Section 1. Introduction

fMade in China or by China?

Corporate Governance and Technological Capability Development in the Chinese Electronics Industry – The Survey Evidence Jiajia Liu, Andrew Tylecote University of Sheffield {Jiajia.Liu, A.Tylecote}@Sheffield.ac.uk

Section 1. Introduction Using survey data, this paper shows how corporate governance and finance affect the Chinese firm’s technology capability development. Observers around the world are impressed by the rapid growth of China’s economy, however, they also notice that Chinese firms has lagged behind the development of the Chinese economy (Gu and Lundvall 2006). It is believed by both outsiders and domestic policy makers that, in the long run the development of technology capability in Chinese firms will largely determine the pace and sustainability of its economic growth (Liu and Wang 2003; Gu and Lundvall 2006). China since 1979 has followed the conventional wisdom of “buy-absorb-innovate” (Rosenberg and Frischtak 1985; Lall 1993; OECD 1994; Kumar, Kumar et al. 1999; Bennett, Liu et al. 2001; Lee 2001). Such strategy was enthusiastically implemented in the hope that through giving out some market, the economy and the industries will benefit from technology transfer and its spill-overs. After over 20 years of endeavour to catch up, China has achieved some superficial success. However, at present the majority of Chinese firms, particularly manufacturing companies, are still involved in medium or low-technology activities and have failed to develop the capabilities that can generate new and sustainable competences (Bennett, Vaidya et al. 1996; Tylecote and Liu 2006). They operate with low profitability largely due to the lack of technological dynamism and moreover, under the new World Trade Organisation (WTO) regime, the competitive pressures are exacerbated by the entrance of large, ambitions multinational competitors. In the literature there are two types of explanations; one is that in the past Chinese authorities have unduly protected and subsidised large state firms so that they could survive in a competition –free environment, therefore these firms have lost incentive and finally the ability to effectively acquire and develop dynamic capabilities (Lu and Feng 2004). The authors therefore argue that the Chinese government should have just left it to market forces to decide which firms emerged to challenge the world in higher-tech industry. Yet South Korean experience shows that many favoured firms, such as Samsung in electronics and Hyundai in motor vehicles, did extremely well – as did the 100% state-owned firm POSCO in steel (Tylecote 2006). The other mainstream criticism is towards the inconsistent industrial and technology policy that has curbed development of firms in medium/high- and high-tech sectors (Nolan 2001; Qian 2002; Lu and Feng 2004; Xie and White 2004). However, in spite of general ‘failure’, there are a small number of ‘bridge-head’ firms that not only survived but also flourished, such as Lenovo, Huawei, Chery and Guizhou Tyre (Lu and Feng 2004; Xie and White 2004; Liu and Tylecote 2006; Tylecote and Liu 2006). Hence the reality in China calls for an applicable explanation and solution. 1

This paper uses firm level survey data to examine the effect of corporate governance and finance on technological development in the context of China’s electronics sector. We found that: 1) ownership structure influences technological capability development; compared to majority (50% or more state share) state-owned (MASOEs) or private enterprises (POEs), minority (less than 49% state share) state-owned enterprise (MISOEs) illustrate significant superiority in technological capabilities; 2) management selection method influences technological capability development; firms with shareholder selected managers generally out-perform technologically and financially, whilst firms with authority appointed managers come bottom. 3) Intelligent shareholder-engagement leads to intelligent investment/technological strategy (emphasising low visibility activities), which leads to successful development of technological capability. The remainder of the paper is structured as follows. Section 2 briefly reviews the theories underpinning this study. Then major issues of this research are discussed within this theoretical context to yield five hypotheses. Section 3 explains the design of a survey based on previous interview findings, and method of date collection as well as analysis. Section 4 discusses the results of quantitative analysis using the responses. Section 5 concludes with policy advice and suggestions for future research.

Section2. Theory and hypotheses The development of technological capability in Chinese firms has lagged behind the development of the Chinese economy, and it is widely agreed that one of the main reasons for this is the country's system of finance and corporate governance. Domestic private firms in China generally have good corporate governance but have generally lacked the time and money required to develop strong technological capability. Few SOEs have used their privileged access to finance to invest in developing real dynamic technological capability – they have preferred to buy packages, or bundles of equipment and technology from foreign providers on whom they remain dependent. Foreign firms (operating hitherto mostly as joint ventures with SOEs) have strong technological capability at home, but limit what they deploy in China, and strive to avoid the diffusion of that to their Chinese partners, let alone rivals. Ownership and corporate governance in China are varied and changing fast. The ‘SOEs’ are diverse in proportion of state ownership, level of the state involved (central/provincial/local), and relationship with state owners; and proportions and relationships are changing in ways which are live issues for policy and thus highly relevant for research. The central problem in finance and corporate governance is information asymmetry – in finance, between receivers and providers, and in corporate governance between agent and principal: management and owners, if these are ‘outside’ shareholders or the state (Jensen and Meckling, 1976). The managers of SOEs are responsible to officials who are themselves not principals, but agents of more senior officials. Such second-order agency must increase the resulting distortions of behaviour. These will particularly affect activities directed at technological development, because many of 2

their immediate outputs have low visibility from the point of view of principals (and financiers). Their costs however are highly visible. If the principal (or financier) is ‘dis-engaged’ from the firm, therefore ill-informed about it, the manager will feel under pressure to spend sub-optimally on such activities – and perhaps more on relatively high-visibility activities. Such pressures will be the greater, the shorter the manager’s time horizon in the job (Tylecote and Ramirez, 2006). Two other aspects of corporate governance are relevant: (i) How much expertise do owners have regarding the technologies and markets relevant to the firm? Industrial expertise, combined with engagement, gives good understanding of the value of technological activities. (ii) How are stakeholder spill-overs from technological change managed? Spill-overs are costs and benefits to stakeholders, mainly employees, and related firms. Stakeholder inclusion involves cooperative efforts to make improvements. Tylecote and Cai (2004) showed that these insights were relevant, with some adaptation, to the Chinese context. The choices of managers of Chinese state-owned enterprises (SOEs) have to be understood in the context of their career progression. The traditional SOE top manager’s career path is essentially that of an official, chosen for his position by other officials and looking to be moved before long (perhaps five years) into a higher position, in a larger firm or a ministry. The time horizon in the job is therefore short, and while in it, the need is to make a good impression on senior officials – themselves subject to regular rotation and unlikely to ‘engage’ closely with the firm. The progress made towards the ‘marketisation’ of the Chinese economy has modified this situation, and the changes are particularly apparent in firms in which the state has sold some or most of its stake. Many top managers are still selected ‘administratively’ -directly by the state; others have their selection recommended or approved by the state; but some are now selected by the shareholders (including of course the state); and these variations in selection mode can be taken as indicative of the managers’ future career prospects. While there is clearly a relationship between the size of the state’s shareholding and its role in manager selection, it cannot be assumed to be the only factor involved. However, the size of the state shareholding is likely to affect the firm in other ways. It may, notably, be expected to affect its access to finance from (for example) state-owned banks, since the state will look after its own, while where the state’s stake had fallen below 50% the firm might be expected to seek finance from other sources. The distinction between majority state-owned enterprises (MASOEs) and minority state-owned enterprises (MISOEs) may therefore be important. Privately-owned firms (POEs) in China have a very different situation. Being very recently established (since 1980) they have fully-engaged shareholders with the maximum firm-specific understanding, since the CEO is usually the majority, often sole, shareholder. So there is no significant information asymmetry in corporate governance. Their main problem has been poor access to finance (as to some other resources, such as land and licenses) (Cai and Tylecote 2005). The ultimate dependent variable in this study is technological capability – dynamic or otherwise. A branch of the competence/capabilities-based theory of the firm focuses on technological capabilities and the static/dynamic distinction within them (Arnold and Thuriaux 1997), and a sub-branch on developing countries where technology

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transfer is central (Fransman 1986, Bell and Pavitt 1993, 1995). Cai and Tylecote(2005) defined Static Capabilities as the existing technological bases or the existing technology-using skills. These capabilities do not involve those activities which enable modification or manage technological changes from one level to another. By contrast, Dynamic Capabilities are abilities to create new technology or change and improve existing technology – ranging on a continuum from small improvements to major innovations. Based on the above theories and findings from our interview-based case studies, we developed five hypotheses: Hypothesis 1: There will be a positive relationship between the quality of shareholder engagement and the firm’s technological capability. Hypothesis 2: Poor engagement leads to strategy prioritising high-visibility activities (‘High-Visibility Strategy’ or HVS); intelligent engagement leads to strategy prioritising low-visibility activities (‘Low-Visibility Strategy’ or LVS). Hypothesis 3: Strategy prioritising high-visibility activities leads to lower dynamic capabilities than strategy prioritising low-visibility activities, does. If H1, H2 and H3 hold, then Hypothesis 4 follows: Ownership form affects technological capability; more specifically, (H4a) ownership forms giving more intelligent engagement will excel (other things equal) in capability types which are sensitive to low-visibility activities. We would also expect (H4b) that ownership forms giving better access to finance will excel (other things equal) in capability types which are sensitive to high-visibility activities. H5 and 5a follow similarly: (H5) Selection method for top management in SOEs affects technological capability. (H5a) Selection methods giving more intelligent engagement will excel (other things equal) in capability types which are sensitive to low-visibility activities. (There is no H5b because there is no reason why selection method should affect finance.) Moreover, we aim to test the influence of shareholder engagement on technological capability development which is mediated by technological strategy/activity. Figure 1 illustrates the links and relationship among the hypotheses. Corporate governance - Ownership structure - Management selection method - Shareholder’s engagement

H2

Technological Strategy/Activity

H4, 5

H3

Technological capability development - Manufacturing - R&D - Organisational

H1

Figure 1 Relationship among hypotheses

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Section 3. Research design and method Our research was undertaken in the Chinese electronics industry. Being large, varied and representative, the Chinese electronics industry provides an ideal arena for empirical studies - it is the largest industry in terms of both industrial output and export (Liang 2004). However, it is by no means exceptionally successful when it comes to indigenous technological performance - in 2004 solely foreign-owned multinationals contributed 63.2% of the industry’s export and the figure has increased by another 3.1% in the following year. By studying the largest industry in China, and one which has rather typical limitations in its technological performance, our findings will have broad relavence for analysis and will shed more light on policy implications. One cannot rigorously study the determinants of technological capabilities in an industry or country if one does not quantify it. As a widely practised and powerful tool for quantitative research in the social sciences (Black 1999), questionnaire survey is used in the research. Based on previous survey experience we adopted a multiinformant approach, which helps to limit the possibility of common method bias whilst testing the effect of corporate governance on technological development (via strategy). For each firm two questionnaires were designed. One is for the company executive or board member, containing questions related to corporate governance, finance and general technology strategy. The other is for the R&D manager or chief engineer with self-evaluation of firm’s technological capability and specific questions about technology strategy. The main body of questionnaires for the executives were based on literature review (see section 2) and previous case study findings. Questions for technological capability and strategy were developed from frameworks explained on the next page. Our prior experience in collecting data in China (Cai and Tylecote, 2005) aided the design of the questionnaires. For example, based on past survey research in China, the researchers found that it was important to expressly label each anchor of the items that required a response on a Likert scale. Moreover, explanatory texts were kept at minimum to provide a neat appearance and encourage response. Many versions of the survey were produced based on several meetings between the investigators and a number of peer researchers and industry experts in 2006. To ensure internal reliability, one of the investigators, a bilingual Chinese research professor, supervised the translation process of final version of the survey. Finally, we considered common response bias issues. As with any attempt to collect and analyse data using a survey instrument the question of assessment and selfreporting arose (Young, 2000). We address this issue in several ways. For example, we used different response scales for the different sets of items that pertained to each variable. We reversed the items that pertained to shareholder engagement measures. We also verified the data validity by comparing the firms’ financial and market performance with archival industry data (as explained in the next part).

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Sample and data collection The target population of this research comprises 11655 domestic firms in the Chinese electronics industry. We stratified firms according to the following criteria: (a) ten industrial sub-sectors based on China’s National Bureau of Statistics’ codes (telecommunication, consumer electronics, TV& broadcasting equipments, computers and related products, electronic equipments, integrated circuits & semi-conductors, sealed vacuum electronic devices, electronic parts and components, electronic material, and photo-electronic sectors); (b) 7 locations divided into three categories (coastal region, inland region, and western region). After a pilot survey in 10 firms where previous case studies were undertaken, the majority of survey was sent to 527 firms through postal and email messages in China. Reminders were sent out every three weeks. From March to September 2007, we obtained 195 sets of valid responses, generating a response rate of 36.3%, witch is reasonably high for a multi-questionnaire survey. We used T-tests to check for response bias and did not find any significant difference between respondents and non-respondents for the postal and email data collection efforts on age, size, and sectoral distributions. About 76% of the respondents to both questionnaires have worked in the surveyed firm for at least 5 years. This suggests that they had adequate knowledge with which to answer the survey questions. 21 firms (10.8%) had over 5000 full-time employees, which is large-scale according to the criteria of State Statistic Bureau, and 35 (17.9) had less than 99 staff, which is small-scale. These percentages are comparable to the industrial figures reported in the Yearbook of China Information Industry 2006. Further comparisons with industry statistics were undertaken to provide more insight into the validity of some industrial characteristics. For example, we correlated the sales growth of the SOE with the sales growth characteristics of the SOE’s industry (POE data is not available) and obtained a low but significant Pearson correlation of 0.12 (P