Wednesday, January 26, 2011

On the Relationship of Models of State and Corporate Governance: Democratic Centralism in Chinese State and Corporate Governance

Many academics, and those who hide behind academic theory for political and cultural choices, sometimes build substantial and popular theories grounded in adherence to two distinct and fundamental assumptions about the relationship of state and corporate governance.  

The first is that the normative framework of corporate governance is distinct from that of state governance.  There is an intuitive appeal to this argument, especially if one is also interested in strengthening the notions of dependence (corporations are creatures of the states that "create" them and thus fundamentally distinct from states) and of state exceptionalism (that states are unique bodies corporate). States and corporations are governed differently, they are different, one is a creature of the other.  As a consequence, corporate governance issues are different from  issues of state governance both as a matter of form and function.  But Cf., Larry Catá Backer, The Drama of Corporate Law: Narrator between Citizen, State and Corporation (Winter 2009). Michigan State Law Review, Vol. 2009, No. 4. p. 1111, Winter 2009. 

Of course, there has been an important exception to this academic line.  Both Marxist and free market academic theorists have sometimes argued the connection between state and corporate governance, though they come at this from two distinct angles.  Marxists acknowledge the connection.  Some have viewed the corporation with suspicion, as a potential competitor to the democratic dictatorship of the Party exerted through the state apparatus, unless the entity was controlled as an extension of the state.  That marked the Soviet and Cuban approaches.  Others viewed the corporation as useful, but only when the corporation was structured  like the state and peopled by individuals whose loyalty to the state was clear. This now marks the Chinese approach. But it also suggests a variation on the principal assumption--of corporate subordination to the state.  Free market theorists acknowledging the connection suggested that governance values and approaches that were fundamental to the organization of a democratic state, for example like that of the United States, would inevitably find expression in the organization of entities peopled by Americans and organized in the United States.  Moreover,   as a governance organization dependent on the state, some suggest that state regulation of corporate governance will tend to favor regulation that reproduces its own governance norms.  Recent controversies over shareholder democracy and the control of board elections tend to reinforce this view.  But these controversies suggest a variation on the principal assumption--of corporate subordination to the state. 

The first assumption, and especially its exception, thus point to a second assumption, one that will form the basis of the remainder of these remarks is this: that of the existence of a single optimal form of corporate governance.  If corporations are both dependent on and subordinate to states, they represent an object of regulation in the management and production of national wealth. If that is the case then it might be possible to theorize optimal management and organization of this organization for the production of wealth. With economic globalization producing a powerful unitary system for commercial activity, it is possible to suggest that the optional form of corporate organization can be globalized as well. Harmonization and convergence, within the parameters of the current system of economic globalization, is sometimes understood as evidence of this phenomenon.  Moreover, movement toward a harmonization of political frameworks suggests the plausibility of movement toward an analogous harmonization of corporate governance frameworks. Global corporate social responsibility movements also tend to be grounded on this presumption of global harmonization of corporate governance norms.  The OECD projects of corporate governance suggests another expression of regulatory efforts grounded in this assumption.  Impediments to that convergence are ascribed to path dependence, to historical and cultural accidents, usually the products of cultural distinctions grounded in isolation that can be overcome by the harmonizing imperatives of a single globalized economic order, or to deliberate policies of resistance to global harmonization.  Of course, there are exceptions to this academic line as well.  One important line is based on the assumption that local cultural ideology will trump incentives toward harmonization.  Even within free market systems, differences in notions of the fundamental ordering framework of economic organization will have a profound effect on approaches to corporate governance.  See, e.g., Katsuhito Iwai, "The Nature of the Business Corporation: Its Legal Structure and Economic Functions," The Japanese Economic Review, 53(3):243-273 (2002), .discussed in Larry Catá Backer, Corporate Institutionalism and Fiduciary Duty: On Professor Katsuhito Iwai's Nominalistic and Realistic Corporations Mode, Law at the End of the Day, July 10, 2006. 

Recent developments in China remind us of the danger of two strong a reliance on either assumption.  More importantly, these developments point to the continued importance of national political ideology in the construction of corporate governance norms and practices.    It seems that just as American corporate governance principles reflect the American emphasis on democratic and representational theory  that serve as the foundation of the American political order, so the modern Chinese corporation appears to have taken on the fundamental political ordering characteristics of the Chinese state ordering system. That certainly appears to be the case with respect to the incorporation of the political concept of democratic centralism into corporate governance culture.

The concept of democratic centralism is central to the political organization of the Chinese state.  Article 3 of the Chinese Constitution incorporates the concept.  ("The state organs of the People's Republic of China apply the principle of democratic centralism."  Chinese Constitution ) It is particularly importantly at the intersection of state organization under the leadership of the Chinese Communist Party. 
 In its practice of ruling the country over the past five decades and more, the CPC has developed a series of important theories on, and established an institutional system of, democratic rule, and is actively exploring new ways and new methods of democratic rule. The sense of democracy among the CPC members has been continuously enhanced, and notable progress has been made to improve the democratic work style of Party officials at all levels. Democratic rule means that the CPC sticks to the principle of ruling the country for the people and relying on the people in its rule, guarantees that the people are the masters of the state, upholds and improves the people's democratic dictatorship and the democratic centralism of the Party and the state, and promotes people's democracy by enhancing inner-Party democracy. (From Information Office of the State Council of the People's Republic of China, Building of Political Democracy in China,  October 2005, Beijing, Chapter 8)
Democratic centralism is a part of a Chinese conceptualization of democratic state organization structured on Marxist principles.  "Because situations differ from one country to another, the paths the people of different countries take to win and develop democracy are different. Based on the specific conditions of China, the CPC and the Chinese people first engaged in a New Democratic Revolution, and after New China was founded in 1949, and proceeding from the actual situation of the primary stage of socialism, began to practice socialist democracy with its own characteristics."  (From Information Office of the State Council of the People's Republic of China, Building of Political Democracy in China,  October 2005, Beijing, Preface).   It is also central to the organization of the Chinese Communist Party itself:
Article 10. The Party is an integral body organized under its program and Constitution and on the basis of democratic centralism. The Party's basic principles of democratic centralism are as follows:

1) Individual Party members are subordinate to the Party organization, the minority is subordinate to the majority, the lower Party organizations are subordinate to the higher Party organizations, and all the constituent organizations and members of the Party are subordinate to the National Congress and the Central Committee of the Party.

2) The Party's leading bodies at all levels are elected except for the representative organs dispatched by them and the leading Party members' groups in non-Party organizations.

3) The highest leading body of the Party is the National Congress and the Central Committee elected by it. The leading bodies of local Party organizations are the Party congresses at their respective levels and the Party committees elected by them. Party committees are responsible, and report their work, to the Party congresses at their respective levels.

4) Higher Party organizations shall pay constant attention to the views of lower organizations and the rank-and-file Party members, and solve in good time the problems they raise. Lower Party organizations shall report on their work to, and request instructions from, higher Party organizations; at the same time, they shall handle, independently and in a responsible manner, matters within their jurisdiction. Higher and lower Party organizations should exchange information and support and oversee each other. Party organizations at all levels should increase transparency in Party affairs in accordance with regulations to keep Party members better informed of these affairs and to provide them with more opportunities to participate in them.

5) Party committees at all levels function on the principle of combining collective leadership with individual responsibility based on division of work. All major issues shall be decided upon by the Party committees after discussion in accordance with the principle of collective leadership, democratic centralism, individual consultations and decision by meetings. The members of the Party committees should earnestly exercise their functions and powers in accordance with the collective decisions taken and division of work.

6) The Party forbids all forms of personality cult. It is necessary to ensure that the activities of the Party leaders are subject to oversight by the Party and the people, and at the same time to uphold the prestige of all the leaders who represent the interests of the Party and the people. (Constitution of the Communist Party of China, Ch. II, Art.10).
Americans became acquainted with the concept of democratic centralism at the time of the establishment of the People's Republic of China.  
After a quarter-century of conspiracy and struggle, the great day came at last for China's Red conquerors. In Peiping's crumbling Imperial Palace, under the golden tiles of bygone Mings and Chings, the Communists last week proclaimed their new dynasty. . . .  
In the pillared hall, 636 delegates of the "Chinese People's Political Consultative Conference" cheered deliriously. A 49-piece brass band blared Red songs.
China's new people's republic would be strictly Soviet style. According to the principle of "democratic centralism," party rule would be exerted downward through a tightly knit administration. The "people's" conference was not elected by anyone, but appointed by the Communist bosses. Neither Mao Tse-tung nor any of his comrades had a "mandate" from the people. Mao described the new regime as a "people's democratic dictatorship." (From China: Democratic Dictatorship, Time, Oct. 3, 1949).
But, of course, the Americans did not quite understand, or chose to disingenuously describe, the concept.  For a more recent and sympathetic reading, see, e.g., Stephen C. Angle, "Decent Democratic Centralism,"  Political Theory August 2005 vol. 33 no. 4 518-546, but contra see, e.g., Dennis Tourish, Ideological intransigence, democratic centralism and cultism: a case study from the political left).

Beyond political line (in both China and the United States), the concept of democratic centralism  is subject to some interpretation.  Leon Trotsky explained the concept as contextual, emphasizing either the democratic or the centralism part depending on whether the object was development of position or its application.
Democracy and centralism do not at all find themselves in an invariable ratio to one another. Everything depends on the concrete circumstances, on the political situation in the country, on the strength of the party and its experience, on the general level of its members, on the authority the leadership has succeeded in winning. Before a conference, when the problem is one of formulating a political line for the next period, democracy triumphs over centralism.
When the problem is political action, centralism subordinates democracy to itself. Democracy again asserts its rights when the party feels the need to examine critically its own actions. The equilibrium between democracy and centralism establishes itself in the actual struggle, at moments it is violated and then again re-established. The maturity of each member of the party expresses itself particularly in the fact that he does not demand from the party regime more than it can give. The person who defines his attitude to the party by the individual fillips that he gets on the nose is a poor revolutionist. (From Leon Trotsky, On Democratic Centralism and the Regime (1937))
But whatever its  specific form, the concept remains central to the organization of the Chinese state apparatus. 

It appears also to have become part of the culture of corporate governance in China as well.  Consider a recent speech by the general manager of China United Engineering Corporation, the relevant part of which included the following:
Risks are always accompanied with opportunities. Facing the increasingly rigorous competition, we will rely on the solid strength of China National Machinery Industry Corporation, give full play of the comprehensive advantages of “United Engineering”, and strive to create development platform for "China United Engineering Corporation." We advocate the management culture of "seeking truth from facts, democratic centralism, people-oriented and harmonious development", always try our best to create an inner "equal, fair and harmonious” environment and follow the development conception of "development for the staff, by the staff and to the benefit of the staff”. While continually doing better in designing and consulting business, we will improve our ability on general engineering contracting and project management, explore capital operation carefully, develop new business steadily, and participate in international competition actively. We are dedicated to becoming the first-class international engineering company in design, procurement, and general engineering contracting. (From General Manager Speech, China United Engineering Corporation).

Here we have an approach to corporate governance that closely parallels the approach of political governance.  That approach, and the conflation of political and corproate governance is more clearly stated in the  writings of the Guangxi Golden Throat Group.  
The Guangxi Golden Thtoat Co.,Ltd has a united and enterprising leading body,headed by President Jiang Peizhen .The board's members make decisions in a scientific and democratic way;they support each other and coordinate with each other.They emphasize studying,taking political stands and moral spirit ,and they have a new mindset and determination carry out reforms.They are incorruptible and self-disciplined,and they insist on democratic management and decisions based on scientific reasoning.Holding on to the principles of democratic centralism,they make decisions on important problems after discussions by the Board of Directors,the Party Committee,employee representatives' conferences and shareholder representatives' conferences.
Adhering to Deng Xiaoping's theories and the essence of Jiang Zeming's "Three Represents,"the corporation's leaders often trust and rely on the employees.The corporation's leaders also put a lot of emphasis on developing an enterprise culture,which strengthens the corporation's cohesiveness. (From Guangxi Golden Throat Group About US).
Democratic centralism is viewed as contrary to American political and corporate governance. Cf.  Joel Kotkin, Obama Still Can Save His Presidency,, Nov. 10, 2009. This sense of both the importance of political differences on state and corporate organization was nicely highlighted in an interview of  Tarun Khanna by William Holstein.  William J. Holstein,  Corporate Governance in China and India, Bloomberg/Business Week March 2008:
Much as their societies and political systems are different, are Indian and Chinese companies complete opposites when it comes to corporate governance?
Absolutely. Indian companies are so much better governed. India is sort of a noisier version of the U.S. system, which is that you have to be accountable to shareholders and all the other stakeholders. The principles are the same, but the information acquisition is a little bit more problematic in India compared to the U.S. It's not so easy to figure out everything you need to. But there's a very vibrant, credible business media. No opinion is forbidden to be expressed. Information is noisy and unbiased—no one is willfully distorting the truth.
China is the opposite—it's noise-free but biased. You get a clean story but the story isn't always right. There are views that cannot be expressed. . . . That said, most of the boards are still answering to the Communist Party.
But Khanna also suggests another reason for the continuing strength of the connection between political and national governance, one that has a more universal appeal:  "The reason the Chinese feel less pressured to do something about it is not because they don't know how to do it—far from it, they have the best technical help from Hong Kong and other places. It's because they make a reasoned judgment that it's not worth their while. "  (Id.).  Where the state believes that it is economically advantageous, for internal or external reasons, then corporate governance becomes more likely to seek to harmonize its norms. See Donald C. Clarke, Corporate Governance in China:An Overview, China Economic Review 14:494-507 (2003) (on the problems and contradictions of state sector corporate governance reform). Clarke concludes: "Any discussion of corporate governance in China must take seriously the implications of the state’s policy of continuing and significant involvement in enterprise ownership. . . .  But getting the model right is not enough. Policymakers must also think clearly about the capacity of the institutions—not just legal, but social and economic—that are needed to make the model function as expected." (Id., at  505). What the discussion of the incorporation of the notion of democratic centralism within corporate governance culture in China suggests is that it will be as difficult to separate core political from corporate governance in China as it is in the United States.  The result might require  a recognition that for some time to come the differences in the governance cultures of Chinese and American companies may significantly affect their ability to effectively work together.  It also suggests that efforts to internationalize corporate governance norms will have to continue to be sensitive to the differences in political culture within which corporations operate. 

Still, is it possible to argue that democratic centralism, and capitalist authoritarianism retain a place in American corporate governance in a way that is not alien to the language of Chinese political culture, and that itself provides an alternative basis for harmonization? Let's turn the usual analytical framework upside for a moment and consider the consider the ramifications of an analysis of American corporate governance principles from the starting point of democratic centralism as a basic organizing principle of corporate governance.  Almost a decade ago the anti-democratic element of American corporate governance was not unknown, nor well hidden.  That was a sense that commentators, for example, suggested from the well publicized share offering of Google in 2004.    
Google thus thumbs its nose at one of the major pieties of our day: shareholder democracy. This has been the high-minded response to Enron and the other corporate-looting scandals: Shareholders should have more say -- or, more precisely, some say, since now they basically have none -- about the management of their companies. That way, management couldn't so easily overpay itself or loot the company in more dramatic ways. The Securities and Exchange Commission is considering rules to make it easier for large institutional investors, at least, to challenge management nominees for boards of directors.
It's democracy. Who could be against it? Yet just this week, despite Enron, WorldCom and all, investors kicked and clawed to put money into a company that, in democratic terms, might as well be the old Soviet Union. Apparently they don't care. They want to be serfs. Are they nuts? Financial masochists?
Well, they think they're going to get rich, don't they? And, like the citizens of Singapore, they would rather be rich than free, at least in this narrow context. They cling to this view despite studies waved around by shareholder democracy enthusiasts showing that companies with some fundamental democratic reforms do better than companies without.
More important, and unlike the old Soviet Union, Google will let you leave anytime you want. You just sell your stock. (From Michael Kinsley, Voting 'No' on Shareholder Democracy, Washington Post, Aug. 22, 2004).
And indeed, academic work tend to suggest that shareholders may not know what is good for them.  See, e.g., Lisa M. Fairfax, Shareholder Democracy on Trial: International Perspective on the Effectiveness of Increased Shareholder Power (2008). Virginia Law & Business Review, Vol. 1, No. 1, pp. 1-33, Spring 2008.  But the culture of corporate governance, especially in its construction of shareholder-director relations suggests otherwise.  And that creates tension with American political governance.  See, e.g., Larry Ribstein, Shareholder Democracy v. Democracy, Forbes, Oct. 25, 2010.

But perhaps focusing on shareholder democracy misses the mark, at least in states organized like the United States.  A more relevant measure, one that is controversial within both corporate and political governance circles, is that of enhancing the power of putting forward shareholder resolutions, a method of participation that comes as close as corporate governance dares to the referendum legislation mechanics popular in states like California.  This, too, is sometimes known in the popular pres as "shareholder democracy."
Shareholder proposals are nothing new. According to Securities and Exchange Commission (SEC) rules, any shareholder of a publicly traded company that has held $2,000 worth of that corporation's stock for at least a year can send in a proposal to be voted on at the firm's annual meeting. The proposals have to be about general business practices and not day-to-day operations, which are considered to be at management's discretion. Companies include the proposals, along with management's recommendations on how shareholders should vote, on the proxy statements they send out to all shareholders once a year. Typically, most proposals that don't get management approval are voted down.
But a number of changes may make proxy proposals more contested this year than usual. Last year, the SEC ruled that brokers are no longer allowed to vote on behalf of clients who had declined or forgot to send in their proxy statements. Corporate critics claimed this was a form of ballot stuffing because brokerage firms routinely voted with management. And a number of websites like Moxy Vote have popped up that make it easier for individual investors to see shareholder proposals and vote. Lastly, in the past year, the SEC, which has final say on what proposals can be put up for vote, has been giving shareholders more leeway in what can be included in proxies. (From Stephen Gandel, Nuns vs. Bankers: The Shareholder Proxy Wars, Time, April 21, 2010)

Consider this issue from the perspective of democratic centralism, and the issue assumes a somewhat different perspective.  Large corporations tend to be wary of them and they reflect a substantial change in the way in which corporate governance  operated in the United States, precisely because it tilts the balance toward democracy and away from centralism.  And this tilting is being effectuated not in matters of policy but in matters of corporate activity, reducing the power of the central organs of hte corporation from acting decisively.   See, e.g., Erik Stein, Control Freak Apple Fights Shareholder Proposals It Made Necessary, BNet Commentary Jan 11, 2011.

And the effect of such activity remains unclear.  See, e.g.,  Doron Levit and Nadya Malenko, Non-Binding Voting for Shareholder Proposals, Harvard Journal on Finance (2010) ("Our analysis demonstrates that the presence of an activist investor enhances the advisory role of non-binding proposals, but only if there is substantial conflict of interest between the activist and shareholders. If the activist’s interests are closely aligned with those of shareholders, non-binding voting still fails to convey shareholder expectations." Non-binding Voting for Shareholder Proposals (Jan., 2010); Cotter, James F. and Thomas, Randall S., Shareholder Proposals in the New Millennium: Shareholder Support, Board Response, and Market Reaction. Journal of Corporate Finance, Forthcoming; Vanderbilt Law and Economics Research Paper No. 05-30.

But perhaps democratic centralism as an ordering principle of American corporate governance are most relevant in the analysis of the relationship between a Board of Directors and corporate officers.  One might consider the board of directors in the position of a party in power (serving in the interests of and subject to the ultimate sufferance of the people--in the corporate case, its shareholder/stakeholders) whose democratic dictatorship extends to the apparatus of government of the corporate enterprise.  That enterprise is operated through the organs of everyday governance headed by corporate officers, roughly the national people's congresses of the enterprise.  In this context, the core corporate governance notion of the relationship between a board of directors ("The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors" Delaware Corp. Code, Section 141(a)) and its officers suggests the compatibility of democratic centralism principles and American corporate governance.

But the reality of corporate governance suggests a more complicated relationship.  On example will homew this point.  Consider the Bank of America's description of that relationship:
The basic responsibility of the Board is to oversee the Company’s businesses and affairs, and to exercise reasonable business judgment on behalf of the Company. In discharging this obligation, the Board relies on the honesty, integrity, business acumen and experience of the Company’s management, its outside advisors and the Company’s independent registered public accounting firm. (BANK OF AMERICA CORPORATION Corporate Governance Guidelines, As of December 14, 2010, Sec. 7)
It is one thing to participate in the development of the governance lines of the enterprise.  It is quite another thing when it comes to action. The Board of directors speaks through its majority (e.g., Delaware Corp. Code, Section 141(a)), and the minority is bound to comply with decisions taken by the majority.   "It is important for the Company to speak to associates and outside constituencies with a unified voice. As a general matter, the Board believes that senior management should serve as the primary spokesperson for the Company. If comments from directors are appropriate or necessary, they should, in most circumstances, come from the Chairman of the Board, and be made at the request of the Board or senior management." (BANK OF AMERICA CORPORATION Corporate Governance Guidelines, As of December 14, 2010, Sec. 6). One might argue that Bank of America follows principles of democratic centralism in the organization of its governance culture, which is in part made necessary by the requirements of law.  Certainly Leon Trotsky might find  something familiar in a system in which debate is fostered in the creation of policy but action is determined by a majority fo the ruling clique and then  this determination  binds the minority.  In this context what of fiduciary principles?  One might re conceive them as the equivalent of the core ideological lines on which the corporation is founded.  All directors have a first obligation to remain true to the fundamental theory of corporate politics expressed through law.  Where such violations are egregious, individual directors have a duty to upload the party line over  its breaches by others.  In a sense, then, it is possible to understand  the Bank of America as operating under principles of democratic centralism, principles which form the core of corporate governance and democracy in the United States.  And the consequence?  shareholder democracy  as a concept is likely to be substantially more controlled, shareholder proposals  viewed more suspiciously and the need for loyalty to board determinations and sanctioned actions more acute. This is not mere theoretical speculation--it suggests some of the corporate governance culture issues that may be faced by American corporations that will be acquired by Chinese enterprises. 

What result?  The idea that corporate governance reflects the fundamental political orientation of the state from out of which corporate governance is drawn remains a powerful insight.  More interesting, even though differences in national political culture tends to be reflected in corporate governance cultures, corporations tend to behave in ways that suggest a functional convergence.  However, the meaning and thrust of that convergence, can be understood quite differently depending on the political cultural values used in the assessment.  Americans should be wary of assuming that their political orientation unquestioningly serves as the basis for understanding or assessing corporate governance and its character.  That assumption might have been easier to defend in the days of unchallenged preeminence of American companies.  But that is not the case now.  And some states, particularly China, are rapidly trying to change the framework within which discussion of functional convergence is undertaken.  See Larry Catá Backer, Fracture, Translation or Substitution in Knowledge Production: 19th Century European Ethnic Nationalism With 21th Century Chinese Characteristics, Law at the End of the Day, Dec. 9, 2011.  This essay has suggested the danger of assuming that corporate and state governance are invariably (or usually) distinct and that such distinct spheres of governance can be  understood to converge on the basis of some sort of set of universal understandings of "best" or "ideal" presumptions or norms.  However, convergence is some sort is likely, as a functional reality, not because of the convergence of national governance frameworks, but because of the deepening of the normative frameworks around which economic globalization is organized.  The understanding of that functional convergence, ironically, will be a function of the normative assumptions of the political governance framework of the analysts. Americans  assume that this political framework will invariably be one grounded in American political principles at their peril.  Other states, powerful states, have already begun, quite deliberately, to put forward their own frameworks as an organizing basis for such converging trends.  That these alternatives can serve as a rational basis for  policy deliberations about corporate governance is readily apparent.  

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