exchanges in Shanghai and Shenzhen in 1990 and 1991, respectively, created the preconditions for the Modern Enterprise System. Corporatization was fully underway after the Company Law came into effect in 1994.

An Alternative to Privatization?

Chinese reform achieved astonishing performance as shown in figure 111 in terms of the growth of industrial output, GDP, GDP per capita, and exports. It is very clear that in the first three phases the Chinese model of reform is totally based on a central assumption that the problems of SOEs can be addressed sufficiently by market forces, significant privatization is unnecessary. All reform measures are designed and implemented around a central target of establishing a competitive market, leaving the ownership structure basically unchanged. The existing evaluations of this model, however, are inconclusive and controversial. The review of these evaluations is organized into two parts as follows: the first part discusses different interpretations to the nature of Chinese reform and the second part examines the empirical evidences presented by different schools.

Data Source: Constructed by the author based on China Statistical Yearbook 1996, 1997, 1998, 1999, 2000, 2001, 2002.

The Nature of Chinese Reform

Sachs and Woo12 identify two schools of thought in interpreting China’s successful economic performance and the nature of Chinese reform. One school, labeled by Sachs and Woo as ‘experimentalist school,’ attributes the economic success to the evolutionary, experimental, and incremental nature of Chinese reform. The other school, the ‘convergence school,’ holds that China’s successes are derived from the convergence of its institutions with those of existing market economies. Correspondingly, the experimentalist school believes that to sustain success China must continue the distinctive innovations and exceptional strategies. While the convergence school holds that the gradualist nature of Chinese reform is not innovation at all. It simply reflects the lack of a comprehensive and coherent reform blueprint in advance. China’s future depends on how fast and how well its institutions are harmonized with normal market economies. Privatization, therefore, will be inevitable with the progress of harmonization. Specifically, as one of the proponents of the experimentalist school, Naughton13 argues that the Chinese approach illustrates the feasibility of gradual reform. It shows that SOE performance can be improved through incentive mechanisms and competitive markets in the context of a state-run economy. Jefferson and Rawski14 argue that the expanded autonomy, reconfigured incentive, and dual track system created a competitive market structure, which induced SOEs to behave like private firms and resulted in rapid economic growth and a significant increase in productivity, demonstrating the viability of gradualism and experimentalism of the Chinese model. Focusing on large SOEs in China, Nolan and Wang 15 argue that, contrary to the ‘transition orthodoxy,’ large Chinese SOEs have grown and modernized rapidly, showing the possibility to reconstruct industrial institutions without privatization. McMillan16 attributes China’s economic success to the ‘nonconformist’ nature of Chinese reform, namely the massive entry of new firms and the introduction of profit incentives with only minor privatization. McMillan even advocates generalizing a Chinese approach to other transitional countries.

The most important ingredient of Chinese gradualism is the dual-track system. Laffont and Qian17 defend this institutional arrangement, arguing that the dual-track system represents a dynamic process in which reform starts in areas or sectors where political constraints are weak and then, after building up constituencies and momentum, extends to other regions or sectors. This propagation process of the dual track system will eventually lead to drastic reforms of overall institutions. Liu and Garinos18 argue that the dual track system is optimal because it facilitates competition but avoids the cost of ownership transfer.

The convergence school, however, disagrees on the correlation between gradualism and China’s economic performance. Sachs and Woo19 attribute China’s rapid economic growth to its extremely low initial condition which provides ample space for rapid catching up. China’s phenomenal growth is largely due to the changes outside the state sector, including the transfer of surplus agrarian labor to the industrial sector, the rapid development of non-state firms, and the openness to the world economy. All these changes have nothing to do with the gradualism20. The increasing deterioration of SOE financial performance since the mid-1990s actually illustrates the failure of gradualism. Furthermore, they attack the dual-track system, arguing that it merely delays the most critical problems China has to overcome for the future.

Particularly, Sachs, Woo, and Yang21 point out that, if not recognized that economic reforms are only a small part of large scale constitutional transition, the assessment of reform performance will be very misleading. In this sense, China’s economic success so far might be illusionary because, under political monopoly due to the absence of constitutional transition, economic reform will be easily hijacked by state opportunism. China’s gradualism represented by the dual track system, despite its short-term benefits of buying out the vested interests, generates very high long-term costs of constitutional transition.

Qian22, however, argues that gradualism and convergence are not necessarily conflicting. Acknowledging that the transitional institutions such as the dual track system and fiscal contracting incur higher costs and generate lower benefit than those ‘best practice’ institutions, Qian emphasizes that they are the most feasible policy choices for Chinese reform. More importantly, the plan track was finally abolished and fiscal contracting was ultimately replaced with a rule-based modern tax system, illustrating that transitional institutions do not necessarily lead to a partial reform trap, and incremental reforms do not always create obstacles to block further reforms. The destiny of Chinese reform, of course, is to converge with those of existing market economies in developed countries. But the contribution of gradualism and transitional institutions innovated by Chinese reform should not be denied because of their ad hoc nature.

In brief, the interpretations of the nature of Chinese reform and the corresponding policy choices they advocated for the future are contentious. Empirical evidences are found supportive of different schools of arguments. To look closer at the truth of Chinese reform, this paper turns to the empirical studies of the Chinese style approach.

The Empirical Evidences

As summarized in table 2, the empirical evidences on Chinese economic and SOE reforms are mixed and inconclusive as well. Some found positive correlation between reform measures and efficiency or productivity improvement, while others found counterproductive or insignificant impact of reforms on firm performance. The following discussion of these empirical studies is organized around specific reform measures.

Table 2: Empirical Studies on Economic and SOE Reforms in China


Sample description, study period, and methodology

Summary of Empirical Findings and Conclusions

Groves, Hong, McMillan, and Naughton (GHMN)23

Using data of 769 SOEs in four provinces in China from 1980 to 1989, examine whether SOE managers respond to expanded autonomy to strengthen employee incentives and whether these incentives lead to productivity growth.

Managers were induced by output autonomy and profit retention to strengthen worker discipline. The fraction of bonus in workers’ salary and the fraction of contract workers in total labor forces generate increased productivity. However, evidence showing that expanded autonomy increase pre-tax profit is weak. Much of the benefits of autonomy have gone to the SOE workers instead of remitting to the state.

Groves, Hong, McMillan, and Naughton24

By the same data of 769 SOEs as the authors did in 1994 in four provinces in China from 1980 to 1989, examine the evidence of managerial turnover, the relationship of performance to managerial contract term and manager selection.

66 percent of SOEs experienced managerial turnover. Managerial turnover with prior low performance is usually involved with auction in the selection, larger security deposit and shorter managerial contract term of new managers. Significant performance increase occurred under a new manager if the previous one was demoted. Meanwhile, managerial incentives are significantly related to linking manager’s pay to firm performance. The authors conclude that China had developed a managerial labor market that incorporated many of the incentives present in Western managerial labor markets.


Using a panel data set of 272 SOEs from 1980 to 1989, examines the effectiveness of China’s incremental industrial reform by measuring the change of marginal productivity of factors and total factor productivity (TFP).

The marginal productivity of labor and capital except intermediate materials experienced significant increase. Growth in TFP was 4.68 percent per year from 1980 to 1989 and accounted for over 73 percent of output growth. The improved resource allocation, growth in employee bonus, and the increase of competition all contribute significantly to the growth of TFP. The findings suggest that SOE restructuring can improve firm performance without formal privatization.

Liu and Zhuang26

With the same panel data as GHMN did in 1994 and 1995 but with a different stochastic cost frontier function, measure the effect of various reform measures on cost efficiency which combines both technical and allocative efficiency.

Despite cost efficiency improved annually with 1.18 percent, the efficiency effects of the industrial reform programs are mixed. Competition has significant positive effect. But the expanded autonomy and the increased proportion of contracted employees are counterproductive, and the use of bonus has no significant effect on cost efficiency. An adequate structure of incentives remains unsolved. But China’s experience shows the SOEs are reformable without privatization.

Xu, Zhu, and Lin27

Relying on a data set of 884 SOEs nationwide in China during all of 1997 and the first quarter of 1998, study the effects of political control, agency problems, and ownership types on the performance of reformed SOEs.

Both the lessening of politician control through expanded enterprise autonomy in labor deployment and the mitigation of agency problems through introducing corporate governance mechanisms have positive effect on SOE performance. Relative to state ownership, foreign ownership has positive effect, while employee ownership has negative effect. Furthermore, expanded enterprise autonomy except for labor autonomy has a negative effect, indicating serious agency problems caused by partial reform measures.

McGuckin and Nguyen28 (1993)

With a data set of enterprises with different ownership (state, collective, and private) in 1980, 1984, and 1985 from the industrial census in 1985, examine the impact of two waves of reforms (1978-1979 and 1983-1984) on the change of gross output and value-added.

Collective and private firms outperform SOEs in the growth of total factor productivity. The proportion of technical workers in total workforce is positively correlated with productivity growth. The profit retention rate in SOEs contributes significantly to the productivity improvement. However, bonus to employees has negative effects.

Dougherty and McGuckin29

Using data of 23,000 large and medium industrial firms in China in 1995, isolate the impacts of jurisdiction governance and ownership structure from other factors on productivity.

Regardless of ownership type, industrial enterprises controlled by local governments exhibit significant superior productivity to those owned by central government. Thus decentralization plays a prominent role in improving firm performance. Among centrally controlled firms, ownership is a key determinant of different productivity performance. But for locally controlled firms, virtually no productivity difference between different non-state ownership types, indicating local government administration tends to equalize performance across ownership types.


Using data set of 539 SOEs in 13 industries over 4 provinces from 1990 to 1994, examine the effects of the softness of budget constraints due to state ownership and competition on the behavior and performance of SOEs.

SOEs supervised by central government, due to the soft budget constraints, exhibit higher wage rates but significantly lower labor productivity and total factor productivity. Competition, in general, has positive effect on the growth of total factor productivity. But it is not adequate to contain the problems of soft budget constraints caused by state (central government) ownership.

Li, Li, and Zhang31

With a big data set over 400,000 SOEs from the third industrial census in China from 1993 to 1995, examine the driving forces behind privatization in China.

Cross-regional competition derived from decentralization triggers privatization.

Shirley and Xu32 (1998; 2001)

Using GHMN panel data set to analyze the experience of Performance Contracts (PCs), examine whether PCs work in China and how firm performance was affected by different PC provisions, including incentives, targets, bidding, contract length, managerial bonding, and competition.

PCs on average were not significantly correlated with productivity improvements in a large sample of SOEs in China. PCs can only improve productivity when they simultaneously specify sensible targets, offer strong incentives, signal commitment, and in competitive environment. And PCs tend to achieve the effects above under the oversight of local government.


With the same panel data set as GHMN did, examine the effects of a series of SOE reforms including expanded autonomy, increased competition, performance contract, and managerial turnover on value-added per employee as the proxy of firm performance.

The study finds significant positive correlation between value-added per employee and increasing competition, managerial turnover, raising profit retention rate, and managerial discretion on wages and production. However, the performance contract did not improve performance significantly.

Huang and Kalirajan34

Using panel data of 67 SOEs from China’s four coastal cities in 1992 and a stochastic varying coefficient frontier approach, examine the contribution of enterprise management reform and the competitive market forces to the growth of technical efficiency.

The proportion of planned production in SOEs is negatively correlated with the firm, capital, and labor specific efficiency measures. The degrees of participation in exports significantly raised the technical efficiency. However, the enterprise management reform measures including asset responsibility system, the contract system, the director responsibility system, and the share-holding system have no significant correlation with the growth of technical efficiency.


Using macroeconomic data from 1978 to 1997, compare different employment adjustments in the dual-track system.

The structural adjustment in employment in the old planning track lagged far behind the market track. The increasing competition from the market track did not force structural adjustment of the old track as long as institutional settings of SOEs are not significantly changed.


With a panel data set of 681 SOEs in four provinces from 1980 to 1994, examine the effect of corporatization on worker wage, employment, and productivity.

Corporatization lowered basic wages by 11 to 15 percent, but the incentive payment keeps unchanged. Corporatization improves productivity by 6 percent as well. Evidence shows the correlation between corporatization and adjusting employment is weak. Corporatization has the potential to be an effective mechanism to restructure troubled SOEs in China.

Lin and Zhu37

Using data set of 2,632 corporatized SOEs in 1998, present the profile of corporatization process and organizational features; examine how the corporatization process was shaped by various factors.

Corporatization is seriously defective due to continued government interference. However, such government involvement is inevitable because of the lack of necessary institutions. The long run success of corporatization, therefore, depends on the development of legal and market institutions.


Using panel data across 30 provinces and municipalities in China from 1985 to 1997, examines the contribution of investment from different ownership to the growth of GDP and productivity in these provinces and municipalities.

The more the investment moves to private hands, the more GDP growth. Provinces with more privatization witness greater gains in productivity and economic growth. And this is robust in different categories of ownership.

Li and Wu39

Based on a panel data set of 680 SOEs in China from 1980 to 1994, examine the relative effectiveness of ownership transformation and management improvement on firm performance (total factor productivity and gross rate of return on assets).

Ownership diversification through introduction of other types of ownership yield significant improvement in performance of SOEs. While the effects of management reform including expanded autonomy and profit incentives are mixed. China, therefore, should focus on ownership reforms in the future.

Wen, Li, and Lloyd40

Comparing enterprises with all different ownership types within six industries as well as across these industries from the third industrial census of China in 1995, examine the relationship between ownership and technical efficiency with the stochastic frontier production function approach.

Evidence shows that enterprises with ownership types other than state ownership, domestic collective ownership, and joint domestic ownership are technically more efficient on average than these three ownership types.

Zhang, Zhang, and Zhao41

Via a panel data set covering all industrial enterprises in Shanghai from 1996 to 1998, examine and quantify the effect of ownership and market competition on the productive efficiency and efficiency growth.

Different ownership types lead to significantly different efficiency levels, with foreign ownership exhibiting highest efficiency and SOEs lowest. The degree of competition from international market is positively associated with firm efficiency. However, domestic competition has no such correlation with efficiency. The ownership effects are robust across different competitive markets and different industries, indicating the overwhelming effects of ownership to competition.

The analysis above presents a brief description of the market oriented Chinese reform. The evaluations of this Chinese model, nevertheless, are mixed and inconclusive. The empirical studies verify the contributions of Chinese reform to the spectacular economic performance, but also find extreme limitations of the competition without privatization strategy. In fact, despite those market measures introduced since the end of the1970s, including the expanded autonomy, the use of incentives and contracts, and corporatization, the financial performance of SOEs has been increasingly deteriorating since the early 1990s. According to Sachs and Woo42, two-thirds of SOEs ran losses in 1992 even with a 13 percent output growth in that year. And in 1996, with total loss at 79.07 billion RMB and total profits at only 41.26 billion RMB43, the whole SOE sector slid into deficit for the first time. The National Statistical Bureau reports that, in 1998, the ratio of total debt (the sum of liquid liabilities and long term liabilities) to total assets in SOEs is 65.9 percent, with 2.2 percent higher than average level nationwide; and the debt interest accounts for 37.9 percent of the total sale profits.44

Having realized the limitations of competition without privatization, the 15th Communist Party Congress in 1997 officially proclaimed an ownership transformation policy of ‘grabbing the large and letting go of the small ones,’ namely privatizing the medium and small SOEs but retaining the dominance of state ownership in large ones. China’s privatization, once again, is characterized by the dual-track strategy. Despite the reserved commitment of the leadership, China’s privatization accelerated. The Chinese reform formally entered its fourth phase of privatization.


China undertook the sale of state property to the private sectors – the strict definition of privatization, although occurring very late at the end of the 1990s, including the Share Issuance Privatizations (SIPs) and direct sale of state assets. Particularly, China’s commitment to a massive or large-scale ‘normal’ privatization program seemed intensified in recent years.

China started SIPs in December 1990 and July 1991 with the inauguration of two stock exchanges in Shanghai (SHSE) and Shenzhen (SZSE), respectively. SIPs grew rapidly in China, although with significant instability. In 2000, the total market capitalization in two stock markets accounted for more than half of GDP. The basic information of SIPs is summarized in table 3.

Table 3: Basic Information of Share Issuance Privatizations in China, 1992-200245


Number of Total Listed Firms

Total Market Capitalization (100 Million RMB)

Ratio of Market Capitalization to GDP

Float Market Capitalization (100 Million RMB)

Ratio of Float Market to Market Capitalization



































































The blueprint for SIPs is the Company Law effective on July 1st, 1994. In accordance with this law and other relevant regulations, tradable shares are divided into domestic (A- shares) and foreign (B-shares, sold solely to foreign investors and residents from Hong Kong, Macau, and Taiwan; H-shares, issued in Hong Kong stock market; and N-shares, issued in New York stock market). The average ratio of foreign shares to all companies is less than 2.5 percent46. Due to their insignificance, analyses of foreign shares are simply omitted in this research.

Not all shares in any listed SOEs are publicly tradable. That is, the publicly traded A-shares only account for a portion of the total shares in listed SOEs. The Company Law requires the ratio of A-shares to be 25 percent or more of total outstanding shares when the company makes its initial public offering. But in practice this ordinance was not followed particularly in the early stages47, the actual ratio of A-shares ranges from 17 to 33 percent of total shares48. A-shares are the only type of equity that is permitted to be traded among domestic investors at the two exchanges. Hence the total shares or the total market capitalizations in Chinese stock markets do not reflect the true traded volume. Instead, China uses an unusual indicator of “float market capitalization” to measure the value of tradable A-shares, which accounts for about 33 percent of total market capitalization in recent years. The effects of A-shares on firm performance in China are inconclusive and controversial. Most scholars argue that A-shares have a trivial impact on corporate governance owing to two reasons: A-shares are extremely dispersed and the turnover rates of A-shares are exceptionally high (the average holding period is about 1 to 2 months, compared with 18 months in United States49, indicating the investors have low motivations and usually free-ride to monitor firm performance because of the loose correlation of cost and benefit of such behaviors. However, still some researchers argue that A-shares have positive performance effects owing to their nature of pure private ownership.

Besides tradable A-shares, a listed SOE has three other shares: state shares, legal person shares, and employee shares. State shares are held by the central government or local governments, but usually controlled by state asset management agencies, financial bureaus, or solely state-owned investment companies. To preserve the dominance of state ownership, it is required that SOEs must issue shares to the government for free and these state shares must not be less than 35 percent of total shares. This requirement, however, was not well followed in practice either. In 1995, the state controlled 35 percent of total shares in SHSE listed firms but only 22 percent in SZSE50. Nevertheless, in many cases, the largest shareholder is always the state, without any comparable and contestable second or third largest shareholders. By 1999, for example, 42 percent of the largest shareholders are state shares51. State shares are not permitted to be publicly traded, but are transferable to domestic institutions even including private institutions upon the approval of the China Securities Regulatory Commission (CSRC). SIPs in China, therefore, are a kind of partial privatization. Although theoretically some researchers argue the desirability of partial privatization52 , generally, most view it as a poor governance structure, making monitoring difficult and the mechanisms of takeover and bankruptcy incredible.

Legal person shares are held by domestic institutions, including industrial enterprises, stock companies, trust and investment companies, foundations and funds, construction and real estate companies, transportation and power companies, and technology and research institutes53. Most of them, however, are eventually state owned. As in the case of state shares, many of the largest shareholders are the holders of legal person shares. In 1995, for example, 24 percent of legal person shareholders in SHSE-listed firms held more than 50 percent of total outstanding shares and the same case for 25 percent of SZSE-listed firms54. Legal person shares are not allowed to be publicly traded, but transferable upon the approval of CSRC. Hence in most cases, the state directly or indirectly (through legal person shares) owns and controls listed companies. Although most domestic institutions are eventually state owned, those with legal person status are somehow independent from the state with separate accounting systems and self-responsibility for benefits and losses. Thus legal person shareholders are suggested to have more incentives than the state to monitor listed firms for efficiency improvement and profit maximization. But still other researchers argue that legal person shares are vulnerable to state interference, and, moreover, sometimes legal person shareholders may benefit themselves at the expense of other shareholders55.

Employee shares only make up less than 2 percent of total shares, functioning primarily as benefits for employees and management rather than an incentive mechanism and completely unimportant in firm operation. After having been held for 6 to 12 months, employee shares can be sold in the open stock market upon the approval of CSRC. The issuance of employee shares was discontinued in 1998, making it even more insignificant in the ownership structure.

To summarize, the patterns of ownership structure in Chinese listed firms through Share Issuance Privatizations (SIPs) are as follows:

  1. SIPs in China are partial privatizations. The state still retains substantial shares in most of the listed firms.

  2. Correspondingly, ownership structures are relatively concentrated. Tenev et al. find in their sample of 257 SHSE-listed firms in 1999 that, on average, the three largest shareholders held 58 percent of total shares, of which the largest one held 47 percent, 8 percent for the second largest and 3 percent for the third largest56.

  3. The total shares are equally divided among three parts: state shares, legal person shares, and tradable A-shares, with each accounting for approximately 30 percent of total outstanding shares.

  4. The tradable A-shares are highly dispersed with exceptionally high turnover rates, indicating individual investors in China primarily seek short-term trading profits rather than dividend or long term growth.

  5. Legal person shareholders are similar to the institutional investors in the advanced market economies, with most of them eventually state owned or controlled.

Consequently, the governance structures, consisting of the board of directors, supervisory committee, and shareholder annual meeting, are biased to the control of state or legal person shareholders. First of all, the board of directors is overrepresented by state and legal person shareholders. Although each of state shares, legal person shares, and tradable A-shares makes up approximately 30 percent of total shares, the board membership controlled by A-shares is extremely low. Xu and Wang find that, in their sample of 154 listed firms in 1995, individual shareholders have no more than 0.3 percent of the total board seats on average57. Tenev el al. find a much higher ratio in their sample of 257 SHSE-listed firms58, but still with no more than 6 percent of total board membership representing individual shareholders. On contrast, based on different samples, some find that the state is highly overrepresented with 50 percent of board membership59, others find the legal persons are overrepresented with 63 percent of board seats60. Secondly, such highly biased governance structures occurred in the supervisory committee and shareholder annual meeting as well, characterized with extremely low presence of individual shareholders. In short, the governance structure is not proportional to the ownership structure, with biases to the state or legal person shareholders.

These ownership and governance structures seem problematic, reflected in the deteriorating performance of Chinese stock markets in the past years. The average earnings per share was 0.35 RMB in 1994, 0.27 in 1995, 0.29 in 1996, 0.248 in 1997, 0.185 in 1998, 0.2069 in 1999, 0.211 in 2000, 0.136 in 2001, and 0.127 in 200261, while China’s GDP was soaring during the same period. However, some researchers argue that such structural arrangements, even though inconsistent with the best practices, are feasible adaptations to the particular political and economic conditions in China, reflecting the government’s serious concerns to protect stock markets and their commitments for continuous Share Issuance Privatizations. In other words, through remaining substantial state ownership and disproportionately high state control, the government can maintain an orderly flow of privatization so as not to overwhelm the fledgling stock markets and thus make it possible for following Share Issuance Privatizations in the future. Meanwhile, high state shares signal the government’s confidence in the listed firms and a business guarantee, lowering the ex ante uncertainties for domestic investors62. Nevertheless, others argue that if the firm performance continued deteriorating, both the concerns to protect stock markets and the optimal signal effects would fail. Resorting to empirical evidences, therefore, is the best way to clarify the debate and figure out what on earth the effects of such ownership and governance structures on firm performance are. The findings from these empirical studies on Share Issuance Privatization (SIPs) in China are summarized in table 4 as follow:

Table 4: Empirical Studies on Share Issuance Privatizations (SIPs) in China


Sample description, study period, and methodology

Summary of Empirical Findings and Conclusions

Xu and Wang63

Using panel data set of all listed firms in China from 1993 to 1995, examine the effects of ownership concentration on firm performance and then differentiate the effects of different ownership type with particular focuses on state ownership and legal person ownership. The proxies of performance are the market-to-book value ratio (MBR), return on equity (ROE), and return on assets (ROA). Ownership concentration is measured by the proportion of shares held by the top 10 shareholders.

Ownership concentration has significant impact on performance. Because the largest shareholders usually concentrate on state and legal person shareholders, this impact should be interpreted as positive correlation of firm performance to state and legal person ownership concentration. However, the positive effects on firm performance are only found in the legal person ownership types. Both state ownership and individual ownership are negatively correlated with firm performance. Furthermore, the inefficiency of state ownership is evident in its deviating political objectives in excessive employment.

Qi, Wu, and Zhang64

With a data set of all listed firms in SHSE from 1991 to 1996, examine the relationship between shareholding (ownership) structure and firm performance.

Firm performance is positively correlated with the proportion of legal person shares but negatively related with state shares. Moreover, performance increases with the degree of relative dominance of legal person shares to state shares. However, the relationship between firm performance and tradable A-shares and foreign B-shares is insignificant.

Sun and Tong65

With a panel data set of 634 listed firms in China from 1994 to 1998, examine the effects of Share Issuance Privatizations (SIPs) on firm performance by MNR method66, namely comparing the performance of 3 year pre- and 3 year post-privatization. Meanwhile, they explore the relationship between performance changes and ownership structural changes after privatization.

Real net profit (RNP) increased significantly after SIPs, but the ratio of profit to sales decreased. And, contrary to other findings, leverage level increased after privatization increased. These results are robust with considering the changes in macroeconomic activities, indicating partial privatization through SIPs in China achieved limited success. Further analyses show negative effects of state ownership on firm performance, but increase in legal person ownership and foreign ownership contribute positively to performance improvement.

Jia, Sun, and Tong67

Using panel data of 41 firms listed in Hong Kong Stock Exchange from 1993 to 1998, compare performance changes after privatization with MNR methods and explore the relationship between different ownership type and performance changes.

Net profit dropped after privatization, but without statistical significance. However, returns on sales, on assets, and on equity all significantly decreased after privatization. Moreover, privatization did not result in reduction of leverage. Nevertheless, real output increased significantly. Further analyses show that the remaining state ownership has a negative role in profitability, while the legal person shares and foreign shares contribute positively to performance improvement.

Chen, Firth, and Rui68

Using panel data set of 735 listed firms privatized from 1991 to 1997, examine the effects of Share Issuance Privatizations on profitability, asset efficiency, capital expenditure, sales, and debt ratios with MNR methodology but extending the post-privatization period to 5 years.

Both profitability, measured by the ratios of profit to sales, assets, and equity, and asset efficiency, measured by the ratio of sales to assets, deteriorated significantly after privatization. Though sales and capital expenditure efficiencies, measured by the ratios of capital expenditure to sales and to assets, improved significantly. Moreover, the debt to equity ratios dropped after privatization. These findings are robust across different ownership types. Privatization in China, therefore, is unsuccessful at least in terms of profitability and efficiency.

Wei, Varela, D’Souza, and Hassan69

Using panel data set of 208 listed firms (but for some regressions, only 82 firms are used) in China from 1990 to 1997, measure the effects of privatization on firm performance with MNR methods and then compare the performance difference.

Profitability represented by net profit experienced significant increase, but return to sales has insignificant changes. Both real sales and real assets increased significantly. However, employment had insignificant increase. Sales per employee increased and leverage decreased, both significantly. Further analysis shows privatized firms outperform full state-owned firms in profitability. Therefore, privatization works in China.

Wang 70

Using a panel data set including all listed firms in China from 1994 to 2000, examine the effects of two different types of state shareholders, bureaucratic state shareholders and corporate state shareholders, on firm performance and managerial turnovers.

Firms with corporate state shareholders (SOEs or state-owned economic entities act as shareholders) outperform those firms with bureaucratic state shareholders (government bureaus act as shareholders). Meanwhile, managerial turnovers in firms with bureaucratic shareholders are less sensitive to poor performance. No significant differences of performance and managerial turnovers exist between firms with corporate state shareholders and those without state shares at all.

Chang and Wong71

With a survey data of 71 firms listed on SHSE from 1997 to 1999, examine the effects of political interference with proxies of the degrees of party control and the presence of government representatives on the board on firm performance.

By separating the effects of political interferences from agency problems, both the degree of party control and the increasing ratio of the presence of government representative on the board have detrimental impact on firm performance.

Wong, Opper, and Hu72

Using the same survey data set Chang and Wong did in 2002, examine the relationship between ownership structure, political interference (party control), and firm performance.

Party control is negatively correlated with the ratio of tradable A-shares, but has insignificant relationship with the ratios of legal person shares or foreign shares. Furthermore, party control is significantly negatively correlated with performance measured by ROA and ROE. This negative effect, however, can be significantly mitigated by the existence of legal person shares, but not by A-shares or foreign shares. Therefore, both exit (increasing the ratio of A-shares) and voice (increasing the ratio of legal person shares) channels exist to address the party control problem in listed firms of China.

Fan, Lau, and Wu73

Using a panel data set of 496 listed firms in China from 1997 to 1999, examine the effects of ownership structure, board structure, and managerial compensation on firm performance.

Ownership concentration and the fraction of employee shares have positive impacts on firm performance, but the ratio of major officer’s shareholdings does not. Both the ratio of insider directors and managerial compensation are insignificantly correlated with firm performance, indicating the supportive evidences for the effectiveness of governance mechanisms in Chinese listed firms are weak.


With all listed firms in China from 1994 to 1998, examine the impact of different shareholdings on corporate value.

The government shareholding is negatively correlated with corporate value. This relationship, however, is not monotonic. That is, when the share of government shareholding is small and dominated by non-government shareholdings, the negative impact is small too. With more shareholdings moving to government, the detrimental effect increases. But when government shareholdings are sufficiently large as to dominantly control the firm, the negative correlation decrease again. The U-shape relationship indicates government can be both detrimental and helpful.


The objective of this paper is to provide an understanding of the nature of China’s SOE reform. It began with the description of the Chinese model for economic reform. This Chinese approach, despite its spectacular economic achievements, demonstrated an incomplete and informal nature in many of its institutions. These limitations were primarily from the central strategy and assumption of the Chinese SOE reform, namely SOEs could be improved simply with competitive forces, significant ownership transformation was unnecessary. Market measures, including enterprise autonomy, incentives, price liberalization, and corporatization, were all introduced and tried to save SOEs. However, SOE performance has been increasingly deteriorating since the early 1990s.

Having realized the limitations of the Chinese model, China officially initiated privatization programs in the late 1990s. Particularly, the generally defined privatization, the sale of state property, particularly the Share Issuance Privatizations (SIPs), developed rapidly in the 1990s. These privatizations, however, were tainted by the incomplete and informal nature of Chinese reform, reflected in their biased ownership structure and ineffective corporate governance, which is further embodied in the limited performance improvement in those listed firms.

It seems that privatization is clearly the answer for China’s future SOE reform. Particularly, the empirical studies show that private ownership outperformed state ownership in almost every area. In order to maintain the current momentum of rapid economic growth, China should commit itself in a comprehensive and fundamental ownership transformation from state ownership to private ownership. China’s experience in SOE reform, therefore, only provided proofs that privatization is ultimately the fundamental way for economic transition, although it requires more deliberate design and more effective management.

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2 This research mainly focuses on the reforms in the industrial sector, namely the SOE reforms. Other reforms such as agriculture and foreign trade system, which also achieved great success, are omitted.

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4 Naughton indicates that most accounts which hold that Chinese reforms began in the countryside are actually inaccurate. Rural reforms were launched later than industrial reforms but reaped tremendous success by 1984, much earlier than the still troubled and uncertain status of industrial reforms. The Chinese publicists thus usually claim that reforms had begun agriculture.

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11 All original value of GDP, GDP per capita, industrial output value, and exports in 1978 are treated as 1 or 100 percent. The growth rates of GDP per capita and export for 2003 are estimated. Therefore, the value of exports in 2003, for example, is about 50 times of the value in 1978. Caution: the line of the industrial output and value added between 1978 and 1991 reflects the change rate of gross industrial output value, while part of this line between 1993 and 2002 reflects the change rate of industrial value added. Therefore, this line is inconsistent.

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35 Opper, S. “Dual-Track Ownership”.

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42 Sachs, J. D., & Woo, W. T. NBER Working Paper.

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44 National Bureau of Statistics. The Prosperous Industrial Economy. Beijing: National Statistical Bureau, 1999.

45 This table is constructed by the author based on China Statistical Yearbook 1996, 1997, 1998, 1999, 2000, 2001, 2002 (National Statistical Bureau) and the website of China Securities Regulatory Commission (CSRC) at

46 Sun, Q., & Tong, W. H. S. “China Share Issue Privatization: The Extent of it Success”. Journal of Financial Economics, 70, 183-222, 2003 (henceforth “China Share Issue”).

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48 Sun, Q., & Tong, W. H. S. “China Share Issue”.

49 Xu, X., & Wang, Y. “Ownership Structure and Corporate Governance in Chinese Stock Companies”. China Economic Review, 10, 75-98, 1999 (henceforth “Ownership Structure”).

50 Ibid.

51 Tenev, S., Zhang, C., & Brefort, L. Corporate Governance.

52 Jefferson, G. China's State Enterprises: Public Goods, Externalities, and Coase. American Economic Review, 88, 428-432, 1998; Perotti, E. C. Credible Privatization. American Economic Review, 85, 847-859, 1995; Schmitz, P. W. Partial Privatization and Incomplete Contracts: the Proper Scope of Government Reconsidered. FinanzArchiv, 57, 395-411, 2000.

53 Tenev, S., Zhang, C., & Brefort, L. Corporate Governance.

54 Xu, X., & Wang, Y. “Ownership Structure”.

55 Chen, Y. M., & Gong, S. C. Ownership Structure and Corporate Performance: Some Chinese Evidence. In T. A. Fetherston (Ed.), Advances in Pacific Basin Financial Markets (Vol. 6, pp. 177-193). New York: JAI, 2000; Sun, Q., & Tong, W. H. S. “China Share Issue”.

56 Tenev, S., Zhang, C., & Brefort, L. Corporate Governance.

57 Xu, X., & Wang, Y. “Ownership Structure”.

58 Tenev, S., Zhang, C., & Brefort, L. Corporate Governance.

59 Xu, X., & Wang, Y. “Ownership Structure”.

60 Tenev, S., Zhang, C., & Brefort, L. Corporate Governance.

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Profitability? Unpublished manuscript, The Hong Kong Polytechnic University, Hong Kong, 2002; Mok, H. M. K., & Hui, Y. V. (1998). Underpricing and the Aftermarket Performance of IPOs in Shanghai, China. Pacific-Basin Finance Journal, 6, 453-474.

63 Xu, X., & Wang, Y. “Ownership Structure”.

64 Qi, D., Wu, W., & Zhang, H. “Shareholding Structure”.

65 Sun, Q., & Tong, W. H. S. “China Share Issue”.

66 Megginson, Nash, and Randenborgh in 1994 first use the comparison of 3 year pre and 3 year post privatization to measure the effects of privatization on firm performance. Then Megginson and Netter (2001) call it as ‘MNR’ methodology.

67 Jia, J., Sun, Q., & Tong, W. H. S. (2002). Privatization via Overseas Listing: Evidence from China's H-Share Firms. Unpublished manuscript.

68 Chen, G., Firth, M., & Rui, O. Have China's Enterprise Reforms Led to Improved Efficiency and Profitability? Unpublished manuscript, The Hong Kong Polytechnic University, Hong Kong, 2002.

69 Wei, Z., Varela, O., D'Souza, J., & Hassan, K. “The Financial and Operating Performance of China's Newly Privatized Firms”. Financial Management, 32(2), 107-126, 2003.

70 Wang, J. Governance Role of Different Types of State Shareholders: Evidence from China's Listed Companies. Unpublished Doctoral Dissertation, The Hong Kong University of Science & Technology, Hong Kong., 2002.

71 Chang, E. C., & Wong, S. M. L. Corporate Governance, Political Interference, and Corporate Performance of China's Listed Companies. Unpublished manuscript, 2002.

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Lessons from China's Listed Firms. Unpublished manuscript, 2003.

73 Fan, D., Lau, C.-M., & Su, S. “Corporate Governance Mechanisms”. In A. Tsui & C.-M. Lau (Eds.), The Management of Enterprises in the People's Republic of China. Boston: Kluwer Academic Publishers, 2002.

74 Tian, L., Government Shareholding and the Value of China's Modern Firms. Unpublished manuscript, 2002.


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