The Impact of SOE Reform On Chinese Overseas Investment

Publication: China Brief Volume: 15 Issue: 2

Wu Yibing, director for China of Temasek, Singapore's state-owned investment company and a model for foreign investment in Chinese companies.

Chinese President Xi Jinping’s new round of state-owned enterprise (SOE) reform and his anti-corruption campaign will dramatically change the preferences and performance of SOEs’ overseas economic expansion. The economic and political initiatives undertaken by Xi meet in the state sector, as the Chinese government is tightening its control over assets and overall strategy at the macro-level, while loosening control over corporate governance at the micro-level. The increasing role of private stakeholders in SOEs will improve their management skills at the executive level and improve the transparency of the decision-making process. However, the introduction of private capital will not reduce the state’s control. In the short run, Chinese SOEs will be more prudential in acquiring foreign assets, with increasing awareness of risk control and profitability analysis. Vital to China’s national interests, the energy sector is still at the top of Beijing’s agenda for overseas investment and acquisition, together with an increasing appetite for the cultural, high-technology, healthcare and food industries. To create more investment opportunities for Chinese companies, the Chinese government will also accelerate its negotiations with major trading partners on bilateral or multilateral investment agreements.

When the Chinese government under then-President Jiang Zemin announced the “going-out” strategy to nurture national champions in the global market two decades ago, Chinese SOEs were the first and biggest movers to invest abroad. In 2013, SOEs represented 63.4 percent of China’s overall non-financial overseas direct investment (21st Century Business, January 17). Beyond government initiatives, Chinese companies have diversified their investments into foreign markets in response to diminishing returns at home and to acquire human capital abroad—upgrading their supply chain, improving management capability and acquiring high-tech intellectual property rights (IPR)—as well as to gain access to more mature markets.

Inside China, the ongoing SOE reform and Xi’s widening anti-corruption campaign will have a profound impact on the SOEs’ corporate behavior and resource allocation, both domestically and internationally. [1] These reforms will ultimately improve the competency of SOEs and their overseas investments. Yet in the short-term, the anti-corruption campaign will likely limit SOE investment abroad and open the door for private Chinese companies.

Reform Background

Chinese SOEs are usually regarded as an extension of the Party’s power into the marketplace, as all senior executives are appointed exclusively by the Party’s Organization Department. [2] With government subsidies and preferential policies, SOEs dominate many strategic industries with monopoly advantages, including energy, telecommunications, transportation and infrastructure. This combination of political power and economic interests at the corporate level has created enormous rent-seeking opportunities and led to endemic and rampant corruption. The past paternalistic support from the central government also provided fewer incentives for SOEs to upgrade management style, improve the quality of their products and services, or build their innovative capacity.

When these uncompetitive SOEs have invested overseas in the past, it sometimes led to poor performance and huge losses. Their heavy reliance on the government for financial support and insurance, coupled with their historically domestic-focused business model and low penalties for poor performance, meant Chinese SOEs were less interested in risk analysis, particularly for political and social risks. Their lack of understanding of foreign social and legal environments was another obstacle for Chinese SOEs’ efforts to overcome cultural differences of management styles and consumer preferences. One example of the challenges facing SOEs abroad is Chinese Investment Corporation (CIC), China’s largest sovereign wealth fund. With $575 billion under management, 12 of its overseas investments from 2008 to 2013 were reported as losses, including high-profile cases in the energy sector in Canada and the United States, and this was widely blamed on CIC’s inability to understand foreign markets and risks (21st Century Business, June 20). Other SOEs are learning from CIC and other earlier failures: The China Chamber of Commerce for Minerals, Metals and Chemicals Importers and Exporters, has recently released guidelines on labor rights, environmental protection and community relations, for Chinese companies to invest abroad (China Finance, October 30).

Xi’s SOE Reforms and Corruption Crackdown: Less Is More

To sustain economic growth, the Party has launched a series of SOE reforms in order to turn uncompetitive SOEs into global competitors, the latest in a long line of intermittently successful reforms since Jiang Zemin. On July 15, the State-Owned Assets Supervision and Administration Commission (SASAC) announced the first round of pilot SOE reforms. [3] The SOE reforms are expected to separate government functions from enterprise management, which should ostensibly reduce the Party’s influence over SOEs. The private sector will also have easier access to invest in state-controlled sectors. At the initial stage, the reforms focus on four major initiatives: promoting mixed ownership (state and private); restructuring national capital investment corporations; empowering the board—appointed by the SASAC—to select, evaluate and reward senior managers; as well as placing Central Commission for Discipline and Inspection (CCDI) inspectors on the board (Xinhua, July 16). [4] This pilot reform is expected to be gradually expanded to other SOEs.

In a parallel policy effort, President Xi’s anti-corruption campaign has also targeted senior SOE executives for corruption. In 2014 alone, over 70 senior SOE executives have been investigated, covering the oil, iron, electricity, telecommunications, aviation and shipping industries (Global Times, December 18). Furthermore, the Party began urging officials to resign from their concurrent positions at the companies. Within two months, over 40,700 officials had resigned or been removed from their roles in SOEs, including 229 officials at the provincial and ministerial level (Xinhua, July 23). Previously, senior or retired officials held positions in the private sector, which created massive opportunities for briberies, rent-seeking and misconduct, as the official could take advantage of their contacts inside the government to generate economic benefits for company.

Reforms Impact SOEs at Home…

The injection of private capital into select SOEs will upgrade their decision-making capacity for evaluating overseas investments, especially in regards to risk control. With increased share (about 15 percent), private investors will have a bigger say in the composition of the SOE’s executive board. This change will bring sophisticated management skills and risk control mechanisms to the decision-making process. The Party-appointed executives who currently run SOEs often follow the Party’s policy directives instead of acting in the company’s market interests, thereby sacrificing business opportunities. Furthermore, the companies’ lack of understanding of foreign market rules and business environment overseas also hinder them from avoiding bad investments (South China Morning Post, March 31). The successful experiences of private sector managers in overseas investment will also help the SOEs to make better decisions. In August, President Xi also called for SOE executives’ salary reform during a meeting of China’s Central Leading Group for Overall Reform, naming a ceiling of 600,000 Renminbi ($97,532). The salary reform also includes encouraging hiring top executives from outside government, to reduce the Party’s intervention into corporate governance (Bloomberg, August 25).

The current largest foreign investor in China’s banking industry is Temasek, a Singaporean investment company. Temasek holds a total of $18 billion in stakes of China Construction Bank, the Commercial Bank of China and the Bank of China (China Daily, November 11, 2013). The Chinese government sees the Temasek model as a good example for separating the corporate operations from administrative functions. In the foreseeable future, more private and foreign investors will start to invest or increase their shares in SOEs. Temasek is a Singapore-based investment company, wholly owned by the Singaporean Ministry of Finance. The Singaporean government does not intervene into corporate governance, but appoints senior executives and approves the company’s regular financial reports. The board of directors is majority private investors but also includes some government representatives. Under this split model, the private investors focus on improving the profitability and the officials are responsible for macroeconomic strategy and social justice (CBN, December 6, 2013).

In a mixed ownership structure after the reforms, private stakeholders will be a counterbalance to the Party’s control over SOE decisions and improve the transparency of corporate governance. Although the government will still control the board and the majority of shares, the presence of private and foreign investors signals the Party’s interest in learning from their experience and suggests the Party is willing to cede some control to improve performance. The purpose of introducing private and foreign investors is to maximize returns on assets and mitigate the risks of huge financial losses. Opening up ownership to private, or even foreign, investors will make SOEs more competitive at home and abroad, while retaining or even increasing state control.

In the Party’s considerations, another approach to improve the competitiveness of SOEs is through massive consolidation, which is seen recently in the railway industry. For instance, after being separated for 14 years, Chinese Southern Railways (CSR) and Chinese Northern Railways (CNR) recently consolidated, as they had constant price wars when bidding for overseas deals, such as in Turkey and Argentina (China Business News, December 31; Beijing News, December 31). The cut-throat competition between Chinese companies jeopardizes China’s national interests and results in severe resources wasted and lost. Similar to the railway industry, this consolidation trend is more likely to gain momentum in the nuclear, telecommunications and aviation industry.

…And Abroad

The SOE reforms and anti-corruption campaign are likely to change the overseas investments of Chinese conglomerates in the following ways:

First, SOEs will be more prudent and cautious on high-profile overseas investments. Although the reforms are still in the pilot stage, they will have a spillover effect on other SOEs, given the strong political initiatives behind the reforms. The anti-corruption campaign and audits will also intimidate SOEs from signing large deals without clear official approval. Several pending overseas investment deals have been suspended or canceled as a result of personnel changes and resource reallocation. For instance, CNPC’s overseas subsidiary, PetroChina International (Canada) signed a contract with Canadian oil company Athabasca in 2009 to exploit the oil sand reserve in Mackay River and Dover, with a total value of 3.9 billion Canadian dollars ($3.4 billion). This deal was regarded as a “gamble,” as no substantial research and prospecting were conducted and no proven reserves were found (Caixin, June 9). The deal was about to be completed in June, but the President of PetroChina International (Canada) was removed during the CNPC’s corruption investigation in July (Phoenix News, July 17). It is highly likely this deal will be postponed.

By contrast, private Chinese multi-national corporations (MNCs) will likely be more active in overseas investment in short term. The Chinese government also recently amended regulations on investing in foreign markets, which streamlined the approval process for mergers and acquisitions (Xinhua, September 9). This increased private investment abroad is already evident in the Wanda Group’s recent investment in a landmark building in Chicago and Lenovo-affiliated Hony Capital’s purchase of PizzaExpress (21st Century Business News, October 17). SOE investment abroad will likely rebound after the anti-corruption effort either loses momentum or becomes more institutionalized and predictable.

Second, Chinese SOEs will be less willing to bet on speculative investments, such as purchasing overseas property, and more likely to focus on the strategic sectors of China’s domestic economic growth. Energy will remain the primary sector for SOE overseas investment, along with high-speed trains, telecommunications and aviation. Attention is also increasing on the cultural, clean energy, healthcare and food industries. With improved risk management, SOEs will attempt to avoid high-risk large-scale investment, in particular, on property and in the financial industry. SOEs will target high-quality foreign assets, with high profitability and moderate risk, which could help them upgrade their global supply chain and offer a fast track to catch up with international conglomerates (South Morning Post, March 31).

Third, the Chinese government will provide more support to create a better investment environment for SOEs, mainly through bilateral and multilateral negotiations on investment treaties. The government realized that foreign policy support is essential to level the playing ground for Chinese MNCs to enter into and compete with international conglomerates in foreign markets. The bilateral investment agreement (BIT) was one of the rare moments of progress in the most recent U.S.-China Strategic and Economic Dialogue (Xinhua News, July 9). In the past few years, a series of high-profile investment deals by both Chinese state and private companies in “sensitive” sectors were blocked by the U.S. government on national security grounds. Based on the proposed BIT, the United States will be obliged to increase the transparency of its security review measures and give Chinese companies fair treatment and equal investment opportunities. Following the U.S.-China model, Beijing will pursue more BIT initiatives with its other major trading partners, such as the European Union.

Future Reform Path Uncertain

The pilot round of SOE reforms failed to meet analysts’ expectations by excluding large SOEs in strategic industries. Changing the bureaucratic structure and corporate culture of SOEs will be a challenge for the current leadership’s anti-graft agenda, which requires a sustained effort over time. One thing is for sure—SOEs will still take a leading role in China’s economy, likely with tightened state control over SOE assets but less intervention in corporate governance and business operations. The government has sent a clear signal that the purpose of the reform is to strengthen SOEs, not to weaken them, by introducing private sector experience and enhancing the role of market. Ultimately, the Party will still set the grand strategy for investment priorities, but it appears willing to allow greater freedom of action for individual SOEs to pursue profitability within those bounds.


  1. When SOEs invest overseas, they need to build or rent offices, factories and compounds, as well as dispatch staff abroad. As the SOE reforms and domestic politics change the investment destinations and priorities, SOEs are expected to reallocate their resources (capital and personnel) accordingly.
  2. Richard McGregor, The Party: The Secret World of China’s Communist Rulers, 2012.
  3. SASAC, affiliated with the State Council, is the leading government body to supervise and manage the state-owned assets of the enterprises under the supervision of the Central Government (excluding financial enterprises). Its responsibilities range from appointing top executives, approving mergers or sales of state assets, as well as drafting laws related to SOEs. Currently, 113 central government SOEs are under the supervision of SASAC.
  4. Six SOEs were selected, including State Development and Investment Corporation (SDIC), China National Cereals, Oils and Foodstuffs Corporation (COFCO), Sinopharm, China National Building Materials Group (CNBM), Xinxing Cathay International and China Energy Conservation and Environmental Protection Group (CECEP).