In view of the gradual nature of China's reform of state ownership, it recommends three sets of actions:

First, aligning the incentives of local governments and the managers of state-owned enterprises with national interests;

Second, separating the control rights of the state from its cash flow rights by modifying the nature of state equity claims;

Third, reducing state ownership gradually.

The report says that the new institutions of corporate governance, developed in response to partial reforms in China's state enterprise sector, are likely to remain imperfect in the context of dominant state ownership and political control over managers. But improved corporate governance practices are necessary for China to develop fully functioning factor markets.

Speaking at the corporate governance conference in Beijing, World Bank Group President James D. Wolfensohn said: "As China begins to implement its commitments under the WTO, the policy focus on corporate governance sends a signal that the government is committed to further reforms. This, in turn, provides a strong reassurance that the remarkable gains that China has made in development and poverty reduction over the last two decades will be sustained and enhanced."

"Complex reform issues, including corporate governance, often pose difficult trade-offs," Mr. Wolfensohn said to conference participants including Chinese senior policy makers, company directors and executives, academics and accounting professionals in Beijing as well as others in Yinchuan, Ningxia who were able to participate through the World Bank's Global Distance Learning Network -- with the financial support by the Australian government. "It is important, as problems are being addressed, to keep a balance and not to undermine some of the key elements of a functioning market system. For example, it is important not to sacrifice financial stability and efficiency in attempts to mitigate the social costs of restructuring."

The report offers an empirical snapshot of the latest stage of China's reforms and illustrates the complexity of institution-building for better corporate governance. It emphasizes that an effective corporate governance system should be capable of identifying weaknesses before they develop into systemic problems, by taking prompt corrective action, and learning from failures. To this end, an effective corporate governance system needs to contain a multiplicity and a certain redundancy of control mechanisms. This implies that priorities in corporate governance reforms should be given to mechanisms that are relatively underdeveloped or altogether missing from a country's institutional arsenal and exhibit strong synergies with other existing corporate governance mechanisms, says Stoyan Tenev, the study's leading author and a principal economist at the International Finance Corporation.

In this context, the report identifies a wide range of policy actions to be taken by the government, including, for example, enhancing regulatory capacity by realizing the enormous potential in the areas of self-regulation and mobilizing civil society in the enforcement process; developing an institutional investor base by improving the regulator's ability to supervise institutional investors and the corporate governance of institutional investors themselves; and strengthening the role of creditors in corporate governance by a range of actions, such as, introducing new legislation to transform the bankruptcy process of state enterprises from an administrative process to a more market driven one, and enhancing the profit incentives of banks through corporatization and ownership diversification.

The policy recommendations of the report were described by Vice President Chen Qingtai of the Development Research Center of the State Council, as "constructive and valuable." He wrote in a preface to the report that the study has reached the "core of the problems China is now facing at the microeconomic level." "Focusing on the building-up of enterprise related institutions, the report provides clearly articulated overall concepts as well as strategies and approaches for solving particular problems," wrote Vice President Chen.

The study was conducted by the World Bank and the International Finance Corporation in collaboration with the Development Research Center of the State Council. It reflects the increasing emphasis the World Bank Group is placing on improving corporate governance practices as part of the general effort to support the development of market institutions needed for sustained growth and poverty reduction.

(www.china.org.cn May 26, 2002)