State Owned Enterprises (SOEs) are not just a China phenomenon. According to the paper in focus this week, from researchers Sung C. Bae (Bowling Green State University), Taek Ho Kwon and Chenyang Liu (both from Chungnam National University), they account for up to 22% of global market capitalization* and 50% of total global GDP.
[*Of listed companies I assume, the paper isn’t clear]
In China they control over 50% of the total assets of all enterprises and may produce almost 30% of national GDP.
It’s a well established fact, wherever they’re found, SOEs perform worse than private sector peers. So when in China a natural attempt-to-improve experiment took place, from 2013 when President Xi Jinping initiated his anti-corruption campaign, social scientists’ interest was attracted. The big question being; can SOE dullards be tuned up, and if so, by how much?
This work is especially pertinent now as China Inc. appears to be making a fresh attempt to sweat public assets, and their stewards, in preference to fostering private sector initiative.
The main findings were as follows:
- ROEs and ROSs (Return on Equity and Return on Sales i.e. net profit) both rose significantly. At the end of the study period (2009~2019) China’s SOEs were still behind the private sector on those metrics but the gap had closed significantly, in fact, to almost parity.
- Operating costs declined. Superficially this would be cause for celebration but as we’ll see below what was driving this was not, ultimately, to the benefit of minority shareholders.
- Cash went up. The researchers suggest the absence of corruption meant ‘grease’ required to run the business was no longer necessary and this is how extra cash came to accrue. I suspect a suspension of ‘tunneling’ may have also had something to do with this.
- Investment went down. This partly explains the cash gains but it also suggests managers became risk averse. If you don’t spend any money you can’t be accused of putting business your cousin’s way, and etcetera.
The biggest winner in this process was the state in the form of higher taxes, and who doesn’t want to see more of those? The answer, as it turns out, is minority shareholders.
The paper highlights a counterintuitive side effect of these changes which was a “..significant decrease in shareholder market returns…”. This was due to the flip-side of extra taxes being the curtailment of investment which in turn suffocated long-term growth.
A clear case of ‘be careful what you wish for’. Yes, firms became better run, but only in a narrow short-term sense. Greater efficiency benefits for the majority owners ended up being eclipsed, for minorities, by the long-term dis-benefit of the absence of growth prospects which weighed on the stock prices of the affected companies.
If planners have learnt from this recent experience then perhaps the next iteration of SOE tuning will avoid this investment-suppression conundrum and minorities will be better served?
Ms. Markit, judging by recent stock price moves, appears to be reserving judgement.
The paper is an easy read and you can access it via this link Reform and SOE Performance.
Happy Sunday.