Foreign Investment and Corporate Governance in China Yanni Yan Foreign Investment and Corporate Governance in China Also by Yanni Yan INTERNATIONAL JOINT VENTURES IN CHINA Foreign Investment and Corporate Governance in China Yanni Yan © Yanni Yan 2005 All rights reserved No reproduction, copy or transmission of this publication may be made without written permission No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1T 4LP Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages The author has asserted her right to be identified as the author of this work in accordance with the Copyright, Designs and Patents Act 1988 First published 2005 by PALGRAVE MACMILLAN Houndmills, Basingstoke, Hampshire RG21 6XS and 175 Fifth Avenue, New York, N.Y 10010 Companies and representatives throughout the world PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St Martin’s Press, LLC and of Palgrave Macmillan Ltd Macmillan® is a registered trademark in the United States, United Kingdom and other countries Palgrave is a registered trademark in the European Union and other countries ISBN 1–4039–4362–1 This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data Yan, Yanni, 1958– Foreign investment and corporate governance in China / Yanni Yan p cm Includes bibliographical references and index ISBN 1–4039–4362–1 Investments, Foreign—China Corporate governance—China Corporate governance—Law and legislation—China I Title HG5782.Y33 2005 332.67′3′0951—dc22 2004052230 10 14 13 12 11 10 09 08 07 06 05 Printed and bound in Great Britain by Antony Rowe Ltd, Chippenham and Eastbourne Contents List of Figures ix List of Tables x Preface xi Acknowledgements xiv List of Abbreviations Part I xvii Foreign Investment in Transitional Economies The Rise of the Transitional Economies Introduction Outlook of the transitional economies Strategic profile of foreign investment Economic profile of foreign investment Socio-cultural profile of foreign investment Foreign investment in the industrial sector Geographical distribution of foreign investment Overview of the Chinese domestic investment profile Market entry modes of foreign investment Principal issues identified Plan of the book Summary Foreign Direct Investment 3 7 10 11 13 20 22 25 26 Introduction The theory of foreign direct investment Foreign investment and economic liberalization The implications of opening Chinese markets Summary Part II 26 26 34 39 43 Building Blocks for Corporate Governance Building Blocks for National Institutions Introduction Reform of national financing 53 53 54 v vi Contents Reform of political institutions Reform of national taxation Encouraging foreign investment firms Summary Building Blocks for Corporate Governance 58 65 69 73 74 Introduction Theoretical perspectives on corporate governance Corporate governance at the national level Corporate governance at the organizational level Summary 74 74 77 84 94 Research Undertaken into Foreign Investment and Corporate Governance 95 Introduction The formation model The ownership investment model The corporate governance model The corporate culture model The organizational learning model Research measure construction Pilot study Interview procedure Sampling Choices of industrial sectors Data collection Coding Summary Part III 95 95 97 98 100 101 101 104 105 108 109 110 112 114 Managing an International Strategic Alliance Forming an International Strategic Alliance Introduction Ownership determinants: resource-based theory Ownership leverage: resource dependence theory Ownership, localization and internalization theory Developing a checklist for forming a strategic alliance Strategic motives The feasibility study Summary 119 119 119 121 123 126 129 131 138 Contents vii Ownership Investments and International Technology Transfer Introduction Ownership configuration International technology Motivation for technology transfer Process of technology transfer Absorptive capacity and technology transfer Technology transfer performance Summary Exercising the Strategic Role of the Board and Management Introduction Strategic role of the board of directors The strategic alliance’s management Summary Corporate Culture and an International Strategic Alliance in Transition Introduction National cultural model Management of corporate culture Summary 10 Organizational Learning Introduction Learning conceptualization Achieving learning advantages Dynamic organizational learning Determinants of organizational learning Learning achieved throughout an alliance’s hierarchies Summary Part IV 142 142 142 150 153 155 158 160 162 163 163 163 175 184 185 185 185 189 208 209 209 209 210 216 220 224 229 Implications for Research and Practice 11 What We Still Need to Learn Introduction Performance conceptualization Objective versus subjective performance measures Strategic alliance formation Ownership investments Corporate governance 233 233 233 237 240 242 244 viii Contents Corporate culture Organizational learning Building main themes for foreign investment and corporate governance Summary 245 246 249 252 Appendix I: Major Tax Payments for Foreign Firms in China 254 Appendix II: Interview Questionnaire for Forming an International Strategic Alliance 260 References 269 Index 276 List of Figures 1.1 1.2 2.1 2.2 3.1 4.1 5.1 7.1 8.1 8.2 9.1 9.2 10.1 10.2 10.3 Strategic investment profile in China Foreign investments and corporate governance The strategic importance of the influence of governance and economic liberalization in China An overview of foreign investments in China Building blocks for national institutions in China ‘New diamond’ of corporate governance in an international strategic alliance Research undertaken for foreign investment and corporate governance International technology transfer in an international strategic alliance Governance field analyses of international strategic alliances A general model of resource provision, key appointments and management of an international strategic alliance Exercising cultural attributes in an international strategic alliance Management of corporate culture in an international strategic alliance Organizational learning in an international strategic alliance Determinants of organizational learning Learning successes affected by an international strategic alliance’s hierarchies ix 14 23 35 41 54 77 113 153 164 174 187 191 211 221 225 References Agarwal, Sanjeev and Ramaswami, Sridhar, N 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financial control 172; staffing control 169–72; strategic orientation 168–9; strategic priorities 167–8; technological innovation 172–5 board ratio 114 Bottomore, T B 144 Buckley, P J 123 business integration 181–4 business tax 66, 256, 259 capabilities 120–1, 122–3, 149–50 capability-driven bargaining power 90 capital intensity 30 capital markets 56 reputation-building in 63 capital resources 145–6, 151 central government tax revenue 258 shared with local government 259 central region 11 Child, J 90, 172, 177 Chinese managers 8, 106, 204 perception of management of corporate culture 205–6 and recruitment 192–3, 194, 200 training 194–5 Ciborra, G 120–1 coastal cities 10–11, 39, 45, 46, 109–10 collective-owned enterprises 13, 14, 191 collectivism–individualism dimension 188 commercialization of technology 158 comparative advantage, theory of 27, 29 compensation and remuneration 197–201, 205–7 competition 42 demand condition for 77, 78, 81–2 competitive advantage of nations 28, 33–4 Confucian dynamism 189 connections (guanxi) 188–9 ‘constituency’ model of business performance 236–7 consumption tax 66, 255 context-based bargaining power 92–3 contract specifications 131 Contractor, F J 89, 96 contracts, contractual ownership 97–8 contractual resources 97–8, 148–50, 151 contractual view of the firm 60–1, 64 276 Index 277 control separation of ownership and 143–4, 144–5 staffing control 169–72 top-down 187 co-operative joint ventures (CJVs) 16–17, 41 co-ordination 89 corporate culture 22, 114, 185–208, 245–6 business integration 181 influence of national culture 185–9 international strategic alliances in transition 201–8 management of 189–201; recruitment and selection 191–4; remuneration and compensation 197–201; training and development 194–7 model 100, 249, 251–2 corporate governance 23, 24, 74–94, 114, 244–5 institution of 21–2 model 98–100, 249, 251 at the national level 77–84; demand condition for market competition 77, 78, 81–2; factor empowerment for the legal constitution 77–81; related and supporting industries 77, 78, 82–3; strategy, structure and rivalry 77, 78, 83–4 at the organizational level 78, 84–94; agency theory 78, 85–7; bargaining power theory 78, 90–4; transaction cost economics 78, 87–90 strategic role of the board of directors 164 theoretical perspectives on 74–7 ‘three rights’ 21, 150 see also institutional environment corporate headquarters level learning 225–6, 228 corporate level learning 101, 217–18, 225, 227–9 Cullen, J B 149 cultural fit 136–8, 140 culture business integration and 181 corporate see corporate culture national 22, 181, 185–9 and negotiation 127–9 socio-cultural profile of foreign investment 7–9 demand condition for market competition 77, 78, 81–2 dependence, resource 121–3, 125, 157 Deshpande, R 182–3 deutero-loop learning 101, 219–20, 224, 225–6, 228 development, training and 194–7, 200–1, 205–7 diamond of corporate governance 77–84 demand condition for market competition 77, 78, 81–2 factor empowerment for the legal constitution 77–81 related and supporting industries 77, 78, 82–3 strategy, structure and rivalry 77, 78, 83–4 diamond of national advantage 28, 33–4 directors, board of see board of directors distribution channels 133–4 division of labour 28–9 documentation, corporate 105 domestic investment 11–14 Donaldson, L 121 double-loop learning 101, 218–19, 224, 225, 226–7, 228 Dunning, J H 60, 87, 123–4, 148 dynamic organizational learning 216–20 economic change, theory of 59, 63 economic growth 4–5 economic instruments for capital flows and technology controls 35, 37–8 economic liberalization 34–8, 44–9 implications of opening Chinese markets 39–43 economic ownership 144 economic profile of foreign investment effective ownership 143–4 efficiency operational 83 transaction cost economics 87–8 egalitarianism 199, 246 278 Index Eisenhardt, K M 85 encouragement of foreign investment 14, 47, 69–73, 81 enterprise income tax 66, 259 entry modes 14–20, 68, 88 environment 236–7 institutional see institutional environment legal 75–6 socio-economic 76–7 equity-based investment 27, 29 equity-based production 27, 29–30 equity-driven bargaining power 90 equity investment 97–8, 144–5, 151 equity joint ventures (EJVs) 17–18, 41 Etzioni, A 234 excise duty 66–7, 255–6 expatriates 106, 171, 194, 195, 206–7 experience, learning gained from 221–2, 248 explicit knowledge 152, 222–3 export-oriented firms 35, 37, 67, 67–8, 71–3 factor empowerment for the legal constitution 77–81 factor proportion theory 27, 30–1 fair dealing 91–2 feasibility study 131–8, 140 partner firms’ ownership 131–2, 140 partners’ potential contributions 132–5, 140 prospective projects 135–8, 140 femininity–masculinity dimension 188 financial control 172 financial guarantees 56 financial orientations 189, 190 financial performance measures 237–40 financial services sector 55, 56–7 financial system, national 54–8 first-order learning 101 see also corporate level learning foreign direct investment (FDI) 22, 23, 26–50 and economic liberalization 34–8 economic profile encouragement of 14, 47, 69–73, 81 geographical distribution 10–11 implications of opening Chinese markets 39–43 indicators for a research framework 249–52 industrial sector distribution 9–10 market entry modes 14–20 overview of FDI in China 41–3 policies 7, 11, 41, 43, 44–9 socio-cultural profile 7–9 strategic profile 5–6 theory of 26–34 Foreign Investment Enterprise and Foreign Enterprise Income Tax Law 45, 67, 68, 69, 70 Foreign Investment Enterprise and Foreign Enterprise Income Tax Law Implementation Rules 68 foreign managers 106, 171, 194, 195, 206–7 foreign-owned firms (FOFs) 13, 14 formation learning 222–3 formation model 95–7, 249–50 see also alliance formation ‘four modernizations’ 44 franchising 15, 41 free trade 81 Fuller, M B 96 geographical distribution of foreign investment 10–11 Geringer, J M 97, 99 goal congruence 132 ‘goal’ model of business performance 234–5 Gomes-Casseres, B 90 governance field analyses 164 governance model 98–100, 249, 251 see also corporate governance government employees, recruitment of 191–2 government loans 55–6 government policy 4–5, economic liberalization 34–8; implications of opening Chinese markets 39–43 FDI policies 7, 11, 41, 43, 44–9; encouragement of FDI 14, 47, 69–73, 81 TCE and 88 and technology transfer 156, 159 see also taxation Gray, B 92, 99, 145–6, 146 growth, economic 4–5 guanxi (connections) 188–9 Guo, A 149 Index 279 Hall, W 148 Harrigan, K R 121 headquarters, corporate 225–6, 228 Heckscher–Ohlin (H–O) model 27, 30–1 Hennart, J.-F 88 hierarchies, learning throughout 224–9 high-tech-oriented firms 35, 37, 67, 67–8, 70–1, 72–3, 109 Hofstede, G 186 Hong Kong 43 host country nationals 171 Hughes, M 145 human resource management 189–201, 202 recruitment and selection 191–4, 201, 201–2, 205–7 remuneration and compensation 197–201, 205–7 training and development 194–7, 200–1, 205–7 human resources managing a multicultural workforce 175–7 operational fit 138 Huselid, M A 182 implicit knowledge 152, 222–3 import substitution 72 import tariff rate 66–7, 256 incentives 41 tax 67–8 income tax enterprise income tax 66, 259 on enterprises with foreign investment 259 on foreign firms 66, 67, 67–8, 256–7, 259 individual 66, 257 individualism–collectivism dimension 188 Industrial Catalogue Guiding Foreign Investment 47, 48 industrial sectors choices for research 109–10 distribution of FDI 9–10 targeting policy 39–40, 72–3 industry-based learning 214–16 information exchange and alliance formation 127–8 sharing in a strategic alliance 179–80 infrastructure 83 infrastructure-related projects 35, 36 Inkpen, A C 213 innovation 33 board of directors and technological innovation 172–5 institutional economics 96–7 institutional environment 21–2, 53–73, 89–90 encouragement of foreign investment 14, 47, 69–73, 81 market institutional dimensions 75 national financing 54–8 national taxation 7, 14, 65–8, 254–9 political institutions 58–64 intangible resources 90–1, 243 integration, business 181–4 intellectual property rights 35, 36, 38, 60, 82, 161, 173 Interim Regulations on FDI Directions 47 internalization 243–4 international investment, theory of 27, 29–30 international joint ventures (IJVs) 6, 45 co-operative 16–17, 41 equity 17–18, 41 international production, theory of 27, 30 international strategic alliances 8–9, 12, 24 board of directors see board of directors corporate culture see corporate culture formation see alliance formation learning in 211–13, 216 management 8–9, 174–5, 175–84, 240; business integration 181–4; feasibility study 135; localization strategies 177–9; multicultural workforce 175–7; reporting systems 179–80 organizational learning see organizational learning political institutional environment 59, 60–2 technology transfer see technology transfer in transition 201–8 280 Index inter-partner learning 213–14, 216, 220 inter-personal relationships 200 interviews interview procedure 105–8, 111–12 questionnaire for alliance formation 260–8 research measure construction 101–4 irreversible assets 122–3 Janger, A R 100 Johnson, J L 149 joint planning 136 joint ventures see international joint ventures Killing, J P 88 knowledge explicit and tacit 152, 222–3 local 92, 135 resources, capabilities and 120–1, 122–3 Kogut, B 89 labour division of 28–9 intensity 30 land appreciation tax 258 Land Use Rights 131 learning model 101, 249, 252 see also organizational learning Lecraw, D J 92 legal constitution, factor empowerment for 77–81 legal environment 75–6 liberalization, economic see economic liberalization licensing 15–16, 41 loans, government 55–6 local context/local sourcing 36–7, 40, 178, 248 local firm-specific resources 59, 92 local government level learning 225, 226–7, 228 local government tax revenue 258 shared with central government 259 local knowledge 92, 135 localization advantages 60, 123–5 localization strategies 60, 177–9 long-term strategic orientation 169, 189, 190 Lorange, P 96, 122 loyalty 193–4, 204 Lyles, M A 219 management separation from ownership 144–5 strategic alliances see international strategic alliances managerial expertise 147–8, 170 managers Chinese see Chinese managers foreign 106, 171, 194, 195, 206–7 general manager 170–1 senior managers 169, 170, 171, 175 styles 106 and technology transfer 147, 154 manufacturing sector 9–10 market competition see competition market entry 58, 80–1 modes 14–20, 68, 88 regulation 83–4 market expansion 57–8 market imperfections 123–4 masculinity–femininity dimension 188 McQueen, M 148 Means, G C 79, 85, 143–4 merit-based wage systems 198 Mintzberg, H 90 modern corporatization 12 Morgan, S 98, 142–3 multicultural workforce 175–7 national bias 107 national culture 22, 181, 185–9 dimensions 186–9 and negotiation 127–9 national institutions see institutional environment negotiation 127–9, 212 networks guanxi 188–9 resource dependence theory and network density 122 new product development 162 nominal ownership 143, 145 non-capital resources 146–8, 151 non-contractual resources 97–8, 148–50, 151 non-partner-related resources and capabilities 132, 134–5, 140 Nonaka, I 149 normative institutions 75 Index 281 objective performance measures 237–40 obsolescence bargaining 247 Ohlin, B G 27, 30–1 one-stop administrative services 35, 38 open coastal cities (OCCs) 10–11, 39, 45, 46, 109–10 open economic zones (OEZs) 45, 47 operational efficiency 83 operational fit 138, 140 operational learning 223–4 organizational capabilities 120–1, 122–3, 149–50 organizational learning 22, 114, 209–29, 246–8 achieving learning advantages 210–16 determinants of 220–4 dynamic 216–20 in an international strategic alliance 211–13, 216 learning achieved throughout hierarchies 224–9; central government/corporate headquarters level 225–6, 228; corporate level 101, 217–18, 225, 227–9; local government/ regional office level 225, 226–7, 228 learning conceptualization 209–10 model 101, 249, 252 overseas training 194–5 ownership 88 advantages and bargaining power 93–4 determinants 119–21, 125 leverage 121–3, 125 partner firms’ ownership 131–2, 140 rights 142–3 ownership configuration 21, 142–50 capital resources 145–6, 151 contractual resources 148–50, 151 equity investment 144–5, 151 non-capital resources 146–8, 151 non-contractual resources 148–50, 151 ownership investments 113–14, 242–4 see also ownership configuration ownership, localization and internalization (OLI) theory 60, 123–5 ownership model 97–8, 249, 250–1 partner firms’ ownership 131–2, 140 partner-related resources and capabilities 132, 133–4, 140, 243 partner search 241 partners’ potential contributions 132–5, 140 performance 233–53 alliance formation 240–2 conceptualization 233–7 corporate culture 245–6 corporate governance 244–5 effectiveness 205–7 objective v subjective measures 237–40 organizational learning 246–8 ownership investments 242–4 research indicators 249–52 of technology transfer 153, 160–2 Pfeffer, J 121 physical resources 138 Pierce, J L 98, 142–3 pilot study 104–5 policy-incentive measures 35–6 political institutions 58–64 Porter, M E 27, 33, 77, 96, 215 potential contributions, partners’ 132–5, 140 power distance 186–7, 204 pragmatism 189, 190 preferential tax 65–7 principal–agent relationship 63, 78, 85–7 private-owned enterprises (POEs) 13, 14 procedures, rules and regulations 182 product development 162 product life cycle (PLC) 28, 31–3 production costs 87 production-oriented firms 35, 37, 67, 67–8, 69–70, 72–3 property rights 143–4 quality of resources 241 questionnaire survey 110–11, 260–8 Ramaswami, S N 124 regional development 84 regional targeting policy 72–3 regulation economic liberalization and FDI 35–8 market entry 83–4 regulatory institutions 75 282 Index related and supporting industries 77, 78, 82–3 remuneration and compensation 197–201, 205–7 Renner, K 143, 146 reporting systems 179–80 representative offices 14 reputation-building 63 research and development (R&D) grants 156 research indicators 249–52 research institutes 155 research methodology 24, 95–115 choices of industrial sectors 109–10 coding 112–14 corporate culture model 100 corporate governance model 98–100 data collection 110–12 formation model 95–7 interview procedure 105–8 organizational learning model 101 ownership model 97–8 pilot study 104–5 research measure construction 101–4 sampling 108–9 resource-based bargaining power 92–3 resource-based view of the firm 119–21, 125, 242–3 resource dependence theory 121–3, 125, 157 resource-driven bargaining power 90–1 resource tax 66, 259 resources capabilities, knowledge and 120–1, 122–3 capital 145–6, 151 contractual 97–8, 148–50, 151 deficiencies 247, 250 distribution 58–9 human see human resource management; human resources intangible 90–1, 243 non-capital 146–8, 151 non-contractual 97–8, 148–50, 151 non-partner-related 132, 134–5, 140 partner-related 132, 133–4, 140, 243 physical 138 provision of 174–5 quality of 241 tangible 90–1, 243 retention 197–8, 200, 201–2 Ricardo, D 27, 29 risk 62 role theory 245–6 Roos, J 122 Rubel, M 144 Rubenfeld, S A 98, 142–3 Rugman, A M 87, 124, 148 rules, regulations and procedures 182 Sakano, T 149 Salancik, G R 121 sampling 108–9 Schaan, J.-L 99 Schön, D A 219 Scott, J 75, 143, 144, 145 Seashore, S E 236 sectors, industrial see industrial sectors selection, recruitment and 191–4, 201, 201–2, 205–7 semi-structured interviews 103, 104 senior management 169, 170, 171, 175 services sector 10, 109 shareholders/stakeholders 79 shareholding system 13 single-loop learning 101, 217–18, 225, 227–9 Smiley, R H 96 ‘social goal’ training 195–6 socio-cultural profile of foreign investment 7–9 socio-economic environment 76–7 special economic zones (SEZs) 39, 45, 109–10 specialization 28–9 staff development 194–7, 200–1, 205–7 state-owned commercial banks 57 state-owned enterprises (SOEs) 11–13, 14, 191 strategic alliances see international strategic alliances strategic assets 132 strategic fit 59, 135–6, 140 strategic level learning 101, 219–20, 224, 225–6, 228 strategic management theory 96–7 strategic motives 129–31 strategic objectives 129–31, 240–1 strategic orientation 168–9 strategic positioning 96 strategic priorities 167–8 Index 283 strategic profile of foreign investment 5–6 strategy, structure and rivalry 77, 78, 83–4 subjective performance measures 237–40 subsidies 198–9 suppliers 178–9 supporting industries 77, 78, 82–3 surveys 101–2, 110–11 system level learning 101, 218–19, 224, 225, 226–7, 228 ‘system’ model of business performance 235–6 tacit knowledge 152, 222–3 Takeuchi, H 149 tangible resources 90–1, 243 taxation 7, 14, 65–8 encouraging foreign investment 69–73 major tax payments for foreign firms 254–9 preferential tax 65–7 tax incentives and rewards 67–8 technical level learning 101, 217–18, 225, 227–9 technical ownership 144 technical training 195 technological skills 170 technology 135 board of directors and technological innovation 172–5 commercialization 158 economic instruments for technology controls 35, 37–8 non-capital resources 147–8 technology development projects 157 technology licences 158 technology-oriented firms 35, 37, 67, 67–8, 70–1, 72–3, 109 technology ownership 98 technology support 156 technology transfer 21, 129, 150–62 absorptive capacity and 158–60, 173 licensing 15–16 motivation for 153, 153–5 performance 153, 160–2 process 153, 155–8 TCE analysis 88–9 Teece, D 88–9, 158 Thompson, J D 236 ‘three governance rights’ 21, 150 Ting, W L 97 top-down control 187 training and development 194–7, 200–1, 205–7 transaction cost economics (TCE) 78, 87–90, 220 transactional market imperfections 124 transfer pricing 86 transitional economies 3–25 Chinese domestic investment 11–14 economic profile of FDI foreign investment in 22 foreign investment in industrial sector 9–10 geographical distribution of FDI 10–11 market entry modes 14–20 outlook of 3–5 principal issues 20–2 socio-cultural profile of FDI 7–9 strategic profile of FDI 5–6 trust 177, 182–3, 226 uncertainty avoidance 188–9 urban real estate tax 66, 258 Vachani, S 92 value-added tax (VAT) 259 Verbeke, A 87 Vernon, R 27, 32 66, 254–5, Webster, F 182–3 Weitz, B 148 wholly-owned subsidiaries (WOSs) 19–20, 41 Williamson, O E 87, 145, 146–7, 164, 172 World Trade Organization (WTO) 3, 6, 40–1 Yan, A 92, 99, 145–6, 146 Yan, Y 172, 177 Yin, R K 101, 104 Yuchtman, E 236 .. .Foreign Investment and Corporate Governance in China Also by Yanni Yan INTERNATIONAL JOINT VENTURES IN CHINA Foreign Investment and Corporate Governance in China Yanni Yan © Yanni... profile in China Foreign investments and corporate governance The strategic importance of the influence of governance and economic liberalization in China An overview of foreign investments in China. .. to foreign investments including domestic retail, banking and insurance Foreign investment in agriculture and infrastructure remains small Despite all the changes in the industrial sector investment