Political constraints, organization design and performance measurement in China’s state-owned enterprises

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Abstract

This study develops a theoretical model to test how political constraints on labor decisions mediate the effects of economic liberalization forces on aspects of organizational design such as delegation, performance measurement, and incentives in Chinese state-owned enterprises. Hypotheses tests using a large survey of divisional managers generally confirm the model: that the influence of three liberalization forces (industry level growth and foreign firm competition, joint venture experience and stock market listing) on organization design is mediated by political constraints.

Introduction

Since 1997, most state-owned enterprises (SOEs) in China have become markedly more independent as a result of a massive liberalization program, which has not only created greater autonomy for business expansion but has also introduced competitive pressure under which SOEs strive to grow or struggle to survive through significant improvements of productivity, efficiency, innovation, and services. To achieve these ends, the development of a more “Western” micro-level organization design is now commonly viewed as the fundamental force that determines the successful restructuring of SOEs (Jefferson et al., 1996, Qian, 1996, Shirley and Xu, 2001).1 For instance, recent research indicates that the use of incentive schemes in China’s SOEs enhances productivity (Qian, 2001, Xu, 2000, Zhuang and Xu, 1996). Lee (2001) reports increased delegation during the process of the financial restructuring of a large SOE. Other studies find that liberalization forces such as market competition (Firth, 1996), foreign joint venture experience (Firth, 1996, O’Connor et al., 2004), and stock market listing (O’Connor et al., 2004) are associated with the level of adoption of various Western management accounting techniques, including performance measurement systems.

To date, however, there has been little systematic examination of how these organizational design components are constrained by political conditions, which tend to be an important feature of economies in transition, especially China (Qian, 1996). Recent studies highlight the prevalence of political constraints. For instance, Li (2000) provides evidence that tighter governmental control results in more unprofitable production and surplus employment. Xu, Zhu, and Lin (2002) find that political interference tends to dominate labor decisions, whereas other decisions are dominated by agency costs. According to Qian (1996, p. 429), “understanding this interaction between the effective control by managers over some decisions and the ultimate control by the Party and the government over other decisions is the key to understanding the problems with the past reform and the issues to be addressed in the future.” The question of how to break up the old vested interests in state-owned industry has been described as a “forbidden area” of reform, because it affects the government’s ability to regulate, monitor, or control employment and other resource allocation issues. “The contradictions in the situation are obvious to many Chinese enterprise managers and academic analysts, but there is only limited research on how to resolve them because of the issue’s great political sensitivity.” (Hassard, Sheehan, & Morris, 1999, p. 76).

This paper extends the literature on Chinese SOE reform by examining the mediating influence of political constraints on organizational design in China’s SOEs. Political constraints are defined in this paper as the degree to which governmental authorities and Communist Party representatives intervene, regulate, or control an SOE’s labor decisions (hiring, firing, and promotion). As these political constraints are in play along with market liberalization forces (Li, 2000), it is likely that the effect of liberalization forces on the organizational design or decisions of SOEs is mediated by political constraints. For example, market competition has a positive direct effect on the adoption of Western management controls (e.g., Firth, 1996), but also an indirect effect because it is associated with higher growth industries, which were the first to experience the reduced political constraints (Chen, 2000) that can slow the adoption of Western management controls. The direct effect potentially provides a misleading impression of the influence of competition. We suggest that this possible mediating effect is important because, in a socialist market economy such as China, economic reforms take place under various political constraints, and accordingly SOEs need to cope with not only economic transformation and market liberalization but also political constraints and regulatory conditions.

We develop a theoretical model to test the mediating influence of political constraints on the associations between liberalization forces, and the use of three organizational design components (delegation, performance measurement, and incentives) within SOEs. Consistent with the recent China reform literature, we use agency theory to develop the separate links in the model.2 We use the firm as the unit of analysis and focus on the organizational design components at the divisional manager level such as profit-center managers (in various divisions, branches, or units) and cost-center managers (in various departments), as the decisions and actions of managers at this level are likely to have a far greater effect on the enterprise than those of lower level managers (O’Connor et al., 2004). We use an analytical framework that was developed by Jensen and Meckling (1992), Milgrom and Roberts, 1992, Milgrom and Roberts, 1995, and Brickley et al., 1995, Brickley et al., 2001, in which the delegation of decision-making authority (delegation), objective performance measures, and incentive compensation within an organization’s hierarchy jointly constitute the organization’s design. The consideration of the interdependencies among these components adds another dimension to our understanding of organizational design and is consistent with recent studies in the management (Mendelson, 2000), economics (Delmastro, 2002) and accounting (Nagar, 2002) literatures. For example, Nagar (2002) finds that understanding the influence of firm growth on the strength of incentives is enhanced when the interdependency of delegation and incentives is taken into consideration.

The remainder of the paper is organized as follows. The next section develops the three hypotheses that comprise the model. The research methods and measurement of the variables are then explained, followed by the results. The paper concludes with a discussion of the findings.

Section snippets

Liberalization and political constraints

One of the main thrusts of recent SOE reforms has been to encourage SOEs in growth industries in certain locations to seek alternative sources of capital to decrease their reliance on the state. The major liberalization forces that pertain to Chinese SOEs include market competition (industry growth, foreign competition), export market sales, joint venture experience, and stock exchange listing (Huang and Duncan, 1997, Lin, 2000, Lin et al., 1998, Xu, 2000). In the transition from central

Sample and data collection

We collected survey data from 502 divisional level managers in 502 SOEs. The respondents represented a range of functions such as accountancy (identified n = 68), administration (92), human resources management (30), production (88), sales and marketing (92), and research and development (36). Access to the managers was obtained through a list of executive MBA alumni who worked in SOEs that operated in two Chinese provinces (Hubei and Guangdong). The survey was distributed in 1999 to four

Results

To test the hypotheses, we first assessed the model using a series of nested models beginning with the least constrained model—one that included all of the paths that were shown in Fig. 2.16 To do this, some of the paths in the model were constrained (i.e., set equal to 0), which prevented them from subsequently being estimated. The sequence of

Conclusion

The model that we develop in this paper provides a general theoretical framework to explain the determination and evolution of Chinese SOE organizational design. The model relates the use of three organizational design components to five determinants: liberalization forces (industry, export sales, joint venture experience, stock exchange listing) and political constraints over labor decision-making in the SOE. This model is helpful in understanding variations in the organizational design among

Acknowledgements

Earlier versions of this paper were presented at the UNSW Management accounting symposium, Sydney, 2003, the AFAANZ conference, Brisbane, 2003, the AAA Annual Meeting, Atlanta, 2001, the Academy of International Business, Sydney, 2001, and in seminars at the University of Melbourne and Monash University, July 2002. The authors are indebted to the participants, Chee Chow, Sue Haka, Joan Luft, George Milkovich, Michael Morris, Gordan Richardson, and Michael Shields for their suggestions and

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