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An Empirical Study of Corruption within China's State-owned Enterprises Author(s): Wenhao Cheng Source: China Review, Vol. 4, No. 2, Special Issue on: Corruption in China (Fall 2004), pp. 55-80Published by: Chinese University PressStable URL: http://www.jstor.org/stable/23461884Accessed: 23-09-2015 23:14 UTC

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The China Review, Vol. 4, No. 2 (Fall 2004), 55-80

An Empirical Study of Corruption within Chinays State-owned

Enterprises

Wenhao Cheng

Abstract

China's state-owned enterprises (SOEs) have been harmed greatly by

corrupt practices committed by insiders, especially those by the general

managers. This article explores why SOE general managers abuse their

power and how they manage to do so. First of all, the author argues that

given the very limited income provided by the enterprises, many

managers have developed strong incentives to enrich themselves by

abusing their power. Second, decentralizati on of the managerial power of

SOEs, which is an important reform policy, enables general managers to

control the most lucrative activities of the enterprises. Various corrupt

opportunities, including both those given by the system and the ones

general managers have created, further facilitate their corrupt practices,

and the institutional weakness of existing supervision systems provides a

relatively safe environment for the general managers' adventures. It is the

combination of all of these factors that has led to rampant corruption

within China's SOEs.

Wenhao CHENG is an Associate Professor at the School of Public Policy and

Management, Tsinghua University. He received his BA in International Politics

from Peking University in 1996 and his doctoral degree in Political Science from

Yale University in 2002. His research covers a number of important topics such as

governance, corruption control, electronic government, etc. He also founded the

Anti-corruption and Governance Research Center of Tsinghua University in 2000.



56 Wenhao Cheng

It takes more than one person to make a state-owned enterprise prosper, but it

only takes one person to totally destroy it.

Researchers into Chinese corruption have paid relatively little attention to

corruption within China's SOEs, an issue that we cannot afford to ignore. State-owned enterprises, which form the foundation of China's public sector, actually play three roles in corruption. First, many of them have

suffered greatly from corruption committed by insiders. Second, individual

state-owned enterprises, just like their counterparts in the private sector, often engage in corrupt practices themselves. For instance, many of them

are willing to bribe officials in order to obtain loans, quotas and

government contracts, when these resources are open for competition

because of market reform.

The third role played by SOEs, which researchers tend to ignore, is that they sometimes assist the corrupt practices of public officials by providing false receipts, bank accounts, and similar documents to them. To

function and to profit, every enterprise has large numbers of bank transactions and large amounts of cash flow that are difficult for outside

groups to monitor. At the same time, enterprises are subject to less financial oversight than government agencies, because they are supposed to make decisions freely based on the best judgment of the managers. Therefore, in the eyes of corrupt officials, enterprises are a safe haven for

hiding, transferring, and laundering their corrupt proceeds. Thus, although SOEs often suffer from corruption perpetrated by

insiders, they also engage in corrupt practices themselves, at times, and facilitate the deals of public officials, simultaneously playing multiple roles in corruption. This article will focus on corruption on the part of insiders in order to see how corrupt practices could be committed in the first place, and why existing supervision systems failed to prevent them from happening.

How Serious Is the Problem?

On the surface, corruption within SOEs can be demonstrated by the

extravagant life-style of many SOE managers. One survey showed that

among one hundred SOE managers in Shenyang, the capital city of

Liaoning Province, 70% had bought big houses for themselves and 82% had obtained luxurious business cars using public funds after assuming the

position.1 An investigation carried out by government agencies into 400 entertainment facilities located in six capital cities led to the surprising



An Empirical Study of Corruption within China's State-owned Enterprises 57

finding that as much as 60% of their total revenues came from SOEs. And

sometimes their spending became very extravagant. For example, one

entertainment centre in Xi'an City introduced a very luxurious service

package named "You are the Emperor." The package included 15 different

entertainment programmes that lasted for a total of 8 hours and was priced at RMB5,000. Rich people rushed to bid for the title of "the first Emperor" at auction. The general manager of one loss-making SOE eventually won

the title with a bid of RMB68,888.2 By way of comparison, in the

meantime, the average yearly income of SOE workers in that province was

RMB6,230.3 In addition to the wilful spending of SOE managers, Chinese SOEs

also suffer greatly from the three major types of corruption in China: graft,

bribery and embezzlement. From 1999 to early 2000, corruption cases

handled by People's Procuratorates at all levels involved more than 15.000

suspects that worked for SOEs. More than 12,000 of these cases involved

graft or bribes of over RMB50,000 or embezzlement of over RMB 100,000.

There were also 570 cases involving graft and bribes of more than

RMB500,000 and 790 cases involving embezzlement of over RMB1

million.4

Rampant corruption within SOEs can also be demonstrated by the

official statistics of localities. From 2000 to September 2001, the People's Procuratorate of Beijing registered 512 graft and bribery cases occurring in

SOEs, accounting for 60% of all cases it registered in that period.5 In the

first half of 2001 alone, the People's Procuratorate of Shanghai registered 209 graft and embezzlement cases involving SOE personnel, accounting

for 71% of all cases it registered in the period.6 In some cases, corruption within SOEs became so devastating that it

pushed the enterprises to the brink of bankruptcy. In recent years, the

correlation between corruption within SOEs and the financial losses they

made has almost become a rule. For instance, the People's Procuratorate of

the Baoshan District of Shanghai, China's largest industrial city, has

successfully broken 24 graft and bribery cases in 12 loss-making SOEs.7

Jiangyin City in Jiangsu Province once launched a campaign specifically to

target the so-called "rich monks in poor temples" phenomenon. Within two

months, investigators had identified 33 corrupt managers within 33

enterprises that were losing money for unexplainable reasons.8

After reviewing the current situation of corruption within SOEs, it is

logical to raise three questions. First, why has corruption within SOEs

become so rampant? Second, who carried out those corrupt practices, and



58 Wenhao Cheng

how did they succeed in doing so? Third, is there any connection between

corruption in SOEs and certain reform policies that have been introduced

in the last two decades? These are the questions that I will address in the

following part of this article.

Case studies are extremely helpful in explaining why corruption is so

rampant in SOEs. I have successfully collected 264 SOE corruption cases

published by the Justice Network of Procuratorate Daily (www.jcrb.com. cn) from 1999 to 2001.1 found that these cases not only point to the general trends of SOE corruption, but also provide detailed information about how

those practices were completed. Thus, the analyses which follow rely

heavily on these cases.

Who Engaged in Corrupt Practices within SOEs?

In theory, three types of SOE employees are able to engage in corrupt

practices. First of all, ordinary workers may have opportunities to steal

public funds. They include accountants, cashiers, and sales representatives. Although these people do not hold substantial managerial power, they are the persons who come into contact with those resources that flow in and out of the enterprises on a daily basis. Therefore, there are times at which they can steal money by taking advantage of their low positions in the command chain and of the information asymmetry problem that is built into the

system. They could do so in various ways, including forging financial

records, hiding revenues, and secretly cutting spending. Among the 264 SOE corruption cases I collected, 38 involve corrupt

practices on the part of ordinary workers. As Figure 1 shows, accountants were responsible for 21 out of the 38 cases, while sales persons and fee collectors contributed 9 and 4 cases respectively. It seems that accountants

are better positioned than others to abuse their power.

Middle-level staff are another group of people who are more likely to

engage in corrupt practices. Unlike ordinary workers, they hold genuine managerial power, especially the power to distribute certain types of resources. For example, modern industrial production is a very

complicated process that often requires various supporting activities,

including purchasing raw materials and equipment, improving technologies, producing and selling products. As a result, industrial

enterprises often have a distribution of labour arrangement among middle level staff. They usually have several directors, each of whom is in charge of a certain aspect of the enterprise such as procurement, sales, and




Figure 1

Others

Fee Collectors

Sales

Accountants 21

10 15

Number of Cases

20 25

financial management. Figure 2 describes the distribution of labour

between top and middle-level staff in one typical Chinese SOE.

Although the directors work under the direct guidance of the general

manager, they also enjoy a certain freedom of action when handling issues

falling into their sphere of responsibility. This freedom is usually authorized by the senior management, which wants them to respond

quickly to changing situations. But sometimes directors can abuse their

power by taking advantage of their relative autonomy and by withholding critical information about their work. For instance, directors of

procurement can always find a number of suppliers with whom to bargain. When these suppliers have similar qualifications and they ask for roughly the same prices, it is relatively safe for directors of procurement to choose

Figure 2



60 Wenhao Cheng

the one who offers the most kickbacks. And directors of finance can

sometimes hide some sorts of irregular revenues that are known only to

them and a few accountants. They could then wait for a while and finally

keep the money for themselves.

Because the operation of modern enterprises, especially that of the

really huge ones, involves numerous activities, senior managers are simply not able to monitor every activity closely. The more layers there are in a

hierarchic arrangement, the more information will be withheld when it is

transmitted to the top. Therefore, even in a SOE that is under the tight control of an astute general manager, there is plenty of room for middle

level staff to make self-serving arrangements.

Among the 264 SOE corruption cases that I have collected, 49

involved the corrupt practices of directors. Figure 3 reflects the distribution

of the cases among different departments.

Figure 3

Construction

Procurement & Supply

Sales

Others

Finance

15

3

4

8

19

i i t 10 15 20

Number of Cases

As Figure 3 shows, finance (19) and sales (8) are the two single biggest contributors to the corruption cases. This is understandable, because

directors of finance have easy access to large amounts of cash flow.

The financial management sector as a whole has contributed 40 cases

to the 87 corruption cases involving ordinary employees and directors,

including the 21 cases involving ordinary accountants. This confirms that

financial management is the most vulnerable part of China's SOEs.




The third group of corruption perpetrators are SOE managers,

including both the general managers and vice managers. Because vice

managers are often entrusted to supervise the operation of multiple

departments, they have much more discretionary power than department heads. Thus, they can make corrupt deals either by bargaining with

outsiders individually, or by colluding with directors under their control.

In Chinese SOEs, however, it is general managers who not only

possess the most decision-making power but also have the most

opportunities to enrich themselves. Official statistics, for example, show

that general managers are responsible for a substantial proportion of

corrupt practices taking place within SOEs. The People's Procuratorate of

Liaoning Province investigated the wrongdoings of 2,226 SOE employees from 1997 to June 2000, and 1,067 of them were general managers.9 In

2000, Wuxi City in Jiangsu Province uncovered 52 corruption cases in

state-owned enterprises that were performing poorly and punished 56

persons, of whom 41 were general managers.

The cases I have collected can also prove this point. As Figure 4

shows, general managers alone have contributed 117 cases, 44.3% of the

total 264 cases. And general managers and vice managers together contributed 145 cases, or 54.92% of all cases. The percentage is

disproportionately high.

Corruption cases involving general managers not only account for a

Figure 4

Other 1

Party Official □ 6

Sub 1 25

Vice Manager J 28

Ordinary Worker 38

Director 1 49

General Manager 1 1 1 1 1 1

0 20 40 60 80 100 120 140

Number of Cases



62 Wenhao Cheng

large portion of the total SOE corruption cases, they also often involve

large amounts of money. For instance, among the 32 big cases (graft or

bribery cases involving more than RMB50,000, or embezzlement cases

involving more than RMB 100,000) that have been registered in Xianyang City, Shanxi Province in the last three years, about 60% involved general

managers.

My research also confirms this point. On average, the 117 general

manager cases involve RMB3.03 million in graft, RMB7.34 million in

bribes, and RMB21.26 million in embezzlement. By way of comparison, the 18 cases of bribery by powerful local bank officials (14 were directors or vice directors of the banks) that I studied involved RMB0.742 million on

average, about one tenth of the total amount received by SOE general managers. In other words, general managers of state-owned enterprises can

sometimes extract many more bribes from the business activities of the

enterprises than bank officials can from the precious bank credits they control. This comparison alone proves that these managers do in fact control enormous economic resources.

Besides the large amounts of money involved in their corrupt practices, general managers also tend to engage in many types of

corruption. According to my calculation, 47 out of the 117 cases involve two or more core types of corruption, with 9 cases involving graft, bribe

taking and embezzlement. This confirms the rule that "bad things often come together," and Figure 5 shows the percentage of different combinations of corruption types in the 117 cases.

By all standards, then, general managers are the main perpetrators of

corruption within SOEs, and they therefore deserve to be the focus of any systematic research on SOE corruption.

Three questions surface when we focus on the corrupt activities of

SOE general managers. First, why would SOE general managers abuse their power? Second, how are they able to abuse their power successfully? Third, why have existing supervision systems failed to contain their

corrupt practices? I will address these questions one by one in the

following section.

Why Would SOE Managers Abuse Their Power?

Both strong incentives and adequate opportunities are required for an individual to engage in corrupt practices. Thus, one direct reason for SOE

managers to abuse their power for personal gain is that they have strong




Figure 5

G.B&E

B&E

Embezzlement

G&E

G&B

Graft

Taking Bribes

1 "1 1 9

10

1 13

1 14

14

20

J 31 1 I T 1 1

□ Series I

10 15 20 25 30 35

Number of Cases

Notes: B = Bribes, E = Embezzlement, G = Graft.

incentives to do so. As rational persons, they would find strong incentives

to corruption only when the expected benefits for abusing their power far exceed the expected costs. Let us now find out how they reach such a

conclusion.

As I mentioned at the beginning of this article, SOE managers and staff

have dual identities. They are not only employees of enterprises, but also

enjoy the status of cadres (gan bu). As cadres, it is possible for SOE

managers to assume party or government positions at some time in the

future and hence they need to consider carefully both their economic and

political interests before abusing their power. Let us first take a look at their economic interests.

The legal income of an SOE manager usually consists of two parts, the

basic salary (jiben gongzi), and a bonus. As a cadre, the manager's basic

salary is mainly determined by the executive rank held rather than the

financial strength of the enterprises he/she leads. Frankly speaking, managers' salaries are very limited, if their capabilities and responsibilities are taken into consideration. Although bonuses complement their salaries,

they are not very substantial. For example, from 1979 to the mid-1990s, the "Chinese Tobacco King" Chu Shijian successfully converted a small



64 Wenhao Cheng

cigarette factory he led into the most profitable SOE in China. During Chu's tenure, the factory contributed tax revenues totalling RMB20 billion

to the state each year. However, despite his great contributions, in 1990 Chu's basic salary was only RMB480 per month. With his bonus also taken

into account, his total monthly income was only RMB 1,000.10 Low pay is a problem that bothers almost every SOE manager in

China. Yu Zhi'an, former general manager of Changjiang Energy Group of Hubei Province, embezzled US$10 million to establish a private electricity company in the Philippines. He then fled to the Philippines to manage his

private business. Because Yu, Chu and many other influential SOE

managers began to abuse power when they approached the retirement age of 60, their fall has been called the "Age 59 Phenomenon" in China. One common explanation for the phenomenon points to the low pay SOE

managers receive.

In addition to their low pay, SOE managers also face two gaps. One is between their legal income and that of private businessmen of similar

background. While the People's Republic of China remained a highly egalitarian society for the first three decades of its history, more recent economic reform has led to the emergence and widening of the income

gap. According to Forbes, the total assets of the Top 50 richest persons in mainland China in 2001 amount to US$13 billion. And the richest family on the mainland, peasant entrepreneur Liu Yonghao and his brothers, is

reported to own assets totalling US$1 billion." Although SOE managers are usually better educated and trained than private entrepreneurs, their

legal income only accounts for a tiny portion of that of the latter. Under these circumstances, it is not unexpected that some SOE managers will feel that they are treated unfairly by the state.

The other gap facing China's SOE managers is the one between their

legal income and the enormous economic resources under their control.

One objective of China's SOE reform is to reduce government intervention in SOE operation and to allow managers to enjoy a high degree of

autonomy when making managerial decisions. To achieve this end, the state has continuously decentralized decision-making powers to SOEs. As a result, managers have gained control over almost every critical aspect of

SOE operation, including procurement, production, sales, and financial

management. As a result, the decentralization process has actually

transferred enormous resources from government control to the hands of

SOE managers. This has directly increased their expected benefits from

corrupt practices, if they choose to abuse their newly gained power.




The three factors mentioned above have jointly provided some SOE

managers with strong incentives to engage in corruption. Thus far, we have

reviewed the economic interests of SOE managers and how they play a role

in the cost-benefit calculations of these managers. In fact, SOE managers also need to take their political interests into account before they decide to

abuse their power. Because appointment and promotion of managers is

carried out by government agencies that oversee the enterprises in

question, whether or not managers can continue enriching themselves

depends heavily on their personal relations with their superiors. As long the relations remains close, managers can expect to stay in office, or be

promoted, even if their performance is very poor indeed. For this reason,

SOE managers have spent substantial time and resources on pleasing their

superiors, including sending bribes and facilitating the corrupt deals of the

latter. As a result, the appointment of many incapable and/or apparently

corrupt mangers to leadership positions at other SOEs, or even their

promotion to government positions, is a frequent occurrence, despite

workers' complaints about their poor performance and corruption.

The record-breaking case of Xia Renfan, former general manager of

the Shenyang Passenger Transportation Group, is a very good example.

During his tenure, Xia appropriated RMB8.34 million for himself,

embezzled RMB 18.38 million, and received bribes worth RMB668.314.

He even owned a private villa that covers an area of 210 acres, costing over

RMB20 million and taking three years to build. To secure his position and

to be promoted, Xia repeatedly bribed the then mayor of Shenyang, Mu

Suixin, with US$30,000, a watch worth RMB90,000, and RMB50,000 in

cash. Mu then strongly recommended Xia to be appointed as the director of

the Shenyang Transportation Bureau, but his proposal did not go through because of the resolute resistance of all the leaders of the Bureau. The then

director of the Bureau even resigned voluntarily to show his opposition.

Although workers in Xia's group have repeatedly reported his

wrongdoings to anti-corruption agencies, the latter could take no action

because of the interference of Mayor Mu. It was not until Mu himself was

caught in early 2001 that investigators could officially start to process Xia's cases.12 Xia was finally prosecuted on four criminal charges.

This case shows how a corrupt relationship between SOE managers and their superiors can secure their position and power. Thus, generally

speaking, managers need not worry very much about their political future

as long as their superiors still trust them and the and-corruption agencies do not have solid evidence to prove they are corrupt. As long as their



66 Wenhao Cheng

political status is secure, managers have a relatively stable context in which

to cash in on their managerial power. Add to this the low pay that they receive, which makes them feel that they have nothing to lose, and the

combination of all these factors leads to the intensification of their

incentives to corruption.

How Could General Managers Abuse Their Power

Successfully?

Incentives to corruption do not equal real corrupt activities. Thus, after

studying the reasons why strong incentives develop for general managers to abuse their power, it is logical to consider how the managers could abuse their power successfully. My answer to this question consists of three parts. First of all, general managers had more resources to steal after the

economic reform started. Second, SOE reform has granted them more

autonomy in managing and distributing these resources. Third, they have identified ample opportunities for corruption and created even more of them using their legitimate power. These opportunities, combined with their managerial power, have made possible large-scale corrupt practices. I will address the three points one by one in what follows.

Increased Resources

Although the SOE sector as a whole has declined in relation to the private sector, many state-owned enterprises currently own many more fixed

assets and circulating funds than they did before the economic reform started. For most of the pre-reform years, SOEs were forbidden to keep the

profits that they made. Instead, they had to turn in almost all of their profits to the government and apply for funds when they needed to spend them.

SOEs were at one point allowed to make decisions freely on purchases of less than RMB200 only. For any purchase larger than that, they had to seek the approval of the relevant government agencies.13 Thus, the financial freedom of SOEs was extremely limited during that time.

Such a tight financial control imposed by the government greatly limited the autonomy of SOEs to operate and make decisions. Having fully recognized the negative consequences of this problem, in 1978 the state

began to experiment with some new financial arrangements between SOEs and the government. Under the new arrangements, state-owned enterprises

were allowed to keep a small portion of the profits they made.14 In 1983,




the state furthered the reform by converting profit submission into tax contribution. In other words, SOEs could now keep the profits and pay

taxes based on state-set rates, instead of turning in most profits to the

government and then letting the latter decide if they could use some of the

funds for certain purposes. This reform has greatly increased the financial

resources that SOEs can keep, manage and spend. SOEs have another important source of financial resources: bank

credits. Because China's national banks favour state-owned firms when

issuing loans, a substantial portion of the total loans they made went to

SOEs. Until 1993, industrial and commercial SOEs received about half of

all the loans issued by China's major financial institutions each year.

Although the percentage has continued to decline since then and was only 35% in 2000, the absolute amount of the loans SOEs receive is still

increasing. The consistent inflow of bank credits, combined with the profits that

SOEs can keep for themselves, have substantially increased the financial

resources available to SOEs. Meanwhile, the total fixed assets of SOEs

have also grown steadily, owing mainly to the investments they have made

repeatedly in equipment, production plant, etc. Figure 6 reflects the robust

increases of both SOEs' circulating funds and their fixed assets.

Increased resources have clear implications for the corrupt practices of

Figure 6

Sources: Zhongguo tongji nianjian 1993 (China Statistical Yearbook, 1993), p. 430; and China

Statistical Yearbook, 1994-1999.



68 Wenhao Cheng

SOE general managers. When the enterprises they lead now own

circulating funds of millions and valuable fixed assets, in theory general

managers have many more things to steal or trade with outsiders. The only

problem which remains is how they could manage to do so. Unfortunately, it is relatively easy for general managers to graft and embezzle those

resources, because they have a virtual monopoly of various managerial

powers.

Expanded Power

Before the economic reform started, state-owned enterprises were tightly controlled by the state. Under the central planning system, SOE managers could not independently decide whom to hire, what to produce, or the

selling prices of their products. Instead, they always had to obtain approval from the relevant oversight agencies before they could implement any

plan. The state also took over most of the critical activities of enterprises.

For instance, it was responsible for supplying raw materials, selling all

products, setting prices, appointing staff, and even setting salary levels. Under these circumstances, the limited power of general managers was further restricted to the internal management of the enterprises, and it did not enable them to interact with the outside world. In other words, they were simply not able to touch the most lucrative activities of the

enterprises, let alone benefit from them.

Such controls inevitably made China's SOE sector very stagnant. Because the state took care of almost everything, state-owned enterprises

finally lost the incentive to innovate and improve themselves. This

problem had bothered China for decades before the reforms of the urban

economy were officially launched in 1984. Having fully recognized the

negative consequences caused by heavy state control, reformers decided to

gradually reduce government interference in SOE operations. The first step was to increase the freedom of SOEs to handle their financial resources. But reformers soon recognized that in order to convert SOEs into real

enterprises that could operate independently, they had to decentralize more

decision-making power and let enterprises themselves make most major

decisions. The Law of Industrial State-owned Enterprises,15 which came into force in 1988, granted SOEs the legal right to make critical decisions. In 1992, the state made another drastic move by decentralizing fourteen

decision-making powers to SOEs.16




These decentralized powers relate to almost every important aspect of

SOE operations, including hiring, purchasing raw materials, producing,

setting prices and salary levels, managing the funds they retain, and

making investments. The state also granted SOEs the right to resist wilful

interference on the part of government agencies.

Although even now, government agencies still try to retain some

control over SOE operations, the decentralization has in fact increased the

autonomy of SOEs substantially. It is undeniable that they now enjoy more

freedom than they did two decades ago. But progress in this realm has come at a great price. There is nothing

wrong with the decentralization of decision-making powers per se. But the

problem is that although in theory, it is SOEs that gain those powers, in

reality most of the powers that were decentralized went to SOE managers.

Because general managers assume the main responsibility for managing

SOEs, they found that their personal powers were suddenly expanded.

Unfortunately, such a drastic expansion of personal power was not

accompanied by the establishment of an effective supervision system. On

the one hand, both government and party control over the SOEs were

weakened intentionally by the reform measures mentioned above, and

general managers could also use state stipulations to resist supervision from above. On the other hand, democratic management of SOEs, which

the SOEs law envisioned, has not been achieved. Thus, the old supervision

system receded before a new one could rise to fill the power vacuum. As

a result, general managers not only found their personal power had

expanded drastically, they also recognized that they enjoyed great freedom

in using (and even abusing) their newly gained powers. When an effective

system of checks and balances does not exist, rapid decentralization will

inevitably lead to disaster.

To general managers that have morality and a real commitment to the

enterprises they manage, expansion of managerial power enables them to

do a better job than they could otherwise do. But to those who prefer to

serve their own interests first, the decentralization process has granted

them the control over the most important (and also the most profitable)

transactions of their enterprises. To them, abusing power for personal gain is not only a real possibility, but also relatively easy to do.

In a typical Chinese SOE, five types of activities are very profitable.

They are procurement of raw materials and equipments, sales, financial

management, construction, and asset management. All of these activities

involve transfer of resources of high value. Therefore, general managers



70 Wenhao Cheng

can either steal and embezzle the transferred funds directly, or trade other

non-monetary resources for bribes. Figure 7 describes the relationship

between the five activities.

Figure 7

Construction

Procurement Financial Management Sales

Asset Management

As we consider the five types of activities, we might wonder which

ones are more prone to the corrupt activities of general managers. I found

that among the 117 corrupt general managers I studied, 85 abused their

financial management power; 21 abused their procurement power; 20

profited by misappropriating assets of the enterprises; 18 received bribes for granting construction contracts; 14 made corrupt deals in selling the

products of their enterprises. Figure 8 shows the number of times that the above powers were abused by general managers.

Figure 8

Sales

Construction

Asset Management

Procurement

Financial Management

14

18

20

21

20

85

40 60

Number of Cases

80 100




According to my calculation, 25 out of 38 cases of corruption practised by ordinary workers, 19 out of 49 cases where it was practised by directors, and 85 out of 117 cases where general managers were implicated, involved

corrupt activities in the financial management process. All in all, financial

management is the most vulnerable part of SOEs. This is not difficult to understand. Financial management always

involves a large flow of cash, so stealing from it often lead to enormous

benefits. The poor financial management of many SOEs has made it

relatively easy for general managers to do so.

In a narrow sense, financial management means the management of all

the financial resources of an enterprises. But in a broad sense, it includes such activities as revenue collection and expenditure. All of these activities

belong to a unified process that keeps the "blood" of an enterprise

circulating. Figure 9 describes the relationship among the three activities

mentioned above.

Figure 9

Revenue Management Expenditure

Financial Management System

General managers hold the most power in managing the financial

resources of the enterprises and tightly control the three stages mentioned

above. I further examine the exact location of the corrupt activities within

the process. Although not all case reports provide enough information to

support this classification, I did obtain some rough findings. I found that

among the 85 cases, 11 involved corrupt activities in the revenue collection

process, 28 in the spending process, and 14 in both of them. Thus, it seems

SOE spending is most prone to corruption.

Let us cite some concrete examples to demonstrate how general

managers managed to steal public funds. It is relatively easy to do so at the

payment collection process. Since there is a buyers' market for most

commodities, payments often lag behind the delivery of goods or services.

Sometimes it even takes several months for the sellers to receive payment.

Financial personnel of the enterprises often do not know when they can

expect buyers to pay. And, most importantly, they often do not know how

much buyers need to pay, because selling prices are only known to the



72 Wenhao Cheng

people who negotiated the deals. In most cases, it is corrupt general

managers who tightly control the most lucrative selling activities.

General managers can abuse their financial management power in

several ways. A high-risk strategy is to graft some or all the proceeds of a

business transaction. But there are also other strategies that involve less

risk of discovery. For example, general managers can list prices which are

much lower than the real ones, when they register the deals with their

enterprises. They can pay the enterprises the sum cited at the prices they declared and keep the rest for themselves. Because general managers are

the most powerful persons in SOEs, and also because they can both

promote employees and remove them from their current positions, few

financial personnel dare to question their activities. This has paved the way for general managers to employ different strategies.

Let us cite one concrete example. Ruan Yongming, who was once the

general manager of the Huanzhu Hotel in Hepu County, Guangxi Province,

bought 44.8 acres of land through a subordinate company of the hotel at a

cost of RMB620,000. He then sold the land for RMB13.6 million. Ruan

asked someone to use a false account to forward only RMB6.1668 million

to the account of the company and distributed all the profits that were left

to others. Ruan himself took as much as RMB2.2195 million.17 In this

case, because only Ruan and those who were directly involved in the

transaction knew the price, outsiders (including the financial personnel of

Ruan's company) simply did not know how much revenue the transaction

had actually generated. Such a situation of information asymmetry provided great opportunities for Ruan to hide large amounts of revenue.

There are more corrupt opportunities associated with the spending activities of SOEs. Because it is general managers who make or approve major spending decisions, they can enrich themselves in various ways. One

strategy that they often use is to receive more of a refund than they really

deserve. For instance, they can use false receipts to get a greater refund

from the enterprises than they actually spent. Because sellers and service

providers would be willing to do almost anything to secure their business, in many cases they can provide false receipts with increased charges for the

purchases. Buyers can then present the receipts to the finance department

of their enterprises for refunds. General managers have inherent

advantages in cheating in this manner, since they are the ones who approve major spending activities. They can purchase something, obtain a false

receipt, approve the purchases and then order the finance department to

refund the expenses. Because they can complete all these activities




themselves, they deem it a relatively effortless and safe way to steal public funds.

For instance, Wei Wei, the then general manager of Jianyin Liquefied Petroleum Gas Corporation of Hebi, Henan Province, purchased 450 gas containers at a cost of RMB60,300 for his company in October 1994. He

managed to obtain a false receipt, which showed that the total expense was

RMB81,000. Wei then got a full refund from the finance department of his

company and easily made RMB20,700 from a single transaction. Wei was

emboldened by his success and stole public funds three more times within

the next year.18

Compared with stealing public funds directly, embezzling them can

sometimes lead to more benefits with fewer risks. One common strategy

employed by corrupt general managers is to take public funds out of the

bank accounts of their enterprises, invest them in lucrative activities that

can bring them quick money, and then return the public funds to the

finance department of the enterprises. According to Chinese criminal law, the maximum penalty for embezzlement is 10 years imprisonment. By contrast, serious graft crimes can result in life imprisonment and even the

death penalty. Thus, many general managers prefer embezzling public funds to outright theft. They have taken full advantage of the "penalty cap" mentioned above by embezzling huge amounts of money, which they dare

not keep permanently. Among the 1 17 cases of corruption by general

managers, 46 involved embezzlement and 57 involved graft. But the

embezzlement cases involve RMB21.2586 million on average, six times

more than the average amount for graft crimes (RMB3.0324 million). This

proves that the "penalty cap" for embezzlement even encourages corrupt

general managers to convert large amounts of public funds into their own

milch cows. As many corrupt officials proudly claim, "You will remain

safe as long as you have not put public funds into your own pocket."

Ample Opportunities

In the above section, we have studied how general managers enriched

themselves by misusing their managerial power. Besides the broad power that they obtained as a result of SOE reform, general managers can

facilitate their corrupt endeavours by utilizing and even creating many

opportunities for corruption. Some of the opportunities are system-given, while others were created by general managers using their legitimate

power. Because there are various types of opportunities for corruption in



74 Wenhao Cheng

every aspect of SOE operation, I will cite only two, to show how they

emerged and how they facilitate the corrupt activities of general managers. One typical opportunity for corruption that the system provides is the

lack of official rules regarding the most lucrative transactions of SOEs. For

instance, until recently, there was no rule that required SOEs to award

construction contracts through running a public bid. Similarly, there was

no rule to define how these enterprises should purchase goods and services.

When there is no rule to follow, general managers are not violating a rule

when they make deals with suppliers that can offer the highest bribes, even

if the prices the latter charge are much higher than the market level. Not

until 2000 did the state introduce a few guiding principles for the

procurement activities of SOEs.

General managers themselves often create opportunities for corruption

using their legitimate managerial power. One example is the so-called

"family control" (jiazu kongzhi). Family control means general managers

tighten their control over the operation of their enterprises by appointing their family members, relatives or close friends to critical management

positions. In this way, general managers and their appointees form a

corrupt closed circle and can do anything they wish without being noticed

by outsiders, including ordinary workers. When heads of various

departments all belong to a patronage network, any check and balance

arrangement will collapse. For instance, to remove the obstacles to his

corrupt practices, Li Hongmei, the former general manager of the

Pingshang Glass Factory in Shandong Province appointed trusted

subordinates to critical positions and let them control financial

management, sales, production, and other important activities of the

factory. After finishing the preparatory work, Li then began to abuse his

power. His rampant corruption finally drove the big factory, that once

owned RMB200 million of fixed assets, out of business.19

Forming a corrupt network within an enterprise is an effective way for

general managers to make possible various corrupt activities, especially those very complicated ones that need the cooperation of employees from

multiple departments. Although such networks were not given but were created by general managers, the appointment power of the latter is the key to their success in doing so. Thus, opportunities for corruption basically originate from the general managers' intentional misuse of their legitimate powers. Once these opportunities are in place, they will build on general managers' broad power and make it possible for them to carry out even the

most complicated corrupt practices successfully.




Lack of Supervision

When studying the corrupt activities of SOE general managers, we should

always keep in mind that these activities all took place in the face of three

supervision mechanisms that are supposed to check the power of general

managers. These mechanisms are the party committee of the enterprise in

question, its workers' congress, and the government agency that oversees

the enterprise (see Figure 10).

Figure 10

Related Government Agencies

SOE Managers Party committee

/

Workers' Congress Discipline Inspection Commission

Almost every Chinese SOE is overseen by one government agency. For example, state-owned food factories are usually overseen by the local

Light Industry Bureau, and coalmines by the local Coal Industry Bureau.20

Before the beginning of the economic reform, government agencies tightly controlled the operation of the state-owned enterprises they oversaw.

Government agencies still have great influence over them, even though the

state has managed to decentralize most of the managerial powers to

enterprises. First of all, they are responsible for providing guidance

regarding the overall development of the enterprises. Second, and more

importantly, they select and appoint the general managers of those

enterprises. In theory, the appointment power alone can enable government

agencies to effectively deter the corrupt practices of SOE managers.

Unfortunately, however, this is not what happens in practice. First of all, there usually is a close personal relationship between agency leaders and

enterprise managers. Sometimes the relationship has been developed over

a period of time through repeated corrupt arrangements between the two

sides. If managers are corrupt, they will naturally try to bribe their

superiors to secure the protection of the latter. If agency leaders are bribed,

they and the general managers belong to the same corrupt network. Under

these circumstances, they will try their best to protect the managers in order



76 Wenhao Cheng

to secure their own corrupt benefits, instead of investigating and exposing the wrongdoings of the latter.

Even when there is no conspiracy relationship between the two sides, information asymmetry has made it almost impossible for government

agencies to monitor the behaviours of enterprise managers effectively. Most government agencies have dozens of enterprises to oversee.

Therefore, they are only able to monitor the overall performance of the

enterprises. In other words, they are only able to review the macro-level

things, including long-term development strategies, production plans, and the financial statistics of the enterprises. But the corrupt activities of

general managers are deeply hidden in micro-level affairs, including

procurement and selling. Because corrupt practices are hidden in the

routine business activities of the enterprises, it takes a deal of time, energy and patience to identify the wrongdoings of general managers. Government agencies simply do not have the resources and the incentive

necessary to undertake such work. When anti-corruption agencies have

finally received credible tips regarding the wrongdoings of general managers, it has been too late. In many cases, the enterprises have been

completely rotted out by corruption. Besides their lack of resources to monitor the operation of the

enterprises effectively, government agencies also face restrictions imposed from above. To guarantee the autonomy of managers in making decisions, the state no longer allows government agencies to intervene in the daily operation of the SOEs that they lead. This has granted managers an

effective protection against supervision imposed by government agencies. As a result, external supervision is weak, superficial and sporadic, and is

simply not able to deter the corrupt activities of SOE managers. Can supervision systems located in SOEs have any deterrent effect? In

almost every state-owned enterprise, there is a party committee to manage

the party affairs of the enterprise. It usually contains a Discipline Inspection Commission, which is responsible for enforcing party rules within the enterprise and investigating the alleged wrongdoings of SOE

managers and other staff. Thus, in theory, there is a formal anti-corruption agency in each SOE. But in reality, the Discipline Inspection Commission is not as effective as it is supposed to be. This is true, in general, because the status of the party committee declined substantially in relation to that of the managers after the economic reform began. And based on the principle of "separating party affairs from government ones" (dang zheng fenkai), party committees of SOEs focus primarily on such issues as party member




management and propaganda, instead of intervening in the management of

the enterprises. As a result, the committees as a whole, and the Discipline

Inspection Commissions in particular, do not know enough about the

transactions of the enterprises. But it is these transactions that give rise to

various corrupt practices. Thus, party organs within SOEs face the same

problems as government agencies.

Let us cite a concrete example. After the fall of Xia Renfan, the corrupt

manager in Shenyang who spent RMB20 million to build a villa for

himself, the director of the party Discipline Inspection Commission of his

company said sadly:

Off course there were clues to Xia's wrongdoing. But we all thought that it

was not our business. Whoever breaks the law, he himself will pay the price.

We were not able to check Xia's power even if we had wanted to do so....

Although general manager and party secretary are of the same rank, their powesr

differ substantially. It is as if one is commanding from the sky while the other

is standing on the ground. In reality, if the party secretary fails to protect the

interests of the general manager, he will even have difficulty getting money

from the enterprise to finance party activities.21

The above testimony reflects the general difficulties facing the party

organs within SOEs when they are dealing with corrupt general managers. In many cases, the corrupt activities of general managers lasted for several

years, and even ordinary workers could detect the existence of corrupt

practices. But it was not until prosecutorial agencies or Discipline

Inspection Commissions of higher levels intervened that an official

investigation could begin. This proves the inherent weakness of the anti

corruption organs of SOEs.

In addition to the problem caused by a shortage of accurate

information, there is another factor that can, at times, completely cripple the function of the Discipline Inspection Commission. In many SOEs, the

general manager is also the head of the party committee, so that he or she

is responsible for leading the Discipline Inspection Commission of the

enterprises. It is common sense that no clerk can check the power of the

boss. Thus, when the Discipline Inspection Commission is faced with a

corrupt manager and party secretary, it can do nothing.

The Workers' Congress is another entity that is supposed to check the

power of the general manager. According to China's law of industrial

SOEs, major decisions of the enterprise are supposed to be approved by its

Workers' Congress before they can be implemented. This stipulation



78 Wenhao Cheng

seems to empower Workers' Congresses and enable them to block any

decision that is likely to bring corrupt benefits to managers. In reality, however, the Workers' Congress is even weaker than the Discipline

Inspection Commission, and the reasons for this are clear. First of all, the

Workers' Congress does not hold any "real" power. It is the relevant

government agencies which are responsible for appointing the general

manager. The Discipline Inspection Commission at least holds nominal

investigative power. But, unfortunately, the Workers' Congress does not

have any solid power. In some extreme cases, managers even disband the

Workers' Congress in order to prevent any challenge to their authority. Second, it is often difficult for the Workers' Congress to tell whether

certain decisions made by managers will actually serve their own interests. At times, these decisions may benefit both the enterprises and managers themselves. For instance, a decision to upgrade production facilities will

definitely benefit the enterprise in the long run, but the construction

projects it would involve would grant the general manager a new

opportunity to make special deals with contractors. In fact, almost all of the

corrupt practices in which general managers were involved were tied to

perfectly legitimate activities of the enterprise. Under these circumstances, the Workers' Congress will face a dilemma if it attempts to boycott decisions that are likely to bring corrupt benefits to the general manager, because doing so will definitely hurt the public interest. Moreover, the Workers' Congress meets only infrequently, while corruption can take

place anytime and anywhere. Thus, it is not even capable of catching up with the new developments, let alone checking them.

In sum, although in theory there are three supervision systems that can check the power of general managers, in reality none of them can exert any

deterrence. The inherent weakness of both internal and external

supervision systems, combined with the extensive managerial power that

general managers hold, grant them great freedom in abusing their power.

Conclusion

Corruption within SOEs is a classic example of how the economic reform has both strengthened the incentives to corruption of power holders and increased their opportunities for abusing their power. First of all, SOEs own many more resources than they did in the pre-reform years and

therefore corrupt general managers now have more to steal from. The

inherent complexity of the SOE operation enables them to hide their




corrupt practices in every routine activity of the enterprise. Second, decentralization of managerial power enables them to control the

distribution of the resources directly, and they can also make major decisions that will generate substantial corrupt benefits. Various

opportunities for corruption, including both those given by the system and

the ones general managers have created using their legitimate power, further facilitate their corrupt practices. And the institutional weakness of

existing supervision systems provides a relatively safe environment for

general managers' adventures. It is the combination of all of these factors

that has led to the rampant corruption engaged in by SOE managers.

Notes

1. Zhang Yan, "Guanyu qiongmiao fu fangzhang xianxiang de poxi yu sikao"

(Some Thoughts on Rich Monks in Poor Temples), Renmin ribao (People's

Daily), 21 March 1997.

2. Ibid. 3. Zhongguo tongji nianjian, 1997 (China Statistical Yearbook, 1997).

4. Beijing qingnian bao (Beijing Youth Daily), 12 February 2000.

5. China News Agency telegram from Beijing, 29 October 2001.

6. Jiancha ribao (Procuratorate Daily), 7 August 2001.

7. Jiancha ribao, 19 October 1999.

8. Zhang (Note 1).

9. Justice Net (www.jcrb.com.cn), 4 October 2000.

10. Chu publicized these numbers when he received the Outstanding Entrepreneur

Lifetime Achievements of China award in 1990.

11. http://finance.sina.com.en/g/20011026/121726.html

12. "Jutan Xia Renfan fubai toushi"(The Corrupt Activities of Xia Renfan), Justice

Net, 30 November 2001.

13. Gao Shangquan and Yang Qixian, Zhongguo guoyou qiye gaige (Reforms of

China's SOEs) (Jinan: Jinan Publishing House, 1999), p. 33.

14. Ibid. 15. The full title of the law is Zhonghua renmin gonghe guo quanmin suoyouzhi

gongye qiye fa (Law of the People's Republic of China on Industrial

Enterprises Owned by the Whole People).

16. Most of the decision-making powers were mentioned in the Law of Industrial

State-owned Enterprises of the People's Republic of China when it came into

force in 1988. But the "Stipulations on the Reform of SOE Management Style,"

formed in 1992 confirmed the freedom of SOEs in exercising those powers.

17. (Seven Corrupt Officials in Hepu Grafted RMB7 Million) Jiancha ribao, 2

December 2000.



80 Wenhao Cheng

18. (Financial Loss Exposes a Corrupt Manager), Jiancha ribao, 7 March 2001.

19. You Zhang, Su Bo and Yun Cai, "Jiazu shi guanli gaokua yijia da guoqi"

(Family Control Led to the Collapse of a Large-sized SOE), Justice Net, 27

December 2000.

20. In 2001, the state decided to convert the eight highly influential national

industry bureaus into national trade associations, but these unions still retain

some power over the enterprises within their respective fields.

21. See Note 12.



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