Toward a theory of internal governance structure of China’s large SOEs

Abstract

This research constructs a simple model to reveal the trade-off between decentralized and centralized governance structures of large state-owned enterprises (SOEs) in China. Our model shows that delegating the decision-making authority to large SOE managers enhances their initiative in terms of local investment while also perhaps leading to the ex-post moral hazard problem. The managerial entrenchment effect causes a misalignment between large SOE managers’ personal interests and organizational interests. We construct a model by introducing a mechanism called the constrained-delegation governance structure approach to illustrate the issues, such that by eliminating some of large SOE managers’ managerial entrenchment investment choice through partially delegating SASAC (State-owned Assets Supervision and Administration Commission of the State Council) officials’ decision-making authority to the party committee within large SOEs, the trade-off between centralization and decentralization with respect to loss of control versus the local initiative can be resolved. We also show and discuss how the efficiency of the constrained delegation governance structure within Chinese large SOEs delivered through party committee control is mitigated with the presence of collusion between the party committee secretary and large SOE managers. By eliminating the self-selection endogeneity issues, some further empirical evidence including the robustness check shows that (1) the existence of a party committee could reduce the overinvestment problem of listed large SOEs, and that (2) the monitoring effect of the party committee is more pronounced when the CEO herself is a party member.