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THE CHINESE STYLE MANAGEMENT BUYOUTS

Jun Du and Bach Nguyen

Introduction

A management buyout (MBO) is an acquisition in which a firm’s equity is fully or partially acquired by the incumbent management team, often with the participation of private equity (PE) investors (Wright et al., 2001). MBOs originated in the US but later on occurred globally, for both private and public firms. The majority of the transactions are by divisional, secondary, private-to-private, and family-owned buyouts. Strömberg (2008) estimates that public-to-private MBOs account for less than 7% of total worldwide buyout transactions in terms of number of deals, and 28% in terms of value, which explains why the public-to-private MBO is not the dominant theme of the literature.

MBOs in China have specific characteristics that differ from other countries. Most of the Chinese MBOs happened during the era of enterprise reform in China (1998–2004), aiming to help state-owned enterprise (SOEs) to survive the sharply increased competition in the gradually marketized economy (Liu, 2008). MBOs, among several other means, were meant to transform the poorly performing SOEs into modern corporate organizations, often in private ownership. There are marked differences in the motivation of managers, private investors, and facilitators (in this case, local governments) in these buyouts from those that happened in the West. Without a deep understanding of the historical and institutional background in which Chinese MBOs took place, it would be difficult to understand the selection issues that occur in the process of MBOs, and evaluate the MBO performance found in the literature. This chapter provides a review of these issues by paying particular attention to the Chinese characteristics that define the MBOs in China.

In addition to the lack of in-depth analyses of the differences among Chinese MBOs, Western MBOs, and MBOs in other emerging or transitional economies, a main hurdle to studying China’s privatization has been the lack of systematic data (Guo et al., 2008). As a result, there are only limited studies on this topic and hence inadequate insights could be drawn from the current literature. This chapter reviews the existing evidence, sets up the distinctive institutional background, and summarizes what we have learned about the fastest growing emerging economy in the world.

The remainder of the chapter is structured as follows. First, we provide a brief account of the historical background to China’s privatization when public-to-private MBOs took 213place. Then, we review the literature to highlight the distinctive features of MBOs in China in comparison to those conducted in Western economies. We also discuss the financial and non-financial performance of MBO firms. Finally, we conclude the chapter with suggestions for future research.

Historical background

The first MBO case in China, Stone () Group in 1998, turned a failing SOE into a well-known business success. Many similar dwindling SOEs followed the example and succeeded, while others eventually ended up being failures, some even leading to massive national asset losses. This brought huge controversy, which ultimately brought an end to the popularity of MBOs in 2004. To understand MBOs in China and their performance, it is essential to understand China’s enterprise reform and SOE privatization in particular. This historical context not only provides pointers for understanding the motivations of the reform, but also the sources that determine their outcomes.

Privatization in China differs from that in other transitional economies in some important ways (Du & Liu, 2015). At the national level, in contrast to the mass privatizations in Russia and Central Eastern economies (CEE), where central governments pushed the privatization policy at the outset of liberalization, Chinese government delayed privatizing the state-owned sector as long as it could. Following China’s earlier enterprise reform centered on the control rights reform prior to the mid-1990s, SOEs faced the waking market with the rapid entry of domestic private firms and foreign investors. A series of decentralization programs were implemented including government agencies’ original function of managing SOEs, which was nearly dissolved, and the majority of the SOEs being degraded to the supervision of lower government affiliations (Liu, 2008). Then, the crucial reforms of the double-track price system¹ ended and the new financial accounting system and income tax law in 1994 became the turning point of China’s enterprise reform and a new beginning for the marketized economy. This resulted in SOEs facing an unprecedented and devastating scale of loss-making in the state sector (Du & Liu, 2015). As a result, the government and the loss-making SOEs ended up with no choice but to implement radical reform. In this sense, both sides, SOEs (agents) and local governments (principals), gained momentum for the reform.

The external environment was already relatively developed for the subsequent enterprise reform. The sharply increased competition promoted by the marketized economy has served as a prerequisite for privatization, which is opposite from what has been observed elsewhere in the world (see Mickiewicz, 2009). China’s institutional factors explain why the MBO was a promising option for SOE reform. Unlike the CEE countries, where at the time of mass privatization a strong institutional structure for product, labor, or financial markets had not been established, Chinese governments had significantly improved institutional infrastructure at the time of implementing gaizhi. In addition, financial markets had developed to a level that sufficiently supported leveraged MBOs (Xu et al., 2008). In addition to the external conditions, the Chinese government had a strategic plan and prioritized the buyout in the process of its execution.

While political control in China is highly centralized, there is regional economic decentralization to local governments. Local governments oversee whether and how to privatize SOEs within their jurisdictions, unlike in Russia and the CEE where it was entirely controlled by central government (Gan et al., 2010). This was an important contextual factor 214that explains the shared interests of the local governments and the failing SOEs when they opted for privatization as a solution, and chose a specific approach of privatization.

More specifically, provincial and municipal governments have relatively large freedom in setting up their own strategies and tactics of achieving the unified economic goal. In principle, SOEs may propose a restructuring plan themselves. Once approved by the local government, SOEs could carry out the restructuring plan as proposed, and select the specific approach and pace according to the circumstances (Du et al., 2014).

The large-scale privatization in China took place between the late 1990s and 2005. Gan (2009) estimates that between 1998 and 2005, more than 90,000 firms with more than 11 trillion RMB (US$1.4 trillion) worth of assets were privatized. As far as we know, there are no official statistics of the overall scale of MBOs in China during this period. The sporadic reports of the MBO statistics are all based on small surveys, which give us some indications of MBO size. However, the measures of the relative size of MBOs in different studies can be very different and thus hard to compare. For example, Gan et al. (2010) estimate that 47% of the privatized SOEs were through MBOs. Liu (2008) reports that 15% of the privatized SOEs’ largest shareholders were managers and employees from the previous SOEs, and estimates that the majority of the wholly privatized SOEs might have been through MBOs or employee buyouts (EBOs).

While recognizing the advantages of MBOs as an approach to privatizing SOEs, there were considerable concerns about large losses of national assets around 2004. Specifically, the process of SOE property rights reform created legal loopholes which left opportunities for management to abuse the system for personal gain. In some cases, government officials and company management worked together to prevent real open and transparent bidding in order to secure under-priced sales to their own advantage. Some other financial scandals revealed cheating in financial reports to create deficit or hide increased value. MBOs were particularly singled out for business irregularities at the time, and aroused heated debate in economic and government circles (Nie, 2005).

In 2003, the State-owned Assets Supervision and Administration Committee (SASAC), the ultimate owner of state-owned assets, issued statements prohibiting the management of a company targeted for MBO from intervening in matters directly affecting the transfer of state-owned property rights. In the process of fundraising, management was prohibited from borrowing from state-owned and state-holding banks and enterprises, their own enterprises, or from using these enterprises’ state-owned properties for the purposes of guarantee, mortgage, collateral, and discount. In 2004, the Ministry of Finance (MOF) stopped approving SOE share transfers to MBOs. In 2005, SASAC proclaimed a ban on MBOs in large-sized enterprises and required prudence to be taken in MBOs in small- and medium-sized enterprises (Kun-Chin & Shaofeng, 2013). The existing empirical findings indeed show that the peak of public-to-private MBOs in China was around 2003 and they were brought to a halt by 2006 (Guo et al., 2008).

Distinct characteristics of MBOs in China

Motivation of MBOs in China

One of the key distinct features of China’s MBOs was that they were politically purposeful, and in most cases under the control of the state. As reviewed earlier, an MBO was one of the approaches devised by the government to save the ailing SOEs in the unprecedented 215crisis. These restructurings aimed to improve firm values and efficiency by changing SOEs’ ownership structure from state-owned to partially or fully private-owned (Sun et al., 2010). It is noteworthy that it was restricted to non-strategic industries.

For small and medium SOEs, local governments were provided with sufficient autonomy to own and run local SOEs in their own ways (Gan et al., 2010). This was carried out under the State’s development strategy under the slogan “retain the large, release the small” (juada fangxiao) and its exit from the competitive sectors (Du & Liu, 2015). For large SOEs, the State used a more hands-on approach, and carefully pushed forward reform in a veiled way of “transforming the system” and gaizhi due to political and ideological constraints (Garnaut & Song, 2005). Towards the end of 2004, a large proportion of Chinese SOEs were restructured under the strict three-year schedule placed by former Premier Zhu Rongji to turn around loss-making SOEs, some of which were through an MBO.

From the managers’ viewpoint, opting for an MBO addressed the fundamental problem of incentive alignment. Under the old State’s property right regime, managers were not compensated in line with their efforts and contributions. Managers could not take a dividend from (unlisted) SOEs by law, while their salaries and bonuses were only moderate, which was demotivating. The lack of entrepreneurial incentives was a key reason for organizational inefficiency and declines in profit margins in the face of rapidly increasing market competition (Zhang, 2006). Hence, privatization was considered the window of opportunity for new growth opportunities facilitated by a new ownership structure, such as a buyout (Wright et al., 2001).

Following MBOs, the concentrated ownership allows managers to create value and improve efficiency (Renneboog & Simons, 2005). This is particularly true for public-to-private transactions that suffer more from agency problems due to their dispersed ownership structure. Jensen (1986) argues that increased managerial ownership could improve firm performance because managers have greater stakes in value creation. Managers, having substantial ownership shares following buyouts, are motivated to work harder to maximize their share values.

In contrast, in Western countries, MBOs may occur for reasons other than incentive realignment. For example, low managerial equity firms are more frequently targeted by takeover attempts. Upon becoming the target of a takeover attempt, these managers might opt to undertake an MBO to maintain their position. High managerial equity firms are not concerned about hostile takeover attempts. The MBOs in high managerial ownership firms are more likely to be voluntary transactions (Halpern et al., 1999). Another situation is that in the absence of an insider (family member or manager) to succeed the retiring family, an external management team might acquire the business in an MBO transaction (Scholes et al., 2008). In general, it is noteworthy that MBOs in other contexts are not limited to solving principal-agent problems as they are in the context of China.

The role of PE investors

MBOs often occur with the participation of PE investors (Wright et al., 2009). In many cases, the ability of managers to self-finance a takeover is limited due to the large amounts of capital required. Thus, they often resort to external borrowing and seek financial support from buyout specialists (DeAngelo & DeAngelo, 1987). This is a typical case in Western countries. In China, however, even when management could not secure sufficient finance, there are two reasons why MBOs did not always have PE involvement.

First, due to incomplete accounting regulations, management could take risks to exploit their firms prior to the buyout transactions. This financial preparation could help the management 216team sufficiently to afford the buyout without PE investors. A typical example is the MBO of Yutong Bus. In the two years leading up to the MBO, the management team lifted the salary cap on senior managers and allocated handsome profit-sharing and dividend payouts to themselves, allowing them to raise money for the MBO (Kun-Chin & Shaofeng, 2013). Specifically, Yutong Bus decided to pay cash dividends of 6 RMB for every 10 shares to its shareholders, even though the company’s earnings per share was only 0.72 RMB. After two years, the management had received a minimum of 28.2 million RMB, accounting for 20% of the costs of the subsequent buyout.

Second, Li et al. (2010) find that Chinese management usually bought on average less than 30% of the total equity through a newly established holding company wholly owned by the management or with employees. The management typically paid only around 10% of the total price on deal completion, with the remainder paid in instalments and obtained finance mainly from personal networks. Banks were strictly forbidden from providing loans for buyouts. However, in some buyouts of township and village enterprise (TVEs), the management obtained finance from local credit unions or other undisclosed sources.

One of the disadvantages of the gradual ownership transformation is that governments still have their control rights to the firms. This situation could reduce the incentives of the management team or become a constraint for them to operate within the strategic requirements of local authorities until they have collected sufficient ownership shares that allow them to make fully independent decisions. This situation is the reverse of that in the West, where buyout specialists typically hold a significant proportion of ownership shares in the transactions (Kats, 2008).

The participation of the PE investors is to ensure that ownership structure change is a one-off event. Since PE sponsors are repeat players in the buyout market, they may suffer a reputation loss if their investments are unsuccessful and underperform the market (Cao & Lerner, 2006). Thus, PE firms will actively join with the management to improve firm efficiency towards value maximization. Compared with the intervention of PE firms in the West, the intervention of governments in China is more unproductive and provides firms with less value-added services. However, there are some hard-to-neglect benefits that these firms could enjoy by maintaining a sustainable business-government alliance. They include: protection from political harassment, favorable access to scarce resources including land, “soft” loans from state-owned banks, independent export–import rights, and foreign exchange quotas (Sun & Tong, 2003).

The role of local authorities

The decentralization program gave local governments ownership rights to control and operate local SOEs, which assigned local governments a pivotal role in most of the MBOs. Gan et al. (2010) find that an MBO is a popular privatization approach in regions with a well-developed private sector (coastal provinces). Moreover, governments in interior regions tended to choose other privatization approaches. They also find that the local governments facing hard budget constraints or that have more fiscal surpluses tend to choose an MBO approach to privatization; and vice versa, for governments with soft budget constraints. The contingency of MBO as a means of privatization on the financial governance quality of local authorities suggests that provincial governments play a significant role in promoting/restricting MBOs at local markets.

In addition, there is evidence showing that local governments may have strong incentives to collude with the management team and support buyouts against the will of the central 217government (Kun-Chin & Shaofeng, 2013). A good example again is Yutong Bus. Local officials foresaw that the management would likely lose the motivation to run the firm efficiently if the MBO failed, but they also counted on Yutong management to promote local related enterprises, supply-chains, employment, and to expand local tax bases. Therefore, local governments decided to connive with the management and circumvent central government policies and regulations to facilitate the buyout in several ways such as strong lobbying activities, overlooking abnormal dividend payouts and high compensation for management, and awarding various honors and awards to the management even after the outcome of the Shanghai stock’s investigation into the falsified accounts of the company. Therefore, it is evident that the legally contrived MBO could not have been completed without the tacit cooperation of local governments.

Because of the essential role of local authorities in the buyout process in the Chinese context, Sun et al. (2010) theorize the management–politician alliance by identifying two contrasting outcomes of management–politician alliances: first, successful privatization MBOs implying sustainable original alliances and, second, failed MBOs implying the collapse of the original alliances. Based on this setup, they suggest a range of factors that affect the stability of the business–government alliance in an MBO including rents’ generation after the buyout, rents’ appropriation away from the firm, distribution of appropriated rents, information asymmetry, regulation from central governments, and legitimacy of the MBOs. Unfortunately, there is little empirical evidence of the management–politician alliance in the context of MBOs.

Performance of Chinese MBO firms

Theoretical predictions and methodological issues

It is notable that the majority of the literature does not directly address the theoretical concerns of MBO performance per se, but discusses more broadly the outcomes of ownership change or privatization. While the theoretical literature on the effects of privatization is well established and provides evidence from different economies (reviewed by Megginson & Netter, 2001; Djankov & Murrell, 2002; Estrin et al., 2009), the empirical evidence is mixed. The focal argument of these theories is that establishing clear property rights through privatization provides economic incentives and better motivates improved economic performance of firms and economies (Estrin et al., 2009). Based on the theory of welfare economics, private ownership would bring more economic efficiency than the state ownership of production. Empirically, there is evidence of positive or marginally positive profitability effects (Song & Yao, 2004; Jefferson & Su, 2006; Rousseau & Xiao, 2008), but a few studies also report none or negative profitability effects (Calomiris et al., 2008). Jefferson and Su (2006) report significant increases in productivity post-ownership change, but insignificant changes in productivity, suggesting that where ownership change does not result in a decline in the level of asset ownership by the state, there remains the possibility for rent capture by either the state or local employees. Frydman et al. (1999) also find that privatization improves performance, but only when SOEs are acquired by outsiders. Most of these studies wrestle with the question of whether management performance improves after privatization.

The studies of the ownership change performance vary considerably in terms of their data and methodology, sample size, and findings. Also, due to data availability issues, the scope of the investigation can be limited. The identification of the ownership change effect is challenging for several reasons. For example, it is difficult to evaluate the effects of ownership 218change where the ownership structure is itself endogenous to the system that includes both political and performance goals (Megginson & Netter, 2001). In addition, accounting practice in China during the reform era was still not scrutinized, which means that the collusion with governments in overstating SOEs’ pre-MBO performance was possible.

Many authors of empirical research try to apply appropriate econometric methods to treat the problem of endogenous variables, including a difference-in-difference approach with endogenous selection using the matching estimator technique (Bellak et al., 2006), an instrumental variable approach (Basu et al., 2004), 3SLS (Driffield et al., 2007) control function approach (Driffield & Du, 2007), and GMM method (Bennett et al., 2007; Hu & Izumida, 2008). However, the majority of the studies in the Chinese context fail to treat carefully the selection of privatization when evaluating its performance outcome. Du and Liu (2015) provide a detailed analysis of the patterns of selection in China’s privatization. They find that the worst and the best performing SOEs tend to remain in the state sector, and these two extreme types of SOEs are privatized with less magnitude in private share holding when they are selected to privatize. In terms of timing, the worst and best performing SOEs also tend to be privatized later in time, if they are ever privatized.

Empirical evidence

Financial performance of MBOs

Xu et al. (2008) provide some simple statistics that could yield an informative comparison of MBO firms with other privatized SOEs, as well as firms before and after the buyout. By comparing with the mean and median of several financial variables before and after privatization, the findings suggest that, on average, after an MBO, firms increase assets and sale revenues while reducing debt burdens. These operational expansions in turn result in significant improvements in profitability. The statistics thus suggest that privatization works well for Chinese SOEs. On average, firms after privatization become larger and expand their sale operations subsequently. Thus, all three measures of profitability, including profit as a ratio of assets, as a ratio of sales, and as a ratio of number of employees appear significantly higher than before privatization.

It is noteworthy that MBO firms are smaller than the average privatized SOE in terms of assets and sales revenue. Their profitability before the buyouts is also lower than the average privatized SOE. However, after the buyout, all measures of profitability soar markedly to a level higher than the average. In addition, the significant improvement of labor productivity suggests that SOEs fail to improve their productivity because they cannot lay off redundant workers with permanent contracts with the government. Based on this finding, Gan et al. (2010) argue that the MBO is the best method to improve firm efficiency compared with other methods of privatization, at least for China.

Gan et al. (2010) argue that good firms may be selected for MBOs. Therefore, MBO firms cannot be directly compared with non-MBO firms to draw a conclusion that the MBO is a better privatization method. In order to deal with this issue, they use an instrumental variable estimator to control for the selection of MBO firms. The instrument variables they use include: the fiscal balance of the local government, the share of SOE in total industrial output of a city, whether the government provides a firm with land, whether privatization includes the land of a firm, and whether the government provides loan guarantees to the firm. They argue that these variables are correlated with the regressor MBO and are not correlated with the performance of local firms. Thus, they are valid instruments for the MBO 219variable. They find that the positive effects of MBOs on firm performance are statistically significant and economically more important using the instrumental variable approach.

Nonetheless, the too-good-to-be-normal effects of MBOs on firm performance raised another research question: is it the case that insider management deliberately manipulate firm performance before the buyout to reduce its sale value? The accounting manipulation hypothesis argues that ex-post MBO value gains do not represent real performance improvements since managers expropriate shareholders by using their private information and buy it below market value.

Lu and Dranove (2013) compare the performance of Chinese MBO firms to the performance of matched control firms. They find that MBO firms experience a significant decrease in profitability immediately prior to privatization and a return soon thereafter. The short-term reduction in profits is accompanied by a decrease in labor productivity, an increase in overdue accounts receivable, and an increase in R&D investment. They also claim that a similar pattern is not observed among firms acquired by outsiders. Thus, they conclude that insiders intentionally suppress the performance of their firms to acquire them at less than fair value.

Li (2003) proposes a solution for this moral hazard problem by suggesting reversing privatization as a screening mechanism. Specifically, the government’s right to reverse privatized SOEs could be regarded as a call option on the firm with a strike price, X. If the firm value exceeds X in a pre-determined period after privatization, the government will exercise the call option and buy the firm back. If the firm value is below X, the government will not exercise it and allow the firm to remain private. This solution, however, may reduce the incentive of the management team to improve firm performance, or worse may even alleviate their buyout intention.

Finally, it is noteworthy that Chinese MBOs provide support for Kaplan and Strömberg’s (2008) argument that performance-improving activities in MBOs tend to be one-off changes, and once they are implemented, benefits of future changes become relatively smaller. In particular, Xu et al. (2008) find that performance of Chinese MBO firms is negatively associated with the number of years after the buyout events. This finding raises a fundamental question about the phenomenal performance improvements immediately after the buyout. It is unclear whether significant efficiency improvements immediately after a buyout are due to management incentive alignment or the intentional manipulation of the management team to reduce the takeover price before the buyout. The discussion in the next section may provide some insights into this issue.

Non-financial performance of MBOs

One of the key non-financial changes after an MBO is the board transformation. Li et al. (2010) find that after buyouts, the size of the general board declines but cases of the duality roles of chairman and CEO increase. This ownership-management structure could facilitate incentive alignment, for example in the form of increased meeting frequency among members on the management board (Li et al., 2010). This finding is in line with the control hypothesis, suggesting that efficiency improvements in MBOs are largely due to the increased quality of monitoring because MBO boards convene more frequently (Grossman & Hart, 1980)

However, in their study, Li et al. (2010) reveal that the key issues addressed in board meetings are mostly related to MBO transactions, rather than other issues concerning firm operation and performance. This finding raises a fundamental concern about the sources 220of efficiency improvements. How could MBO firms improve performance after a buyout if the board does not work on it? This finding casts doubts on the validity of the management incentive alignment hypothesis in the context of China. It also suggests that the manipulation hypothesis may have a non-negligible explanatory power for the success of Chinese MBOs.

In terms of management compensation after buyouts, there is a consensus finding that executives’ compensation is not tied to firm performance. This is interpreted in significantly different ways among scholars. Chen et al. (2010) argue that non-performance-based compensation structures tend to lead to entrenched insider managers further colluding with government officials and extracting firm assets. Therefore, they suggest that the Chinese government should consider exerting rigorous restrictions on executive shareholdings and MBO transactions. Transparent constraints would help reduce rent-seeking coalitions between managers and local politicians. By contrast, Gan et al. (2010) argue that MBO firms do not need to have performance-based pay to align executives’ incentives. Their reason is that managers of MBO firms are owners, hence ownership and control are already aligned.

Finally, despite controversial opinions concerning the source of performance improvements, there is a consensus that Chinese MBO firms are moving towards greater levels of professionalization by introducing international accounting standards and independent auditors, as well as a board of directors (Xu et al., 2008; Li et al., 2010; Lu & Dranove, 2013). In contrast, firms that are privatized to outsiders are significantly less likely to establish a board of directors, to change the core management team, or to adopt international accounting standards. It is possible that the reason behind the professionalization of MBO firms is that they are considering listing and using the stock market as an exit platform.

Post-MBO firms detach from governments’ control

There is another distinct characteristic between MBOs and other forms of privatization.

Unlike the privatized SOEs through IPO, in which the state still plays a non-negligible role and often retains rights to make decisions about firm’s daily operations (Li et al., 2010), the government’s control reduces much more in the case of MBOs. To some extent, the average intervention from governments after MBOs decreases to a level which is very close to that of regular private firms (Guo et al., 2008). For non-MBO privatized firms, the intervention remains almost nine times higher in comparison to MBO firms (Gan et al., 2010). This indicates that an MBO could completely change a firm’s ownership structure in contrast to other privatization methods.

Another unusual feature of corporate governance in China is that almost all firms, including private and foreign firms, must have a committee of the Communist Party; and the party committee is involved in major decision-making within the firms. Gan et al. (2010) find that the party committee becomes less important after privatization; and this reduction is more substantial in MBO firms than in the firms privatized through other approaches. They also report that the average number of interventions made by the party committee in corporate decision-making is 16% of total decisions for MBO firms, significantly lower than firms that were privatized by selling to outsiders (25%), or by other methods (59%).

MBOs create concentrated ownership

Another non-financial feature of Chinese MBOs is that they create concentrated ownership. However, the level of concentration tends to be less severe than that in firms privatized by other methods. Gan et al. (2010) find that the ownership of the largest shareholder of MBO 221firms is significantly lower than for non-MBO privatized firms. The ownership by the second and third largest shareholders is also at the same levels with other firms. These statistics signal that ownership in MBO firms is not as highly concentrated as firms privatized using other methods. Nonetheless, it is noteworthy that the sum of the three largest shareholders in MBO firms on average exceed 50% of the total shares of a firm, which is a legal benchmark to obtain control rights.

A highly concentrated ownership structure has an advantage in reducing management costs because it alleviates heterogeneous decisions of the management board and prevents insider conflicts. Moreover, concentrated ownership also helps to align managerial interests with those of shareholders (Tseo et al., 2004). However, this kind of ownership also comes with a disadvantage, i.e., a small group of large shareholders has an absolute right of control over the firm and thus power to expropriate the resources of minority shareholders.

MBO firms suffer from less severe ownership concentration compared to firms privatized by other methods because one individual in the management team is typically unable to finance sufficient capital for the buyout. Therefore, several managers, sometimes with the participation of employees, together team up as a buyout crew, with a leading member who is usually the CEO of the firm (Tseo et al., 2004). This distinct feature of MBO firms allows management to have sufficient ownership concentration, but not over-concentrated in one member of the team. Therefore, MBO firms with average levels of ownership concentration could successfully align managerial incentives without an absolute power to expropriate outside shareholders (Gan, 2009).

Conclusion

This chapter provided a review of MBOs with Chinese characteristics that mostly occurred during 1998–2004. During this extraordinary enterprise reform period in China, a large number of MBOs took place so as to turn failing SOEs into profitable businesses. We reviewed the historical background and institutional context of these buyouts that are crucial to understanding their causes and consequences. Particular attention was paid to comparing and contrasting the differences in the incentives of the management involved in these buyouts, the role of PE investors, and the unique yet vital role of local governments.

The chapter also reviewed the performance of MBOs in China. Overall, the literature on this topic is sporadic and the data scarce. The intertwined relationship between business and government threads its way through the history of MBOs in China and, more generally, the evolution of Chinese enterprises. Much of the success of the reforms lies in the alignment of the entrepreneurs’ incentives and government objectives.

Overall, there are only a few studies with any empirical data to examine the performance of different types of privatization including MBOs in China, which our existing knowledge is based upon. The confounding factors that may make MBOs particularly successful in SOE transition are still lack of theoretical considerations and sufficient empirical supports. Understanding more about the performance of MBO firms in comparison to other types of ownership change would help draw a larger picture of MBOs in China, and further understand better the Chinese economic transition.

Given the unique institutional setup of MBOs in China over this period, it would be very interesting to follow up the buyout companies for a longer period than the current literature has done. Contrasting and comparing the long-term performance of the firms that experienced MBOs and other types of privatization would highlight the effects of the alignment of 222entrepreneurs’ incentives and government objectives on determining the success of the deal, and in particular the role of local governments in the process.

In addition to the well-researched public-to-private MBO type, it is also worth investigating other types of MBOs (private-to-private MBOs, foreign-to-domestic, domestic-to-foreign) that are largely left unexplored in the literature. We know relatively little about them and whether these cases are different from those in more advanced economies. China’s private sector is rapidly growing more dynamic, and MBO transactions among private and foreign invested firms has become increasingly popular under the improved property rights protection from the governments.

Note

  1    It was designed as a transitional price mechanism from a planned economy to a market economy.

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