The Chinese government's hand in business makes IRin China a complicated affair
As Western companies, particularly internet firms, look to expand operations into China, the issue of government interference and control is something IROs need to understand.
On January 24, 2006, the Chinese government shut down Bing Dian (‘Freezing Point’), a publication renowned for covering topics such as corruption, Taiwan, censorship and nationalism in school history books – issues that are not up for public debate in China.
The next day, Google launched a Chinese version of its search engine (www.google.cn). This site is restricted by the Chinese government’s censorship rules so that any web pages deemed ‘inappropriate’ are blocked.
The internet sector is currently receiving the most attention in terms of government intervention. ‘Censorship is the issue du jour for business in China,’ says Cedric Chao, partner at law firm Morrison & Foerster. It was only in 1995 that the internet was made commercially available in China. Today there are more than 100 mn internet users in the country, which has become one of the fastestgrowing markets in the world.
For some, the embryonic stage of the internet industry – and of the Chinese market in general – is justification for companies to adapt their practices to suit China. Many foreignbased companies comment that investors have only recently grasped how important it is to make inroads there.
‘When we started in China in 1985, our presence there wasn’t on investors’ radars,’ says James Jarrett, VP of legal and government affairs for Intel. Jarrett was previously president of Intel China and, before that, VP of IR. ‘I was in the IR job until 1996 and I don’t recall a single question coming up about China during that time. I was always amazed at how little awareness there was among the investment community about what was happening in China.’
Jarrett says that the situation began to change in the late 1990s. ‘At this point you started to see more interest as financial analysts came to understand China was becoming a big player in the software world,’ he notes. But despite this increased interest, Jarrett claims there was still an information gap. ‘Analysts still had a lack of understanding about China’s potential. It’s only in the last six years that this has changed.’
Staying neutral
Google’s decision to go into China and follow the government’s rules created quite a stir. CEO Eric Schmidt’s defense was that Google had to follow each nation’s laws and customs, emphasizing the neutral status of the company.
This is the position also taken by Intel, whose semiconductors are used in the Chinese government’s computers. ‘We supply a chip that can be used for 100,000 different things,’ says Jarrett. ‘We’re a pretty neutral force. You buy the chip and you can program it to do a lot of different tasks, so it’s not something we can control. Our job is just to provide technology.’
Google includes a note at the bottom of censored searches informing the user that content has been blocked. The search engine is also choosing not to offer e-mail, blogging or social networking in China for fear that it will not be able to protect users’ privacy.
This is the situation in which Yahoo! found itself two years ago when it was asked by the Chinese government for information about journalist Shi Tao, who was accused of revealing state secrets via Yahoo! e-mail. Yahoo! provided the information and Shi Tao was sentenced last April to ten years in prison. The e-mails allegedly included information on the Chinese government’s guidelines for reporting on the 15th anniversary of the Tiananmen Square massacre.
Leading the way
Chunming Zhao, a senior equity analyst covering technology and the Chinese internet at Susquehanna Financial Group, thinks Google’s China launch is a positive sign. ‘The censored Google.cn is a symbol,’ he explains. ‘It signifies that the Chinese market is important enough for Google to take this localized approach.’
Companies adapting – or compromising – their Western business practices is not something Zhao, as an analyst, worries about. ‘Many institutional investors have asked if I am worried or surprised about Google’s actions,’ he says. ‘My answer is no. Google had to adapt in order to operate in China and to show respect for the local environment; the last thing you want to do is annoy the Chinese government.’
Information flow
Government interference and ownership does, however, affect perceptions of Chinese issuers. ‘We can’t work with Chinese companies who cannot adapt to a formal approach to investor communications,’ says James Shapiro, senior managing director of Galileo Global Advisors. Shapiro notes a big difference between state-owned and private companies in that private companies are generally more transparent.
But if a state-owned company explains its business well, investors and analysts are less apprehensive, notes Shapiro. He highlights a case where a client was a well-known state-owned company that operates in the West. ‘It was always clear that the government directly owned a large majority of this publicly traded company,’ he says. ‘But people accepted that this is part of the nature of many large companies in China, and it wasn’t an issue because the company was run well.’
A further example of this is that of the so-called ‘red chip’ stocks listed in Hong Kong. Many of these businesses have Chinese state-owned enterprises as their parent companies but aren’t disregarded for their transparency or investor communications.
According to Chao, state ownership is not the issue. The real problem for investors and analysts looking at Chinese equities is transparency of ownership. ‘Sometimes I have had dealings with state-owned enterprises, and you do have to wonder how much control there is on the part of the government,’ he comments. ‘In some cases you’re not entirely sure who the owner is.’
This lack of transparency can complicate deals as well. According to Chao, when contracts are signed or deals are made with Chinese issuers, it sometimes turns out that the real owner of the company or assets is another party entirely. As a result, there are a number of investigative consulting firms springing up in China that look into the party with which their client is dealing, paying particular attention to any possible links with the government.
Fear of the unknown
According to Arvind Ganesan, director of the business and human rights program at Human Rights Watch, the opaque nature of some Chinese business practices constitutes a major risk for companies and their investors. ‘No one can be sure of the limits the Chinese government will go to, or what they will demand next,’ he says. ‘Companies may end up capitulating to arbitrary demands.’
The ‘unknown’ intentions of the Chinese government in terms of regulation may be the most challenging aspect for IROs working for companies doing business here. Shapiro agrees that the bigger issue for Western companies in China isn’t the difference in regulations between China and the West, but the uncertainty of how these regulations will impact companies.
‘The rules are in flux, and it’s hard to know exactly what they are,’ he says. ‘On top of this, you get mixed messages depending on who you ask about how flexible the rules are. It would definitely help if there was more transparency regarding the rules companies are
subject to in China.’
Jie Chen, IR manager at Shanghaibased Focus Media, regularly fields questions from investors about regulatory issues. In particular, she’s often asked about the Chinese government’s involvement in company operations. In response to these concerns, Focus Media includes details about domestic Chinese regulations in its annual report.
The IR department at Chinese firm Baosteel Group tells a similar story. ‘Sometimes we do have international investors asking whether the government will interfere with the company’s daily operations,’ says an IR representative from the company. Baosteel’s IR team feels that solid communication and transparency about internal operations can overcome any investor worries. ‘Our sound corporate governance is one of the reasons why quite a number of institutional investors show strong interest and many have invested in the company,’ its IR representative says.
Linda Chien, IR manager at Chinese recruitment firm 51job, agrees: ‘Investors don’t ask if the government is involved in our operations, but they do ask how existing or new regulations may impact our business. This is the risk of doing business in China and most investors are aware of it.’
For Chien, any risks for Western issuers moving into China are far outweighed by the potential benefits. She cautions, however, that companies will have to go along with what the Chinese government decrees. ‘Companies will need to operate within the rules and regulations,’ she says. ‘I don’t think this dynamic is going to change any time soon.’
These Chinese IROs are keen to stress that what is more important than investor concerns is the changing nature of the Chinese market. Despite the controversy over Google’s entry into China, these IROs see clear signs that China is opening up to the West.
Professor Oded Shenkar, Ford Motor Company chair in global business management at the Fisher College of Business, Ohio State University, and author of The Chinese century, believes that while companies and investors should see changes in China as an indication of a more open society, they should also realize the limits to change there.
‘There will be changes, but China is never going to adopt a completely Western style of business and government,’ he says. ‘The sooner both sides accept and adapt to this, the smoother the progression will be.’ It seems this is the lesson for both sides: adapt as soon as possible to avoid any problems further down the line. With clear communication as the cornerstone, maybe perfect balance can be achieved.