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State Advancing:
China’s State-Owned Enterprises after the Global Financial Crisis
Sihan Chen
Yale University
&
Jeremy L. Wallace
The Ohio State University
May 23, 2014
Abstract:
This paper uncovers specific mechanisms through which state-owned enterprises (SOEs)
advanced their political and economic importance domestically and globally during the recent
global financial crisis. SOEs engaged in a massive investment binge, much of which was funded
by directed loans and other types of government favoritism. State-owned Yanzhou Coal’s 2009
acquisition of Australian-firm Felix Resources depicts the uneconomical side of much of the
investment binge engaged in by many major SOEs during the financial crisis. The dubious,
court-ordered 2009 bankruptcy of privately-held East Star Airlines contrasts with the
government’s favoritism towards and protection of SOEs during the same period. The resurgence
of China’s SOEs, often referred to by the phrase “state advance, private retreat” (guojin mintui),
was facilitated by strong government support through complex mechanisms, at the expense of
private competitors and others should give pause to undue optimism over the role of markets in
China’s economy today.
2
China’s private sector grew rapidly in the 1980s and 1990s while the state-owned sector
declined. The privatization of state-owned enterprises (SOEs) was a key piece of China’s
transition from a planned to a market economy. After the major SOE reforms started in mid-
1990s, SOEs appeared to be retreating on all fronts: thousands of SOEs were shut down every
year while most of the remaining ones were struggling to keep themselves profitable, as they
dealt with the withdrawal of government support and faced increasing competition from
domestic private enterprises and foreign companies.
However, by 2013, China’s SOEs had become stronger than ever—among China’s 500
largest companies in 2013, SOEs possessed 91% of the total assets, generated 82% of the total
revenues and reaped 86% of the total profits.1 Moreover, there were 84 Chinese SOEs on the
2013 Fortune Global 500 List; in 2008, the number was merely 26.2 In contrast, there were only
5 Chinese private enterprises on the 2013 Fortune Global 500 List.3 Thus, instead of being
squeezed out by the more efficient private enterprises, today’s SOEs overshadow their private
counterparts and have outgrown companies in other major economies.
This paper examines the financial crisis’s impact on China’s SOEs, as the 2008 crisis
represents an important turning point in their history. Through a close examination of two cases
during the crisis, this paper aims to uncover some specific mechanisms through which the SOEs
enhanced their political and economic importance domestically and globally. We argue the
resurgence of China’s SOEs was facilitated by strong government support, sometimes by
favoritism at the expense of private competitors, shareholders, taxpayers and other entities
1 观察者 (Guancha), “中国企业 500 强榜单发布 国企占 62%,” Aug 31, 2013. Accessed online at:
http://www.guancha.cn/economy/2013_08_31_169453_s.shtml 2 CNN Money, Fortune Global 500 List, 2013. Accessed online at:
http://money.cnn.com/magazines/fortune/global500/2013/full_list/ ; CNN Money, Fortune Global 500 List, 2008.
Accessed online at: http://money.cnn.com/magazines/fortune/global500/2008/full_list/ 3 CNN Money, Fortune Global 500 List, 2013.
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involved. This paper identifies five key patterns on the SOEs and their institutional environment
during the financial crisis—reckless expansion, existence of conflicts of interests, collusion with
the government, localization of political interests, and exploitation on the weakness of the legal
system—each of which has significant political, economic, and social implications.
This paper is organized into two major sections. The first examines the investment binge
engaged by China’s SOEs during the financial crisis, while the second analyzes governmental
favoritism and protectionism that facilitated the growing dominance of the SOEs during the same
period. Yanzhou Coal’s acquisition of Felix Resources demonstrates the phenomenon of the
“investment binge.” The bankruptcy of East Star Airlines is dominated by government favoritism
and protectionism. The paper concludes with a discussion of the implications going forward of
the state advancing in the economic sphere.
Literature
SOEs are of paramount economic, political and social importance in China today. There
is a significant literature on China’s SOEs that focuses on the SOE reforms in the 1990s and
early 2000s, exploring the problems facing SOEs before the reforms, the driving forces and
mechanisms of the reforms, and their impacts.
China’s SOEs have long been criticized for their inefficiency and negative impacts on the
overall economy. Allen et al. (2005) find that China’s economic growth from 1980s to 1990s
was primarily driven by the private sector, despite the fact that the SOEs consumed most of the
state’s resources.4 There are two major views on the root causes of the problems of China’s
SOEs. The more tolerant view holds that SOEs are inefficient because they need to produce
4 Allen, Franklin, Jun Qian, and Meijun Qian. "Law, finance, and economic growth in China." Journal of financial
economics 77, no. 1 (2005): 57-116.
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social and political goods, which serve the overall interests of the state and society rather than
just those of the enterprise. For example, Lin et al. (1998) illustrate several such root causes: first,
many SOEs were involved in the production of basic industrial goods or life necessities, the
prices of which were heavily suppressed to facilitate national economic development and to
safeguard people’s basic needs; second, SOEs bore the costs for all social benefits of their
employees; third, SOEs needed to keep redundant workforce to avoid social unrest caused by
unemployment.5 The infiltration of political and social concerns in the management of an SOE
also means that many of its business decisions are made by government officials, who often have
limited business expertise. For example, Li (1996) shows that local governments are directly or
indirectly involved in over 75% of the investment decisions of SOEs.6
The harsher view holds that the root cause of the SOE’s problems is its defective
governance structure. Zhou and Wang (2001) argue that the obsolete state asset management
system led to high agency cost which resulted in the SOEs’ problems.7 Similarly, Vickers and
Yarrow (1991) argue that SOEs inadequately monitor their managers, who thus have limited
incentives to improve the enterprises’ performance.8 Alongside the principal-agent problem,
SOEs tend to operate with soft budget constraints. Groves et al. (1995) argue that since
government officials cannot determine whether the poor performance of an SOE is attributable to
5 Lin, Justin Yifu, Fang Cai, and Zhou Li. "Competition, policy burdens, and state-owned enterprise reform."
American Economic Review 88, no. 2 (1998): 422-27. 6 Li, David D. "A theory of ambiguous property rights in transition economies: the case of the Chinese non-state
sector." Journal of Comparative Economics 23, no. 1 (1996): 1-19. 7 Zhou, Mi, and Xiaoming Wang. "Agency cost and the crisis of China's SOE." China Economic Review 11, no. 3
(2001): 297-317. 8 Vickers, John, and George Yarrow. "Economic perspectives on privatization." The Journal of Economic
Perspectives (1991): 111-132.
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its inherently low productivity, its heavy policy burden, or managerial incompetence, the state
will always have to subsidize for SOE losses without punishing the managers.9
The empirical analysis of SOE reforms yields mixed conclusions about their impacts.
Wei and Varela (2003) find that there were insignificant changes in an SOE’s profitability after it
was privatized, either partially or completely, while Song and Yao (2004) find that privatization
had a significantly positive impact on firm profitability.10
On the other extreme, Wang et al.
(2004) find that return on sales declined 8.3% around the time of an SOE’s privatization,
damaging firms.11
Some scholars address such contradictory results by breaking the SOEs into
several categories. Ng et al. (2006) find that the performance of partially privatized companies
was on average inferior to either completely privatized or completely state-owned companies due
to the ambiguity in ownership and control rights.12
Rousseau and Xiao (2008) support the finding
of Ng et al. (2006) by showing that privatization, when accompanied by a change of control, has
had positive effects on profitability and the productivity of labor.13
Bai et al. (2006) argue that
privatization resulted in significant gains in the operating margin for SOEs affiliated with the
county or city governments, but not for SOEs affiliated with the provincial or central
governments, suggesting that larger SOEs were better at utilizing government support.14
This
finding is particularly significant, as SOEs associated with the phenomenon of “guojin mintui”
9 Groves, Theodore, Yongmiao Hong, John McMillan, and Barry Naughton. "China's evolving managerial labor
market." Journal of Political Economy (1995): 873-892. 10 Wei, Zuobao, and Oscar Varela. "State equity ownership and firm market performance: evidence from China's
newly privatized firms." Global Finance Journal 14, no. 1 (2003): 65-82. Song, Ligang, and Yang Yao. "Impacts of
privatization on firm performance in China." China Center for Economic Research, Working Paper Series
E2004005 (2004). 11 Wang, Xiaozu, Lixin Colin Xu, and Tian Zhu. "State‐owned enterprises going public The case of China."
Economics of Transition 12, no. 3 (2004): 467-487. 12 Ng, A., A. Yuce, and E. Chen. "State Equity Ownership and Firm Performance: China’s Newly Privatized Firms."
In Academy of International Business 2006 Conference Proceedings, Beijing, China, vol. 90. 2006. 13 Rousseau, Peter L., and Sheng Xiao. "Change of control and the success of China's share-issue privatization."
China Economic Review 19, no. 4 (2008): 605-613. 14 Bai, Chong-En, Jiangyong Lu, and Zhigang Tao. "The multitask theory of state enterprise reform: empirical
evidence from China." The American Economic Review (2006): 353-357.
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(the state advances while the private retreats)—which is a key concept behind this paper—are
overwhelmingly affiliated with these high-level governments.
More generally, scholars argue that the reforms did not fundamentally change the
institutional structures or the behaviors of the SOEs. For example, Hu (2000) argues that the
government's actual policies and practices were in stark contrast with the official goals of the
SOE reforms.15
As a result, the government continued its direct involvement in the economy and
much of the society. Similarly, Sun and Tong (2003) argue that there was limited change in the
governance and thus behavior of SOEs because the government was still the controlling
shareholder and kept its effective control of the partially privatized enterprises.16
Financial Crisis and China’s SOEs
Academic interest in China’s SOEs waned after the “completion” of the reforms as it
became accepted that SOEs would lose their dominant positions in China’s economic, political
and social landscapes. Developments in the roles and prospects SOEs after mid-2000s have been
chronicled by a limited literature, with even less on the relationship between the global financial
crisis and the SOEs.
An exception to this lacuna on the impacts of the global financial crisis on the SOEs is
found in a short essay titled “Guojin Mintui: The Global Recession and Changing State-
Economy Relations in China” by Dali Yang and Junyan Jiang in the recently published book The
Global Recession and China’s Political Economy.17
Yang et al. (2012) argue that government
15 Hu, Xiaobo. "The state, enterprises, and society in post-Deng China: Impact of the new round of SOE reform."
Asian Survey 40, no. 4 (2000): 641-657. 16 Sun, Qian, and Wilson HS Tong. "China share issue privatization: the extent of its success." Journal of financial
economics 70, no. 2 (2003): 183-222. 17 Yang, Dali L., ed. The Global Recession and China's Political Economy. Palgrave Macmillan, 2012.
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favoritism towards SOEs facilitated the phenomenon of “guojin mintui.”18
We build on their
analysis by exploring the political forces that drove the observed changes and elaborating on the
specific mechanisms by which these changes took place in both domestic and international
spheres.
Investment Binge
The overall patterns of the investment binge engaged by China’s SOEs can be seen by
examining global FDI outflow and overseas investments by Chinese enterprises. The data on
global FDI outflow are based on and tabulated from “World Investment Report 2013,” a report
compiled by United Nations Conference on Trade and Development.19
The data on overseas
investments by Chinese enterprises are based on and tabulated from “China Global Investment
Tracker,” a dataset compiled by The Heritage Foundation.20
The global financial crisis enabled the major SOEs to engage in an investment binge
which rapidly and drastically enhanced their dominance domestically and influence globally. As
shown by Table 1, overseas investments by Chinese SOEs grew rapidly from 2005 to 2008; from
2009 onward, the growth moderated but remained steady. On the contrary, overseas investments
by Chinese private enterprises were insignificant from 2006 to 2009. Only after the worst of the
crisis had passed in 2010 did overseas investments by Chinese private enterprise begin to enjoy
sustained growth.
18 Ibid. 19 United Nations Conference on Trade and Development, “World Investment Report 2013: Annex Tables,” Jun 26,
2013. Accessed online at: http://unctad.org/en/pages/DIAE/World%20Investment%20Report/Annex-Tables.aspx 20 The Heritage Foundation, “China Global Investment Tracker.” Accessed online at:
http://www.heritage.org/research/projects/china-global-investment-tracker-interactive-map. United Nations
Conference on Trade and Development, “World Investment Report 2013: Annex Tables”; The Heritage Foundation,
“China Global Investment Tracker.”
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Table 1: FDI Outflow by Chinese Enterprises here21
One may argue that the overseas investment binge, partly attributable to the financial
crisis, did not benefit the SOEs vis-à-vis their private counterparts, since the private enterprises
enjoyed faster growth in overseas investment from 2010 onward. However, the SOEs
consistently enjoyed around 90% share of the total overseas investment, while contributing less
than half of China’s economic output.22
As shown in Table 2, the top 15 enterprises ranked by
total overseas investments from 2008 to 2012 are all SOEs.
Table 2: Top 15 Chinese Enterprises by Total Overseas Investment from 2008–12 here23
One may also argue that the overseas investment by Chinese SOEs after the start of the
financial crisis was not even a “binge,” since growth of such investments from 2009 onward was
moderated. Again, the existence of a “binge” should be viewed from a relative perspective. As
shown in Table 3, FDI outflow by developed economies in 2012 was roughly half of its value in
2007, whereas total global FDI outflow in 2012 was only slightly more than half of its value in
2007. In comparison, as also shown in Table 1 using the China Global Investment Tracker data,
FDI outflow by Chinese SOEs in 2012 was more than double its value in 2007. As China’s SOEs
significantly outpaced their foreign competitors in overseas investment during the financial crisis,
they gained competitive advantages—in scale, synergy, technology, new markets, and branding,
among others—over their foreign counterparts.
Table 3: Global FDI Outflow about here24
There are three major reasons why the SOEs managed to engage in such an investment
binge. First, the export sector’s sudden collapse forced the government to rely more heavily on
21 The Heritage Foundation, “China Global Investment Tracker.” See also the Appendix Tables. 22 See Appendix Table 2. 23 The Heritage Foundation, “China Global Investment Tracker.” 24 United Nations Conference on Trade and Development, “World Investment Report 2013: Annex Tables”
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investment for economic growth. Since the early 2000s, exports and investment have been the
two major engines for China. From 2005 to 2007, exports averaged 38% of China’s GDP,
making China’s one of the world’s most export-oriented economies.25
However, in the first
quarter of 2009, when the central government announced many of its policy directives to battle
the financial crisis, China’s export dropped 20% from a year earlier—implying that to achieve
the central government’s goal of an 8% real GDP growth rate, investment would have to increase
roughly 40% from a year earlier. A shift from export to investment disproportionally favored the
SOEs at the expense of private enterprises, since SOEs dominated capital intensive sectors.
Second, the rapid expansion of bank loans in China after the start of the global financial
crisis supplied the SOEs with enormous amounts of capital available for investment projects. In
an effort to significantly increase investment activities, the central government in November
2008 urged the state-owned banks to increase their lending to support China’s economy. A surge
in new bank loans soon followed. For example, new loans originated at Bank of China recorded
a compounded annual growth rate of 33% from 2008 to 2010.26
Third, the global financial crisis temporarily depressed the prices of various assets across
the world, making it a potentially golden opportunity for the SOEs to invest overseas. From
March 2008 to March 2009, the S&P 500 index dropped approximately 50%, which means that
an average S&P 500 company could be bought in early 2009 for half of its early 2008 price.27
25 The World Bank, “Exports of goods and services (% of GDP).” Accessed online at:
http://data.worldbank.org/indicator/NE.EXP.GNFS.ZS?page=1 26 Wei, Lingling; Davis, Bob, “For a Top Chinese Banker, Profits Hinder Political Rise,” The Wall Street Journal,
February 18, 2013. Accessed online at:
http://online.wsj.com/article/SB10001424127887324196204578297961462046562.html Indeed, those who did not
extend loans were punished politically. 27 Google Finance, “S&P 500.” Accessed online at:
https://www.google.com/finance?q=INDEXSP%3A.INX&ei=P7Y9U8ClMojKsQf6twE. The average market price
for smaller companies dropped even more in percentage terms due to higher risk perceptions and lower stock
liquidity.
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With enormous amounts of bank loans available, China’s SOEs seized the opportunity to enlarge
and strengthen themselves. However, as illustrated in Yanzhou Coal’s acquisition of Felix
Resources below, China’s SOEs were not always able to exploit the depressed prices of global
assets, and sometimes ended up paying inflated prices for overseas acquisitions.
Yanzhou Coal
In August 2009, Yanzhou Coal (Yanzhou) entered into a binding scheme with Felix
Resources (Felix), to make an acquisition of the entire equity interest in Felix for US$2.9
billion.28
Felix was an Australia-based explorer and producer of coal. Felix owned equity
interests in a number of coal mines located in New South Wales and Queensland, including
Ashton Coal Mine, Minerva Coal Mine, Yarrabee Coal Mine and Moolarben Coal Mine, with a
total coal reserve of 1.4 billion tons attributable to Felix.29
Before the acquisition of Felix,
Yanzhou had an insignificant overseas presence. The deal initiated Yanzhou’s overseas
expansion, which was followed by more acquisitions in Australia (discussed below). The size of
the deal was substantial for Yanzhou, which was China’s fourth largest coal producer. As of July
31, 2009, the market capitalization of Yanzhou was US$7.6 billion, which was less than three
times the market capitalization of Felix.30
Moreover, as of June 30, 2009, Yanzhou only had a
cash balance of US$1.5 billion on its book, which means that even if Yanzhou decided to
exhaust all its cash balance for the acquisition of Felix, it still needed to rely on banks for about
half of its financing, at a time when the global financial market was in bad shape.31
28 There have been significant fluctuations in exchange rate between RMB and USD, and that between RMB and
AUD. We use RMB since it is the reporting currency of Yanzhou Coal. The conversion to USD, only if necessary, is
based on historical (instead of current) exchange rate. 29 Yanzhou Coal Mining Co Ltd., Annual Report 2009 30 Google Finance, “Yanzhou Coal Mining Co Ltd (ADR).” Accessed online at:
https://www.google.com/finance?q=NYSE%3AYZC&ei=WFdAU_CEDuSJsQeQ-wE 31 Yanzhou Coal Mining Co Ltd., Interim Report 2009
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The acquisition of Felix was not an isolated event for Yanzhou. From 2009 to 2011, Yanzhou
engaged in investment sprees both domestically and overseas. After the acquisition of Felix,
Yanzhou continued to expand its business in Australia.
- In August 2011, Yanzhou acquired Syntech Holdings Pty Ltd and Syntech
Holdings II Pty Ltd, both of which were coal producers in Australia, for
US$222 million.32
- In September 2011, Yanzhou acquired Wesfarmers Premier Coal Limited
(Wesfarmers Premier) and Wesfarmers Char Pty Ltd. (Wesfarmers Char), for
US$289 million.33
Wesfarmers Premier was engaged in the exploration,
production and processing of coal whereas Wesfarmers Char was engaged in
the research and development of the technology and procedures relating to
processing coal char from low grade coal. Both companies were based in
Australia.
- In December 2011, Yanzhou acquired Gloucester Coal (Gloucester), a coal
producer in Australia that also owned a stake in a coal exporting port, for
US$2.1 billion.34
- In addition to the acquisitions in Australia, Yanzhou also expanded in Canada.
In September 2011, Yanzhou acquired 11 potash mineral exploration permits
and eight potash mineral exploration permits for US$260 million.
In sum, in a mere span of three years, Yanzhou made five major acquisitions overseas that had a
combined price tag of US$5.8 billion. Domestically, Yanzhou also made various investments,
including an RMB2.8 billion acquisition of Inner Mongolia Xintai Coal Mining Company
(Xintai) in 2011 and spent RMB8.6 billion on property, plant and equipment in the same year,
more than four times it spent in 2008.35
Table 4 shows the breakdown of the acquisition price of RMB 20.6 billion (USD 2.9
billion) of Felix. The most striking part of the table is that Yanzhou made a fair value adjustment
of RMB 16.5 billion on the intangible assets of Felix, without any apparent justification in its
32 Donny Kwok, “Yanzhou Coal buys Australian coal producers for $222 mln,” Reuters, Aug 2, 2011. Accessed
online at: http://in.reuters.com/article/2011/08/02/yanzhou-coal-idUSL3E7J201620110802 33 Denny Thomas, “China Yanzhou to buy coal firms from Australia's Wesfarmers,” Reuters, Sep 27, 2011.
Accessed online at: http://uk.reuters.com/article/2011/09/27/wesfarmers-yanzhou-idUKL3E7KR1V520110927 34 Elisabeth Behrmann and Cathy Chan, “Yanzhou Coal Buys Gloucester for $2.1 Billion to Gain Port, Mines
Access,” Bloomberg, Dec 23, 2011. Accessed online at: http://www.bloomberg.com/news/2011-12-23/yanzhou-
coal-agrees-to-buy-gloucester-for-2-1b.html 35 For more on these domestic investments, see the annual reports of Yanzhou Coal from 2008 to 2012.
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public filings or press release. This “fair value adjustment” essentially made up for 80% of the
total price that Yanzhou paid for Felix.
Table 4: Breakdown of the Acquisition Price of Felix by Yanzhou about here36
Another way to determine whether the Felix deal was overpriced is to look at the market
value of the assets acquired from Felix after the global financial market stabilized. The assets
acquired from Felix, Syntech, Wesfarmers and Gloucesters were all absorbed into Yancoal
Australia, Yanzhou’s Australia subsidiary.37
In June 2012, Yancoal Australia was listed in
Australian Stock Exchange with a debut market value of US$1.5 billion.38
By March 30, 2014,
the market value of Yancoal Australia had declined to US$396 million.39
In comparison,
Yanzhou paid a combined price of US$5.5 billion for the four acquisitions in Australia, and
US$2.9 billion for Felix alone. That is, the market value of the Australian assets acquired by
Yanzhou has declined by more than 90% in less than five years. In other words, at the time of the
acquisitions, Yanzhou might have paid prices which could be inflated by more than ten times
from the intrinsic value of the assets.
An examination of the entire process of Yanzhou’s acquisition of Felix reveals the
reasons why the acquisition price was so inflated at a time when global asset value had been
severely deflated. When Yanzhou first expressed interest in Felix in December 2008, the shares
of Felix were trading at about A$5 a share, which corresponded to a market capitalization of
36 Yanzhou Coal Mining Co Ltd., Annual Report 2009. It is important to note that intangible assets are generally
insignificant for energy companies, such as oil & gas, coal, and metals, whose values are primarily based on the
reserves of oil, gas, coal and metal ore they have. Some other companies, such as Internet companies, may have very
substantial amounts of intangible assets. 37 Yanzhou Coal Mining Co Ltd., Annual Report 2011 38 AAP, “Yancoal makes $1.5bn debut, biggest Australian listing since 2010,” The Australian, Jun 28, 2012.
Accessed online at: http://www.theaustralian.com.au/business/mining-energy/yancoal-makes-15bn-debut-biggest-
australian-listing-since-2010/story-e6frg9df-1226411228711 39 Google Finance, “Yancoal Australia Ltd.” Accessed online at:
https://www.google.com/finance?q=ASX%3AYAL&ei=X1dAU9iAEvDLsQf9Wg
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US$0.8 billion.40
Market speculation in the subsequent eight months pushed up the price to about
A$17 a share right before the acquisition.41
As the acquisition price is usually based on the
market price immediately before the deal plus an agreed-upon premium, the more than three-fold
surge in the stock price of Felix over the course of the speculation significantly pushed up the
cost of acquisition for Yanzhou. Although market speculation often can increase the stock price
of a target company in anticipation of an acquisition, the scale of the surge Felix’s stock was
exceptional. Even more unusual was Yanzhou’s persistence on completing the deal after the
drastic surge in price, which might reflect Yanzhou’s mentality of “expanding at all cost.”42
Initially, in August 2009, when the deal with Felix was announced, Yanzhou indicated
that it would finance the deal with existing cash and bank borrowings.43
In September 2009,
Yanzhou amended its financing proposal. Under the new proposal, all financing needs of the
Felix deal would come from bank borrowings from the financing group led by Bank of China,
Sydney Branch.44
Eventually, in October 2009, Yanzhou signed an agreement with Bank of
China, China Construction Bank and China Development Bank for a loan of US$2.9 billion,
which covered the full acquisition price of Felix.45
Table 5: Borrowings of Yanzhou Coal about here46
Included in the balance as of December 31, 2009 are loans amounting to approximately
RMB 21 billion (USD 3 billion) obtained by Yanzhou for the purpose of settling the acquisition
40 Peter Smith, “Yanzhou digs deep in bid for Felix,” Financial Times, Aug 13, 2009. Accessed online at:
http://www.ft.com/intl/cms/s/0/b3821dd8-87ee-11de-82e4-00144feabdc0.html#axzz2xZBzH2cK 41 Ibid. 42 Another possibility is personal profit taking by Yanzhou insiders at the company’s expense, although there is
currently little evidentiary basis for this speculation. 43 Jason Scott and John Duce, “Yanzhou Coal to Acquire Felix for About A$3.5 Billion,” Bloomberg, Aug 13, 2009.
Accessed online at: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=atD1wqLMFFbg 44 新浪财经 (Sina Finance), “建行将参与兖煤收购 Felix 银团贷款,” Oct 12, 2009. Accessed online at:
http://finance.sina.com.cn/stock/s/20091012/15276827706.shtml 45 Yanzhou Coal Mining Co Ltd., Annual Report 2011 46 Ibid.
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of Felix. These borrowings carried an annual interest of approximately 4%, which was
exceptionally low. Putting to perspective, one year fixed deposit interest in China is
approximately 3%, whereas benchmark one year loan interest in China is approximately 6%. The
existing bank loans that Yanzhou acquired from Felix carried an annual interest of approximately
7.6%, which means that Felix could only borrow at 7.6% annual interest from local Australian
banks before its affiliation with Yanzhou.
From 2009 to 2011, Yanzhou was 53% owned by Yankuang Group, which was wholly
owned by the Shandong Provincial Government. Yanzhou was under the direct control of
Shandong SASAC (State-owned Assets Supervision and Administration Commission). The
investment binge engaged by Yanzhou and the consequent expansion of its business would not
be possible without strong government support.
Indeed, Yanzhou lists “strong support from the PRC government” among its key competitive
strengths in its 20-F (annual filing to the U.S. Security and Exchange Commission, or SEC),
which provides detailed elaboration of such strong support:
- The majority of Yanzhou’s directors and senior managers maintained close
professional relationships with the government officials, regulatory authorities
and industry experts;
- The majority of directors and managers of Yankuang Group (parent company
of Yanzhou) were jointly appointed by the Organization Department of the
Communist Party of China and the SASAC of the Shandong Provincial
Government;
- The government encouraged the overseas expansion of Yanzhou through its
“Go Out” policy, which facilitated Yanzhou’s overseas acquisitions;
- Yanzhou received other government support, including financing
arrangements at reduced costs, preferential tax and foreign exchange treatment
and governmental subsidies for its foreign investment projects.47
Yanzhou’s acquisition of Felix illustrates the recklessness of China’s SOEs’ expansion.
The size of the deal, the amount of debt raised, and the price paid all reflect Yanzhou’s
47 Yanzhou Coal Mining Co Ltd., Annual Report 2011
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determination to expand at all cost. However, Yanzhou was not an isolated case. Many major
SOEs engaged in similar reckless expansions through acquisitions in the aftermath of the
financial crisis. Although China’s SOEs can gradually learn to improve their valuation of foreign
assets, financing of the deals, and subsequent management of the acquired assets, the main
danger in the SOEs’ reckless expansion lies in incentives, not expertise. As the managers of
SOEs typically have short tenures, they thus have the incentive to place heavy emphasis on
short-term performance while neglecting the long-term interests of their companies. Some
benefits of an acquisition, such as scale and prestige, can be realized immediately; but the
problems that may arise from an acquisition, such as the difficulty to repay debt and the
depreciation of the asset value, generally only start to emerge a few years after the transaction.
As a result, the managers of SOEs have the incentives to engage in overseas investments, even if
such investments are economically irrational.
Government Favoritism/Protectionism
Despite to the Chinese government’s rhetoric in support of the growth of private
enterprises and a competitive market economy, the government has consistently exhibited
favoritism and protectionism towards the SOEs. The government has excluded many of the most
essential, and often most profitable, industries from private competition.48
For example, In
December 2006, the State Council announced that, “the State should solely own, or have a
majority share in, enterprises engaged in power generation and distribution, oil, petrochemicals
and natural gas, telecom and armaments. The State must also have a controlling stake in the coal,
aviation, and shipping industries.... Central SOEs should also become heavyweights in sectors
48 One principal slogan along these lines was “grasp the large, let go of the medium and small.”
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including machinery, automobiles, IT, construction, iron and steel, and non-ferrous metals.”49
In
addition, the state sector retains overwhelming dominance in banking, insurance, media, tobacco,
and railways, setting aside a huge chunk of China’s economy for the SOEs.
After the start of the financial crisis, there have been a large number of instances in which
government favoritism and protectionism towards the SOEs had severely hurt the interests of
private enterprises. Below are some such examples:
- In 2010, the SASAC announced the formation of a state-owned electric
vehicle alliance which consisted of 16 SOEs, including car producers, battery
manufacturers and charging station operators.50
At a time when the electric
vehicle industry was both highly promising and competitive, the formation of
the alliance greatly benefited the SOEs at the expense of their private
competitors, as the 16 SOEs in the alliance would “receive $15 billion in
funding from the government to collaborate on electric vehicle R&D and
determine a set of standards for plug-ins in China.”51
- In the iron and steel industry, the central government and some provincial
governments used “carrot and stick” (primarily the latter) during the financial
crisis to force the smaller and generally more profitable private companies to
be absorbed into their inefficient but bigger state-owned counterparts, or
otherwise denied the opportunity for private and foreign companies to
compete against the SOEs. For example, Rizhao Iron & Steel was forced to be
acquired by Shandong Iron & Steel;52
Ningbo Iron & Steel was forced to be
acquired by Baosteel;53
Delong Steel was denied a potentially highly
profitable deal with Evraz Group (Russia) by government bureaucracy.54
- In the aluminum industry, China Zhongwang, which was the second largest
industrial aluminum extrusion product manufacturer in the world and Asia’s
biggest, was a major victim of government favoritism and protectionism
during the financial crisis. First, Zhongwang’s major acquisition of a state-
49 Scissors, Derek, “Testimony before the U.S.–China Economic and Security Review Commission,” Mar 30, 2011.
Available online at: http://www.heritage.org/research/testimony/2011/04/chinese-state-owned-enterprises-and-us-
china-economic-relations 50 Zach McDonald, “Could China's State-Owned EV Alliance Actually Hurt the Market for Plug-ins?” Plug-In Cars.
Accessed online at: http://www.plugincars.com/could-chinas-state-owned-ev-alliance-actually-hurt-market-plug-ins-
74437.html 51 Ibid. 52 凤凰财经 (iFeng Finance), “山东钢铁重组民企日照钢铁.” Accessed online at:
http://finance.ifeng.com/topic/news/rzgt/ 53 金融界 (JRJ), “宝钢收购宁波钢铁,” Feb 8, 2009. Accessed online at:
http://biz.jrj.com.cn/2009/02/0806403514237.shtml 54 中金在线 (CNFOL), “德龙钢铁生死劫“窝心”丁立国,” Oct 19, 2009. Accessed online at:
http://news.cnfol.com/091019/101,1280,6662245,00.shtml
17
owned aluminum company was called off unexpectedly and without explicit
reasons, possibly due to government intervention.55
Second, Aluminum
Corporation of China formed a close partnership with Sapa AS (Norway),
which is the global industry leader, with the almost explicit goal to contain the
competitive threats from Zhongwang.56
- In the coal industry, central and provincial government policies forced the
smaller coal companies (most of which were private) to be closed down or
acquired by bigger coal companies (many of which were state-owned).57
In
particular, most of the acquisitions were eventually carried out by SOEs since
their private counterparts, even if comparable in scale, did not have the
financial backing of state-owned banks which was often necessary in these
acquisitions.58
These cases all illustrate the general mechanisms through which government favoritism and
protectionism transformed into competitive advantages for the SOEs during the financial crisis.
The bankruptcy of East Star Airlines during the financial crisis detailed below illustrates the
mechanisms by which government favoritism and protectionism facilitated to crush private
enterprises and strengthen SOEs in the airlines industry.
Bankruptcy of East Star Airlines
Before 2005, the airlines industry in China was completely state dominated, with the
market shared among the Big Three – Air China, China Southern Airlines and China Eastern
Airlines – and their subsidiaries. However, in 2005, private airlines started to emerge and by
2008, there were already seven private airlines companies in China: Spring Airlines, East Star
Airlines, Okay Airlines, United Eagle Airlines, Hefei Lianhua Airlines, Shanghai Juneyao
55 腾讯财经 (Tencent Finance), “铝业民企购国企第一案失败,” Aug 26, 2010. Accessed online at:
http://finance.qq.com/zt2010/zhongwangsg/index.htm 56 腾讯财经 (Tencent Finance), “瑞典铝型材商与中铝建合资公司 阻击中国忠旺,” July 23, 2010. Accessed
online at: http://finance.qq.com/a/20100723/002196.htm 57 环球网财经 (Huanqiu Finance), “国务院再提煤炭重组 民企仍担忧弱势被收购,” Aug 29, 2010. Accessed
online at: http://finance.huanqiu.com/roll/2010-08/1054997.html 58 Ibid.
18
Airlines, and China Express Airlines. 59
For a brief period of three years, private airlines
experienced rapid growth and quickly became popular among travelers, mostly by offering lower
prices than those offered by state-owned airlines.
However, in 2008, the entire airlines industry in China faced serious challenges. In the
first half of 2008, the record oil prices drastically increased airlines’ costs. In the second half of
2008, the onset of global financial crisis brought about a significant decline in the demand for
both passenger and cargo service, hurting their revenues. Even a sharp decline in oil prices was
not beneficial and resulted in enormous losses to airlines on their oil derivative contracts.60
As
result, almost all airlines in China suffered disastrous losses in 2008. Air China, China Eastern
Airlines and China Southern Airlines had net losses of RMB 9.4 billion, RMB 15.3 billion, and
RMB 4.8 billion, respectively.61
In particular, the net loss of China Eastern Airlines represented
over 500% of its equity, which meant that it had become insolvent and needed an enormous
amount of new capital to keep it alive.62
The government quickly stepped in to alleviate the grave challenges faced by state-owned
airlines. In the case of China Eastern Airlines, although its liabilities had already exceed its
assets by RMB 12.6 billion by the end of 2008, no entity ever pushed for its bankruptcy or
restructuring, as would typically occur for such an insolvent company. Instead, China Eastern
Airlines received generous financial supports from government associated entities. In January
2009, China Eastern Airlines obtained a two-year credit facility of RMB10 billion from Shanghai
59 南方周末 (Southern Weekend), “东星航空停飞，总裁被监视居住？” Mar 18, 2009. Accessed online at:
http://www.infzm.com/content/25559 60 These derivatives are financial instruments used to hedge oil price risks. Essentially, firms had locked in higher
prices in a bid to protect themselves from possible further oil price increases. 61 Air China Ltd., Annual Report 2008; China Eastern Airlines Corp. Ltd., Annual Report 2008; China Southern
Airlines Co Ltd., Annual Report 2008 62 China Eastern Airlines Corp. Ltd., Annual Report 2008
19
Pudong Development Bank.63
In February 2009, the company obtained a three-year credit
facility of RMB15 billion from Agricultural Bank of China.64
In the same month, the government
injected RMB7 billion of new capital into China Eastern Airlines.65
In March 2009, the company
obtained a three-year credit facility of RMB11 billion from Construction Bank of China.66
In a
span of three months, China Eastern Airlines received RMB43 billion of financial assistance
from state-owned entities. As a result, China Eastern Airlines faced no existential threats,
experienced no disruption in operations, and quickly rebounded in its financial performance.
Similarly, Air China and China Southern Airlines received generous financial assistance from
state-owned entities. The state-owned airlines not only received enormous amounts of finance,
but also did so with minimal collateral, which is typically required in bank’s lending to private
entities. For example, even for Air China, the most financially healthy among the Big Three,
about 80% of its bank loans in 2009 were unsecured, which means no collateral was pledged to
the bank loans.67
In contrast, private airlines which faced similar difficulties at a much smaller scale
received very limited, if any, assistance from the government. Indeed, the state-owned airlines
saw the financial crisis as a perfect opportunity to squeeze out their private competitors.
Exploiting the financial difficulties faced by the private airlines, the state-owned airlines
colluded with the government to force the private airlines out of the market through acquisition,
bankruptcy and restructuring. Among the biggest four private airlines, only Spring Airlines
survived through the financial crisis: East Star Airlines was forced into bankruptcy; United
63 Ibid. Note: the 2008 Annual Report includes “post balance sheet events” which were significant events that
happened after December 31, 2008, but before the company filed its annual report in June 2009. 64 Ibid. 65 Ibid. 66 Ibid. 67 Air China Ltd., Annual Report 2009. RMB28 billion out of RMB35 billion.
20
Eagles Airlines was acquired by Sichuan Airlines (a joint venture of several state-owned airlines);
and Okay Airlines was acquired by DTW Logistics and subsequently exited the air passenger
market.
East Star Airlines at the Beginning of the Crisis
East Star Airlines was founded in 2005 in Wuhan by the East Star Group, a private
conglomerate. By 2008, East Star had become the second largest private airlines company, flying
nine aircraft and more than twenty flight routes centered in Wuhan.68
East Star operated. As
Wuhan was becoming an increasingly important aviation hub, East Star once had bright
prospects. However, the record high oil price in first half of 2008 and the sharp decline in
demand in second half of 2008 severely hurt East Star in similar ways as they did to the airlines
industry in general. As a result, East Star experienced a liquidity crisis.69
Consequently, some of
the counterparties started to terminate non-essential services to East Star and threatened to
terminate all services if East Star continued to fail to repay in time.70
It should be noted that a
liquidity crisis—as East Star experienced—differs fundamentally from a solvency crisis—as
China Eastern Airlines faced during the same time period. In the case of East Star, it still had
68 新华网 (Xinhua Net), “东星航空资不抵债面临破产,” Mar 22, 2009. Accessed online at:
http://news.xinhuanet.com/fortune/2009-03/22/content_11053378.htm. 百度百科 (Baidu Wiki), “东星航空有限公
司.” Accessed online at:
http://baike.baidu.com/view/377273.htm?fromtitle=%E4%B8%9C%E6%98%9F%E8%88%AA%E7%A9%BA&fro
mid=10928394&type=syn 69 By March 2009, East Star had failed to repay on schedule its financial obligations to a number of counterparties
and creditors, including: RMB 180 million to China National Aviation Fuel (CNAF), RMB 60 million to Wuhan
Airport, RMB 53 million to Guangzhou Airport, RMB 5 million to Shenzhen Airport, and RMB 4 million to
Hangzhou Airport, among others. 凤凰财经 (iFeng Finance), “谁在导演东星航空破产,” Aug 11, 2009. Accessed
online at: http://finance.ifeng.com/topic/dxhk/news/industry/20090811/1067638.shtml ; 网易财经 (NetEase Money),
“白云机场受益联邦快递 失手东星航空,” Jun 22, 2009. Accessed online at:
http://money.163.com/09/0622/01/5CCIC4B000251LJJ.html ; 民航资源网 (CARNOC), “东星态度积极 萧山机
场“欠费门”初步解决,” Jan 7, 2009. Accessed online at: http://news.carnoc.com/list/123/123042.html 70 新浪旅游 (Sina Travel), “因拖欠机场服务费 杭州萧山机场封杀“东星”航空,” Jan 6, 2009. Accessed online at:
http://travel.sina.com.cn/air/2009-01-06/091651763.shtml
21
RMB 160 million in net assets, which means that its assets were more than sufficient to cover its
liabilities; the emergency arose from East Star not having enough cash in hand.71
China Eastern
Airlines, on the other hand, had liabilities that far exceeded its assets.72
A typical response for a solvent company to its liquidity crisis would be to borrow a bank
loan, issue a corporate bond, or issue some new capital shares. However, obtaining bank
financing had always been one of the major difficulties faced by private enterprise in China,
whereas issuing bonds or shares was not a feasible option at the trough of the financial crisis.
Thus, in second half of 2008, East Star started to search for strategic partners or investors with
sufficient financial strength to help East Star get through its liquidity crisis and preserve its
promising business. In particular, East Star had a series of negotiations with Aviation Industry
Corporation of China (AVIC), the parent company of Air China.73
The negotiations had initially
proceeded well, and by early March 2009, Kong Dong (Chairman of Air China and General
Manager of AVIC) disclosed to the media during the annual meetings of the National People's
Congress and Chinese People's Political Consultative Conference that the acquisition of East Star
by AVIC would be completed within one month.74
The main objective of AVIC in its attempt to acquire East Star was to strengthen its
market position in the central China region. Wuhan, the economic center of central China, was
also the aviation center of central China.75
Moreover, Wuhan was expected to have above-
average economic growth in the subsequent years, due to favorable central government
71民航资源网 (CARNOC), “东星态度积极 萧山机场“欠费门”初步解决” 72 And, as such, could be forced into bankruptcy or restructuring under normal economic institutional framework. 73 南方周末 (Southern Weekend), “东星航空停飞，总裁被监视居住？” 74 凤凰财经 (iFeng Finance), “中航称不存在野蛮收购东星航空,” Mar 17, 2009. Accessed online at:
http://finance.ifeng.com/roll/20090317/451216.shtml 75 智库·咨询 (MBA lib), “2008 年中国城市 GDP 排行榜,” Apr 6, 2009. Accessed online at:
http://news.mbalib.com/story/10010 . Wuhan was the city with the 15th highest GDP in China, and the highest in the
central China region, in 2008.
22
policies.76
By 2008, Wuhan was an important market for domestic airlines and was expected to
become even more important in the subsequent years. However, as of 2008, Air China did not
have any planes based in Wuhan, and had very limited access to its market. In comparison, Air
China’s major competitors were much more established in Wuhan: China Southern and China
Eastern had 20 and 15 aircrafts based in Wuhan, respectively.77
East Star Airlines was the third
largest player in the Wuhan market. Thus, if Air China was able to acquire East Star, it would
gain a significant foothold in an increasingly important market.
On the other hand, the Hubei government’s main objective in its attempt to facilitate Air
China’s acquisition of East Star was the promotion of local economic and political interests. The
evaluation of local government officials in China is in large part based on local GDP
performance; headline projects also enhance the standing of local officials in the political
hierarchy.78
Exploiting the incentive structure of local government officials, AVIC signed an
agreement, titled “Agreement between Hubei Provincial Government and AVIC on Establishing
Wuhan as an Aviation Hub” on March 10, 2009.79
The agreement promised that AVIC would
open international flights between Wuhan and Paris, Tokyo and Singapore by 2010, and those
between Wuhan and Los Angeles, London and Berlin by 2015.80
This plan, if realized, would
boost the prestige and political standing of Hubei and Wuhan officials, since only a very small
76 宜居城市 (eLive City), “2013 年中国城市 GDP 排名,” Feb 8, 2014. Accessed online at:
http://www.elivecity.cn/html/jingjifz/2296.html . Indeed, by 2013, Wuhan was the city with the 9th highest GDP in
China. 77凤凰财经 (iFeng Finance), “奥凯航空总裁：救一家南航 够救 30 家奥凯了,” Jan 24, 2009.
Accessed online at: http://finance.ifeng.com/news/industry/20090124/341123.shtml 78 For more on the politics of promotion, see Wallace, Jeremy. “Information Politics in Dictatorships.” In Emerging
Trends in the Social and Behavior Sciences. (eds.) Robert Scott and Stephen Kosslyn. Wiley and Sons. Forthcoming. 79南方周末 (Southern Weekend), “东星航空停飞，总裁被监视居住？” 80南方周末 (Southern Weekend), “东星航空停飞，总裁被监视居住？”
23
number of cities in China had direct flights to each of the aforementioned foreign destinations.81
Thus, local government cadres had strong incentive to support AVIC’s plan to acquire East Star,
which was essential for the expansion of Air China’s business in central China.
East Star’s Rejection of AVIC’s Offer
Although the acquisition of East Star by AVIC would well serve the interests of AVIC
and the Hubei Government, the interests of East Star also need to be considered since they are
the party being acquired. On March 13, 2009, East Star’s Board of Directors announced that the
company would reject AVIC’s acquisition offer and terminate all negotiations with AVIC, citing
differences in philosophies and business practices, and foreseeing difficulty in effective
cooperation.82
However, a close examination of statements from those party to the talks reveals
that the deal was rejected over treatment of existing employees and acquisition price.
One of the major factors that led to East Star’s rejection of AVIC’s acquisition offer was
AVIC’s proposed treatment of East Star’s existing employees. According to an East Star press
release, AVIC’s interests in the acquisition centered on East Star’s strong position in a promising
airlines market while AVIC had limited interest in retaining the physical properties and
employees of East Star.83
As a result, AVIC planned, as part of the acquisition proposal, to
conduct massive layoffs of existing employees of East Star, according to Wan Yijian, Chief
Marketing Officer of East Star.84
For example, AVIC planned to keep only three employees out
of an existing group of 500 in the market department and only one third of the existing group of
81 Mostly Beijing, Shanghai, and Guangzhou. 82南方周末 (Southern Weekend), “东星航空停飞，总裁被监视居住？” 83 凤凰财经 (iFeng Finance), “中航称不存在野蛮收购东星航空” 84 凤凰财经 (iFeng Finance), “东星航空员工曝与中航合并谈判破裂内幕,” Mar 18, 2009. Accessed online at:
http://finance.ifeng.com/news/industry/20090318/454078.shtml
24
several hundred employees in the R&D department of East Star.85
Unsurprisingly, virtually all
employees, including those who could participate in the decision-making process (such as
managers and shareholders), opposed AVIC’s offer.86
In a blatant attempt to aid AVIC, the Wuhan Government deployed police to visit the
employees of East Star one by one and forbid them from voicing their opposition.87
Moreover,
AVIC, with the assistance of the government, forced the pilots of East Star to sign agreements to
reduce their remunerations after the completion of the acquisition.88
Even more than the treatment of the existing workforce, the acquisition deal was broken
off because East Star and AVIC had very disparate price targets. East Star had asked for an
acquisition price of RMB 600 million, whereas AVIC was only willing to offer RMB 160
million as of March 13, 2009 (when East Star rejected AVIC’s bid).89
East Star’s confidence in
its evaluation partly came from Goldman Sachs’ attempted investment the year before. In early
2008, Goldman Sachs was in talks with East Star to acquire 25% of the latter’s equity for
US$100 million (approximately RMB 700 million at that time), which implied a price tag of
approximately RMB 2.8 billion for the entire company.90
To be fair, the market valuations of
most companies in early 2008 were inflated and most had declined substantially by early 2009
(for example, the S&P 500 index dropped approximately 50% from March 2008 to March
85 Ibid. The scales of layoffs in other departments were likely comparable. 86 凤凰财经 (iFeng Finance), “中航集团收购东星航空迷雾.” Accessed online at:
http://finance.ifeng.com/topic/dxhk/ 87 凤凰财经 (iFeng Finance), “中航集团收购东星航空迷雾.” According to anonymous employees of East Star. 88 Ibid. Again, the sources here are anonymous East Star employees. 89 凤凰财经 (iFeng Finance), “武汉政府回应东星停飞：还没低级到逼迫民企重组地步,” Mar 17, 2009.
Accessed online at: http://finance.ifeng.com/news/industry/20090317/450227.shtml 90 凤凰财经 (iFeng Finance), “东星拒绝中航背后：高盛曾高价洽谈入股,” Mar 18, 2009. Accessed online at:
http://finance.ifeng.com/stock/zqyw/20090318/454841.shtml
25
2009).91
East Star had a clear idea of the market situation, and willingly cut its asking price by
more than 75% from its valuation in early 2008.
However, for AVIC, even RMB 600 million was far too expensive for the acquisition.
AVIC’s offering price was based on the net asset value on the balance sheet of East Star, which
was around RMB 160 million as of early March, 2009.92
Valuing East Star based on the book
value of its net assets is problematic as many valuable assets—flight routes, pilots, customer
network and loyalty, brand image, and licenses—are considered intangible and so not included in
the book value.93
Indeed, these assets—the flight routes in particular—were the key focus of
AVIC in its acquisition attempt, as explained above. Further, East Star had experienced rapid
growth, while book value is typically used for mature companies that match the economy’s
overall performance. Indeed, at the time of the acquisition attempt, even Air China, a more
mature and slower growing company than East Star, was trading at more than three time its book
value.94
It was thus unsurprising that East Star rejected AVIC’s acquisition offer.
East Star’s rejection of AVIC’s acquisition offer antagonized the local government and
AVIC as both stood to reap substantial benefits if the deal came to pass and AVIC had already
announced that the deal would be completed in March. In response, on March 15, 2009, Wuhan
Government demanded that local branch of the Civil Aviation Administration of China (CAAC)
91 Google Finance, “S&P 500.” Accessed online at:
https://www.google.com/finance?q=INDEXSP%3A.INX&ei=P7Y9U8ClMojKsQf6twE 92 新浪财经 (Sina Finance), “东星航空破产之谜：为何非死不可,” Jun 2, 2009. Accessed online at:
http://finance.sina.com.cn/chanjing/gsnews/20110602/10409936957.shtml 93 According to international accounting rules, such assets are internally generated intangible assets, which should
not be recorded on a company’s balance sheet and hence book value. Thus, in the creative accounting of Chinese
SOEs analyzed here, the intangible assets of an anonymous energy commodity company (Felix) were highly valued,
while the value of the flight routes and other intangible assets that were precisely named as the source of interest
were deemed as possessing no value. 94 As of March 13, 2009, the day that East Star rejected AVIC’s offer, Air China had RMB 20 billion in net assets
on its balance sheet, but had a market value of RMB 63 billion. Google Finance, “Air China Ltd.” Accessed online
at: https://www.google.com/finance?q=SHA%3A601111&ei=EOA9U9igMfDLsQf9Wg .
26
terminate East Star’s rights to operate civilian commercial flights.95
The next day, Lan Shili,
founder and CEO of East Star, was detained by the police in Zhuhai Airport and brought back to
Wuhan for house arrest.96
On March 18, an anonymous East Star employee sent an email to the
media to reveal the behind-the-scene events of the acquisition negotiations.97
The email accused
Wuhan Commission of Transport officials, who were led the negotiation between AVIC and East
Star, of actively lobbying for the suspension of East Star’s operation, due to personal conflicts
with East Star.98
Another employee of East Star revealed these “personal conflicts” resulted from
a RMB 40 million dispute where the Wuhan Commission of Transport allegedly refused to pay
East Star for its services.99
The forced suspension of East Star quickly worsened its financial conditions as its costs
amassed while its revenue streams evaporated. By April, the Wuhan Government had submitted
a proposal to the Intermediate People’s Court of Wuhan to force East Star into bankruptcy.
Bankruptcy in this case, if passed in court, would entail East Star ceasing to exist, the auctioning
off of its tangible assets at likely fire sale prices, and the disappearance of a significant portion of
its intangible assets. East Star as an operating entity would be more valuable and capable of
repaying a larger portion of its debts, than as a liquidated entity. Consequently, most of its
creditors preferred restructuring East Star, and expressed willingness to contribute to the
95 互动百科 (Baike), “东星航空停飞事件.” Accessed online at: http://www.baike.com/wiki/东星航空停飞事件 96南方周末 (Southern Weekend), “东星航空停飞，总裁被监视居住？” 97凤凰财经 (iFeng Finance), “东星航空员工曝与中航合并谈判破裂内幕” 98 Ibid. 99凤凰财经 (iFeng Finance), “东星复航无期 武汉政府表态推进其与中航,” Mar 18, 2009. Accessed online at:
http://finance.ifeng.com/news/industry/20090318/454455.shtml
27
restructuring by postponing debt repayment, converting debt to equity, or even injecting new
capital into the airline.100
On April 8, China National Aviation Fuel (CNAF), the largest creditor of East Star,
submitted an application to the Wuhan Court for a restructuring of East Star.101
However, on
June 16, the Wuhan Court rejected the application of CNAF.102
Subsequently, other creditors,
such as Zhengzhou Airport, Guangzhou Airport, and Shenzhen Airport, all filed applications to
the Wuhan Court for a restructuring of East Star.103
However, Wuhan Court rejected all such
applications and ruled that East Star had lost the material foundation of a restructuring as it had
become impossible for East Star to resume normal operation.104
The suspension of East Star’s
operations in March and subsequent three months of inaction by the court worsened East Star’s
financial condition and made it difficult for East Star to resume normal operations by June.
Moreover, according to Yin Zhengyou, the lawyer representing CNAF, Wuhan Court had no
legal basis of rejecting the creditors’ applications for a restructuring of East Star: first, after East
Star entered the process of bankruptcy protection, ownership and control of the enterprise was
transferred from the shareholders to the creditors (but not the government), who thus had the
right to decide whether East Star should be restructured or liquidated; second, Wuhan Court had
no legal obligation and no business expertise to decide whether East Star had the material
foundation for a restructuring.105
In addition to the creditors, some third-party investors attempted to restructure East Star.
In particular, Wang Chaoyong, a wealthy private entrepreneur and friend of Lan Shili, was
100凤凰财经 (iFeng Finance), “谁在导演东星航空破产,” Aug 11, 2009. Accessed online at:
http://finance.ifeng.com/topic/dxhk/news/industry/20090811/1067638.shtml 101 Ibid. 102 Ibid. 103 Ibid. 104 Ibid. 105 Ibid.
28
willing to commit the RMB 200 million that he deemed the firm needed to resume operations.106
On August 25, Wang’s active lobbying brought some hope for East Star as the High People’s
Court of Hubei ordered the lower-level Wuhan Court to re-examine the applications for
restructuring East Star.107
However, within 24 hours, the Wuhan Court made a final ruling,
rejecting the applications and announcing the official bankruptcy of East Star.108
It is difficult to comprehend the determination of the Wuhan Court to force East Star into
bankruptcy without understanding the involvement of AVIC (or Air China) and local
government officials in the dispute. While East Star was fighting for a restructuring, Air China
established Air China (Wuhan), which rented the East Star’s office building and absorbed some
of East Star’s pilots, ground staff, and aircraft.109
On June 25, 2009, Air China (Wuhan)
commenced its commercial flights and ironically used all the flight routes, time, and numbers of
East Star.110
These events took place two months before the court announced the official
bankruptcy of East Star on 25 August. The Wuhan Government extended valuable support to
AVIC in other ways as well, extending it land grants, renting it office space, and easing the
transfer of pilots from East Star to Air China.111
AVIC/Air China won the East Star crisis, inheriting most of the intangible assets at no
cost and acquiring most of the tangible assets at very low prices in the bankruptcy liquidation.
East Star’s owners lost their equity stakes, while its creditors only managed to recover 10% of
their loans.
106新浪财经 (Sina Finance), “东星航空破产之谜：为何非死不可.” 107 Ibid. 108 Ibid. 109凤凰财经 (iFeng Finance), “谁在导演东星航空破产.” East Star’s aircraft had been leased from General Electric,
but Air China took over the leases. 110 Ibid. For example, East Star used to have a flight from Wuhan to Shenzhen at 9am with flight number “8C 8233”;
now the same flight at the same time by Air China had a flight number “CA 8233.” 111 Ibid.
29
Conclusion
In contrast with views from the mid-2000s that expected the state sector’s place in the
Chinese economy to continue to diminish, we find that SOEs remain crucial economic and
political actors in contemporary China. Their position was further enhanced during the global
financial crisis as can be seen in their investment behavior as well as the clear favoritism of
government officials at different levels for state over private firms.
The cases of Yanzhou Coal and East Star Airlines show how government financed
reckless investments can evaporate, how conflicts of interest can hurt the economic performance
of firms and tilt the playing field strongly in favor of SOEs, how local and national political
interests can undermine markets, and how China’s weak legal system can be exploited by
politically powerful firms. Particularly troubling is the extent of collusion between SOEs and
government officials, as seen in the favoritism displayed to AVIC/Air China over East Star by
the Hubei and Wuhan governments, and especially the Wuhan court that ordered the firm’s
bankruptcy. Such collusion is increasingly institutionalized as prominent political leaders have
more connections with and backgrounds in SOEs; indeed, a growing group of active SOE chiefs
are concurrently holding political positions in the party-state apparatus.112
The incentive
structures facing officials at different levels can also be taken advantage of by politically
powerful SOEs, privileging parochial over general interests.
In the much celebrated 3rd
Plenum of the 18th
Party Congress in 2013, policy statements
decreed that reforms were to closely resolve that the market would maintain a decisive role in the
112 Li, Cheng. "China’s Midterm Jockeying: Gearing Up for 2012 (Part 4: Top Leaders of Major State-Owned
Enterprises)." China Leadership Monitor 34, no. 4 (2011): 105.
30
allocation of resources in the economy.113
Our analysis cautions against interpretations that such
statements represent a continuous linear progress on this dimension in China’s reform era. A
more optimistic perspective could take the 3rd
Plenum’s calls for the market to play a greater role
as responding to private firms, foreign enterprises, investors, and consumers frustrated at the
extent to which the state-owned sector advanced during the global financial crisis.
113 “Decisive role” comes from (“紧紧围绕使市场在资源配置中起决定性作用深化经济体制改革”)
http://news.xinhuanet.com/politics/2013-11/15/c_118164235.htm.
31
Tables
Table 1: FDI Outflow by Chinese Enterprises114
USD in billions 2005 2006 2007 2008 2009 2010 2011 2012
SOE 8.3 19.7 30.1 57.6 55.2 64.4 65.6 69.4
Private 1.7 0.1 0.3 0.9 0.8 3.6 8.7 7.9
Total 10.0 19.8 30.4 58.4 56.0 68.1 74.3 77.4
114 The Heritage Foundation, “China Global Investment Tracker.” A similar result is found in Table 1 [[X]] in the
Appendix.
32
Table 2: Top 15 Enterprises in China by Total Overseas Investment from 2008 - 2012115
Rank
Total Investment
(USD in billions) Investor SOE?
1 46,210 Sinopec (China Petroleum and Chemical
Corporation) Yes
2 38,390 CNPC (China National Petroleum Corporation) Yes
3 31,330 CIC (China Investment Corporation) Yes
4 29,730 CNOOC (China National Offshore Oil
Corporation) Yes
5 18,960 Chinalco (Aluminum Corporation of China) Yes
6 10,970 SAFE (State Administration of Foreign
Exchange) Yes
7 8,070 Sinochem Yes
8 6,850 Yanzhou Coal Yes
9 6,370 Minmetals Yes
10 5,970 Three Gorges Yes
11 5,040 China Ocean Shipping Yes
12 4,270 Huaneng Power Yes
13 3,560 China Railway Construction Yes
14 3,260 MCC (Metallurgical Corporation of China) Yes
15 2,990 Jilin Huroc Nonferrous Yes
115 The Heritage Foundation, “China Global Investment Tracker.”
33
Table 3: Global FDI Outflow116
USD in billions 2005 2006 2007 2008 2009 2010 2011 2012
Developed economies 744 1152 1890 1601 828 1030 1183 909
Developing economies 140 245 330 344 273 413 422 426
China 12 21 27 56 57 68 75 84
Transition economies 19 31 52 61 48 62 73 55
World Total 903 1428 2272 2006 1149 1505 1678 1390
116 United Nations Conference on Trade and Development, “World Investment Report 2013: Annex Tables”
34
Table 4: Breakdown of the Acquisition Price of Felix by Yanzhou117
117 Yanzhou Coal Mining Co Ltd., Annual Report 2009. It is important to note that intangible assets are generally
insignificant for energy companies, such as oil & gas, coal, and metals, whose values are primarily based on the
reserves of oil, gas, coal and metal ore they have. Some other companies, such as Internet companies, may have very
substantial amounts of intangible assets.
35
Table 5: Borrowings of Yanzhou Coal118
RMB millions 2008 2009 2010 2011
Borrowings – due within one year 82 1,598 615 19,588
Borrowings – due after one year 176 20,912 22,401 14,869
Borrowings – total 258 22,510 23,016 34,458
118 Yanzhou Coal Mining Co Ltd., Annual Report 2011.
36
Appendix
Brief Explanation on Methodology and Sources
This paper utilizes case studies to study the specific impacts of the financial crisis on a
given SOE and the specific mechanisms through which these impacts were realized. In the
selection of cases and the subsequent in-depth research on the cases, this paper mainly uses news
articles and public filings of listed companies as the primary sources. First, a thorough search of
news articles, both in English and in Chinese, was conducted for the period since January 2008,
with a focus on the two year immediately after the start of the financial crisis in September 2008.
In particular, local Chinese news articles sometimes offer detailed narratives on important events
in local companies, but such valuable primary sources are rarely picked up by western media or
academic scholars. Chinese news articles also offer detailed accounts and analysis of important
government directives when they are released.
Second, public filings of listed companies are another important primary source for the
paper. Many of the companies covered in this paper are publicly listed companies, which are
required to file various documents with the stock exchanges or other regulatory agencies. These
documents offer rich primary evidence that is often overlooked or inadequately studied by
academic scholars. Since it is illegal to present false information in such public filings, these
documents are more credible than news articles in offering insights on various aspects of a
company.
News Articles and Other Sources
AAP, “Yancoal makes $1.5bn debut, biggest Australian listing since 2010,” The Australian, Jun
28, 2012. Accessed online at: http://www.theaustralian.com.au/business/mining-
energy/yancoal-makes-15bn-debut-biggest-australian-listing-since-2010/story-e6frg9df-
1226411228711
Air China Ltd., Annual Report 2008
Air China Ltd., Annual Report 2009
China Eastern Airlines Corp. Ltd., Annual Report 2008
China Southern Airlines Co Ltd., Annual Report 2008
CNN Money, Fortune Global 500 List, 2008. Accessed online at:
http://money.cnn.com/magazines/fortune/global500/2008/full_list/
CNN Money, Fortune Global 500 List, 2013. Accessed online at:
http://money.cnn.com/magazines/fortune/global500/2013/full_list/
Denny Thomas, “China Yanzhou to buy coal firms from Australia's Wesfarmers,” Reuters, Sep
27, 2011. Accessed online at: http://uk.reuters.com/article/2011/09/27/wesfarmers-
yanzhou-idUKL3E7KR1V520110927
Donny Kwok, “Yanzhou Coal buys Australian coal producers for $222 mln,” Reuters, Aug 2,
2011. Accessed online at: http://in.reuters.com/article/2011/08/02/yanzhou-coal-
idUSL3E7J201620110802
Elisabeth Behrmann and Cathy Chan, “Yanzhou Coal Buys Gloucester for $2.1 Billion to Gain
Port, Mines Access,” Bloomberg, Dec 23, 2011. Accessed online at:
http://www.bloomberg.com/news/2011-12-23/yanzhou-coal-agrees-to-buy-gloucester-
for-2-1b.html
37
Google Finance, “Air China Ltd.” Accessed online at:
https://www.google.com/finance?q=SHA%3A601111&ei=EOA9U9igMfDLsQf9Wg
Google Finance, “ConocoPhillips.” Accessed online at:
https://www.google.com/finance?q=NYSE%3ACOP&ei=lVRJU5CSFMPS6AGS8gE
Google Finance, “S&P 500.” Accessed online at:
https://www.google.com/finance?q=INDEXSP%3A.INX&ei=P7Y9U8ClMojKsQf6twE
Google Finance, “Yancoal Australia Ltd.” Accessed online at:
https://www.google.com/finance?q=ASX%3AYAL&ei=X1dAU9iAEvDLsQf9Wg
Google Finance, “Yanzhou Coal Mining Co Ltd (ADR).” Accessed online at:
https://www.google.com/finance?q=NYSE%3AYZC&ei=WFdAU_CEDuSJsQeQ-wE
Jason Scott and John Duce, “Yanzhou Coal to Acquire Felix for About A$3.5 Billion,”
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00144feabdc0.html#axzz2xZBzH2cK
Sarah-Jane Tasker, “Yanzhou Coal talks up bilateral benefits of $3.5bn Felix Resources
acquisition,” The Australian, Jan 6, 2010, accessed online at:
http://www.theaustralian.com.au/business/mining-energy/yanzhou-coal-talks-up-
bilateral-benefits-of-35bn-felix-resources-acquisition/story-e6frg9df-1225816652528
Scissors, Derek, “Testimony before the U.S.–China Economic and Security Review
Commission,” Mar 30, 2011. Available online at:
http://www.heritage.org/research/testimony/2011/04/chinese-state-owned-enterprises-
and-us-china-economic-relations
The Heritage Foundation, “China Global Investment Tracker.” Accessed online at:
http://www.heritage.org/research/projects/china-global-investment-tracker-interactive-
map
The World Bank, “Exports of goods and services (% of GDP).” Accessed online at:
http://data.worldbank.org/indicator/NE.EXP.GNFS.ZS?page=1
United Nations Conference on Trade and Development, “World Investment Report 2013: Annex
Tables,” Jun 26, 2013. Accessed online at:
http://unctad.org/en/pages/DIAE/World%20Investment%20Report/Annex-Tables.aspx
Wei, Lingling; Davis, Bob, “For a Top Chinese Banker, Profits Hinder Political Rise,” The Wall
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Zach McDonald, “Could China's State-Owned EV Alliance Actually Hurt the Market for Plug-
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8%AA%E7%A9%BA&fromid=10928394&type=syn
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Accessed online at: http://finance.ifeng.com/news/industry/20090124/341123.shtml
38
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http://finance.ifeng.com/topic/dxhk/news/industry/20090811/1067638.shtml
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http://finance.ifeng.com/topic/news/rzgt/
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http://finance.ifeng.com/topic/dxhk/news/industry/20090811/1067638.shtml
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17, 2009. Accessed online at:
http://finance.ifeng.com/news/industry/20090317/450227.shtml
观察者 (Guancha), “中国企业 500 强榜单发布 国企占 62%,” Aug 31, 2013. Accessed online
at: http://www.guancha.cn/economy/2013_08_31_169453_s.shtml
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民航资源网 (CARNOC), “东星态度积极 萧山机场“欠费门”初步解决,” Jan 7, 2009.
Accessed online at: http://news.carnoc.com/list/123/123042.html
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2010. Accessed online at: http://finance.qq.com/a/20100723/002196.htm
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online at: http://money.163.com/09/0622/01/5CCIC4B000251LJJ.html
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http://news.xinhuanet.com/fortune/2009-03/22/content_11053378.htm
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online at: http://finance.sina.com.cn/stock/s/20091012/15276827706.shtml
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39
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On the Heritage Foundation’s “China Global Investment Tracker”119
This dataset only includes investments which could be tracked from public media. As a result,
investments of a relatively small scale are likely excluded from the dataset. However, this would
not compromise the quality of the analysis as the major investments usually make up for an
overwhelming portion of the total FDI outflow of a country. For example, in 2012, the total FDI
outflow by Chinese enterprise (according to the dataset from Heritage Foundation) was US$77.4
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Appendix Tables
Appendix Table 1: Year-on-Year (YOY) growth of FDI Outflow120
2006 2007 2008 2009 2010 2011 2012
SOE 137% 53% 91% -4% 17% 2% 6%
Private -94% 155% 207% -9% 365% 140% -9%
Total 97% 53% 92% -4% 22% 9% 4%
Appendix Table 2: Share of FDI Outflow by Type of Enterprise121
2005 2006 2007 2008 2009 2010 2011 2012
SOE 83% 99% 99% 99% 99% 95% 88% 90%
Private 17% 1% 1% 1% 1% 5% 12% 10%
Appendix Table 3: YOY Growth Rate and CAGR of Global FDI Outflow122
YOY growth rate CAGR
FDI Outflow 2008 2009 2010 2011 2012 2007-10 2007-12
Developed countries -15% -48% 24% 15% -23% -18% -14%
Chinese SOEs 91% -4% 17% 2% 6% 29% 18%
World -12% -43% 31% 11% -17% -13% -9%
120 The Heritage Foundation, “China Global Investment Tracker.” 121 The Heritage Foundation, “China Global Investment Tracker.” 122 United Nations Conference on Trade and Development, “World Investment Report 2013: Annex Tables”; The
Heritage Foundation, “China Global Investment Tracker.” CAGR is Compounded Annual Growth Rate.