Wednesday, January 7, 2009

Central SOEs to be Held to a Higher Standard in 2010

(And they really mean it this time.)

SASAC's Assistant Director in charge of performance assessment announced that SASAC is preparing to look harder at SOE performance beginning in 2010. They had been planning to implement tougher measures in 2009, but apparently the financial crisis, any number of natural disasters, the Olympics (feel free to throw in any other excuse you can think of) have necessitated a relaxation of the rules.

But they really are planning to judge SOEs based on "economic value added" (EVA) starting next year. Honest, they really are serious this time.

All cynicism aside, EVA is a pretty rigorous financial calculation based on the idea that a business must cover both its operating costs and its capital costs. It is calculated by subtracting the opportunity cost of capital from a firm's net operating profit after tax.

Part of the reason for choosing this calculation is a concern that SOEs have traditionally engaged in unproductive investment without regard to the cost of capital. According to aggregate statistics from China's Statistical Yearbook, there is a pretty significant gap between private and state-owned industrial firms in terms of asset productivity. (These stats compare only state-owned enterprises with private enterprises. These stats for state-controlled enterprises were not available.)

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Part of the reason for this is that a lot of these SOEs are probably still saddled with old, unproductive assets. Another reason is that the leaders of these SOEs have often been motivated, not by profitability, but by size. Traditionally, anything they could do to make their respective enterprises larger before moving on to their next political appointment was considered to be a good thing.

SASAC has been expressing its concern about this over-investment for years, and according to the article, they plan to establish a threshold above which investment must get approval from SASAC. Furthermore, the EVA measure, which some enterprises have reportedly adopted voluntarily, will become a part of the annual evaluation.

However, I can imagine a few difficulties as SASAC attempts to implement these measures. I cannot imagine how they will begin to calculate the cost of capital for these firms given that SASAC's 142 SOEs collectively control about 22,000 subsidiaries (see SASAC 2007 Annual Yearbook in your local university East Asian Library). SASAC lacks the small army necessary to oversee this process.

Also, they will need to decide on some sort of benchmarks against which to measure performance. But against what kind of firm would you benchmark a sprawling state-owned industrial firm? Other state-owned firms?

Finally, SASAC will need to put some teeth in its rules and mete out punishment if it expects these standards to be followed. However, I'm not certain whether SASAC even has the power to enforce such standards. The leaders of these SOEs, while some may be recommended by SASAC, are generally appointed by the Party with approvals from other relevant organizations.

It sounds like a nice idea though.