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Changes in the Corporate Governance System Design Clauses in the Second Review Draft of the Amended Draft of the Company Law

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The 38th meeting of the Standing Committee of the 13th National People’s Congress held in December 2022 reviewed the “Company Law of the People’s Republic of China (Second Review Draft of the Revised Draft)”. The review draft will be open for comments from December 30, 2022 to January 28, 2023. The revised draft of the new company law has 15 chapters and 262 articles. On the basis of the current company law’s 13 chapters and 218 articles, 70 articles have been added or revised.

The second review draft has made new revisions to the first review draft on the basis of maintaining the main revisions of the first review draft. For example, the second-review draft continues to maintain the first-review draft to reduce the threshold for shareholders’ interim proposals from the original 3% to only holding more than 1% of the company’s shares individually or collectively, but the second-review draft stipulates that shareholders have reasons to doubt the company’s business execution. Those who violate laws and regulations or the company’s articles of association may submit a written request to the company and entrust an intermediary agency such as an accounting firm or a law firm to consult the company’s accounting books and accounting vouchers within the necessary scope. The daily shareholding of more than 1% is increased to 3% (but the company’s articles of association are allowed to stipulate a lower ratio threshold, and the company has reasonable grounds to believe that shareholders’ inspection of accounting books and accounting documents has improper purposes, which may damage the company’s legitimate interests, and may refuse to provide inspection. , and shall reply to the shareholder in writing and explain the reasons within 15 days from the date of the shareholder’s written request. If the company refuses to provide inspection, the shareholder may file a lawsuit in the people’s court). The changes in the above thresholds indicate that the Company Law is emphasizing the protection of investors’ rights and interests in a more detailed and balanced way.

What is particularly commendable is that the second review draft noted the uniqueness of the category stocks launched on the Science and Technology Innovation Board in 2019. It is clearly stated in the second review draft that a company that issues class shares should include in its articles of association the order of distribution of profits or remaining property for class shares, the number of voting rights for class shares, measures to protect the rights and interests of small and medium shareholders, restrictions on the transfer of class shares, and shareholder rights. Other matters deemed necessary by the meeting shall be clearly stipulated.

The class of shares here is the type of shares that we usually talk about in terms of voting rights allocation weights that are not equal to (greater or less than) the proportion of capital contribution. The typical form is AB dual share structure shares. For example, on January 20, 2020, Youkede Technology, the first “same-share-different-rights stock” in China’s A-share market, issued two types of stocks, of which Class A shares have five votes per share and Class B shares have one vote per share. In fact, dual-class shares have existed for hundreds of years, but as a kind of “unequal voting rights”, due to violation of the “principle of equal rights for the same share” that investors recognize more, dual-class shares have not been recognized by companies for a long time. Acceptance of mainstream theory and practice of governance. With the advent of the Internet era, in order to lead the innovation of business models, more and more companies choose to issue AB shares with dual share structure, so that the weight of voting rights allocation is tilted towards the entrepreneurial team. Snap, a video social networking site founded by two students who dropped out of Stanford University in the United States, even began to issue ABC triple shareholding structure shares when it was listed on the New York Stock Exchange in 2017.

A research conducted by my research team and I took China concept stocks as an example (see Zheng Zhigang, Zhu Guangshun, Li Qian and Huang Jiji, “Dual Shareholding Structure, Sunset Clauses and Corporate Innovation-Evidence from American China Concept Stock Companies” , “Economic Research”, No. 12, 2021) showed that it is precisely because many new economy companies have introduced sunset clauses in the company’s articles of association when they issue shares with a dual-class structure, which has improved the common situation of the previous simple structure of different rights for the same share. The potential problem of “separation of cash flow rights and control rights” has formed the so-called state dependence of control rights, and achieved a good balance between innovation orientation and investor rights protection. The “separation of cash flow rights and control rights” here refers to the limited real money (cash flow rights) that minority shareholders invest in the company to reflect (in order to make wrong decisions). Its inclined structure of different rights for the same share has an asymmetric influence (control right) on the company’s important decision-making and invested funds, thus forming a “separation” of cash flow rights and control rights. The so-called sunset clause here refers to the general term for the transfer and withdrawal of Class A shares held by the entrepreneurial team, conversion to Class B shares, and the restrictions on the power of the entrepreneurial team in the Articles of Association. For example, in order to prevent the actual controller from abusing the voting rights of Class A shares or harming the interests of the company or other small and medium shareholders, some companies that issue AB dual-class shares have made special provisions on special voting rights in the Articles of Association. When the shareholders of the company exercise their voting rights on the following matters, the number of voting rights enjoyed by each Class A share shall be the same as the number of voting rights enjoyed by each Class B share: amending the Articles of Association; changing the number of voting rights enjoyed by Class A shares; hiring or dismissing The company’s independent directors; the engagement or dismissal of accounting firms that issue audit opinions for the company’s regular reports; and the company’s merger, division, dissolution or change of company form.

We have seen that AB dual-class shares are popular in the design of the corporate governance system of new economic enterprises. Actively carry out institutional innovation, maximize strengths and avoid weaknesses, and make up for the shortage of dual-share structure stock issuance by introducing sunset clauses, so as to achieve a balance between innovation orientation and rights protection. The above-mentioned revisions of the second review draft undoubtedly conform to the above-mentioned trend in the development of dual-class structure stocks in the global capital market. We are pleased to see that our research provides theoretical analysis and empirical evidence support for the above revision of the second review draft.

Focusing on the design of the general corporate governance system, a prominent modification of the second review draft can be summarized as “no matter whether a limited liability company or a joint stock company “may” not have a board of supervisors (replaced by an audit committee in the board of directors)” and “employees of a limited liability company Entry on behalf of directors”. The second review draft proposes that whether a limited liability company (Article 69) or a joint stock company (Article 121) can set up an audit committee in the board of directors in accordance with the provisions of the company’s articles of association, and exercise the powers of the board of supervisors under the Company Law. A company with an audit committee does not have a board of supervisors or supervisors. Among them, the audit committee is composed of more than three directors, more than half of the independent directors, and at least one independent director is an accounting professional. This means that for many companies, the establishment of a board of supervisors has become an option in the design of the corporate governance system. Some scholars even believe that the board of supervisors and supervisors will withdraw from the arena of corporate governance in China.

We know that the board of supervisors system is the product of the organizational system of the board of directors of listed companies in China and learning from the experience of countries with mature market economies. On the one hand, we learn from common law countries such as the United States, Britain, Australia, and Switzerland, and adopt a “mixed model”, that is, the board of directors has the two functions of supervising managers and conducting strategic consulting at the same time, thus forming a so-called “mixed function (in the board of directors)”. “; on the other hand, we learn from Germany, Japan, Poland, France, Italy, the Netherlands and other civil law countries, adopting a “two-tier model”, that is, between the shareholders’ meeting and the managers, there is not only one layer of the board of directors, but a There are two layers of board of directors and board of supervisors. However, unlike the purely Japanese-German model, the supervision and strategic consulting functions are performed by the board of supervisors and the board of directors respectively (among them, the board of supervisors is responsible for performing the supervisory function, while the board of directors is responsible for performing the strategic consulting function), while in the practice of corporate governance in China , although there are two layers of the board of directors and the board of supervisors, on the one hand, the two functions of the board of directors’ supervision and strategic consulting continue to be “mixed” in the board of directors, and the division of functions is realized by setting up various professional committees such as remuneration, internal control, strategy and nomination. On the other hand, the “Company Law” gives the board of supervisors a parallel status with the board of directors, including the right to supervise the directors and managers of the company, which makes the managers of Chinese companies subject to “dual supervision” from the board of directors and the board of supervisors at the same time.

If we regard supervision as a more important function of the board of directors, then the supervisors (especially expatriate supervisors) under the two-tier model in Germany and other countries are actually more like independent directors in the mixed model in the United States and other countries. However, in the actual implementation process, referring to the Japanese organizational model of the board of supervisors, the board of supervisors of listed companies in China is partially composed of company employee representatives. Because they are subject to the board of directors or directors who concurrently serve as the company’s management in terms of administrative relations, it is difficult to effectively play their supervisory role, resulting in the use of supervisory boards in name only. In order to improve the problem that some supervisors are limited by employee representatives, state-owned enterprises have further learned from the “German” supervisor production model, and some supervisors have begun to be dispatched by superior departments and controlling shareholders. With the revision of the “Company Law” in 1999 and the promulgation of the “Provisional Regulations on the Board of Supervisors of State-owned Enterprises” in 2000, China has gradually established a system for the board of supervisors of state-owned enterprises to be dispatched abroad.

In the new round of solicitation of opinions on the revision of the Company Law, whether the board of directors organizes a two-tier (including the board of supervisors) or a single-tier (excluding) has become an option for the company. But as far as I know, there are many voices against the above modification for various purposes. In fact, the choice of which organizational model of the board of directors is more effective is largely related to the main problems faced in the practice of corporate governance in various countries, and is also related to legal traditions and institutional cultures such as civil law or common law. The core is whether the effective supervision brought by the establishment of the board of directors can cover the cost of the board of directors’ organization and operation. Therefore, in theory, the organization of the board of directors itself is also a question of comparing the benefits and costs of system design. For example, instead of setting up a board of directors for strategic consulting purposes, a 100% holding company may directly hire a management consulting agency; in some investment banks, due to the design of salary contracts with sufficient incentives and direct communication with performance, there is no need to set up a board of directors.

In view of the fact that Germany’s “expatriate supervisor” system is essentially the independent (external) director system in the UK and the United States, and the fact that the current dual supervision of Chinese companies from the board of directors and the board of supervisors still reduces supervision to a “vase”, the above revisions signify in a certain sense China’s expatriate supervisor system has begun to move closer to the independent (outside) director system. Independent (external) directors instead of expatriate supervisors has become one of the important ways to standardize corporate governance, especially for state-owned enterprises.

I noticed that, on the one hand, the second-review draft considers whether a limited liability company should set up a board of supervisors or supervisors as a company option, but on the other hand, it is quite surprising to mention that “a limited liability company with more than 300 employees, except Where a board of supervisors is established according to law and there are company employee representatives, the board of directors shall include company employee representatives; other limited liability companies may have company employee representatives among the board members. The employee representatives on the board of directors are democratically elected by the employees of the company through the employee representative meeting, employee assembly or other forms. This means that, unless the supervisory board is retained, representatives of the company’s employees will be required on the board of directors of future limited liability companies.

Theoretically, the practice of employee representatives as supervisors or directors can be traced back to the “universal sharing of control rights” emphasized by the theory of stakeholder co-governance. The so-called stakeholder doctrine here refers to emphasizing that the directors of a company should be responsible to employees, customers, suppliers, communities and the government, not just to shareholders. Professor Tirole of the University of Chicago in the United States once summarized it as two typical characteristics of “universal sharing of control rights” and “extensive social responsibility”.

We know that the reason why independent directors play an important role in the board’s performance of supervisory duties is that, compared with internal directors with professional attachments, independent directors who come from outside, part-time and pay more attention to professional reputation have lower costs to challenge board resolutions , it is more likely to issue negative opinions on proposals that harm the interests of shareholders, and truly play the supervisory function of the board of directors. It is an undeniable fact that employee supervisors who are professionally dependent cannot effectively supervise the executives and directors who determine their career destiny, which has been widely criticized in corporate governance practice. In fact, this is the reason behind the “selection” clauses of the board of supervisors and supervisors in the new round of solicitation of opinions on the revision of the Company Law.

Professor Tirole pointed out that due to the difficulties in effective implementation of the “extended scope of responsibility” and “unfulfilled responsibilities” emphasized by stakeholder doctrine, stakeholder doctrine eventually became “beautiful visions and great ideas”. I understand that participating in the sharing of company rights as employee representatives may be like stakeholderism, and often becomes at a loss in the face of a series of practical issues such as “Who is qualified to be a representative?” and “Who does she really represent?”

Regardless of the development trend of international or Chinese corporate governance practices, the role of independent (outside) directors in corporate governance is expected to be high. In companies with highly dispersed shareholdings in the United Kingdom and the United States, it has become a popular practice to have all outside directors except the CEO as the only inside director. According to a research report by Spencer Strart, among the 10.8 board members of S&P 500 companies in the US in fiscal year 2020-21, the average number of independent directors is 9.3, accounting for 86%.

Then, why independent directors become the key to the performance of the board of directors’ supervisory duties? I once saw a joke circulated on the Internet. This joke is like this: The leader told a joke, and the whole office burst into laughter. Some wiped tears, some covered their stomachs, and some beat the table. The colleague next to her smiled and asked her: Why don’t you smile? Xiaomei said: I have already resigned.

After reading this passage, my first feeling was that what was being told here was not the story of Xiaomei, but the story of the independent director.

In a nutshell, the reason why independent directors become the key to the board system is that independent directors themselves have the following three characteristics. First, independent directors come from outside. She has no direct interest relationship with insiders, and it is easier for her to make objective and neutral judgments based on the interests of small and medium shareholders. Second, the independent director is a part-timer. She has a stable career and income, and she will not bend her waist for “five buckets of rice”. When she disagrees with insiders or is even unhappy with her performance of duties, she can resign and walk away; third, independent directors are often in the professional field Successful people who have achieved something. Compared with ordinary people, she cherishes her feathers more and pays more attention to the reputation she has accumulated in the industry for a long time. Long-term career development is more attractive to her than short-term petty profits.

Of course, the independent director system, which has high hopes, is not without problems. There are still many aspects that need to be seriously improved in the future, but compared with other systems, it is easier and more convenient to improve. For example, the second review draft states that directors should be responsible for the resolutions of the board of directors. If the resolution of the board of directors violates laws, administrative regulations, the company’s articles of association, or the resolution of the shareholders’ meeting and causes serious losses to the company, the directors participating in the resolution shall be liable for compensation to the company; The director is exempt from liability. And “has expressed dissent when voting” refers to whether the director issued a negative (reserved) opinion when voting, or expressed concerns, but was finally persuaded and chose to vote for it. There are at least two or more ambiguities. This needs to be further clarified in the new round of amendments to the Company Law. The second review draft clearly encourages companies to purchase director liability insurance for directors to perform their duties, which is a positive response to the overwhelmed independent director responsibilities after the Kangmei Pharmaceutical case.

(This article only represents the author’s point of view. Responsible editor email: Tao.feng@ftchinese.com)

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