Walter Hutchens’ Blog

The China Securities Regulatory Commission (CSRC) has offered for public comment a draft opinion on listed companies’ use of their equity to incentivise officers and employees. This is an important government signal that PRC-listed companies can use stock options and other equity-linked incentive plans to induce managers to work for the benefit of public shareholders.

In any system that splinters ownership into shares and then separates that dispersed ownership from daily control, the interest of public shareholders and corporate insiders can diverge. This is true in all stock markets but has been a particular problem in China. This inherent problem to stock markets is amplified in China because a special characteristic of PRC stock markets is that most shares of most listcos are not listed. Rather, most shares remain illiquid as legal person or state-owned shares (in either case generally in government hands, directly or indirectly). This means holders of listed, publicly tradeable shares are a minority; holders of non-tradeable shares can out-vote them. Thus the interests of public shareholders (holders of listed, tradeable, liquid shares) often get ignored or abused by majority shareholders who own illiquid, non-listed, not-easily-tradeable shares. So this problem endemic to stop markets is made worse in China because of the capital structure of its listed firms. But that’s not all. The problem is made even worse because China hasn’t had good mechanisms to control this problem. In other jurisdictions shareholder lawsuits, statutory protections and stock options may be used to discipline insiders/majority shareholder and better align their interest with public shareholders. But for years these mechanisms have been ineffectual or non-existent in China.

With China’s stock markets trading near 8-year lows, many PRC regulators “get it” and are working to address the problems. Recent changes allow public shareholders to vote as a class to approve certain fundamental matters; programs are in place to make non-tradeable shares tradeable (to “fix” the capital structure problem) and now with this draft opinion the CSRC is offering its “opinion” (yijian) on how to “standardize” (guifan) the use of stock options and other equity-linked incentives to align the interests of insiders and holders of publicly tradeable shares.

Of note, only companies that have already made illiquid shares tradeable are eligible to use stock option incentives. To date, 240 firms are in that category.

The draft opinion is titled 上市公司股权激励规范意见 (shangshi gongsi guquan jili guifan yijian) and is posted in Chinese on the CSRC website here. The draft opinion can also be downloaded as a word-processing “soft copy” from a link at the bottom of the page.

The period for public comment is only one week—a time period shockingly short by U.S. standards. But China still lacks an administrative procedure act that requires any public notice and comment period whatsoever before enactment of a regulation, so the CSRC’s frequent solicitation of public comments is to be praised even if the comment periods seems too truncated.