1. DO YOU THINK THE BAOSTEEL GROUP SHOULD CONSOLIDATE ALL OF THE GROUP’S ASSETS INTO A SINGLE PUBLICLY-LISTED COMPANY OR REMAIN A TWO-TIERED STRUCTURE?

To be able to argue whether the Baosteel Group should consolidate the entire Group’s assets into a single publicly-listed company or remain a two-tiered structure one first needs to review the underlying situation, Baosteel was faced with.
In order to stay competitive on the increasingly fierce global steel market Baosteel was required to not only advance in technology but also to increase its output. To reach its aggressive targets, Baosteel continued its quest for domestic acquisitions. In 2008 Baosteel set up a new company which was authorized to oversee two existing state-owned enterprises: the Shaoguan Iron & Steel Group and the Guangzhou Iron & Steel Group. Each of the two enterprises controlled a listed subsidiary.
By acquiring these two companies Baosteel Group could increase its output as the new company had the permission to build a new 10-million-ton steel-making base in Zhanjiang City. The new base in Zhanjiang City was promising as it would solve the lack of steel-making facilities in Guangdong, save money due to the shorter distance to Australian iron ore sources and face a ready market with Honda’s and Toyota’s manufacturing facilities demanding their flat rolled steel. They needed, however, to modernize the enterprises, eliminate the obsolete capacity and shut down environmentally critical operations.
Besides the favorable effects of the Guangdong project it also raised difficult governance issues. The first issue was how and whether to respond to minority investors in the Baoshan listed subsidiary who were asking why the project was being pursued by the Group and not the listed company. Baosteel officials decided to develop the project under the group in order to not harm the performance of the listed subsidiary Baoshan. As the project might not be benefical right from the beginning it would affect the balance sheet of Baoshan and additionally to handle it under the group would be easier than having to respond to the regulations for listed companies.
The second issue which rose upon this project was the growing potential for competition among the Group’s various steel companies. By acquiring these companies Baosteel owns controlling interests in four listed steel companies. As Baosteel is the controlling shareholder in each of these listed companies, Baosteel is required to respect the interests of minority shareholders in each of these entities. Due to the concept of a modern company, listed on a stock exchange, all interests of every single shareholder is important and should be taken into account. But as the different entities are likely to compete with each other it seems to be an impossible task to satisfy the interests of all investors.
A way to solve this dilemma of honoring the opposing interests of the investors of each entity would be to consolidate all of the Group’s steel assets into a single publicly-listed company. The rising question is whether Baosteel should take this consideration into account. Therefore the advantages of both operational forms, the single publicly listed company and the two-tiered structure, shall be analyzed in the following. (see image 1)
By consolidating all the group’s steel assets into a single publicly-listed company Baosteel could remove the problem of competition and realize a potential of synergistic effects. Thereby Baosteel would be able to cater for the needs of all the Shareholders. The different entities wouldn’t compete anymore and thus the performance of the company as a whole would be decisive for the shareholders. Baosteel would no longer be in the dilemma of having to decide in which entity they should invest and thereby meet the needs of these shareholders whereas neglecting the interests of the other subsidiaries’ shareholders. Additionally the Management of the company would be facilitated and Baosteel could adopt international management processes for all the entities. Besides these tremendous advantages Baosteel would be able to allocate the assets more efficiently and reach a better market coverage and an improved utilization of financial and human resources.
Besides the advantages, the consolidation of the group’s assets inherits also a number of problems. As the different subsidiaries due show differences in management, systems and culture it seems to be a tough job to find common grounds to establish a single company. Besides managerial problems the consolidation would also raise issues concerning status and “face”. If the company Bayi for instance would be merged with Baoshan it would have been degraded from being independent to a grandson of the Baosteel Group. As hierarchy is still an important concept deeply enshrined in Chinese culture this might be problematic and have adverse effects on the company’s performance.
On the other side of the coin there are also advantages favoring the two-tier structure. By keeping the two-tier structure, Baosteel is more flexible in making acquisitions without encumbering the listed company’s financial statement. Therefore the acquired assets are only transferred to the listed subsidiary when having proved its profitability. Consequently the listed subsidiary’s performance is not affected by the possible transition phase which is necessary to restructure the inefficient operations of an acquired company. Moreover the company stays unburdened by public company disclosure requirements, which facilitates the operating process of Baosteel.

Advantages of a single publicly-listed company Advantages of a two-tiered structure
Removal of the competition between subsidiaries Flexibility in making acquisitions without encumbering the listed company’s financial statements
Potential synergistic effects among various steel assets Unburdened by public company disclosure requirements
Ease of Management
Uniform Adoption of international management processes
More efficient allocation of assets
Better market coverage
Improved utilization of financial and human resources
IMAGE 1: ADVANTAGES OF THE DIFFERENT OPERATIONAL FORMS
To sum up the question whether to consolidate the group’s assets or to stick to the two tier structure is mainly a question of finding the right way how to handle the requirements of a modern company which interfere with the structure of Chinese SOEs.
The two-tier system emerged historically due to the partly privatization of state owned enterprises. According to the concept of a modern company the interests of the Shareholders, maximizing the Shareholders’ Profit, shall be pursued by a company. By keeping the two-tiered structure, however, it is nearly impossible for Baosteel to fulfill the needs of all of its shareholders as the listed companies are competing with another. (see image 2) Though Baosteel will definitely operate the businesses in a way that its overall performance is profitable it might not be equally profitable for each single listed company. But as the stakeholders are only benefitting from the performance of the listed subsidiary, their interests might not be honored by maximizing the value of the group.
If for example Baosteel decides about his budget whether to invest in the subsidiary A, B or C, they favor one of these subsidiaries on behalf of the others. In a modern enterprise there should be loyalty to every single shareholder not only to the major stakeholder. Therefore Baosteel would need to consolidate the assets in a single publicly listed company in order to fulfill the principle of a modern company. Nevertheless the consolidation can for sure not be done over night. One has to take the special characteristics of a Chinese state-owned enterprise into consideration. Thus a consolidation can only be done step by step by carefully taking into account the Chinese context.

IMAGE 2: CONFLICTING INTERESTS OF SHAREHOLDERS

2. IS IT NECESSARY THAT THE OUTSIDE DIRECTORS OUTNUMBER MANAGEMENT DIRECTORS?
The board of directors is one of the most important management teams within the company, as they are watching over the investments in publicly owned companies. Whereas in US listed companies it has already become common that the board of directors is mainly composed of “outside” directors it is a big step in Chinese corporate governance. An “outside director” refers to a person who is not an employee of the company but serves on the company’s board of directors. Moreover an “outside” director must not have any direct business interest in the company. It is essential to have the board filled with non-employee directors so that independence from management and business implementation can be insured.
In our opinion it is necessary that the outside directors outnumber the management directors. To understand the reasoning one has to take a closer look in the historical development of Corporate Governance in China.
In the past with the opening up of China, the old governance system became insufficient. The top person of the company had unlimited power over the company. Moreover corruption became rampant and numerous SOEs were operating inefficiently. In response, the government decided to introduce the “modern enterprise system”. This new system included to separate the company’s ownership from the right to operate the company. Therefore the company operated under a board of directors, which entrusts the managerial powers to professional managers. Thereby the government intended that the members of the board would constrain one another in the exercise of such powers. In reality however the decision-making powers remained in the hands of the top person on the board. SASAC even admitted that the supervisory board inherited often only a cosmetic role.

"It has become increasingly clear that there couldn't be any substantial change in a SOE when its board of directors does not have outside directors," Liu Dongsheng, a SASAC official charged with overseeing Baosteel's reform, told Xinhua.
As Liu Dongsheng put it, it is crucial to have outside directors on the board in order to secure independence. As outside directors do not have direct business interests in the company they are in a better position to make right decisions and supervise the company. Researchers argue that independent directors will show the greatest tendencies to intervene to block management-proposed actions that they feel ill-advised. Therefore they are more efficient to prevent managers to pursue their own interests at the expense of the shareholder objectives. If Baosteel would have only introduced a minority number of outside directors to the board, it would have hazarded that the board of directors does not fulfill its intended effect and is again dependent. By having a majority of outside directors on the board, Baosteel changes the corporate governance structure by making the board truly independent while at the same time continuing to be responsible for the state. Besides the supervision of the manager’s activities, independent directors have another positive effect on the company. In the case of Baosteel the outside directors demanded detailed market analyses and in-depth studies. This might be due to the fact that they are not employees of the company and are therefore not that familiar with the daily operations. Management directors might tend to oversee possible solutions as they are two deep in the “topic”. Therefore outside directors can also help the company to reflect about itself and prevent possible blind spots. This potential benefit can also be observed in the fact that Baosteel’s board started to discuss also about financial performance and longer-term strategic issues. To conclude we think that it is necessary that the outside directors outnumber the management directors in order to secure the independence of the board and efficient business operations. BIBLIOGRAPHY
McDonald, M. L., Westphal, J. D., & Graebner, M. E. (2008, March 26). What do they know? The Effects of Outside Director Acquisition Experience on Firm Acquisition Performance. Retrieved November 3, 2011, from Strategic Management Journal: http://www.emeraldinsight.com/bibliographic_databases.htm?id=1755043&show=abstract
Paine, L. S., & Donovan, G. A. (2009). Baosteel Group: Governance with Chinese Characterisitcs. Retrieved November 1, 2011, from Harvard Business School: http://hbr.org/
Shen, S., & Cang, A. (n.d.). Financial Times.com. Retrieved November 1, 2011, from Baosteel to pay $4.2bn for Guangdong acquisition: http://www.ft.com/intl/cms/s/0/b8189d00-4199-11dd-9661-0000779fd2ac.html#axzz1cnnDVQXe
Time Magazine US. (n.d.). Time Magazine US. Retrieved November 2, 2011, from COMPANY DIRECTORS.: The Shift Is from Inside to Outside: http://www.time.com/time/magazine/article/0,9171,809842,00.html
Xinhua. (2006, January 29). people.com.cn. Retrieved November 4, 2011, from Outside directors installed at China's leading steel maker : http://english.peopledaily.com.cn/200601/29/eng20060129_239167.html