Reframing Related Party Transactions in China's State-Owned Enterprises

Abstract

This paper analyzes understudied aspects of related party transactions (RPTs) in China’s state-owned enterprises (SOEs). This paper defines the government as an “institutional controlling shareholder” of SOEs. In addition, this paper examines two types of RPTs in the SOE sector: “corruption-RPTs” and “policy-RPTs.” Corruption-RPTs are those associated with tunneling for the personal greed of SOE executives and party-government officials. Thus, from the standpoint of public investors, corruption-RPTs are always detrimental and generate cash-outflow wealth-transfers. Policy-RPTs are conducted by the government as a means of enacting public policy. In contrast to corruption-RPTs, policy-RPTs are associated with two opposite concepts—“institutionalized tunneling” (in favor of the controlling shareholder of SOEs, the government) and “propping” (to the detriment of the government). Although it is well known that investors in China are subject to the problem of insufficient investor protection, this paper finds that investors can sometimes benefit from policy-RPTs (e.g., investors of a propped SOE). Besides, this paper demonstrates that SOEs gain a variety of additional benefits from government policies in China that favor the financial interests of SOE investors. Accordingly, this paper shows that investors in Chinese SOEs are, to some extent, compensated and protected by an informal, extra-legal investor-protection mechanism. Moreover, this paper explores an overlooked topic in China’s SOE sector—how the political motivations of SOE executives and party-government officials function in the context of RPTs.

Keywords: Related Party Transaction (RPT), State-Owned Enterprise, Corruption-RPT, Policy-RPT, Institutionalized Tunneling, Propping, Extra-Legal Investor-Protection Mechanism, Political Motivations

JEL Classification: G30, G34, K22