7. “Reward of Enterprise Control” and “Entrepreneur-Controlled Enterprise”: Entrepreneurial Human Capital in Public-Owned Enterprises

For preliminary discussions on entrepreneurial human capital and its position in the firm as a contract, see Zhou (1996a, b).

Shen et al. (1994: 128).

HG Charter is revised and promulgated once a year to standardize corporate management since the establishment of its predecessor Hengdian Town Industrial Corporation. Before 1994, it was titled Regulations on the Economic Responsibilities System. These documents provide important records for studying changes in the company system (hereinafter referred to as the Charter).

See the Charter, 1991: 1. All previous versions of the Charter clearly defines the enterprise as “township collective ownership.”

According to people involved, the town government had, in fact, long stopped appointing the management of HG. The last appointment record we found in the archives dated back to December 1984 when Xu Wenrong was appointed by the Hengdian Township People’s Government as the Manager of Hengdian Company and concurrently the Director of Dongyang County No.1 Light Textile Factory, and Director of Dongyang County Electronics General Factory (Hengdian Government Document No. (1984)-9). XU’s title changed from the Manager of Hengdian Town Industrial Corporation to the General Manager of HG) without appointment by the township government.

Xu (1994: 74).

The author have already discussed concluded: the concept of “human capital naturally belongs to the person” is the foundation for understanding the Incentive Theory (Zhou 1996b).

This fact distinguishes the HG model from the “ownership by workers’ society in Yugoslavia”.

Before 1987, the Charter stipulates that the bonus for the Group President shall be the highest bonus for subsidiary managers; since 1987, the Charter says that the bonus for the GM (namely President) of the Group shall equal 140% of the highest bonus for subsidiary managers.

Take 1993 for example, HG total after-tax profit was 61.15 million yuan. According to the company policy, the total amount of annual bonus for the president can be 733,800 yuan (The director of the corporate finance center told us that Xu Wenrong usually would not withdraw his bonus. But our focus of study here is the incentive mechanism, so that is another story). For the same year, the bonus of the workers of loss-making enterprises was zero, and that of the manager was negative (meaning the manager had to compensate 5–10% of the loss).

Measuring the actual contribution of team members can be costly; therefore, examining the inputs to instead of the output can save the measurement cost (Barzel 1982).

Grossman and Hart (1986) are the first scholars to use “residual rights of control” rather than “residual claims” to define “enterprise ownership”. Hart and Moore (1990) “give a more definitive meaning to the definition of residual rights of control”, and define it as “the right to determine how the assets can be used for purposes beyond its special purpose specified in the initial contract”. However, this shall not become the reason to interpret “residual rights of control” as a right to move away from the “contract”. Because although how to distribute the income is a right that is not clearly specified in the contract, but it is still part of the content of the contract, especially of the company as a contract. Therefore, whether we go with “residual claims” or “residual rights of control” to define ownership, it does not change the fact that the “residual rights” are contract-based property rights. In reality, POEs are not formed based on contracts. Without the initial contract, there are no “residual rights” to be defined. This is why it is difficult to find clearly defined “residual rights” in POEs. However, the decision-making process and the decision power regarding how to use corporate resources still cannot be skipped by POEs. Therefore, this paper directly defines the decision-making power of the exclusive use of corporate resources as enterprise control.

HG’s Balance Sheet (Chen 1995, Tables 2–4).

HG’s asset-liability ratio is not high (generally 50–60%, see Chen 1995). The main source of group investment is its own capital. Since over 50% of the retained after-tax profits of HG’s affiliates are handed to the Group headquarter, the headquarters and the president directly control a considerable amount of capital.

This trend can be seen from the changes in the corporate management system defined by the Charter over the years: in 1986, it was a collective contract responsibility system with factory directors or managers as the main contractors; in 1989, the collective contracting was changed to just one person’s namely the director’s contracting; in 1990, it was changed to director (one person) contracting or leasing system; in 1992, it became director/manager risk-based contracting responsibility system”; in 1994, it stipulated that “the general managers and the factory directors are the legal representatives of the enterprise”. At present, as the legal representatives of HG affiliates, the managers have the autonomy in personnel organization, production management, operation, labor management as well as reward and punishment and income distribution within the prescribed scope” to ensure various enterprise targets are met (see the Charter 1996, Page 5).

Hengdian Silk Factory, founded in 1975, is the starting point of HG. The initial total investment of the factory was 295,800 yuan, 50,000 yuan of which was borrowed by Xu Wenrong from 39 production brigade members (promised to repay in 3 years), and the rest was bank loans. Here, the entrepreneur’s fundraising played a decisive role. First, the 50,000 yuan Xu raised became the credit basis for bank loans. Second, bank loans became the basis for further larger scale fundraising, which accounted for the majority of the total investment. When I asked for the reasons why the villagers were willing to hand over “the money they saved song long and so hard” to Xu to set up the factory, they mentioned Xu’s “credibility”, “ability”, and “track record”. I would interpret this as the Hengdian townfellows were using their own words to summarize the “trust” as proposed by Casson (1982), namely “how can the fund contributors trust that the entrepreneur will use the funds in their interest?” The fact that XU can earn the trust of the village creditors is due to his personal reputation, which later was translated into corporate credit. Ever since then, Xu’s personal reputation has become an inseparable part of HG’s intangible assets.

The resources retained by the group also include the “residual” contribution from other human capitals. Even under the private property system where various factors are invested in the firm according to an initial contract, there is still the “public domain” proposed by Barzel (1989) (see Wang [1996]), which poses particular difficulties to POEs and will be discussed later.

Xu (1994: 103).

“The ability of entrepreneur and institution entrepreneur defines enterprise control” can be fully understood in the framework of “game of property rights” elaborated by Wang (1996).

Enterprise control only works as a reward to entrepreneurs and would-be entrepreneurs. For others, it is probably a burden.

And we understand further why Xu Wenrong himself was against the HG Joint-Stock System Restructuring Plan from higher government in 1993. “According to instructions from the higher level, Xu Wenrong can get rightly at least 10% of shares and remain to be the boss” (Sun 1995: 96), but his total control of the enterprise may shrink as the Group asset gets quantified down to individuals (as a result of the joint stock system restructuring), or he may need to make even greater efforts to obtain the same level of control in another property rights structure.

Zhou (1996b).

In fact it is a very common arrangement in the history of enterprise institution for pure “salary taking managers” (let alone the founder) to get some shares of the enterprise as they make more contributions. This kind of arrangement is nothing unusual in the “modern enterprise institution” in the West. But the tradition of Chinese enterprises also offer give shares to its pure managers as a reward. For example, there are two arrangements in the famous “Piaohao” (early form of banks) in Shanxi Province: the founding shares and the “identity shares” (management shares). The founding shares are the investors’ shares, and the identity shares are shares awarded to managers and senior managers for many years of contribution (the identity shares can still get dividend after the holder dies, and the name changes to “posthumous shares”). For Piaohao with longer history, the identity shares accounted for a bigger share in the total capital. For instance, 57% of Xiechengqian Piaohao’s shares were identity shares in 1906, and 54.5.5% of Dadetong’s shares were identity shares (cited from Huang 1992: 57–59).