Meng Xiangyun, Board Secretary, Chongqing Iron & Steel Company Ltd, looks at the governance practices of an A+H share listed company to illustrate the importance of effective checks and balances and incentive systems in modern companies, especially companies with mixed ownership.
Corporate governance is essential to the modern corporation. It clearly defines the rights, obligations and responsibilities of shareholders, directors, supervisors and the management, and establishes clear checks and balances among them. These parties have different roles in the company. Shareholders are the owners of the company who contribute capital to the company. Final decisions on the future of the company are made at shareholders’ meetings, the highest authority of the company. The board of directors, elected at shareholders’ meetings, makes decisions on the development objectives and key operations of the company and is delegated the governance of the company. The management, hired by the board of directors, executes the decisions of the board and is subdelegated the governance of the company. Supervisors are tasked by shareholders to oversee the work of the board of directors and the management to check whether their actions are in the interests of the shareholders and whether they carry out their duties properly.
The fundamental principle of corporate governance is to establish checks and balances in the design of the top tiers of the company, allowing various parties to carry out their respective duties and responsibilities and guarding against operational risks, thereby maximising benefits to the company. In addition, as ‘delegates’, the board of directors, the board of supervisors and the management have roles and positions naturally different from those of shareholders. To enhance the governance of the company, effective incentives must be given to the directors, supervisors and managers to increase their sense of belonging and ownership, so that they are more committed to their work.
I. Background of the company
Chongqing Iron & Steel Company Ltd was established in 1997. With the approval of the former State Commission for Restructuring the Economic System of the People’s Republic of China and the former Securities Commission of the State Council, it issued overseas listed foreign shares (H shares) in Hong Kong in 1997, which were listed for trading on the Stock Exchange of Hong Kong. With the approval of the China Securities Regulatory Commission, the A shares issued by the company in the Mainland were listed on the Shanghai Stock Exchange in 2007. Due to a mismatch between the product portfolio of the company and market demand, relatively high costs, poor governance and continued poor sales of its products, the company faced delisting. Judicial reorganisation of the company started in July 2017 and was completed in December 2017.
By implementing the reorganisation, consolidating assets, reducing liabilities, clearly delineating staff responsibilities and innovating its internal systems, the company evolved from a state-owned enterprise into a company of mixed ownership. The scale of its production and sales and its income and profits achieved a historical breakthrough.
II. Major governance issues
The ‘Guiding Opinions of the General Office of the State Council on Further Improving the Corporate Governance Structure of State-owned Enterprises’ points out that ‘the modern enterprise system has taken shape initially in most state-owned enterprises, but is far from perfect in practice. In some cases, effective corporate governance is not yet in place, with key problems including lack of clear delineation of powers and responsibilities, insufficient controls, and lack of checks and balances. Some boards of directors are ineffective and unable to play their intended role’.
Prior to reorganisation, the company was a typical state-owned enterprise, facing corporate governance issues common among such enterprises. The major issues addressed by its corporate governance reforms included those highlighted below.
1. Board structure
There were no proper rules governing the board structure and the election of board members. The board could not perform the functions and role of the board in a modern corporate governance structure. Limited in powers, the board of directors could not make decisions on the appointment and remuneration of the management. The interests of the company were not necessarily, nor directly, related to the personal interests of the directors. Directors did not have clear responsibilities, were not remunerated and were not accountable in substance.
2. Board independence
There was no monitoring mechanism to achieve effective checks and balances. There were too many overlaps between the board of directors and management, and managers were basically members of the board. This reduced the independence of the board, affected the board’s ability to monitor the management, and undermined the checks and balances between the two. The responsibilities of the board of supervisors were not fulfilled and no accountability system was in place.
3. Incentive and control systems
An effective incentive and control system was absent. Before the reorganisation, there was no rigorous appraisal and incentive systems for the management. No effective mechanism was in place for the appointment and removal as well as promotion and demotion of directors, supervisors and managers and for their remuneration to be increased or reduced.
III. Corporate governance reforms
Improving the corporate governance structure
After judicial reorganisation, the company took on the vigour of mixed ownership in a manner responsible to investors and shareholders. Corporate governance was enhanced. The controlling shareholder adjusted the governing structure of the company. Specific measures included those highlighted below.
1. Adjusting the structure of the board of directors. To allow the board of directors to fulfil its important role in the modern corporate governance structure, improvements were made to the composition, expertise and competencies of the board of directors. In terms of composition, while maintaining the total number of board members at nine, the number of deputy chairmen was increased to two and the number of independent non-executive directors was increased from three to four.
2. Making good use of specialised committees under the board. To better assist the board in its work, specialised committees comprising members with different professional expertise were formed. For example, currently the Remuneration and Appraisal Committee is chaired by an independent director with rich experience in strategic cost management, incentive system design and performance appraisal, while its members have extensive experience and practical expertise in various aspects including production and operation management, legal matters and management accounting.
3. Avoiding overlaps between the board and the management. To reduce overlaps between decision-makers and managers and avoid confusion in personnel or functions between the board of directors and the management, the management was also restructured. As a result, only one senior management staff is a member of both the board and the management. This facilitates independent and effective monitoring of the management by the board of directors on behalf of the shareholders, resulting in effective checks and balances between decision-makers
4. Adopting a market-oriented approach in the selection and appointment of managers. Leveraging the background and resources of the majority shareholders, the board introduced a management team with rich experience in the management of the iron and steel industry. Adopting a market-oriented approach, managers who know the industry and give priority to management were appointed. By adjusting the growth strategies, implementing change management and launching an internal competition scheme, the growth impetus of the company was greatly enhanced.
Improving corporate governance systems
1. Refining the meetings of shareholders, directors and supervisors. The requirements regarding meetings of the shareholders, directors and supervisors were refined. For example, agenda items are currently broadly invited (from line functions, directors, supervisors and senior managers) and motions are drafted according to a set of standards. The board secretary coordinates the efforts of the finance department and senior management in reviewing relevant meeting documents in advance. Every participant of the meetings is accurately informed of the time and venue of meetings and provided with the agenda and meeting documents before the meetings in a timely manner. Board support services are planned in detail and every part of the entire process is fully attended to.
In addition, to ensure the effective implementation of the board’s decisions, a ‘board decision notification system’ was adopted whereby the board issues timely written notifications to management regarding matters that require the management’s attention and implementation. The management has to report progress to the board in a specified timeframe to complete the cycle.
2. Preparing or amending internal documentation on governance. To regulate the operations of the board and enhance the quality of its decisions, the documentation for eight fundamental areas of governance, including the standing orders of the board of directors, were amended and refined. Balancing delegation and restriction of powers as well as control and efficiency, the board amended the operational rules of the general manager to further clarify the decision-making process and the powers of the general manager. Moreover, the company put in place several basic management systems, including those relating to project investment, share investment and internal controls.
Setting up a sound incentive and control system
1. Introducing remuneration reforms. Having determined the positioning of its business in the market and the direction of its human resources strategy, the company introduced an incentive scheme to lower costs and enhance efficiency and a profit-sharing scheme, which are linked to cost control and operational performance. The purpose of the ‘dual incentive and control schemes’ is to motivate staff.
The company pursued reforms to its incentive system. Results are used as the overriding criteria in assessing performance. Work is assigned according to the duties and responsibilities of respective managers, and performance indicators are refined. Job briefs with performance indicators are signed with senior managers, whose performance is appraised in accordance with their achievement of the monthly, quarterly and annual indicators, with their remuneration determined accordingly.
2. Implementing a staff shareholding scheme. In order to motivate staff members in general and encourage sharing of responsibilities, risks and profits, the company introduced both performance incentive and shareholding incentive systems. The interests of the management, key personnel and shareholders are now aligned. The objective was to allow staff to grow together with the company, to promote the long-term steady growth of the company and to enhance shareholders’ value. The draft employee shareholding scheme for 2018–2020 was considered and approved at the meeting of the shareholders in May 2018, and the proposal on the first phase of the employee shareholding scheme was considered and approved at the meeting of the directors in December 2018.
The employee shareholding scheme is a measure to achieve the sharing of profits and risks among the workers and owners of the company. It helps improve the engagement of staff and the competitiveness of the company, engage key personnel, and align the interests of the management, key personnel and shareholders, and is hence conducive to the long-term steady growth of the company.
3. Extensive delegation of powers by the board. The board of directors fully supports the management in its reforms of the operations and management of the company. Powers are sufficiently delegated to management to allow managers to take up substantial responsibilities, and strong incentive is given to senior managers in terms of remuneration. The management respects and efficiently implements all decisions of the board of directors.
IV. Initial results of governance reforms
Through judicial reorganisation, Chongqing Iron & Steel Company Ltd found a new lease of life. By enhancing its governance structure and governance systems, the production and operations of the company returned to normal. Among the measures taken, the implementation of incentive and control systems and checks and balances in corporate governance are the most important. Leveraging the advantages of mixed ownership, various stakeholders are involved in the decisions of shareholders and directors to achieve effective decision- making. The board and the management have separate functions. While checks and balances are in place through the operation of a monitoring system, the board and the management also complement each other. A market-oriented approach is adopted to recruit and appoint managers, and a market-oriented appraisal system has been introduced. Through an employee shareholding scheme, managers are motivated to participate in the operation and governance of the company, and an effective talent recruitment and incentive and control mechanism is put in place. Corporate governance is essential to the modern enterprise. Whether the corporate governance framework is effective is an important factor affecting the performance of a company. Good governance can rationalise the shareholding structure of the company, enhance its internal control, reduce its agency costs, enhance its core competitiveness and improve its operational performance, and results in the sustainable development of the company.
Meng Xiangyun, Board Secretary
Chongqing Iron & Steel Company Ltd
公司治理个案分析 – 激勵與制衡