Participants attend an international seminar on the independent director system organized by Shanghai Stock Exchange in December 2006. Photo: IC

China's listed companies are preparing for an unprecedented wave of resignations by independent directors, following a Party directive on government officials with commercial second jobs.

So far more than 200 listed companies have reported resignations. Some were by ex-government officials while others were university professors or administrators.

As part of an anti-corruption campaign, the Organization Department of the Communist Party of China (CPC) Central Committee issued a circular in October banning incumbents and college personnel from assuming posts outside their office.

The circular stipulated that only those who have retired from their government role for more than three years are allowed to take up jobs at companies, and that they still require approval from the relevant authorities.

As a result when public companies convene board meetings, one of the issues they have to resolve is the resignation of board members whose directorships violate the circular's mandate.

System malfunctions 

"Officials have strong political connections, and hiring people with such backgrounds as directors raises questions over ethical practices and breeds collusion between business and government," said Zhang Huiming, a professor with the School of Economics at Fudan University.

Public disclosures of listed companies over the past month have shown that a number of former high-ranking government officials have given up board seats. Officials at the Organization Department of the CPC Central Committee said recently that tens of thousands of government officials have relinquished their external posts, including more than 200 provincial and ministerial officials.

Disclosures from China's listed firms' 2012 financial reports showed that more than 640 independent directors were ex-officials.

An ex-official-turned independent director who recently resigned from a listed Chinese bank was making 364,000 yuan a year, the bank's 2013 financial report showed. The CPC said in the circular that no ex-officials should be paid for their work at companies.

The rank of these officials goes as high as the ministerial level. Some have even served as director of more than one public company. Their role in these companies has often been questioned.

The Chinese securities regulator introduced independent directorships to public companies in the early 2000s in the hope that such arrangements, along with the supervisory boards, could enhance public companies' corporate governance and protect minority shareholders' interests.

However, instead of inviting qualified and competent professionals to serve on their boards, public firms have been inclined to reserve such seats for prominent government officials and scholars in exchange for their political and social influence.

Liu Jipeng, director of the Capital Research Center at the China University of Political Science and Law, said that competence at fulfilling the responsibilities required of an independent director was not the major criteria for some public companies when considering potential candidates.

Liu suggested that what some public firms were looking for was someone who would take the money and become a yes man.

"Some of these officials-turned-independent-directors don't even attend board meetings and don't vote on major decisions the company makes," Liu said.

Independent directors are supposed to ensure a public company operates in line with regulatory requirements. Yet in practice, analysts say some directors just looked the other way, while those who do exercise their right to supervision find themselves having other problems.

Such was the case of Zheng Lixin and Xu Zhuangcheng, independent directors at Tianmushan Pharmaceutical. The company reported on May 29 that its restructuring plan had been delayed. Both Zheng and Xu questioned the validity of the company's financials and voted against the restructuring. This led to a motion by the firm's largest shareholder to remove them from the board. The Shanghai Stock Exchange is now looking into the dismissals.

Government withdrawal

Liu said misconduct by many Chinese public companies can be attributed to corporate governance. He added that a public company is vulnerable to power abuse by a controlling shareholder - usually those who run the company - when independent directors do not do their job well.

The People's Daily, the CPC's flagship newspaper, said in a commentary on June 9 that the surge in resignations by ex-officials-turned-directors has provided a good opportunity for the government to withdraw from the marketplace.

It also said that even though hiring officials as board members may have proved beneficial in the short term, such decisions will not help a company in changing the market environment and does no good in cultivating sound corporate governance.

To Xu Feng, a partner at Shanghai Huarong Law Firm, it all boils down to the issue of representation. "These independent directors are handpicked by the majority shareholder so how do you think they can represent the interests of minority shareholders and turn against the people who brought them on board?"

Xu cited a study conducted by his law firm showing that most of the independent directors removed over the past few years had one thing in common: They failed to exercise their due diligence to ensure corporate compliance and represent minority shareholders.

Xu urged regulators to overturn the current system in which many directors are nominated by majority shareholders.

"There should be voting proxies for small and medium shareholders. While retail investors can share in the growth of a public company, they should have these proxies to decide company matters on their behalf," Xu said.

"Such proxies have already been introduced to represent institutional investors such as private equity funds and other investment funds in public companies, and they could represent retail investors in the future."


Newspaper headline: Wave of resignations from company boards