Evaluating SOE Performance: Do Top Executives Deserve Their Bonuses?

This year, China’s largest state-owned enterprises (SOEs), including China Petro, China Mobile, Sinosteel, State Grid, and other industrial giants, are facing a new 3-year Performance Evaluation policy from the Chinese state. Effective Jan. 1, 2010, this new policy requires the SOEs governed by SASAC (State-owned Assets Supervision and Administration Commission of the State Council) to calculate their net profit by taking into account the opportunity cost of capital, both debt and equity. The initial cost of capital is set as 5.5%. In essence, the concept of EVA (economic value added) is being used to evaluate the performance of the SOE top executives.  SASAC now governs 128 central SOEs, with US$3 trillion in assets, US$3 trillion in sales, and 12 million employees, concentrated in sectors of national priority, such as energy, transportation, communication, and heavy machinery (the 30 national financial companies are not governed by SASAC).

The new evaluation policy represents an attempt to constrain executive compensation at SOEs.  With the transformation of SOEs into huge profit centers over the last decade, SOE executive compensation has grown rapidly. Government officials disclosed that in 2007 senior managers earned 18 times the average pay of workers in China’s SOEs.  Although this number is well below the US ratio (360 in 2007), the official survey may well underestimate the gap. In Beijing, the annual salary of a fresh graduate is 40 to 80 thousand RMB annually, and of a middle manager in SOEs 200 to 400 thousand RMB. There are many news reports of SOE top executives who are paid more 2 million RMB. In 2006 Jiafu Wei, CEO of COSCO (HKSE 0517), was reportedly paid 18 million RMB, making him the highest paid SOE executive in China. In 2007 China Ping An Insurance Co. (HKSE 2318), an ex-SOE and publicly traded company, paid Mingze Ma, the CEO, 66 million RMB, which is 1,000 times more than an entry-level position. Executive pay in SOEs is becoming a highly controversial issue in the Chinese society, particularly with regards to companies that enjoy a position of regulated monopoly.

The new policy may restrain the compensation of top executives, as it is estimated that half of the SOEs being affected currently produced a negative EVA. But if the experience of executive pay in the United States is a guide, Chinese executives will counter with financial behavior and accounting tricks that will produce positive EVA, and justify their pay increases, even if the sustainable growth of the companies they oversee is compromised. More generally, a focus on “bottom-line” measures such as EVA is a poor way to evaluate the performance of a company. Rather, the state should provide “patient capital” to encourage sustainable growth and investment in innovation, and evaluate company performance in terms of the actual development and utilization of productive resources.

Background: Currently, there are approximately 113000 state-owned or state-controlled enterprises in China. The 128 central SOEs governed by central SASAC are among the largest corporations in China, and many of them enjoyed monopoly position or shared market with a few SOEs, as these sectors are considered of strategic importance in the national economy. Data from Ministry of Finance shows that in 2009, the total profit of SOEs (excluding the financial sector) in China was RMB1.34 trillion (approximately US$0.2 trillion) in 2009, among which RMB0.7 trillion was generated by central SOEs. Not long ago in 1998, the total profit of SOEs national wide was only RMB21.3 billion, with 2/3 of all SOEs having deficit.

The Chinaanlysis.com newsletter issue 21, April 2010 is a compact version of this article.

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About Yin Li

As a graduate student of economic development, my interest is in understanding innovation, which in my belief, the key dynamism of a modern economy. Through visionary strategy, mobilized organization, and committed resources, successful industrial enterprises generate innovations that have shaped national economy and the world we are living in. Since the beginning of 20th century, innovative enterprises have played the central role in the rise of the American, European and Japanese economy. Now a similar process is inevitably happening in China, which I am devoting this blog to.

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